Medtronic plc
Q3 2011 Earnings Call Transcript

Published: 22 Feb 2011

[Operator:]

Good morning. My name is Darla, and I will be your conference operator today. At this time, I would like to welcome everyone to the Medtronic's Q3 Earnings Release Conference Call. [Operator Instructions] Thank you. Mr. Jeff Warren, you may begin your conference.

[Jeff Warren:]

Thanks, Darla. Good morning, and welcome to Medtronic's Third Quarter Conference Call and Webcast. During the next hour, Bill Hawkins, Medtronic Chairman and Chief Executive Officer; and Gary Ellis, Chief Financial Officer, will provide comments on the results of our fiscal year 2011 third quarter, which ended January 28, 2011. 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 our 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 medtronic.com. Finally, unless we say otherwise, references to quarterly results, increasing or decreasing, are in comparison to the third quarter of fiscal year 2010. And all revenue growth rates are given on a constant-currency basis. And with that, I'm now pleased to turn the call over to Medtronic Chairman and Chief Executive Officer, Bill Hawkins.

[William Hawkins:]

Good morning, and thank you, Jeff. This morning, we reported third quarter revenue of $4 billion, which represents growth of 3% both on an as reported and a constant-currency basis. Q3 non-GAAP earnings of $922 million and diluted earnings per share of $0.86 expense increased 8% and 12% respectively. Our Q3 growth reflects the difference new innovative products are making. Q3 also reflects another quarter of relative stability as Medtronic continues to grow in line with our markets. We remain confident that as the global macroeconomic environment improves, so too will our markets as the underlying demand for innovative medical solutions to treat chronic diseases is only going to grow. As I look across the company, I'd like to highlight three areas where we continue to focus. First, we have built and are executing on a very robust pipeline of differentiated value-added technology to drive share in our core markets and growth in new markets. Second, Medtronic is increasingly well positioned and executing on our plans to capture the tremendous growth opportunities in emerging markets. And finally, we are leveraging our size and scale to deliver superior financial performance. The healthcare world is changing and Medtronic is well positioned to take advantage of these trends. So starting with our pipeline. Our focus on innovation remains our principal strategy for growth. We are committed to executing our pipeline to drive share in our core markets and growth in new markets. Spinal is a good example of this where we are starting to realize the benefits of the investments we make to reinvigorate this important business. We are ramping up the launch of Solera, our new flagship posterior fixation system. During this first phase of Solera's launch, we are excited about the positive surgeon feedback we continue to receive on the advantages of this more durable, versatile and smaller profile system. Solera, when integrated with our neuro monitoring, navigation and imaging platforms, is changing the way spine surgery is performed. Navigated spine procedures allow for extremely precise placement of spinal implants while performing minimally invasive surgery, which should lead to improved accuracy and enhanced patient safety. This differentiated technology is something only Medtronic is doing and it is starting to change the basis of competition in the spine market. The Solera launched builds on the recent introduction of two other posterior fixation platforms, VERTEX SELECT and that TSRH 3Dx. But these systems are only a portion of our new spinal products. Over the coming months, we will be launching several new products including our new Atlantis Vision Elite anterior cervical plate, the T2 ALTITUDE Expandable Corpectomy System, HA-coated TSRH 3Dx OSTEOGRIP Screws and the new DLIF instrument sets. When you combine all of our innovative technologies with the outstanding service and support of our field force, we are reasserting our market leadership. Although we are still early in this product launch cycle, we are starting to see improved growth in market share performance. We are back in our growth mode with a differentiated growth trajectory versus the other large players in the space. Breakthrough innovation is by no means limited to our Spinal business. In Cardiovascular, we are seeing our new highly deliverable Integrity stent platform take share in both the drug-eluting and bare-metal stent markets. In fact, in our addressable markets, where both Integrity bare-metal stents and Resolute Integrity DES are available, we have achieved the number one position in total stent share. In drug-eluting stents, our recently launched RESOLUTE Integrity has been very well received, resulting in two percentage points of share gains in international markets this quarter. In bare-metal stents, the success of Integrity has pushed us to the number one global position. Our bare-metal stent share is nearly nine percentage points in the U.S. this quarter on the strength of Integrity. In Endovascular, Endurant, our market-leading abdominal stent graft in Europe, is now launching in the U.S. ahead of schedule. Endurant is off to a fantastic start and we are focusing on extending our U.S. market leadership. Turning to CRDM. We are very excited by the recent