Medtronic (NYSE:MDT) announced its Q1 earnings for fiscal 2014 on August 20. The company registered 3% operational growth in total revenues to $4.08 billion.  While the overall growth was mostly in line with our expectations, what came as a little disappointment were the dull sales of defibrillators that impacted the performance of its largest division, pacemakers & defibrillators. However, the growth in pacemaker sales offset the pressure. As anticipated, the spinal franchise continued to see a decline in sales. Cardiovascular, diabetes and surgical technologies businesses continued to grow at decent rates. Gross margins declined slightly due to pricing pressure in some of the businesses and foreign exchange fluctuations. Despite the pressure on gross margins, non-GAAP net earnings were up 10% following rigorous cost-cutting measures taken by the company.
We maintain our $56 price estimate for Medtronic, which is 5% premium to the current market price. Below we highlight the key trends coming out of the earnings release.
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Revenue Growth Despite The U.S. Weakness
On a yearly basis, the medical device maker recorded flat growth in the pacemakers & defibrillators division. Defibrillator sales declined by 3% mainly due to weakness in bulk sales in the U.S.  This was mainly due to the timing of new products such as Evera implantable cardioverter defibrillator (ICD) and Viva CRT-D (ICD with pacing capabilities). The company was reluctant to offer bulk discounts on its latest products off the previously contracted price. This led to significantly lower bulk purchases from some hospitals as they were waiting for new products to become available on their new contracts. Bulk sales reached the lowest level in six years during the quarter. Strong growth in procedural volumes in emerging markets like China wasn’t able to fully offset the impact on the large U.S. market. However, what comes as a positive is that daily implants growth changed from negative to positive in the latter part of the quarter. Further, the overall pricing dynamics in the U.S improved.
Pacemaker sales grew 6% mainly due to 14% growth in the international markets. The Advisa pacemaker, a second generation MRI-safe pacemaker, continued to see strong growth in Japan. The pacemaker demand in the U.S. remained a little weak as witnessed through a 4% decline in revenues from the country. A robust 20% growth in Arctic Front Advance cardiac cyroballoon, the first type of next generation device for atrial fibrillation treatment, also added to overall revenues.
Despite weakness in the U.S. market, its second largest business division, Cardiovascular, did relatively well. The Resolute Integrity drug eluting stent (DES) continued to see strong demand in Japan and emerging markets. The Symplicity renal denervation device (a radiotherapy-based system to treat high blood pressure) continued to register modest growth in the international markets. However, the device didn’t seem to meet initial expectations as the company lowered the amount of milestone payments to Ardian’s shareholders. The structural heart part of the Cardiovascular franchise registered 13% growth as transcatheter valves seeing mid-teens growth. However, what also helped was the advanced customer purchases of CoreValve in Germany. The company had to stop selling the CoreValve product following an injunction in Germany, and this led to a rush from customers to stock the product. Such high growth may not continue going forward.
The demand for Infuse bone graft paste continued to decline and weighed on the spinal division. While the pace of decline is tapering, we don’t expect to see a revival in demand anytime soon. However, the core spine business outperformed the overall market with new products in the division gaining broader acceptance. Stronger sales of heart valves and heart stents in the cardiovascular segment lifted total revenues. Sales from the surgical technologies division continued to exhibit near double digit growth on growing demand for navigated spine procedures. The diabetes division saw moderate growth on growing demand for insulin pumps in the international markets.
Japan, with around 30% growth, was the fastest growing market for the company. Sales from emerging markets also saw a robust 15% growth. The overall contribution of emerging markets to the company’s total revenue increased to 12% and Medtronic is gradually moving towards its target of 20%. Overall gross margins declined slightly to below 75% mainly due to the strong U.S. dollar and pricing pressure on some of the products. However, as anticipated, operating profit margins improved with Medtronic’s continuous focus on cost management. Both R&D and SG&A expenditures as a percentage of revenues declined, which led to an improvement in operating profit margins.
Long Term Outlook Strong
The longer term outlook for Medtronic looks sound. The company is doing pretty well than its competitors despite weakness in the U.S. market. Procedures volumes are likely to pick up as the economy and consumer confidence are expected to improve going forward. Further, the company has launched several new and innovative products at regular intervals, which should help in the long term. Medtronic is planning to launch CoreValve by fiscal 2015 and has filed the approval application with the FDA. The device is seeing strong traction wherever it has been launched. Also, in the CoreValve ADVANCE study (concluded in the beginning of this year), the survival rates were among the highest ever reported. This should help Medtronic maintain growth momentum in the cardiovascular franchise.
Earlier this month, the medical device maker received investigational device exemption (IDE) approval from the FDA for Symplicity HTN-4 to expand the indication to include uncontrolled hypertension patients. Further, it completed patients enrollments for HTN-3 pivotal trial and expects the results to be presented by early next year. RDN devices have huge potential and are expected to become a major growth driver going forward (Medtronic: A Look At The Cardiovascular Market). Medtronic will soon introduce the Advisa pacemaker in the U.S. We expect the device to garner a similar response as it did in Japan.Notes:
- Medtronic Reports First Quarter Earnings, Medtronic, August 20 2013 [↩]
- Medtronic’s CEO Discusses F1Q 2014 Results – Earnings Call Transcript, Seeking Alpha, August 20 2013 [↩]