美敦力 (MDT) 2017 Q2 法說會逐字稿

Welcome to the Medtronic's second-quarter earnings conference call.

(Operator Instructions)

I'll now turn the conference over to Mr. Weispfenning. Please, go ahead.

Great. Thank you, Crystal. Good morning. Welcome to Medtronic's second-quarter conference call and webcast. During the next hour, Omar Ishrak, Medtronic Chairman and Chief Executive Officer and Karen Parkhill, Medtronic Chief Financial Officer will provide comments on the results of our FY17 second quarter which ended on October 28, 2016. After our prepared remarks, we will 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 division summary. We also issued an earnings presentation that provides additional details on our performance and outlook. You should note that many 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 and other filings that we make with the SEC. We do not undertake to update any forward-looking statements.

In addition, the reconciliations of any non-GAAP financial measures are available on our website, InvestorRelations.Medtronic.com. Unless we say otherwise, references to quarterly results increasing or decreasing are in comparison to the second quarter of FY16 and all year-over-year growth rates and ranges are given on a constant currency basis, which adjusts for the effect of foreign currency.

Other than as noted, our EPS growth and guidance does not include any charges or gains that would be recorded as non-GAAP adjustments to earnings during the fiscal year. These adjustment details can be found in the reconciliation tables included with our earnings press release. With that, I'm now pleased to turn the call over to Medtronic Chairman and Chief Executive Officer, Omar Ishrak. Omar?

Good morning. Thank you, Ryan. Thank you to everyone for joining us. This morning, we reported second-quarter revenue of $7.3 billion, representing growth of 3%. Q2 non-GAAP operating profit grew 9%. Non-GAAP diluted earnings per share were $1.12, growing at 15% and representing EPS leverage of 1,120 basis points.

Q2 revenue was disappointing and did not meet our expectations. We faced issues that affected our growth including slower than expected revenue as we await new product introductions. Despite this revenue shortfall, we produced strong improvement in operating margins and double-digit earnings per share growth. While some of the challenges that had an impact on revenue in Q2 could persist over the coming quarters, we remain confident in our ability to deliver mid single-digit revenue growth and double-digit EPS growth not only in our current fiscal year but on a sustained basis into the future.

Now normally, the diversity of our revenue base overcomes any quarterly challenges; however, there were enough unexpected and unrelated issues in Q2 to collectively affect our revenue and each of our growth vectors. Our new therapies growth vector, which contributed approximately 195 basis points to our total Company growth, not only just fell below our goal of 200 to 350 basis points but was well below our trend and expectations with the largest impacts from CVG and diabetes.

In CVG, revenue growth was 3%, below our targeted high end of the mid single-digit range and meaningfully below what we believe this business should be able to sustain. In our CRHF division, strong growth contributions from diagnostics, atrial fibrillation and our recently acquired HeartWare LVAD business were offset by weakness in our core cardiac rhythm implantables business, which declined in the low single-digits.

While we continue to take share in the US ICD market, the market itself declined in the mid single-digits, driven by high single-digit market declines in high powered device replacements. In the UK, our implantables revenue declined in the mid-teens, as the National Health Service is changing its procurement model to limit bulk purchases causing a temporary disruption to normal buying patterns of the local trusts. We expect these pressures in CRHF to continue through the fiscal year.

Our CSH division was affected by transient market share losses due to the timing of new product cycles. For example, in the fast growing TAVR market, we lacked until recently a large size version of our Evolut R platform. In drug eluting stents, our new Resolute Onyx DES is not yet available in the US and Japan, driving declines in those markets to competitive DES products. However, at the end of this quarter, we did receive FDA approval for Evolut R XL, which we expect to drive US growth in the back half of our fiscal year. In addition, we expect the introduction of Evolut Pro and Resolute Onyx in the US around fiscal year-end and Resolute Onyx in Japan in FY18.

In our APV division, solid mid single-digit growth was driven by our IN.PACT Admiral drug coated balloon, which continues to lead the market and drive mid 20%s growth. We expect this momentum to continue in the second half of our fiscal year.

Within our diabetes group, we were pleased with the earlier than expected FDA approval of the MiniMed 670G, which not only represents revolutionary technology toward a long awaited closed loop insulin pump system, but also has been received with strong enthusiasm amongst the diabetes community. However, the earlier than expected approval has created a bigger than expected gap between product approval and shipment.

As a result, we created a priority access program for the 630G, which offers upgrade priority to the 670G when launched. We are seeing strong demand for this program primarily from early adopters. We do expect the majority of customers to wait to purchase the 670G once it launches in the spring of 2017. In addition to this dynamic, which is driving lower than expected pump and consumable sales, a portion of our 630G revenue is now deferred until receipt of the upgrade. Going forward, we expect some improved revenue growth for the remainder of this fiscal year. We expect diabetes to ultimately return to double-digit growth once the 670G is fully on the market next fiscal year.

Our Minimally Invasive Therapies Group grew 4% in Q2, consistent with our goal of mid single-digit revenue growth, primarily driven by our open-to-MIS growth driver including strong product sales of our recently launched Valleylab FT10 energy platform and continued performance of our Endo stapling specialty reloads. Surgical Solutions came in slightly below our expectations primarily driven by the impact of competitive reprocessing of our advanced energy vessel sealing disposables in the US. We are confident in our ongoing strategies and new product launches that are designed to address this headwind.