FDA approval of our Revo MRI SureScan. This is one of the most important advances in pacing since we introduced a rate adaptive pacemaker over 25 years ago. Revo is the first MRI-compatible pacemaker to enter the U.S. market and we have a considerable head start on the competition. This exciting new technology is clearly capturing the interest of both physicians and patients. We believe this product will help to draw share and alleviate pricing pressure. We continue to work diligently with the FDA to resolve outstanding warning letters so that we are able to launch key new products, including Protecta, our next generation ICD and CRT-D, and InterStim bowel, an important new indication for our InterStim franchise. Turning to our new markets. We had a number of successes this quarter including our acquisition of RDN, which positions us well in hypertension, one of the largest and most exciting opportunities in MedTech. In our AF Solutions business, we received FDA approval for Arctic front, the only cryoballoon ablation treatment that is approved in the U.S. for paroxysmal AF. This innovative technology eliminates the need for time-consuming point-by-point ablation and complex mapping and navigation. The launch is off to a great start and we are excited that all U.S. electrophysiologists will have access to this unique technology. In Transcatheter Valves, we continue to experience great success with CoreValve in international markets. This quarter, we started the CoreValve U.S. pivotal study. We were also pleased by the FDA's approved modification of the extreme-risk cohort to a single arm with a performance goal and no randomization. This is very positive for patients and should allow us to enroll this trial more quickly and effectively. In addition, subclavian access has been added to both arms to trial, an important new option for patients who cannot be treated transfemoraly. Earlier this month, we welcomed the results of the largest CoreValve registry to date published in circulation. The results affirmed the high rates of procedural success, low rates of adverse events, low mortality and substantial improvements of cardiac function that we continue to experience with CoreValve. Another important area for Medtronic is our increasing focus on emerging markets, where we are extraordinarily well positioned to capture the tremendous growth opportunities. In Q3, I was pleased by our continued strong performance in emerging markets, where we grew over 20%. Revenue from emerging markets is now annualizing at $1.4 billion and represents nearly 9% of Medtronic's total sales. Over the next five years, we expect that revenue mix to exceed 20%. Next month, we will hold the grand opening of our new China headquarters and position training center in Shanghai, as well as our new Asia manufacturing facility in Singapore. These are just two examples of the long-term investments we are making in emerging markets to drive sustainable growth. Last month, we were pleased to join 11 other companies as the initial participants in the U.S., China public private-public partnership on healthcare which is intended to foster long-term cooperation with China in the areas of research, training, regulation and patient access. Medtronic was elected to the PPH board and is taking a leadership role in formulating strategies and policies that complement China's vision for providing modern quality healthcare. Before I turn the call over to Gary, I would like to comment on Medtronic's ability to deliver superior financial performance by leveraging the benefits of our size and scale. Our industry-leading margins allow us to generate significant cash flow. We take a balanced and a disciplined approach to investing our capital for sustainable growth while also returning capital to shareholders. In Q3, we generated $1.1 billion of free cash flow. Year-to-date, we have returned over 70% of our free cash flow to shareholders in the form of dividends and share repurchases. Medtronic remains committed to returning a minimum of 40% to 50% of our free cash flow to shareholders. At the same time, we continue to strategically invest in areas with significant growth potential. We constantly strive to efficiently allocate and leverage our resources while ensuring Medtronic's cost structure is rightsized to current market conditions. Accordingly, we announced this morning that we will be restructuring our business through a combination of cost-saving measures, tighter expense management and workforce reductions. And while these actions are in part due to current market conditions, they are more an outcome of our ongoing efforts to drive leverage across the enterprise. It is never easy to make these decisions, but we believe that this is the right thing to do for Medtronic to continue to position the company for long-term sustainable growth. In the new and changing healthcare environment, Medtronic's size and scale will be an important key to winning. Our market-leading technologies and the breadth of our portfolio puts us in a position of strength when facing our competition and serving our customers around the globe. Our functional expertise and world-class capabilities provide us with the significant competitive advantage in MedTech. We remain committed to executing our long-term growth strategies and delivering sustainable market-leading performance. So Gary will now take you through a more detailed look at our quarterly results.

