美敦力 (MDT) 2012 Q3 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Medtronic's 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 hand the program over to Jeff Warren, Vice President Investor Relations.

Please go ahead.

Thank you, Christie.

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

During the next hour Omar Ishrak, Medtronic Chairman and Chief Executive Officer, and Gary Ellis, Medtronic Chief Financial Officer will provide comments on the results of our fiscal year 2012 third quarter which ended January 27, 2012.

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

First, 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 any forward-looking statement.

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

In addition, the reconciliations of any non-GAAP financial measures are available on the investors portion of our website at www.Medtronic.com.

Finally, unless we say otherwise, references to quarterly results increasing or decreasing are in comparison to the third quarter of fiscal year 2011, and all year-over-year revenue growth rates are given on a constant currency basis.

With that, I'm now pleased to turn the call over to Medtronic Chairman and Chief Executive Officer, Omar Ishrak.

Good morning.

And thank you, Jeff.

Thank you to everyone joining us today.

This morning we reported third-quarter revenue of $3.9 billion which represents 2% growth as reported and 1% on a constant currency basis.

Q3 non-GAAP earnings of $888 million, and diluted earnings per share of $0.84 increased 8% and 9% respectively, after adjusting for the one-time tax benefits in Q3 of last year.

From a revenue perspective, this was a challenging quarter.

But looking down the P&L we saw solid performance in our gross margin, and our team executed to deliver the bottom line.

Our Q3 revenue reflects strength in the majority of our business.

But at the same time, we faced continued challenges in our two largest business, ICDs and Spine.

Similar to recent quarters, our results were bifurcated, with two-thirds of our business posting strong performances growing a combined 9%, while the remaining third declined 9%.

However, as I will explain it does appear that both the ICD and Spine markets are beginning to show signs of stabilization which will result in easier comparisons and should improve our growth over the coming quarters.

Let me discuss ICDs first.

From a revenue perspective, the US market declined in the mid-teens year-over-year, a couple of percentage points lower than Q2.

However, our market data indicates that procedure volumes were relatively stable for the third quarter in a row and we believe that the sequential market slowdown was primarily caused by hospital destocking.

Looking now at our own performance, our US ICD revenue was down 14% year-over-year and was just under 2 percentage points lower than Q2.

But our implant volumes rose consistently in Q3, and that trend has continued into Q4.

In fact, we are currently seeing year-over-year implant volume growth for the first time in over a year.

In addition, our US ICD pricing was sequentially flat in Q3, improving from mid-single digit to low-single digit declines year-over-year.

As a result, we can conclude that our sequential revenue decline was primarily a result of hospital destocking.

It is also worth mentioning that even though we faced these revenue headwinds, our US ICD share is up over 1 point in the past year and we have maintained those gains sequentially, despite competitors' new product launches and without incurring the typical sequential share declines we see at competitors' fiscal year-ends.

Given the fact that the market is showing signs of sequential stability, we are cautiously optimistic that year-over-year declines in the US ICD market should lessen over the coming quarters.

This would significantly improve the performance of our US ICD business and with a corresponding impact in our overall corporate growth rate.

To put this in perspective, if we can improve our US ICD revenue to flat year-over-year results over the coming quarters, this alone would add nearly 1.5 points to Medtronic's overall growth.

Turning now to Spine.

I was not happy with our overall performance.

But let me focus my comments on core metal and Biologics separately because each have unique dynamics affecting its performance.

In core metal, we estimate that the US market declined in the low-single digits which is slightly worse than Q2.

Our business declined 10% in the US and while we lost nearly 1 point of share sequentially, we did hold share versus the major Spine competitors on a comparable basis.

A large part of our share pressure continues to come from certain smaller spine companies such as physician owned distributors which utilize business models and tactics that are coming under increasingly negative public scrutiny.

Looking ahead, we are somewhat optimistic, given the positive trends we saw in the last month of Q3 and that have continued so far into Q4.

Now, while we cannot be certain as to the drivers of these trends, and the market pressures remain with reimbursement and price, we do know that our new products are gaining traction.

Our product and procedural innovation, combined with better sales execution, is becoming more visible to surgeons and generating measurable growth in our new product lines.

While our Q4 core metal results are likely to still be down year-over-year, assuming current revenue trends continue, we do expect better performance in Q4.

Let's now discuss BMP where US INFUSE sales continue to deteriorate.

In Q2, the year-over-year revenue decline was in the upper teens which worsened to 30% in Q3.

We saw an incremental decrease a few weeks after negative and highly controversial data was presented at NASS in the beginning of November.

This impact was more than we expected at the start of Q3.

While the largest declines were realized in late November and December, the declines have been in the 20% to 30% range since the beginning of January.

Until we get definitive answers from the Yale study in the first half of FY '13 there will be considerable uncertainty around our INFUSE financial results.

As I said previously, we believe in the safety and efficacy of INFUSE for approved indications, but we want to address any controversies by understanding the facts.

That is why we commissioned the Yale University study, a very credible third party to systematically analyze all available data.

In summary, while individually each part of Spine has explainable reasons for their performance, collectively the year-over-year declines are simply not sustainable over the long term.

While we continue to believe in the potential of this market, we urgently need to see meaningful signs of improvement from our current initiatives.

If we do not, we will need to reassess our strategy and approach for this business.

Before leaving Spine I do want to highlight the performance of our international Spine business which should not go unnoticed.

International sales now make up nearly 30% of Spine and they continue to grow in the mid-single digits.

As we work to stabilize our US Spine business, I expect international Spine to be a consistent and solid contributor to our Company's growth.

Let me now turn to the other two-thirds of our business that is performing very well and growing at 9%.

This sustained performance continues to demonstrate that innovation can drive growth even in the current market environment, both in the US and around the world.

In these businesses, our innovative products are in many cases capturing the interest of physicians, patients, and hospital administrators.

This ultimately allows us to enhance our pricing and grow our market share.

An example of this is our Revo MRI pacemaker, a significant advancement in pacing that has contributed to over 4 points of share gain in the US.

The market is putting a premium on Revo's unique MRI technology which has revitalized pacing and shows us that new innovation can deliver growth, even in a market that is already substantially penetrated.

In addition to Revo, we have other exciting technologies like the Simplicity System for Renal Denervation, the CoreValve transcatheter valve, the RestoreSensor spinal cord stimulator, and the Enlite CGM sensor that are commercially available in many today and are driving growth.

Furthermore, I'm pleased that our Resolute Integrity Drug-Eluting Stent received FDA approval late last week.

This next-generation platform offers best-in-class deliverability and is the only drug-eluting stent approved for use in patients with Diabetes.