Looking ahead, MITG expects to launch more than 15 new products in the second half of the fiscal year to drive growth, including a new powered stapling platform called Signia and new vessel sealing enhancements. This pipeline gives us confidence that MITG can continue to grow in the mid single-digits in the back half of the fiscal year.

Next, our Restorative Therapies Group grew 3% this quarter and our spine division continued to show improvement. Overall, spine growth was 1%, our strongest growth in seven quarters as we gained global spine share. Our US spine business grew 3%, driven by continued adoption of Infuse and strong adoption of our speed-to-scale launches and surgical synergy strategy, resulting in share gains along with sales of our navigation and imaging equipment in neurosurgery.

RTG did suffer from a voluntary recall of certain neurovascular products which affected revenue. Some of these products will remain off the market in certain geographies for a period of time but the most substantial impact of the recall is behind us as we bought back existing distributor inventory in Q2. Across all of our groups, our product pipeline remains robust.

We have important new growth catalysts that we expect to lead to improved second half growth. Some of these products have already been launched and others are coming to the market in the coming months. We are confident we can drive sustainable growth of our new therapies growth vector and expect to be well within our 200 to 350 basis point goal in the back half of the year and over the longer term.

Next, let's turn to emerging markets which grew 10% and contributed approximately 120 basis points to our total Company growth, slightly below our goal of 150 to 200 basis points. The primary driver was a shortfall in the Middle East, where our revenue declined in the mid single-digits as governments are dealing with an increased deficit affected by declining oil prices.

In Saudi Arabia, the largest market in the region and where we have a strong market leadership position, our overall business declined by approximately 40%, mostly impacting our CRHF, Surgical Solutions and Spine divisions. We expect continued pressure in the Middle East for the remainder of the year, but we also believe that the basic demand for our critical life saving therapies will eventually rebound strongly.

On the positive side, our businesses in South Asia, ASEAN, Eastern Europe and Latin America all grew in the mid-teens or higher. China, our largest emerging market grew 11% with double-digit growth in MITG, and diabetes and high single-digit growth in CVG and RTG. In South Asia, of which India is the largest market, we grew again in the low 20%s with strong growth coming from key tender wins in MITG. In ASEAN, growth was broad based with double-digit growth in Thailand, Singapore, Vietnam, Indonesia and the Philippines. In Eastern Europe, we grew over 20% in Russia as a result of strong momentum in CVG and MITG.

Latin America also had strong double-digit growth in Brazil, Colombia, Mexico, Chile, and Argentina driven in part by new tender wins and continued channel optimization efforts. We expect current emerging market performance levels to be sustained in the back half of the year and continue to believe strongly that the penetration of existing therapies into emerging markets represents the single largest opportunity in med tech over the long term.

Turning now to our third growth vector, services and solutions, which contributed 20 basis points to Medtronic growth. While this overall result was below our goal of 40 to 60 basis points, services and solutions continues to achieve solid revenue growth mostly from CVG-related offerings. We expect to further improve our growth contribution as new models are created and expanded across all our regions.

We continue to see success in our hospital solutions business through which we provide expertise in creating operational efficiency in both cath labs and operating rooms. We are also continuing to grow our chronic care models, including Diabeter for Type 1 diabetes and NOK for morbid obesity, by pursuing global expansion opportunities. Finally, we formally launched our orthopaedic solutions business earlier this month, a comprehensive program to help providers meet their CJR requirements in the US.

Before I turn the call over to Karen, let me reiterate that we are disappointed with our Q2 performance. That said, we also believe that these headwind events were largely temporary in nature. We remain confident in our ability to deliver mid single-digit revenue growth and double-digit EPS growth for the full year.

What should not be lost in the discussion is that despite revenue challenges this quarter, our organization delivered strong improvements in operating margins, including improvements in our gross margin and SG&A and met our goal of delivering double-digit EPS growth. Karen will now take you through a more detailed look at our second-quarter financial results. Karen?

Thank you, Omar. Our second-quarter revenue of $7.345 billion increased 4% as reported or 3% on a constant currency basis. Foreign currency had a positive $50 million impact on second-quarter revenue. Acquisitions and divestitures contributed approximately 120 basis points net to revenue growth.

GAAP diluted earnings per share were $0.80. Non-GAAP was $1.12. After adjusting for the $0.06 impact from foreign currency, non-GAAP diluted EPS grew 15%.

Strong operating performance helped offset the revenue shortfall in the quarter. The majority of a tax benefit during the quarter was offset by a worse than expected impact of foreign exchange on earnings. In addition to the $385 million adjustment for amortization expense, non-GAAP adjustments to earnings on an after-tax basis were: a $24 million charge for the HeartWare acquisition fair market value inventory step-up; and a $35 million restructuring charge; and a $2 million charge for acquisition-related items. Both stemming mostly from our continued integration of Covidien, along with expenses related to our acquisition of HeartWare offset by a net gain from the adjustments of our contingent consideration on prior acquisitions.

Our operating margin for the quarter was 28.9% on a constant currency basis representing a strong 150 basis point year-over-year improvement. Efficiencies in both the gross margin and SG&A, largely a result of execution on our Covidien synergies, drove the increase. We remain on track to deliver $225 million to $250 million of synergy savings in the fiscal year and expect to deliver on our commitment of $850 million of savings by the end of the FY18. Our efforts to realize the Covidien synergies are also serving as enablers to other leverage programs designed to deliver additional long-term margin expansion.