[Gary Ellis:]

Thanks, Bill. Third quarter revenue of $3,961,000,000 increased 2.9% as reported or 3.4% on a constant-currency basis after adjusting for our $22 million unfavorable effect of foreign currency. Breaking this out geographically, revenue in the U.S., up $2,259,000,000 grew 1%, while international sales of $1,702,000,000 increased 7%. Q3 international revenue results by region were as follows

[William Hawkins:]

So thanks, Gary. Before turning to Q&A, I want to note that as you all know, I recently announced my intention to retire at the end of the fiscal year. Our Board of Directors is in the process of looking for my successor and their search is progressing well. And although we do not have any new information at this point, we will update you when we have more news to share. At this point, I expect this to be my last Medtronic earnings call. I would like to say that it has truly been an honor and a privilege to lead the finest medical technology company in the world. And while I'm excited about the prospects of new endeavors, I feel extremely proud of what we have accomplished over the past several years. When you take into account our robust pipeline, our outstanding leadership team and our ability to capture new opportunities in emerging markets and emerging technologies, I could not be more excited for the future of this great company. With that, Gary, I'd like now to open things up for Q&A. In the interest of getting to as many questions as possible, we would respectively request that each caller limit themselves to one question with one follow-up. Operator, the first question.

[Operator:]

[Operator Instructions] Your first question comes from the line of Matthew Dodds with Citigroup.

[Matthew Dodds:]

When you look at the businesses this quarter, it looks like you're down at two businesses that are still kind of problem areas when you look at market share, ICDs and Neurostimulation. So in your view, specially in the U.S., is it really a matter of getting Protecta and ICDs, RESTORE and InterStim indication that will drive you back to holding, maybe, gaining share or is there more structurally that you need to do? And then if you could layer in there also in Japan, in ICDs, you've lost a lot of share there the last couple of years, when do you see that stabilizing?

[Gary Ellis:]

Matt, this is Gary. Overall, as you said, while we've see clearly both that both CRDM and Neuro -- let me address each one this individually. CRDM, as you indicated, we've maintained share in certain markets. We lost a little share this quarter in some of the international market more so than anything else. We are excited about the new products. I think we within CRDM, as far as market share goes, we are seeing the impact of Protecta and the MRI SureScan product are having an impact both in international markets and we're excited about getting those in the U.S. So we think that will help not only maintain our share and potentially gain share but also stabilize pricing as we've talked about. So I think on the CRDM -- and then we've talking about obviously, in the international markets, specially in Europe, where we lost share was in the Value segments and we're launching a couple of new products in that category to stabilize that share and gain share back in the European marketplace. Japan, as you said, we've lost share in the last couple years in various categories, part of that was obviously related to the Fidelis. It was more of an impact in Fidelis in that marketplace probably more than any other. But I think recently, here, what we've seen is the new products, the Protecta that I mentioned we're going to be launching in Japan will clearly have an impact in our ability to, again, maintain share in Japan and regain some share direction. So in CRDM, we've been stabilized, these new products are important and we are seeing the benefits of those where they are launched. Neuro's the same way. We need to get some of the new products approved and RestoreSensor is important not only in the U.S. but also other indication for fecal incontinence in the InterStim product lines. That will certainly drive that business because InterStim and DBS for, in the Neuromodulation business, continue to do very, very well. It's been Pain Stim where we've been struggling a little bit. That's also been part of the market issue. The market has been somewhat soft also on Pain Stim. But we would expect RestoreSensor -- we're seeing that help us maintain a share in the European markets and when we can launch that in the U.S., I think that will actually help us drive share also here in the U.S.