And finally, our international regions again delivered solid mid-single digit growth including strong double-digit emerging market growth.

Taken together, our portfolio of exciting new products and improving comparisons in our challenging markets should position us well to deliver improved growth over the long term.

More generally, we remain focused in the three key areas I've been emphasizing over the past eight months.

Improving execution, optimizing innovation, and accelerating globalization.

Crisp and consistent execution remains critical to delivering better and more predictable business performance.

Some of the efforts in improving execution are starting to show results.

For example, even with the revenue challenges this quarter, the team rapidly made the appropriate operational changes to deliver the bottom line.

We continue to optimize our innovation process with a sharpened focus on customer economic value.

We have started to operationalize this initiative in the following ways.

First, we're incorporating customer economics in the commercial messaging for our key existing products.

Second, we're assembling specific data to quantitatively measure the economic value of selected offerings to providers and payers.

Third, we are engaging strategic customers in comprehensive Medtronic-wide partnerships to demonstrate the economic value that Medtronic can provide on a broad scale.

And finally, we're incorporating customer economic value as a key criteria in our investment selection process.

This is only the beginning.

But we firmly believe that incorporating customer economic value is key to succeeding in the new healthcare environment.

Let's now discuss globalization.

Our biggest near-term opportunity in emerging markets is in our existing therapies which primarily addresses the premium segment and these therapies have similar margins to what we routinely achieve in developed markets.

To provide some perspective, just improving penetration of these therapies in emerging markets to levels similar to those in developed markets, represents over $5 billion in annual opportunity.

Longer term, the value segment is an additional opportunity.

And we are beginning to take initial steps to realize it.

We're laying the necessary groundwork to be the leaders in emerging value segment through our previously discussed $1 billion product cost-reduction initiative, combined with new business models and our investments in emerging market infrastructure.

Through this structured approach, we're putting in place plans to grow our emerging market revenue to 20% of overall Company revenue over the next few years.

In closing, I want to address our capital allocation strategy.

We continue to generate significant free cash flow, generating over $1 billion this quarter.

We remain committed to returning 50% of our free cash flow to shareholders, which still allows us to make the necessary investments back into our business.

I've given our business leaders clear direction to drive more discipline into our external investments, including the need for minimal to no EPS dilution.

To the extent we don't identify targets that meet our strict value creation criteria, we will look for ways to return excess cash to our shareholders.

However, we're somewhat restricted today by the fact that the majority of our cash resides outside the US.

I've tasked our organization to look at ways to improve our US cash flows.

Our dividend policy remains an important part of our return to shareholders.

We were pleased that Standard and Poor's added us to their S&P 500 Dividend Aristocrat Index, an elite group of companies that has consistently raised their dividends over several decades.

Let me now ask Gary to take you through a more detailed look at our results and at the end of the call I'll make some brief closing comments.

Gary?

Thanks, Omar.

Third-quarter revenue of $3.918 billion increased 2% as reported and 1% on a constant currency basis after adjusting for a $13 million favorable impact of foreign currency.

While Physio-Control was part of Medtronic throughout Q3, we are treating it as a discontinued operation and our Medtronic revenue results do not include revenue from Physio-Control.

Q3 revenue results by region were as follows.

Central and Eastern Europe grew 28%, growth in South Asia, Latin America, and the Middle East, and Africa was 18%.

Greater China grew 12%.

Growth in our Western Europe and Canada region was 5%.

Asia-Pacific grew 2% including flat results in Japan, while the US declined 3%.

Emerging markets grew a combined 16% in Q3 and represented 10% of our total sales.

It is important to point out that our results in Greater China were negatively affected this quarter by the Chinese New Year which fell in our Q3 this year while last year it was in our Q4.

Accordingly, we would expect our Greater China growth to accelerate in Q4.

Q3 GAAP earnings and diluted earnings per share were $935,000,000.88, an increase of 1% and 2%, respectively.

After adjusting for certain acquisition related items, Physio-Control divestiture related items, as well as the non-cash charge for convertible debt interest expense, third-quarter earnings and diluted earnings per share on a non-GAAP basis were $888,000,000.84, a decrease of 4% and 2%, respectively.

After adjusting for the one-time tax benefits we received in Q3 of last year, our non-GAAP diluted earnings per share increased 9%.

In our Cardiac and Vascular Group, revenue of $2.029 billion grew 1%.

Results were driven by growth in Endovascular and Peripheral, Structural Heart, AF Solutions, Renal Denervation, Pacing, and Coronary, offset by declines in ICDs.

CRDM revenue of $1.192 billion declined 3%.

Worldwide ICD revenue of $674 million declined 9% and we estimate that the worldwide ICD market declined in the low-double digits.

Despite the continued market slowdown on a year-over-year basis, we believe the US ICD market is showing signs of sequential stability.

In addition, the combination of our Protecta ICD with its shock reduction and lead integrity alert technologies along with a long-term proven performance of our Sprint Quattro Defibrillation leads, which are also now available with the convenience of a DF4 connector continues to perform well, both in terms of share and pricing.

Pacing revenue of $467 million grew 3% in a market that declined in the low-single digits.

Our US Pacing business grew 8%, driven by the ongoing success of our Revo MRI SureScan pacemaker.

Revo continues to command a mid-teens percentage price uplift which is offsetting pricing pressure in the pacing market.

Our AF Solutions business grew in excess of 40%, driven by the ongoing successful US launch and the continued adoption in Europe of our Arctic Front cryoballoon.

We are taking share in the AF market although we would expect more moderate double-digit growth in Q4 as we anniversary the US launch of Arctic Front.

Our Cardiovascular businesses had another strong quarter with revenue of $837 million, growing 8%, with 4% growth in the US and 10% growth in international markets.

Coronary revenue of $382 million grew 3% and we maintained our number-one coronary stent position in markets where we had regulatory approval for both our Resolute Integrity Drug-Eluting Stent and Integrity bare-metal stent.

Worldwide drug-eluting stent revenue in the quarter was $195 million including $37 million in the US.

We were pleased to receive FDA approval of Resolute Integrity late last week, which we believe will be a meaningful driver of revenue growth and significant share gains.

To put the US opportunity into perspective, in Europe where Resolute Integrity is on the market and we have more competitors than in the US, our DES share is over double our US share.

Resolute Integrity is also the only DES that has been approved for use in patients with Diabetes, which is about a third of the US patient mix.

In the international markets we continue to take DES share due to Resolute Integrity's deliverability and clinical performance.

In bare-metal stents, Integrity BMS allowed us to take another 3 points of share this quarter in the US.

Turning to Renal Denervation, we continued to make progress on this multi-billion dollar opportunity in hypertension and expect to generate $35 million to $40 million of revenue in FY '12.