Net other expense was $89 million compared to $57 million in the prior year, reflecting about $90 million in reduced foreign exchange gains versus the prior year, primarily due to our hedging program, partially offset by a $48 million reduction in the US medical device tax. While we hedged the majority of our operating results in developed market currencies to reduce earnings volatility from foreign exchange, FX can create modest volatility to the P&L above the operating margin line.

In addition, a growing portion of our profits are unhedged especially with emerging market currencies, which can create modest volatility throughout the P&L. Looking ahead, we remain committed to our plans to generate 130 to 210 basis points of improvement in our operating margins this fiscal year.

Below the operating profit line, net interest expense was $173 million. At the end of the second quarter, we had $32.4 billion in debt and $11.3 billion in cash and investments of which approximately $6 billion was trapped.

Our non-GAAP nominal tax rate on a cash basis was 14.7%. This was an improvement to our forecast and included $42 million of operational net tax benefits, primarily related to the write-off of a deferred tax liability associated with the prior impairment of an investment in a foreign subsidiary. While we have had tax benefits in both Q1 and Q2, we continue to forecast a tax rate of approximately 17% for the second half of the fiscal year.

Free cash flow was $1.2 billion. We are deploying our capital strategically, consistently and with discipline, with a focus on reinvestment, debt reduction, and return to our shareholders. We paid $593 million in dividends and repurchased a net $985 million of our ordinary shares in the second quarter. This represented a total payout ratio of 101% on non-GAAP net income and 142% on GAAP net income.

Keep in mind, our payout ratio is elevated as we not only return 50% of our annual free cash flow to shareholders but also execute on our commitment to return $5 billion through incremental share repurchases by the end of FY18. At quarter end, we had remaining authorization to repurchase approximately 39 million shares. Second-quarter average daily shares outstanding on a diluted basis were 1.393 billion shares.

Before turning the call back to Omar, let me conclude with our outlook. As Omar mentioned, we continued to expect to deliver mid single-digit revenue and double-digit EPS growth this fiscal year. We expect our revenue growth to improve from the disappointing growth this past quarter. However, given the issues we outlined in the second quarter, some of which could persist in the near term, we now expect our full year revenue growth to be within the mid single-digit range on a constant currency constant weeks basis, as opposed to the upper half of that range signaled previously.

Moving to the back half of the fiscal year, we expect revenue growth to also be in the mid single-digit range on a constant currency basis. With regard to our business groups, we continue to expect MITG to grow in the mid single-digits. We expect RTG to grow in the low end of the mid single-digit range ramping in the back half of the year.

While we expect improvement from the headwinds faced in CVG and diabetes in the second quarter, we recognize that until some of our important new products officially launch, revenue growth is likely to continue to be affected. For that reason, in the back half of this fiscal year, we expect CVG to deliver mid single-digits and diabetes to deliver mid to high single-digit revenue growth.

Keep in mind that CVG had a strong finish to last fiscal year. So on an annual comparison basis, we expect slightly slower growth in the fourth quarter. Because we do not expect the 670G to be on the market until the end of this fiscal year, we expect growth in diabetes to ramp through the back half with stronger growth in the fourth quarter than the third. We continue to expect diabetes to ultimately reach double-digit revenue growth as signaled in the past, once the 670G is fully on the market next fiscal year.

While the impact from currency is fluid and therefore not something we predict, if current exchange rates which include $1.06 Euro and JPY110 remain stable for the remainder of the fiscal year, we expect our full-year revenue to be negatively affected by approximately $20 million to $60 million including an approximate $10 million to $30 million negative impact in the third quarter.

With respect to earnings, we continue to expect double-digit EPS growth on a constant currency, constant week basis for the full fiscal year. For the back half of the fiscal year, we expect non-GAAP diluted EPS growth to be in the 8% to 10% range on a constant currency basis, given slightly less than previously expected revenue, a more normal 17% expected tax rate, and the loss of the year-over-year benefit from a lower medical device tax starting in December. Taking into account the estimated $0.08 to $0.10 impact from the extra week in the first quarter last fiscal year, as well as an estimated negative foreign currency impact to our full-year EPS of $0.20 to $0.22 if current exchange rates remain stable. This EPS growth implies full-year non-GAAP diluted EPS of $4.55 to $4.60.

Lastly, we are modifying our free cash flow outlook methodology. Recall that last quarter, we were focusing -- we were forecasting an adjusted free cash flow of $6.5 billion to $7 billion for FY17, a range that would exclude cash payments related to non-GAAP items that might occur during the year.

Going forward we will include these items to more closely align our free cash flow projection with the results we report each quarter. However, in light of the unpredictability of the precise amount and timing of cash payments, we are expanding the range. Given this, along with the revenue and net income expectations already discussed, we expect our free cash flow for the fiscal year to be in the range of $5 billion to $6 billion. Now, I will return the call back to Omar.

Thanks, Karen. We will open the lines for Q&A but before we do, I wanted to reiterate what for me are the three key points about our Q2 performance. First, we are disappointed in our revenue performance this quarter. The issues that caused the shortfall are identifiable and in many cases temporary. As I mentioned, we have several new product introductions in the back half of the year that we expect to drive our revenue growth back to our normal range.

Second, despite our revenue challenges, our organization delivered an operational discipline including driving the expected Covidien synergies, which lead to strong operating margin improvement and double-digit EPS growth. Third, looking ahead, we remain confident in our ability to deliver mid single-digit revenue growth and double-digit EPS growth not only in our current fiscal year but on a sustained basis in the future. As always, we remain focused in creating long-term dependable value for our shareholders.