[Matthew Dodds:]

On the restructuring, do have a range of how big a charge we're talking about next quarter?

[Gary Ellis:]

We really don't at this point, Matt. It's too early to tell. We're still assessing where the employees are even at as far as geographically and what the impact of that is all going to be. So we really don't have any estimate at this point of what the charge would be.

[Operator:]

Your next question comes from the line of Kristen Stewart with Deutsche Bank.

[Kristen Stewart:]

Just kind of following up on the restructuring, how should we think about the savings going forward from this plan as it rolls out into 2012?

[Gary Ellis:]

Well, this is Gary again. Again, we don't have the details on exactly what that amount is going to be. As we talked about it, the effort we're trying to do here is just kind of an ongoing part of our overall process to leverage the organization and making sure that we are driving efficiency throughout the company. We also are obviously acknowledging the fact that our markets are somewhat softer than we've had to readdress the infrastructure to reduce it to where our market growths are at this point in time. What that savings is at this level, we don't have any estimate for that. We will by the time we put together in our Q4 earnings call, we'll have a better estimate. But again right now, all we know is between 1,500 and 2,000 employees.

[Kristen Stewart:]

And then just on the gross margin, I know that you had said that if not for some of the obsolescence charges we would've been, I guess more in line with where your expectations were. What specifically were the charges that were taken? What business unit were they in?

[Gary Ellis:]

Well, the obsolescence charges, I mean, the good news about -- as we are launching some new products, the Endovascular, Endurant product we mentioned, some the other products, the Solera, we have some set costs but the impact of launching new products means that you have some old products that are becoming obsolete. And so the reality is, we had some charges in Cardiovascular business related to some of those new products and also a little bit in the spine area. In addition, we had some of acquisition costs. As we pull in the acquisition, there's a step-up in purchase accounting you have to do and then there's some inventory adjustments as we brought some of these new acquisitions that were impacting the quarter and obviously, those would've been also in spine and CV where some of acquisitions are at. So it's primarily in those two businesses where we saw the one-time charges.

[Kristen Stewart:]

And the total of those two are 50 to 60 basis points, you said?

[Gary Ellis:]

That's correct.

[Operator:]

Your next question comes from the line of Mike Weinstein with JPMorgan.

[Michael Weinstein:]

Couple of clarification, Gary, if I can. The fourth quarter, are you guys implying $0.91 to $0.93.

[Gary Ellis:]

The reality is with the RDN dilution. What we're saying is again the $3.38 to $3.40. So if you just do the math, you're absolutely right, that you'll end up with basically, I think, more around the $0.93 is where you're going to end up. Because I think the consensus right now is $0.95 when you take the RDN dilution in place, it kind of gets to that $0.93.

[Michael Weinstein:]

The restructuring, can you give us -- and it's sounds like it's very early, but can you give us any insights into where you'll be making the cuts, either in what businesses would the cuts come and within what segments, whether in R&D, sales, manufacturing? And then second, just turning back to this quarter, pretax income declined almost 6% this quarter, which was worse than I think than probably the company was modeling, I think worse than the Street was modeling. So I guess, I just would appreciate some visibility on the tax side in terms of when you saw some of this tax windfalls coming through because I know in early January, you guys have commented that you were comfortable with the consensus then?

[Gary Ellis:]