On the commercial front, we introduced our Simplicity system into new centers in Europe and Latin America and remain focused on expanding reimbursement into additional countries.

We also continue to make progress in our US pivotal study and are tracking towards US approval in FY '15.

Structural Heart revenue of $265 million increased 10%, driven by growth in transcatheter valves.

We continue to split the TCV market with our competitor and have clear market leadership in transfemoral, the largest TCV segment.

While the market in Europe was somewhat softer at the end of the calendar year, we continued to focus on deeper penetration in existing centers, access to new centers, new product introductions, and new access routes including the subclavian and direct aortic approaches.

Direct aortic had positive multi-center data at the STS conference and is becoming an attractive option for surgeons looking for an alternative to the transapical approach.

We are seeing strong interest in our new 31-millimeter CoreValve, which treats a patient population that previously could not be treated by transcatheter valves, and we expect to expand our offering with CE Mark approval of our 23-millimeter valve this spring.

In the US, we are pleased with the progress of our CoreValve pivotal trial.

Enrollment in the extreme-risk arm is complete and we continue to enroll these patients through continued access.

We expect to finish enrollment in our high-risk arm this summer.

Turning to Endovascular and Peripheral, revenue of $190 million grew 17%.

In the US, revenue growth of 25% was driven by the continued success of the Endurant Abdominal Stent Graft.

We have now anniversaried the launch of this product and we would expect more moderate growth in Q4.

Late in Q3, we received CE Mark approval for Endurant II, our next-generation AAA stent graft which we expect will solidify our position as the market leader in this space.

In Peripheral, strong clinical data was presented earlier this month for our complete SE SFA and we expect to receive an SFA indication in the US later this summer.

In drug-eluting balloons we continue to post strong double-digit growth in Europe and we continue to make progress on bringing this technology to the US.

Now turning to our Restorative Therapies Group.

Revenue of $1.889 billion grew 1%.

Growth was driven by solid performance in surgical technologies, Diabetes and Neuromodulations, offset by continued challenges in Spine.

Spine revenue of $784 million declined 10%.

In core Spine which includes core metal constructs, IPDs, and BKP products, revenue of $596 million declined 6%.

Core metal construct products declined 5%.

The global core market remains challenged and slowed sequentially with year-over-year growth now in the low-single digits.

The US market is also declining in the low-single digits with mid-single digit pricing declines offsetting low-single digit procedure and mix growth.

We have a number of initiatives under way to improve our performance, including the upcoming launch of POWEREASE, training surgeons on our new mass mid-lift procedure, continuing to offer differentiated navigated spine surgery solution, as well as the continued roll-out of SOLERA.

While sales of SOLERA are growing at 10% and garnering a double-digit price uplift, we still have less than half of the total sets in the field today.

However, we continue to roll out new sets including the 5.5, 6.0 larger rod diameters to treat complex spine and deformity, the portion of our product line most affected by competitive offerings.

Over the coming quarters, we expect SOLERA to become over 40% of our core metal revenue mix, which should help to drive improvement in our spine performance.

BKP revenues declined 7%.

We now -- we have now posted sequentially flat results for three quarters in a row which is relatively encouraging given the declines we have seen in this business over the past several years.

In the US, we are seeing a modest uptick in BKP procedure volumes and our new products, including the recent launch of the Expander 2 balloon, appear to be stabilizing price.

Biologics revenue of $188 million declined 20% in the quarter.

BMP sales declined 26% in the quarter, including a 30% decline in the US.

However, it is important to note that INFUSE is one of our lower margin products, muting its impact on our bottom line.

Despite the increased pressure on INFUSE, we were encouraged to see double-digit growth in other Biologics including mid-teens growth in the US.

We continue to see strong growth in our differentiated DBM offerings including MagniFuse, a high-performance allograft formulation that was part of our Osteotech acquisition.

Turning to Neuromodulation, revenue of $419 million increased 4%, lead by double-digit growth in uro/gastro.

In pain, we were pleased to receive FDA approval for the RestoreSensor spinal cord stimulator with our proprietary AdaptiveStim technology.

We were unable to fully launch this product until the last week of the quarter due to a supply disruption resulting from the flooding in Thailand.

This issue is now resolved and Q4 is off to a great start.

We expect this breakthrough technology to drive growth and take share in the US market.

In DBS we continue to see very little impact from competition in international markets and we saw strong double-digit new patient growth in the US.

In uro/gastro, the US launch of InterStim Therapy for bowel control continues to go well and is contributing to the success of InterStim.

Diabetes revenue of $367 million grew 8% driven by double-digit growth in CGM.

Our international Diabetes business grew 16% as we continue to see great adoption of our newest products in these markets.

An example of this is our Enlite Sensor which is driving very strong CGM growth in international markets due to its improved comfort, accuracy, and ease of use.

Surgical Technologies revenue of $319 million grew 22%, including $31 million from our Advanced Energy business, which is the combination of our acquisitions of PEAK and Salient.

Our integration activities continue to go well and Advanced Energy is now a $120 million business growing double digits on a pro forma basis.

Excluding advanced energy, Surgical Technologies had strong organic growth of 10% with solid performances across all businesses.

We delivered another good performance in capital equipment, led by our Fusion Navigation system for image guided surgery and the S7 Surgical Navigation system.

In addition, we continue to see robust sales of disposables, especially in ENT Power and Monitoring.

Turning to the rest of the income statement, I would like to note that my comments exclude the impact of Physio-Control.

Their gross margin was 76.2%, up 40 basis points from the third quarter of last year.

While the gross margin did have a 30 basis point benefit from FX, we continued to offset pricing pressure through our $1 billion cost of goods sold reduction program.

We would expect our gross margin in Q4 to be in the range of 75.5% to 76%, which recognizes more of a negative impact from currency, as well as potential obsolescence of Endeavor as we quickly ramp up the US launch of Resolute Integrity.

Third-quarter R&D spending of $364 million was 9.3% of revenue.

We remain committed to investing in new technologies and evidence creation to drive future growth and expect R&D spending to be approximately 9% of revenue in Q4.

Third-quarter SG&A expenditures of $1.371 billion represented 35% of sales which is a slight improvement year-over-year after adjusting for one-time executive separation cost last year.

We expect Q4 SG&A in the range of 32.5% to 33% of revenue which reflects the impact of several initiatives we are focusing on to leverage our expenses while at the same time investing in new product launches.

Amortization expense for the quarter was $84 million, compared to $86 million in the third quarter last year.

For Q4, we would expect amortization expense in the range of $80 million to $85 million.

Net other expense for the quarter was $67 million, flat compared to the prior year.

Net losses from our hedging programs were $33 million during the quarter.