We will now open the phone lines for Q&A. In addition to Karen, I've asked: Mike Coyle, President of our Cardiac and Vascular Group; Bryan Hanson, President of our Minimally Invasive Therapies Group; Geoff Martha, President of our Restorative Therapies Group; and Hooman Hakami, President of our Diabetes Group, to join us. We want to try to get to as many people as possible, so please help us by limiting yourself to only one question and if necessary a related follow-up. If you have additional questions, please contact Ryan and our Investor Relations team after the call. Operator, first question please?

Mike Weinstein, JPMorgan.

So Omar, I think there's pieces of it that I think that people understand. The comments ranging in the diabetes business and just the impact on demand because of the timing of 670G or Saudi Arabia having a significant drop off obviously in demand. I think probably the best way to think about kind of the one question investors are going to have today is on the US business.

So if we looked at US growth corporate wide on an organic basis, it's basically flat this quarter. So I'd love to hear just the group's thoughts on the health of the US device market and what appears to be some slowdown at least reflected in your results and other companies' results over the last quarter?

Yes, thanks, Mike. I think the primary driver for us though is the fact that the US is most sensitive to new product cadence. We're big enough in the market that we flex the market up and down a little bit ourselves. As we launch new products in the US, I think, we will benefit accordingly. Like I mentioned earlier, in CVG, we just launched the Evolut R XL, which will contribute to US growth in the second half and also the introduction of the Evolut Pro and Resolute Onyx in the US around the end of the fiscal year.

You had mention diabetes, that's primarily a US launch on the 670G. So that, we think, again will have a big impact in the market. The slowdown in diabetes was mostly in the US, again, which again impacted the overall market. In MITG, we're launching over 50 new products in the second half to drive growth. In RTG, our continued drive on our speed-to-scale launches and so on, in addition to our sales and navigation and imaging should all help the US. So we think this is a lot in our own control and through successful execution of new product introductions I think we will make an impact.

Omar, if I looked at it, just to push back just a little bit. So it's always harder to tell just on a quarter to quarter basis and some of the implantables business such as CRM, but if I look at Surgical Solutions, the US growth in Surgical Solutions, which is pretty good barometer for device market growth, was lighter this quarter. So maybe if you just want to comment on that?

Then just the follow-up unrelated to the actual quarters, I know there were a lot of questions coming out of the outcome of the US election and the potential for corporate tax reform. So Karen I don't know if you have any preliminary thoughts on the potential implications of tax reform in the US on the Company both from a change in how tax rates are ultimately calculated and to the access to cash? Thanks.

Well, there was a number of points there, Mike. First, from a Surgical Solutions perspective, while it is a barometer in the overall market, there were greater activity than we usually have on reprocessing, which -- for which, we are addressing that through some new launches in the second half. So we think that will impact the market. Again, like I said before, because we are so big, in the market it does move the overall market up and down depending on what we do.

I really don't have any hard data to comment on the overall procedures that would really worry me as a big factor. I think our own performance is the bigger thing here. With respect to the other points, Mike it's too early for me to comment on any changes and so on. In the end, we go back to our universal healthcare needs, improving clinical outcomes, driving value based healthcare, increasing access.

Irrespective of the government and irrespective of the country for that matter, those are the priorities and that's what we stay focused on. I think as long as any reform focuses on that, I think that it will be accepted and will be successful. It not easy but it's one that we must collectively address. With respect to the tax situation again, I don't want to speculate on what may or may not happen here. But I just want to reiterate that the reason we did the Covidien acquisition was operational.

It was primarily driven by market synergies and broadening of our business and the way in which we can drive healthcare forward. At that time, that was the best structure. We continue to believe that is the right way for us in getting access to our cash, which we've deployed effectively, I'm just going to leave it at that. We'll see how things roll-out. We'll kind of go from there, but like I've said many times before, we like to control the things that we can control and execute those well. The rest will happen around us. It's tough for me to speculate. Thanks, Mike.

Understood. Thank you, Omar.

David Lewis, Morgan Stanley.

So I appreciate your comments about sort of the growth being in your own control. I think investors want to hear that, but I think it's sort of undeniable in this last quarter that US implanters saw 2 points of comp adjusted deceleration. So something happened in the US. I think people want to just understand how much visibility you have on sort of this back half improvement of about 100 basis points.

So I guess the question once again is, you have a different pacing of months relative to your peers. Have you seen enough stability or improvement in the last couple of months to believe that whatever happened in the US market here in this quarter is at least stable now and that's something you can sort of build upon with your new products. I do still think there has to be some market effect here with these new products to get investors comfortable that at least the market in your mind is stable to improving.

Yes, that's a fair point, David. The only thing that we pointed out was the device replacements, where we're certainly slower. But I'll let Mike Coyle comment on the CRM market. I'll let Bryan comment briefly on the surgical market because I think that's an important question that you're asking. So Mike, go ahead and just answer the question directly.

David, the bigger impact was in the high power segment, in fact, the pacing market was pretty much in line with what we were expecting. So the high power side of the equation, we saw slightly lower growth in initial implants, but now we are looking at high single-digit declines in replacements for the market. That's something different than we have seen historically. As we go forward, we think that we're in a particularly impacted area for CRT, and that will get better going forward.

But we also expect on the high power side for some standardized CDs that there will be this replacement headwind that's principally coming from the fact there were lower device implants five to seven years ago when these were being put in terms of initial trajectory but an even more important impact is the lengthening life of these devises because of the improvements that we've made to the technology to extend their battery life. That will be a bit of a headwind for us going forward, but what is going to work in our favor is pipeline.