As you know, we hedge much of our operating results to reduce volatility in our earnings.

Net other expense this quarter also includes $21 million in expense from the Puerto Rico excise tax, which is almost entirely offset by a corresponding tax benefit I will discuss in a moment.

Net other expense this quarter was favorable to our expectations driven by lower than expected payments of Spine royalties, and the Puerto Rico excise tax as a result of slower end-market volumes.

Looking ahead, based on current FX rates, we anticipate Q4 net other expense will be in the range of $50 million to $60 million, including hedging losses in the range of $15 million to $20 million.

Net interest expense for the quarter was $33 million, compared to $70 million in the prior-year period.

Excluding the $21 million non-cash charge for convertible debt interest expense, non-GAAP net interest expense was $12 million.

At the end of Q3, we had approximately $9.4 billion in cash and cash investments and $10.2 billion of debt.

For Q4, we anticipate non-GAAP net interest expense will be in the range of $20 million to $25 million.

Let's now turn to our tax rate.

Our third-quarter effective tax rate, as well as our adjusted non-GAAP nominal tax rate in the third quarter, was 19.8%.

Included in this rate is an $18 million tax benefit associated with a US foreign tax credit from the Puerto Rico excise tax, which mostly offsets the charge recorded in other expense.

Exclusive of one-time adjustments, we expect our FY '12 adjusted non-GAAP nominal tax rate in the range of 19.5% to 20% which includes the tax credit associated with the Puerto Rico excise tax.

Our Q3 GAAP results included a one-time deferred tax benefit related to the estimated gain on the sale of Physio-Control.

It is worth noting that the timing of the tax benefit does not correspond to the timing of the sale gain which will be recorded in Q4, but will not impact our non-GAAP earnings.

In Q3, we generated approximately $1 billion in free cash flow.

We are committed to returning 50% of our free cash flow to shareholders.

Fiscal year-to-date we have paid $769 million in dividends and repurchased $780 million of our common stock.

As of the end of Q3 we had remaining authorization to repurchase approximately 75 million shares.

Third-quarter average shares outstanding on a diluted basis were 1.060 billion shares.

In Q4, we have already started our share buybacks to offset the dilution from our Physio-Control divestiture and have bought back over $400 million thus far.

Let me conclude by commenting on our revenue outlook and earnings per share guidance for the remainder of fiscal year 2012.

This morning we reiterated our revenue outlook and tightened our FY '12 earnings per share guidance.

We believe a constant-currency revenue growth rate of 1% to 3% remains reasonable.

While we cannot predict the impact of currency movements, to give you a sense of the FX impact if exchange rates were to remain similar to yesterday throughout Q4, then our Q4 revenue would be negatively affected by approximately $20 million to $40 million.

Turning to our guidance on the bottom line.

At this point in the year, we are comfortable tightening our earnings per share guidance range.

We now expect FY '12 earnings per share in the range of $3.44 to $3.47 which, after adjusting for $0.04 to $0.06 of dilution from the Ardian acquisition and $0.10 of one-time tax benefits we received in FY '11, implies FY '12 earnings per share growth of 7% to 8%.

Based on our guidance, current FY '12 earnings per share consensus of $3.45 appears reasonable.

As in the past, my comments on guidance do not include any unusual charges or gains that might occur during Q4, nor do they include the impact of the non-cash charge for convertible debt interest expense.

Finally, one housekeeping item.

We will be hosting our annual institutional investor and analyst meeting this year on the morning of Friday, June 1.

The meeting this year will be held in New York City.

With that, Omar and I would now like to open the phone lines for Q&A.

We have a number of people waiting in queue so I would respectfully request that you limit yourself to one question and, if needed, only one follow-up so that we can get to as many questions as possible.

If you have additional questions please contact our Investor Relations team after the call.

Operator, first question, please.

Matthew Dodds, Citigroup.

Start off with you, Omar.

In the opening comments you sounded less optimistic, at least near term on Spine versus ICDs.

When you look at Spine, the issue that's really been hampering the US businesses, a lot of it's the pods.

If they're allowed to continue operating as they are today, is it realistic to believe you can turn this business with technology in the next 12 to 18 months?

First of all, the pods are still a small segment, a small portion of the overall revenue.

Although clearly, they're meaningfully affecting our overall share.

Now, if the pod gains continues to gain critical mass and becomes bigger and bigger, then we've got to understand what that business model is and understand it more clearly.

Right now, it's coming under increasingly negative public scrutiny.

We don't think some of those practices are appropriate and therefore, we don't do such things.

If it becomes really big then that means there's some level of acceptance, in which case we need to re-examine our business model in that area and change our strategy.

But clearly, if it gets really big it's something we have to pay attention to.

Okay.

Then, just one quick follow-up for Gary.

On the ICD business, in the US there's going to be a lot of questions on that.

Just quickly on the OUS, can you say where the market's slowing internationally?

Is it Europe or Japan, in your view?

I think, what our data would say is it's primarily in Europe.

Even there I would say, Matt, it's probably in Southern Europe more than anything.

Okay.

Thanks, Omar.

Thanks, Gary.

Bob Hopkins, Bank of America.

First a clarification, Gary, on the quarter you reported $0.84.

How much did Physio contribute to that $0.84 in the quarter?

I think the quarter was $15 million was the profits from operations that were included in that number.

So as we expected all year, the Physio acquisition obviously was complete -- or sale was completed here in beginning of our fourth quarter.

Our expectation was that results for the first three quarters obviously are in our guidance and in our results.

Then for Q4 here, our expectation is as we've talked about is that we will be buying back stock to offset the impact of not having that profits in our numbers.

So, overall the impact was from operations, $0.84 is about $15 million.

The gain, the tax gain that we're backing that out, that's a nonrecurring item.

Okay.

Then a follow-up question on Spine.

It seems like your commentary is basically suggesting to us that we've seen the lows in your Spine growth.

You -- obviously, that business shrank 10% this quarter.

But you made an interesting comment that things in the last month of the quarter looked better.

So, can you quantify that for us?

How much better were things in that final month?

What was the year-over-year growth rate in that final month, given that you called it out and just love to talk a little bit more about Spine?

I don't -- Bob, this is Gary.

I don't even have the absolute number in my mind as far as where the month is.

I know that trend wise, seeing the data, we saw improvement as we went through January and the average daily revenue that it was improving.

Now, it was still down, obviously, so it wasn't -- we're not saying it was growing during that period of time.

But the decline versus the prior year was much less.

We saw that improving in Q3 and we've seen that so far, even as we went through here in Q4.

Biggest part of that was actually both on core metal and also INFUSE, as Omar said in his comments the biggest impact from INFUSE being declined, it was stronger in November and December.