If you remember from TCT, in the first half of the year, across all of our businesses within CVG we had four or five new product introductions in major geographies. That's going to go up to about 25 in the back half with some very important ones in the device implantables area including extending the 3T MRI, bringing (inaudible) to Japan and a large number of other ones that I mentioned at TCT and identified as being the catalyst for us going forward. So I think those are going to be things that we can count on to help our share position and hopefully also help with market growth.

Bryan, a brief comment on the US market?

Yes, it's obviously, we're pretty focused on the same thing. We look at a number of different data points and hearing comments from folks like yourself and other businesses. I hear some people say that things are stable, I hear some people say it's down. I look internally first to try to get a sense. I hear a mix the same way. So until I see something definitive, I feel like the procedures have stayed stable from quarter to quarter. Even if I saw something in the quarter, unless I see a couple of quarters in a row, there's not really a solid data point there. So I haven't seen anything or feel like we should redirect on volume.

Okay. Just maybe two quick follow-ups, Omar. Maybe one for Hooman, and one for Karen. So, Hooman, I think we all understand the disruption in light of 670G, but earlier on, a few months ago, there was more enthusiasm around 630G and the reward program to bridge that gap. The question is did something change in your view about the receptivity of 630G and the transition or reward program? That's first question. For Karen, could your just update us where we are on the buyback program? I think the commentary was most of that was going to get completed in the early part of the year. Have we basically exhausted that buyback? Or what's remaining for the remainder of the year? Thanks so much.

Okay, David, with the 630G, your question specifically look, what I would say is once we had this product in the hands of our sales team and in front of physicians and patients, we actually saw good momentum with the product. Maybe just to provide a reminder, this was approved in early August. It takes a few weeks to demo it, to get it in front of the sales team, to get it in front of physicians. That makes August for us a tough comparison.

Then when we get the 670 approved, which was much earlier than expected, we implemented the priority access program. We saw as the commentary suggested some good uptick with respect to that but primarily from early adopters. So I think if you take a look at it on balance the 630 once it was in the marketplace performed well. I think our dynamic which was purely US based was the fact that in less than two months, we had two major product approvals in the same geography.

There's operational transition that comes with this. There's a degree of I would say perhaps confusion and disruption to demand because of that. That was really the biggest catalyst. Now going forward, we still remain very excited that the enthusiasm around the 670 is great. So we think that as the commentary suggested, we're going to ramp but once this thing is full scale, we'll return to double-digit growth.

David, on the buyback comment, we have purchased $2.5 billion so far this year. We continue to remain committed to repurchasing a minimum of 50% of our free cash flow along with that incremental $5 billion repurchase that we expect to complete over a three-year time frame for FY16 to FY18. As you do know, we typically do front end load, our share buybacks not only in the fiscal year but even this $5 billion incremental share buyback we have tended to front load in that three-year time frame. We still do have some incremental buybacks to go in the second half. Some of that related to our free cash flow and some of that related to continuing to repurchase the $5 billion but we typically do front end load.

Thanks, David.

Great. Thank you.

Kristen Stewart, Deutsche Bank.

In light of these results, does this change your thoughts on maybe smaller incremental tuck-in acquisitions? I know you seemed pretty confident that these are more transient issues, but how are you just thinking from more of a M&A perspective in the market?

I think to some degree we've executed well on the M&A both small as well as mid size tuck-in acquisitions. They helped us actually this quarter in diversifying our revenue base and giving us a much needed boost. I think our ability to execute those is pretty good. I'm thinking about those the right way. As I've said before, we are disciplined about our cash allocation. We've done a lot this year, so we're watching it very carefully. The bar is a little high, but that's purely to do with our capital allocation, not to do with our execution or any of these market dynamics. I think in many ways, we continue to look at different opportunities.

All right. Then is there any -- I don't know how large the deferral is right now. Is there anything to quantify maybe on the diabetes side? How large the deferral is or impacting that growth rate right now?

I think it's tough to quantify that. That's a portion of the drop in our growth rate in diabetes. I think the delay in actual shipment is the bigger portion. But the deferral is only a limited amount.

Okay, perfect. Thanks very much.

Thanks, Kristen.

Bob Hopkins, Bank of America.

I wanted to start out just -- I think it would be helpful if you could try to quantify the things that you're saying were temporary or one-time in nature for this fiscal second quarter. So either in aggregate or broken down by the various things that you kind of called out like the Neuro recall, diabetes, the tenders, is there a way to quantify that and the impact on revenue growth for Q2?

In general, I would say, Bob, that the headwinds that we faced in the quarter caused us to move from our typical mid single-digit growth range to the 3%. Again, we don't think that is something that will continue, we've guided in the back half to go back to the mid single-digit range.

Okay. So just as a broad comment, but no specific quantification. OKay. So the other things I wanted to ask about real quickly was, Karen, one for you. Can you just give us a sense as to the free cash flow guidance you're giving for 2017 on an apples to apples basis? Because I know you're changing the way you're talking about it. So what was it at the beginning of the year? What is it now?

Then for Mike or Omar, I was wondering if you could just comment on -- the TAVR business -- now both you and Edwards have reported numbers that were a little bit below what the Street was forecasting. Can you just comment on the state of the TAVR market? Also on the state of the US ICD market. Things have really slowed down there. What's a sustainable growth rate in your mind at this point? Thank you.