It was somewhat less of a decline in January and we've seen that a little bit here as we start our Q4.

That being said, the business is still down.

It's just not down as much as, obviously, we saw here in Q3.

I think the comments that I made on that was primarily around the fact that if the decline stabilizes, which is what we've been seeing, then at some point in the coming quarters the comparisons versus prior year will become favorable.

That's really -- and we're optimistic that, that will in fact happen.

INFUSE is its own thing here.

Because that has different dynamics and that can lead to uncertainty at any time, until we get this Yale study resolved.

What was core metal down ex KYPHON in the quarter?

For worldwide, mid-single digits.

Great.

Thanks, guys.

David Lewis, Morgan Stanley.

Gary, I wondered if you could give us a little more granularity on gross margins.

It was obviously, the strongest quarter we've seen in basically six quarters.

I know there's some currency give and takes as well as some divestitures.

But it looks like some of that strength will carry forward in the next quarter and your gross margin guidance for the year probably comes at the higher end of the range.

Can you just help us understand maybe as you look back over the last four quarters what's driving the GM strength and do you think some of those trends are sustainable?

Yes.

First of all, I want to make sure it's clear that, obviously, the gross margin we're talking about excludes Physio, which Physio, pulling that out actually improves their overall gross margin for the Company by -- will vary by quarter but say, 50 basis points approximately overall.

So, that just ratchets everything up.

That being said, you're absolutely right, even with that the last several quarters we've been holding relatively steady on the gross margins.

We do expect that, that will continue as we go into the fourth quarter here.

We have been able to offset the pricing pressures we've seen in the marketplace with, obviously, introducing new products that are seeing our pricing pressure probably less than even what's going on in the market.

We mentioned that in CRDM and even to some -- in some cases even in some of the Spine products, with these new products we are seeing some price uplifts.

That's obviously helping us.

But the main thing I think is obviously a differentiator for Medtronic has been the fact that we've been -- the cost out.

We've been taking $1 billion of cost out of our product cost over the last five years.

We have objectives to continue to do that going forward, and have laid out the plans.

So, it has been our expectation that we're going to -- that we can maintain these gross margins even in this tight pricing environment and so that is our expectations.

I did highlight in my comments that in Q4 the positive FX benefit is not quite as strong as what we've seen over the last several quarters.

So, that's why we were a little bit more cautious in our guidance here for Q4.

Okay.

Maybe just a quick follow-up.

I know it's too early to think about fiscal '13 guidance but basically taking Omar's comments as well as some of your comments, Gary.

Is it reasonable to assume as we head into fiscal '13 we see non-ICD Spine performance where it's been, a slight improvement in ICD Spine performance.

Do you remain reasonably comfortable, this remains an upper single-digit EPS growth business?

Thank you.

Again, we're not obviously giving guidance for FY '13 yet, David.

We'll do that, obviously, in the May discussion.

I think the comment with respect to Spine and ICDs is even applicable based on Omar's comments and mine even as we get into Q4 here.

We do believe that these markets are starting to stabilize and as a result the comparisons for us get easier as we get into some of the next quarters here, Q4 and into FY '13.

If our other businesses continue to do well which they should, especially with the new product launches, Resolute Integrity, RestoreSensor, et cetera.

We should see those businesses continue to perform strongly.

That would start to have an impact on improvement in our overall revenue growth.

From there, then we'll clearly continue to focus on driving and delivering a bottom line that's a few percentage points faster than the top line.

That will be our expectation as we go into the future years as we've talked about previously.

But we're not giving guidance yet as far as what that revenue or earnings per share for FY '13 is.

Great.

Thank you very much.

Mike Weinstein, JPMorgan.

Just first a clarification, Omar or Gary.

The third quarter non-GAAP $0.84 you reported, you announced on the last quarter call that you would call out Physio-Control as a discontinued operation.

You did not include it in revenues this quarter.

But you are including the EPS benefit in that $0.84?

That is correct, Mike.

This is Gary.

As you recall last quarter, we didn't know exactly when the deal would close and we've been obviously, including Physio all year in our guidance along -- when we went forward.

We did highlight the fact that once we did sell it we thought we could offset the profit loss by buying back stock but obviously, until we actually have the acquisition closed we couldn't buy back stock to offset that.

So, the assumption is the operating results from Physio, their operating earnings are in our results, but the revenue because it is a discontinued operations does not show above the line.

We did in the press release and in our comments here, we did try to highlight what the revenue from Physio was just so people would have an understanding of that.

But that's how we've done it.

So, the operations are in our guidance, none of the gain, none of the gain aspect related to selling of the asset will be included in the results, but clearly the operations are.

Okay.

Let me move forward.

Two items.

One, Gary, should we assume given the commitment to return the 50% of free cash flow to shareholders and the need to rebalance your US versus OUS cash generation, that the tax rate -- underlying tax rate for the Company moves higher from here in FY '13 and '14?

Mike, we don't know for sure what's going to happen on that.

We're obviously trying to do things to not impact the tax rate.

Our first things are obviously looking at Omar has a lot of initiatives under way on working capital to reduce inventory levels, to improve our focus on capital expenditures.

So, focusing on areas where we can try to improve the cash mix without -- from an operating perspective without actually addressing it from a tax side of the equation.

We are doing analysis as we indicated in some of the recent presentations.

We are doing some analysis to say, what if we did repatriate certain earnings from certain countries and what would that do to the overall tax rate.

Because some countries obviously, have tax rates that are closer to where the US and there's a minimal impact in that regard.

So, we have not made any assumptions right now.

We have not made any decisions in that regard.

I don't know what the tax rate I can expect for FY '13 will be.

But if we have to meaningfully do some things in that regard, yes, you could see a slight uptick in the tax rate but obviously, we're going to try to minimize that to the extent we can.

So, we're trying to do this without addressing that aspect currently and we'll see how successful we are prior to going to the tax rate.

Okay.

Last question, maybe this is for Omar but whoever can jump in here.

Could you talk about the pipelines at both CoreValve and Ardian.

I think there was some increasing concern that competitors are really targeting those products specifically and that they'll introduce products that could potentially leap frog either of them in Europe in 2013.

Could you just give us a better sense of what is in the pipeline for both of those product lines?

Look, let me take a shot and then let Gary also talk about it.

First of all, our investment strategy in both those product lines are pretty high.

We are determined to maintain leadership and we'll maintain leadership by investing in technologies, by creating our own leap frog technologies which we've got in our own pipeline in both of those areas.

As well as driving -- getting enhanced clinical data from increasing the number of indications.

Both of those areas, those are priority investments for us and I'm telling you that we're determined to keep our lead.

We're not going to give this thing up.

Yes, Mike, I can add a little bit.

I mean, again, I don't have all the details on the product technology in either one of those but Omar's absolutely right.

We continue to invest.

CoreValve obviously, as I said in my comments, there's several different things.

We're obviously expanding the number of sizes that are in the marketplace which will broaden the market.

We are obviously coming at it from a different approach, the direct aortic approach versus the transapical.

We continue to look at new delivery systems, [this one] has a recapture built into it.

So, there's a lot of different things that are being done on CoreValve to enhance the product line overall.

So, we believe that we'll be very, very competitive in that marketplace as we have been, obviously, up to this point in time.

Ardian, the same thing.

The reality is obviously that those products are just being launched, there's several new technologies that we're taking along with what we acquired from Ardian.

The business unit is trying several different technologies that we'll probably be able to discuss a little bit more at the analyst meeting in June and walk you through for both of these businesses where we're at.

Omar is absolutely right we are continuing to invest very heavily in these businesses and new technology that will actually be second-, third-generation types of products.

Maybe one other point on that.

We've got a breadth of technologies across Medtronic.

We've got our CBG business has a pretty dedicated focus in making sure that technologies that are available in one business, they're translated to another, to give us increased competitiveness.

That's not a minor advantage.

That's something that we will leverage as we go forward.

Kristen Stewart, Deutsche Bank.

I was just wondering, Omar, if you could just comment on whether with several months under the belt now, if there's anything that you see that really changes more the strategic direction of the Company?

Well, a number of things.

First of all, I laid out the key areas for focus for us, which I've talked about many times, improving execution, optimizing innovation, and accelerating globalization.

Right now I'm focused on still collecting data but more so operationalizing these areas.

As we operationalize them I'm finding that these are in fact the right things to do.

We need even more detail in each of those areas.

The focus on economic value I find incredibly important in this environment.

Partnerships with major US providers and also, understanding the payer ramifications of customer economic value are things that are very important and if anything, the importance of this has been highlighted to me even further in the last few months.

Globalization, the thing for me that was new in the past three to four months was a realization of how much of an opportunity there is in the premium segment with our existing therapies around the world.

That's just a stunning number.

Based on that, one of the areas that actually has changed is a higher priority in finding ways to make sure that these existing therapies are adequately penetrated in these emerging markets.

Then, taking a step back on the value segment, and approaching that with a little more time -- it gives us a little more time to address the value segment and I think that's appropriate.

So I think minor tweaks, whatever perspective you may have on it, major or minor tweaks to the overall strategies which I think are the right ones.

Execution is critically important and again our proactivity in terms of R&D spending is very high on my list and I think using customer economic value as a center point in our investment criteria is important and I just talked about globalization.

I think these three are the pillars that we're building our operations around and as we go forward we're fine-tuning them and operationalizing them to a fair amount of granular detail.

Okay.

Then at the annual investor conference will you give longer-term guidance or will it just be for fiscal '13?

This is Gary.

We haven't obviously decided yet what we'll do on that but my guess at this point in time is that it will probably just be for FY '13, but we'll have to decide.

It gets back to how comfortable we are where the markets are at, to be honest with you.

The market volatility has been probably the biggest issue for us over the last few years which obviously gives us concern about giving long-term guidance, just not knowing exactly where the markets are at.

We haven't decided yet.

We'll see where we're at, at the analyst meeting.

Obviously, we'll be at that point we'll have given guidance for FY '13.

Whether we're providing longer-term guidance will depend on whether we see our markets really stabilizing.

Also, how quantitatively we can understand the impact of some of our initiatives which that's not necessarily that simple.

But we will try to give you as much data as possible and be as quantitative as we can.

Thank you.

David Roman, Goldman Sachs.

Just want to ask one clarification question on the CoreValve trial, whether you could file separately for the extreme-risk indication or whether you had to file the high-risk and extreme-risk together and what then that meant for approval for each indication.

David, this is Gary.

From what I understand is that we can file each one of them separate.

So, that the basically with the extreme-risk arm obviously enrollment done and once we have all the results, that, that can be filed separately without having the high-risk.

Okay.

Then maybe just one follow-up for Omar, then one for you, Gary.

Omar, over the past couple quarters it sounds like your willingness to look toward divesting businesses or reassessing the strategic portfolio at Medtronic has become a little bit more flexible than when you first presented to us back in August and this time in your prepared remarks you cited Spine.

Maybe just elaborate a little bit more what specifically you're waiting for to look at other strategic alternatives for Spine or businesses where the opportunities for innovation or incremental growth just aren't there.

Then for Gary, how should we start thinking about the Med-tech tax which you'll be one of the first companies to present that in your guidance for fiscal '13 and what initiatives are you undertaking to offset the dilution from that required expense.

First, clarification on what I mean by reassess strategy.

Sure, inorganic alternatives of all sorts exist but I'm going to look at organic alternatives as well.

Reassess the way in which we're growing our Spine business.

Things will work for several quarters, if certain strategy's not delivering the results we expect you've got to do some things different.

But organic alternatives are also absolutely in our cards.

I think I made it clear a few months ago.

The way in which we're looking at our whole portfolio and not only at the major business level but within these businesses, is essentially look at each of the sub-businesses that we have, and ask three questions.

Are we in an attractive market?

Do we have a team, and do we feel that we have the capability to win in that attractive market?

By win I mean become a leader.

Three, what is the overall value that Medtronic adds to that specific business and quantify that as much as possible.

These are the three questions we intend to ask for every sub-business we have in our portfolio.

We're today putting the processes in place to do this in a consistent and as quantitative a manner as we can, and based on that analysis which we will perform periodically, maybe two times a year, we will make decisions.

Those decisions will guide the nature of our portfolio.

So, I want to be as consistent and logical about this as possible with a view towards a clear and consistent long-term strategy as opposed to knee-jerk -- what happened in the last few months or whatever.

Because we're here for the long term and we've got to make the right decisions that favor the long-term benefit for Medtronic and our ability to participate in growth markets and win in those markets and also add value from our breadth.

That's the process that we're embarking on and we'll probably share with you a few more details at least on the process at the investors meeting and more importantly we'll put it in place as we go forward.

David, just back to the question on the medical device tax.

Obviously, we're still -- as all companies are, still working on understanding the exact impact of this and you're correct, we'll be one of the first ones that will include that in our guidance because we'll have four months of it in our FY '13 results.

It's still only draft regulations out there at this point in time.

But our expectation based on what we are seeing and hearing is that the net impact of this is probably about $125 million to $175 million for us, per year.

So, in FY '13 you could assume that could be about a $40 million to $60 million impact for one-third of that year overall.