On free cash flow, yes, we are changing our guidance to match what our actual free cash flow is as opposed to before the one-time items that can impact the cash flow. So our former guidance was $6.5 billion to $7 billion adjusted, not including those one-time items. Going forward, as I said, we'll be doing the -- trying to match what our actual free cash flow is with $5 billion to $6 billion.

I don't have an actual apples-to-apples because it's very difficult to predict those one-time items, but I would say that in general, the cash flow guidance has not changed substantially. It's just that going forward, we'll be focused on trying to focus on the actual. That's based on feedback that we've gotten from several investors.

Mike, do you want to take the market question on cardiology?

In terms of TAVR, the overall market grew around 30%. We obviously were in the high teens, it's a story of international versus US, right? In the US, we are waiting for the 34-millimeter to impact the market. We expect to be able to then participate in the market growth that we're seeing, which we think is actually quite strong for the US.

In terms of high power, during the quarter it looked like market growth was on the order of down mid single-digits, we actually did a bit better than that because of share capture. As I mentioned we have a pretty robust set of new products which at TCT that we expect to help us grow faster than the market. Our models would tell us things should moderate a bit relative to the replacement cycle but a bit. I think we're still looking at a down market in the low to mid single-digits.

Thanks, Bob.

Matt Miksic, UBS.

So I think we've covered a lot of the sort of top line issues in the quarter. I wanted to -- Omar, ask you about something that came out of the VEITHsymposium in your presentation with the aortic and peripheral group there, just on contracting. Something you've commented on before, that the amount of sort of multi-line contracting that you've seen taken up in the US and something that was presented there took that maybe a step further into introducing this idea of a warranty offer to -- in exchange for commitments from clients. Love if you could elaborate a little bit on that? Maybe where you see -- if you see the application of that in other areas. Then I had one follow-up.

Well I'm going to make a brief comment on this and then I'll let Mike kind of comment a little further on the specifics of the example that you state. But the main overriding comment I'd make is that the example that you state is truly an example of value based health care. Value based health care means that we become a Company who are paid for outcomes as much as the product itself.

That's a long-term journey but eventually we think that's the right thing for health care. That's the right thing for us. It will make us a more efficient team in our R&D and will get rewarded for what we innovate. Health care will get the right value. In the long-term (inaudible) outcomes and lower cost. So that model you'll see us replicate in many other areas and like I've described in the chronic care world with the diabetes and NOK.

We've talked a lot about our anti-bacterial sleeve which also has the same kind of model. So you'll sell a lot of these things from us. These value based health care models and that one example that you just did is only the beginning. I think our size helps us with a seat at the table to do these contracts. So I think it will give us a differentiated advantage not only because of our size but because of our ability to innovate and link them to outcomes. Mike, any quick specifics on the particular examples I gave?

As you mentioned, we've been attempting to drive more of our revenue into multi-line contracts in order to create stickiness of share versus new products coming into the market. We're now up to 38% of CVG revenue in the US is tied up in multi-line contracts. What you've specifically identified is a trend that we're trying to basically take products we have clearly demonstrated superior outcomes and then create performance guarantees that allow us to then do what Omar said, become a value based health care Company. We've done that extensively with the anti-infective envelope TYRX in the CRM business and what was being outlined by the [APD] team there at VEITH was really using the strong clinical evidence around Endurant and Endurant IIS to create performance guarantees to drive market share in that segment.

That's helpful. A follow-up, just understanding the disappointing growth in the quarter for a variety of reasons that you've talked about and has been discussed on the call, if you could maybe revisit the long-term growth, this mid single-digit growth objective that you put out there? What the components of that are, understanding expecting an improvement in the back half.

Should this include -- should we expect this to include obviously the contribution of HeartWare this year, incremental other acquisitions going forward. Any thoughts on just geography and where you are with the growth breakers you've talked about? Just how do you get there? What are the components of that, would be very helpful.

First, let me point out that we haven't come off the mid single-digit estimate for the year. We are still seeing that and this quarter is not one that we're happy with like I've said. It's not one that we want to repeat and so we're completely confident in our ability to drive sustained mid single-digit growth and all our strategies are aimed towards that and those strategies cover our ability to produce new products across a variety of market segments.

Typically that diversity would protect us. It just so happened this quarter that a collection of them all happened together. In addition to that we've got geographic diversity which we're building and that's our drive towards emerging markets where we've actually even with the enormous impact in Saudi still delivered at 10% emerging market growth. Short of our overall sort of basis point target of 150 to 200, but what one that we think will pick up over time and want to get more to the middle of that target rather than the low end and the services and solutions longer term effort.

But again, another one which will give us sustained growth in the long term so we are deploying multiple strategies for sustained and consistent mid single-digit growth, which employs addressing new therapies, cadence of product innovation, different market segments within that, geographic diversification and real focus on emerging markets and creating this new services and solutions growth vector along the lines that you described earlier based on our value based healthcare initiatives.

Strategic investment, I'm sorry to interrupt, Omar, and strategic investment also part of that, not one of your vectors per se, but I guess how would you think about that in terms of your current target?

Strategic investments would be, well let's put it in two ways, first of all tuck-in acquisitions is part of our overall mid single-digit sort of targeting. Recall that we are driving these tuck-in acquisitions while we are balancing internal costs, so we're not changing our EPS guidance -- double-digit EPS growth guidance stays the same while we do these acquisitions, so we consider them although acquisitions we make internal tradeoffs to fund them so that's the way we think about those. Bigger strategic acquisitions, they are always possible like what we've done in the past and but they have to drive our strategies. The strategic fit that we can satisfy and quantify for ourselves before we go into that. So that's the way we look at it.