We're obviously looking, the businesses and ourselves are looking at a lot of different ways to figure out how much of that if any can we pass on, how do we offset the cost associated with that.

So, we've looked at this as basically one of the costs we're going to have to cover as we put together our plans for FY '13 and as we put together our initiatives on a long-term basis.

This is just a cost of -- it's going to be a cost of doing business here in the US and we're going to have to make the tradeoffs.

There's probably going to be things that we can't do as a result of that, but our assumption is this is a cost we're going to have to incur.

Okay.

Thank you very much.

Larry Biegelsen, Wells Fargo.

Gary, one clarification.

Were those numbers that you gave for the Med-tech tax before or after tax?

Those were after tax, Larry.

Thanks.

Let me focus first on the transcatheter valve market.

Gary, you mentioned the slowdown in outside the US in your fiscal third quarter.

Could you talk about what you saw there?

Was it new competitors?

Was it pricing?

Did you see a pickup in January?

Was this just temporary due to budgets in Europe?

That's my first question, thanks.

Larry, our sense is it's primarily, more procedure related than anything.

It's primarily just because of the capitated budgets that many of the countries in Europe obviously deal with.

What our salesforce would tell us and what we saw was that the data would tell us that actually you saw a little bit of a slowdown, it's just these budgets were fully utilized and so you saw a reduction in procedures.

Also, especially in some -- again, I think it's more again in Southern Europe versus even the Northern European countries.

So, we're not saying we don't think the market's going to completely slow down or not going to come back.

But clearly because of the capitated budgets and the fact they were completely used, end of the calendar year, we saw a slowdown a little bit.

It was still growing but obviously a little bit slower growth.

Some of the other markets you talked about a pickup in January.

Did you see a pickup in that market in January or does that slowdown continue?

I don't know if the slowdown continued.

I wouldn't say it bounced back as much as we saw in some of the other businesses which we tend to see more often.

For example, this happens in a lot of our product lines whether it's Pacing or ICDs, it's not just transcatheter valves but I would say that we probably saw that bounce back a little bit more in some of those other markets.

That might be just due to the fact that those are more mature businesses and the hospitals know how to handle that.

We don't know.

But we didn't see necessarily a bounce back in the growth rates in January yet.

Lastly, Gary, in the US there was some concern about increased seasonality in calendar year Q4 2011.

It sounds like in the US you didn't see a dropoff in January due to increased seasonality.

Is that fair?

Thanks.

No, I don't -- we didn't see anything really from a seasonality in January for our purpose.

I mean, I think historically we have a couple business that's there is a little bit of a seasonality that comes into a case because of the higher deductibles, et cetera, that people will all of a sudden be getting into.

So, for example, our Diabetes business always sees November, December being a little bit stronger and January's a little softer historically.

But the comparisons year-over-year, we saw the same growth.

But that's a normal phenomenon that we'll see.

They see a little bit more seasonality than probably our other businesses because of that deductible issue.

Thanks, guys.

Adam Feinstein, Barclays Capital.

The question's been asked a lot about strategy and thinking out longer term and appreciate all of the details you guys have given.

But with respect to just the portfolio, a lot of the questions were about maybe thinking about selling off businesses and you talked about your thought process in terms of looking at the markets and looking at whether you could win.

But thinking about it slightly different, I guess, in terms of some of these businesses being high-growth businesses that Medtronic could create significant shareholder value, maybe some of these segments could trade at five to six times revenues at standalone public entities.

So, you're not selling those businesses.

But clearly, just creating value where maybe now you're not getting full value for some of the higher-growth segments.

How are you thinking about that in terms of just the thought process and do you think you're getting fair value for some of the higher-growth segments?

Yes, I think that's what I tried to address when I said looking at the overall value of Medtronic.

So, we're going through a fairly granular and quantitative approach.

We're really looking at each of our businesses, high growth and not, where we're seeing -- where we're assessing what are the unique aspects of being part of Medtronic.

In other words, very clearly, are there technologies that we have in one business that we can transfer over to another business, that's unique to Medtronic and our portfolio of products?

So, that makes a value that we're providing that the business on its own would not have.

Are there areas where we've taken technologies and actually created new products which are linked in front of the customer and so the physician practitioner actually uses two of our technologies together in a way that's unique or do we have plans to create such products which again for a Company on its own would have difficulty doing.

Do we have operational and simply cost synergies that are strong and provide extreme value from a profitability and reinvestment perspective for that Company.

So, we look at fairly granular set of criteria, four of five such criteria which we want to look at by sub-business within our portfolio and in a consistent fashion grade that.

If at any time we find that the overall Medtronic is not adding enough value to that sub-business and that business can be better off on its own, then that becomes a candidate for divestiture, absolutely.

By the way, the same rational we expect to apply for acquisitions.

So, the way in which we do acquisitions, also quantify and see their fit with Medtronic and what we can add.

So, those questions apply to our entire inorganic strategy.

Just to give you an example, with the Physio-Control divestiture we're in the process of going through obviously, I would say Physio-Control is probably the farthest removed of all of our businesses.

I would tell you as we go through this process, it's surprising how much we learned where there are more synergies than we even ourselves understand.

So Omar's point of going back, we're finding out there were a lot of more cost synergies than we expected, et cetera.

So, it's more difficult than you envision just to go out and especially divest of a business onto itself, if there's not someone there with the infrastructure to support it going forward.

So, we have to understand all that aspects of it.

But it's not just a cost component as Omar indicated.

It's also back to all the technology and the customer relationships and what that means.

But we are going through this in a very systematic approach across every one of our products.

Okay.

Thank you.

Appreciate the detailed response.

Maybe a quick follow-up.

Based on that, as you think about selling to hospitals in terms of selling bundled products and just the opportunity there, just curious in terms of just how do you see hospital purchasing going in the future, and certainly having that broader portfolio?

Just your thoughts there.

The broader portfolio obviously helps there.

Look, that is not the only factor.

Like I mentioned earlier.

In fact, if we can use technology in some way it's actually a far more differentiated approach from our competition in many ways.

However, the fact that we have a breadth of our products to a hospital is clearly an advantage and we think that in the US, hospitals by and large will be looking at that much more expansively than they've been before.

In my discussions with different CEOs, there's considerable interest in partnerships with Medtronic.

Primarily so, that we can create economic value for the hospital together through the technologies that we have.

They realize that for the hospitals to run efficiently and profitably, they need to partner with broad technology providers and solution providers which we're a pretty good candidate for that.

By the way, that's true outside the US as well.

It has been the case in Europe for a while where hospitals look at companies from a much broader perspective and certainly in some of the emerging markets as well as hospitals are being set up.

The administrative management of the hospital usually looks to companies who have a breadth of offerings.

So, we think that, that's an advantage.

But I do want to point out that, that's not the only advantage by any means.

I think the technology advantage and the customer focus advantage where the customer -- the physician focus advantage are in many ways even greater than the bundling opportunity, but like I said that cannot be minimized either.

All right.

Thank you very much.

Appreciate the detailed response.

Sara Michelmore, Brean Murray.

Maybe a question on the Diabetes business.

It did look like the US business there had taken a step down from the last quarter.

Wondering if there's anything going on there.

Was also looking for an update, I know you had a lot of new products internationally that have helped the growth rate there and what the status is in terms of getting those products to the US market.

Thanks.

Yes.

This is Gary.

The US revenue, the Diabetes business grew about 3% in the quarter and so it was obviously below what we've seen internationally.

It's not unusual.

We've seen that over the last several quarters, our international growth has been more than the US.

But you're right, it was a little softer this quarter.

A little bit -- we saw a little bit slower pump growth at the end of the year here and overall our CGM and everything else was doing fine but pump growth was a little bit slower than what we expected.

We don't think there's any big issue there.

We just think it's more due to the slowing economy.

The economy still has an impact on this business and we think that's part of the issue that we saw here in the US overall.

So, we're not expecting a long-term trend in that regard.

But I think you're going to continue to see the US be a little softer obviously, than the international market where we do have all the new products.

With respect to the new products coming to the US, both and I'm assuming you're talking about really Veo which is the low glucose suspend feature and the Enlite which is our new sensor.

Yes.

We're working with the FDA on that right now.

We're making good progress on the IDE for the US Enlite product.

We're continuing to have conversations with the FDA on working to get Veo into the marketplace overall.

We're excited about getting those products into the marketplace, as quickly as possible but that's still a ways out.

Then just a follow-up on the Restore product in the US.

Is there any way to quantitate what you think that cost you in the quarter?

Was interested in what your latest thinking was in terms of the growth of the pain market in the US.

Thanks.

Well, as we said, I think the pain market in the US from our data would we think is growing to mid-single digits overall.

We obviously did not have the RestoreSensor really -- even though it was approved, we weren't really able to launch it fully until as I indicated in my comments until the very last week in the quarter.

We had a supply issue on some of the components in the products coming from component products coming from Thailand.

So, that really hampered our ability to launch the product fully in Q3 and if anything probably actually hurt us because you had people waiting to get that new product.

The good news is that, that is resolved.

We have launched those products fully now in Q4 and the business is off to a very good start.

So, we expect we are going to gain share back with RestoreSensor and starting here in Q4.

Great.

Thanks, Gary.

Joanne Wuensch, BMO Capital Markets.

Two parts.

One, you talk about inventory management of ICDs by the hospitals.

Are we at the end of that?

Then the second piece of it is if I heard in there directly you talked about minimizing dilution from M&A.

Did I hear that correctly?

If so, have you changed your strategy for M&A?

Let me take the first one and then Omar can take the dilution question.

With respect to the destocking comment, and just the inventory levels overall.

Joanne what I would say, is I think this fluctuates.

As we've indicated before, about 5% of our revenue, or about 20% of the CRDM revenue is in bulk purchases that we have with hospitals.

That's going to fluctuate 10%, plus or minus, in any given quarter and we saw it was lower this quarter for ourselves.

I think the competitors mentioned somewhat of the same thing in some of their comments.

Is it now at a new low or could that continue?

I don't think any of us know for sure.

But that's going to obviously, be up to hospitals and what situation they are in and their inventory levels overall.

So, it's a normal fluctuation that occurs in our markets.

The good news for us is the implants, the daily implants as we indicated in our comment in Q3 and here in Q4 continue to grow -- and sequentially grow, and are actually up over the prior year as we indicated in our comments.

That ultimately has to have an impact on where those inventory levels are at.

From our perspective, that's where we focus and then the inventory levels are going to fluctuate depending on what the hospitals want to do.

On the dilution question, look, to put this in perspective, Medtronic has done several major acquisitions in the past few years which have been dilutive.

These have been good deals.

They're strategic for us.

They in many ways can change the way in which medicine is performed and are appropriate for us.

However, it takes time for us to realize the benefits that these deals have promised, and we're in the middle of realizing those benefits.

They're in plan.

But they take time.

In the meantime, our organic growth has slowed.

So, to do more dilutive deals without any real discipline around it, obviously doesn't make any sense.

So at this stage, what we have in our portfolio, our focus is to translate the deals that we've already done into real benefits, to realize the benefits that were promised and we need to demonstrate that to our shareholders and for us.

At the same time, we're willing to look at other attractive deals which may well have dilution, but if they have dilution then we need to find offsets in the business to fund them.

I think, again, there are always exceptions to this, so I don't want to make any hard and fast rules here.

Our general direction here is that, I really don't want any significant dilution from any inorganic activity in the near term and that doesn't mean that a deal itself cannot be dilutive.

If it is then the business either by itself or collectively Medtronic has to find an appropriate offset.

If I could follow up quickly.

Physio-Control adds how much to gross margins on a go-forward basis, the sale of that?

We've indicated I think it varies by quarter, obviously, depending where we're at but you're talking somewhere around 50, 60 basis points.

Perfect.

Thank you very much.

That concludes our question-and-answer session.

I hand the program back over to Mr.

Omar Ishrak for closing remarks.

Thank you.

Thanks for your questions and before I end today's call I would like to comment on Medtronic's ability to play a leadership role in the changing healthcare environment.

I've touched on some of this in the Q&A.

Let me just summarize.

In the few quarters that I've been at Medtronic it's been clear to me that a large shift is occurring in our industry that goes straight to the core of our industry's business model.

Med-tech has thrived for decades by engaging primarily with the physician who in most instances evaluated the merits of our products solely on their clinical value.

While clinical value and our physician customers will always remain important, there are additional decision factors and decision makers that are playing an expanded role in the purchase of Med-tech products and services.

This has significant ramifications for our industry and Medtronic is focused on modifying our strategies to align all the activities in our value chain to this new environment.

This affects selecting the products and services that we choose to develop, capturing additional evidence on the economic value of our portfolio, modifying how we market our products and services, adapting the structure and skill set of our salesforce, and optimizing our operational efficiency.

Change is never easy.

While not all companies will be able to evolve, there will always be winners and losers in any environment.

Our breadth and our customer relationships are unique advantages that allow us to deliver value to the overall healthcare system and we will emerge stronger, leading our industry and providing better and more cost-effective solutions to many more people around the globe.

With that, and on behalf of our entire Management team, I would like to thank you again for your continued support and interest in Medtronic.