Very helpful color, thank you.

Thanks, Matt.

Larry Biegelsen, Wells Fargo.

Just starting off with the FY17 guidance, I think it would be helpful if you can talk a little bit about where you expect things to get better in the third and forth quarters versus the second quarter? So you grew 3% constant currency this quarter. It sounds like you expect that to improve in the third quarter. Is that correct? Can you talk a little bit about specifically what gets better? Then on the EPS guidance, I know you don't provide quarterly guidance but typically, I think the third quarter is about $0.03 higher than the second quarter. Do you expect that to be the case this year?

Let me take the revenue question. We were pretty clear in the sense that there's a whole series of new product launches that will come in the back half, all the way from TAVR, towards the end of fiscal year the Resolute Onyx. We've got 15 new product introductions in Surgical Solutions, which will address the reprocessing. Most importantly, we have got the 670G, which will launch towards the end of the fiscal year. We expect a ramp up in growth as the next two quarters go by.

So we do think that a significant shift in our new product cadence will give us enough growth to take us well within the mid single-digit range in the back half. Also, we haven't talked much about it, but the improvement in spine and the RTG growth starts to move up to the mid single-digit range which it was in before. So all of these are the main factors. To be clear, look, we restated that the device replacement market in ICDs will continue to slow.

We are not expecting that to turnaround. We expect the NHS and the buying patterns in the UK to remain slow for the remainder of the year. We expect the Middle East to remain where it is. So we're going to say that those market trends will continue. The rest are all new product related and our cadence will address it. I think that's the brunt of it.

I would just add, because you're asking about quarterly gating too. For CVG in particular, we do expect a little bit stronger growth rate in the third quarter than the fourth quarter just given a very strong finish at the end of the year for that business. As I mentioned, in RTG, because of the product introduction we do expect that to ramp up through the back half from the third to the fourth quarter, same with diabetes, a ramp up from the third to the forth quarter. In terms of EPS, it's typically flat, so there's not a big difference that you had mentioned in the third and fourth. We don't typically give guidance.

Understood. But just to be clear, do you expect to be in the mid single-digit range in fiscal Q3? Just lastly, given the results this quarter, how do you feel about the long-term operating margin goals you provided at the Analyst meeting this past June. Thanks for taking my question, guys.

First, we expect to be in the mid single-digit in the back half and in the early part of Q3 as well and I think we stated that. Look, I'll state again, we're not going to make a habit of missing the mid single-digit goal even in the quarter. I'm extremely focused on that and one that we will address. So our mid single-digit goal is one that certainly for the year is still valid and one that we will we expect to give back to during the second half of the year.

In terms of the operating margin, that was one of the positives of this quarter, that we did deliver strong operating margin improvement to 150 basis points of constant currency improvement. We're on track, our synergies are coming up, our value capture programs are all delivering, our gross margins actually are in line with what we expect. So we are certainly still in sync with what we presented at the Analyst conference in terms of operating margin enhancements. I think this quarter is a signal that we can in fact can execute towards that. No. We're going to do that in future quarters but that's the way we see it right now.

We have talked about that operating leverage improving throughout the year. So in the first quarter we had 100 basis points improvement, second quarter 150, and we expect it to continue to get a little bit better from here.

Thanks for taking the questions, guys.

Thanks, Larry.

Raj Denhoy, Jefferies.

I wonder if I could ask a little bit about the idea of growth accelerating again towards the back half. I know its been covered quite a bit, but part of what potentially we're seeing though is that as some of these product cycles wane and some of your competitors launch responsive products -- the question is really, is what you're bringing enough to replace what is waning? Is it really just a situation where perhaps the better parts of some of these businesses may be behind you for a period of time?

No, we don't think so. I think you've just got to look at the product [indications] I think if I take diabetes for example, clearly that's a revolutionary new product which isn't in the market at all. We think the benefits of that are yet to come. That's a clear example of a breakthrough product line. I think in both CVG and MITG, and certainly in RTG, and all our product segments these are strong products. Stuff that we're doing with -- in the transcatheter market are significant enhancements to what we had before. We expect traction on those, so we think our product pipeline is robust. We described that in the Analyst meeting, we haven't come off any of that.

Our feeling about their impact is no less than what it was then. It just so happens that the timing of these launches coupled with some really severe market headwinds all at the same time just kind of -- those are concurrent of these events in one quarter. We expect that sort of collection of circumstances not to repeat. We think that the new product, the robustness of our pipeline will come through and will get the appropriate benefits. So our excitement around new products is not -- and our confidence is not being shaken at all as to their viability and what they can do to the market and to patients.

Fair enough. Then maybe just one quick on one the new orthopaedic offering, which you gave a little more detail around. Perhaps you could just help us understand or frame the opportunity in terms of what you expect from that? Because there are two pieces to it, right? There's the consulting services but then there's also the unique aspect of bringing an orthopedic knee line to the market. So maybe could you just give us some high level thoughts on how you think that business will start to contribute over the next couple of years?

I think I'm actually going to let -- Geoff's going to put some -- well, don't you go ahead, Geoff, put some color on that.

Yes. So sure, Raj, we're right now -- obviously this is new for us and we haven't even -- we don't have a scalable amount of the need to sell quite yet. So the early interest that we're seeing is strong from surgeons that have skin in the game. We're seeing demand for the knee. For hospitals, there's a lot of interest around these risk sharing partnerships but it's new to them and these are complex agreements so that's taking a little bit more time. But, we're feeling bullish about this. But we haven't provided any specific guidance yet because it is so new, the concept, right?

You've got these risk bearing partnerships and that's really the center piece of the offering and it's very difficult to forecast the speed of the ramp. So we haven't provided any guidance. I'll just tell you that we're feeling -- we're happy with the response we're getting. We're still feeling positive about it, both the risk bearing partnership component, which is the center piece and the underlying technologies, the Aquamantys technology that we sell in our advanced energy business as well as new implants the knee and down the road to the hip.

Great, thank you.

Thanks, Raj.

Josh Jennings, Cowen and Company.

Omar, I was hoping you could help us out thinking into calendar 2017, there's been some concerns with Trump being elected and the threat of an ACA repeal that volumes could suffer as there's either a transition or a formal repeal of the Affordable Care Act. Can you help us think about that? In the setting of the fiscal Q2 performance, the organic growth in the first half has been challenged. Was just -- one of the levers you haven't pulled is pruning post the Covidien acquisition. Any thoughts there in terms of accelerating that process or that initiative?

Well let me take those questions one at a time. First of all, with respect to the health care policy, again, I don't want to speculate as to what's going to happen here. But what I do know which I've stated consistently in the past is that a move towards value based health care, a move towards a regime where the entire healthcare market gets rewarded for producing better outcomes will not only lower cost, but that's the only way forward. It doesn't really matter which administration is in place or which country you're in.

That is a basic fact grounded in logic and I think a focus around that will prevail. I think that will be important in any future policies that are made. There's an alignment of stakeholders pushing in that direction. With respect to the pruning, look, we look at divestitures and acquisitions, we look with the same lens. Does it fit our strategy? Can we win in that marketplace?

Can we do our financial metrics of returning 50% back to the shareholders and growing mid single-digits and double-digit EPS growth? Do those financial metrics -- are they in line with that acquisition or not or a divestiture or not? Based on those factors, we make decisions. Certainly, we're looking at different areas of our business all the time. You should expect to get periodic updates from us on that score. Did I miss any point?

No, thanks for that. If I could just ask one for Karen. Just on the looking out into next year, I know it's impossible to predict currency moves, but if the currency rates were to remain constant here, can you help us understand whether there would be a headwind or tailwind in terms of hedging gains or losses in FY18? Just the reason I'm asking is because we do have the medical device tax benefit rolling off next year starting in fiscal 2Q. So I just wanted to get a sense of when the reported operating margin would more closely mirror the constant currency operating margin performance? Thanks a lot.

Yes. No, happy to take that. So what I mentioned is we certainly can't predict exchange rates, but if they do remain stable where they are today and two of the biggest rates that we are exposed to are the Euro and the Yen. So if they remain stable to about $1.06 Euro and JPY110 for the remainder of the fiscal year, I mentioned we would expect our revenue to be negatively impacted by approximately $20 million to $60 million. On an EPS basis -- this takes into account our hedging program too, it's not just our natural exposure. On an EPS basis, we would expect full-year EPS to be $0.20 to $0.22 impacted. We will give guidance for FY18 when we typically do at a later date.

Great. Thanks, Josh.

Chris Pasquale, Guggenheim.

Thanks guys for squeezing me in. One for Mike and then a quick one for Karen. Mike, your US TAVR share is down about 10 points by our math over the past year. That's a pretty big shift. How much of that do you think was the lack of a large Annulus product? Are you seeing, in just the couple of weeks here since the approval, a noticeable pick up in those cases?

The vast majority of that share decline is in that segment. We estimate it represents about 25% to 30% of the overall market. Our shares there were substantially lower than in the other three sizes. So as we bring that in, we would expect it to normalize those shares and grow above the market as we do.

Okay. Then Karen, tax has been a pretty meaningful source of upside over the past couple quarters. You mentioned you expect it to go back up to about 17% in the back half of the year. Just walk through why that is -- why that shouldn't stay at the rates we've seen the last couple quarters?

Yes, it's very difficult to predict the one-time benefits that we would get in tax. They are spotty. They tend to be large. They impacted us positively this quarter, but we can't count on them all the time. So that's why we focus on our more normal 17% tax rate going forward.

Okay. Thanks.

Thanks, Chris.

Okay. So with that, it's time to end the call. But before I finish, I have to repeat the three main points about this call and about our performance and outlook. Like I've said several times, we're not happy about the revenue performance this quarter. But we do think that the shortfall -- the reasons for the shortfall are identifiable and in most cases temporary. We expect our new product introductions primarily to drive a recovery in the back half of the year and longer term.

Second, look, we acknowledge the fact that our organization delivered an operational discipline and delivered strong operating margin and double-digit EPS growth this quarter. Finally, we remain confident in our overall strategy that we laid out in our Analyst meeting. Double-digit -- mid single-digit revenue growth and double-digit EPS growth on a constant currency basis, not only this fiscal year but sustained in the future and that is something that was certainly not coming off.

Okay. So with that, I'd like to thank you all for your interest and your questions. On behalf of our entire management team also thank you for your continued support and interest in Medtronic. For those of you in the US, I want to wish you and your families a very happy Thanksgiving. We look forward to updating you on our progress in our Q3 call, which we currently anticipate holding on Tuesday, February 21. Thank you.

This concludes today's conference call. You may now disconnect.