Well, as far as the restructuring and where it's at, again, we're not going to get specific about which businesses or which geographies or even which kind of a function we'll be addressing, but it's coming across the company. I mean, we're going to evaluate our employee complement across the organization and determine where we need to make some adjustments overall. You can obviously assume from the standpoint of -- as we look at this, there are some markets and some businesses that are growing very dramatically. So whether it's emerging markets or some of these emerging therapies or obviously in some of the acquisitions, that's not where we're going to be primarily focused. It's going to more on those businesses and geographies, developed markets, for example, where it's been a little slower where the markets have slowed down. But that's all what we're going to say at this point in time. And again, it's primarily going to be focused on infrastructure cost, not to say that there won't be some impact on sales or R&D side but the fact of the matter is it's primarily infrastructure related to all of those as we're trying to focus on as we go forward. With respect to the pretax earnings and the competition really of all the things happening in the tax line here this quarter, overall, yes, we did expect that our pretax earnings to be a little bit higher as we went through the quarter and the primary surprise was really on that gross margin as I've mentioned earlier. We would've expected as a mentioned in my comments the gross margin to be closer to 75.5% to 75.6%. So that was a little bit of a surprise that we had not expected, so that impacted us. The other thing that's a compounding issue on the pretax side and kind of complicating the whole issue is this Puerto Rico excise tax issue I mentioned earlier, which is actually reducing our pretax profits but then there's a credit on the tax line itself. That's the accounting that basically the accounting firms have come up with for all of us that are operating in Puerto Rico are going to have to do. And so that complicates a little bit, even your pretax, what's the growth rate or in this case, as you've said, a slight decline from where we've been at previously. So from our perspective, that's something we're going to have -- the Puerto Rico tax thing is just something we're going to have to deal with going forward and it's going to be re-class between pretax and after-tax numbers. So overall, that's kind of explaining what's going on. Now back to the restructuring, that's the intent of the restructuring. We obviously, are seeing that our pretax earnings are not where we need them to be. We need to continue in these little bit slower markets. We're going to have to take some cost out. And that's what we're attempting to do here and so we're getting ahead of the game in trying to address that as we move into FY '12.

[Operator:]

Your next question comes the line of Bruce Nudell with UBS.

[Bruce Nudell:]

Bill, I have a couple of questions. One on AMPLIFY, what's the likelihood that, that will be approved? And if it's not improved, what's the risk of the franchise given commercial payer reaction or Medicare reaction? And secondly on the U.S. ICD market, I think it's down between 1% and 2% this quarter. Do you anticipate a kind of recalibration at sides that were kind of non-compliant as judged by the JAMA article? Where do you see the trajectory over the next several quarters with that key market?

[William Hawkins:]

So first on the AMPLIFY. Again, this is more of clarification, this is not INFUSE. I mean, this is kind of a new indication and it is a new kind of formulation. But we're continuing to work with the FDA to figure out kind of where they are on this. We were encouraged by the panel vote, which was in support of the approval. And so as we learn more, we'll let you know. But it's incremental to kind of our current business. And so if there was a reason for the FDA to delay this anymore, it's not going to have a significant impact. It won't have any really impact on our current business. It's really all upside for us.

[Bruce Nudell:]

Just to clarify that, Bill. You don't feel that not having like posterior lumbar fusion is probably the biggest off-label to use of INFUSE and you don't think not getting AMPLIFY approved could result in retrenchment there?

[William Hawkins:]

No. We've been very clear with our people in terms of the appropriate indications for INFUSE and so I don't see anything that would change as the result of AMPLIFY not getting approved. So again, there's a different formulation. It's really a different product than INFUSE.

[Glenn Novarro:]

And the ICD question.

[William Hawkins:]

So on the ICD, yes, the market was, this quarter, down about 1%. And the U.S., we think that there has been some sort of short-term impact because of the JAMA and the DOJ. I think that, that is a short-term impact, I think, that hospitals are having to adjust a little bit to making sure that they are in conformance with the appropriate guidelines. But I'd take a step back, I continue to be encouraged that this is a large patient population. It is a big market opportunity and I think, we're in just in a little bit of an air pocket here that's result of the reaction to the JAMA and the DOJ article. But we did see this quarter a little bit of a continuation of what we've seen in the last couple of quarters, where the market is in that sort of flat to down here in the U.S. and it's modestly outside the U.S.

[Operator:]

Your next question comes and line of Bob Hopkins with Bank of America.

[Robert Hopkins:]

Gary, first to start off, there's a lot of moving parts here in terms of tax rate to be thinking about and hedging gains and losses going forward and the restructuring. I was wondering, as it relates to 2012, the current consensus is 3.64. Are you comfortable at this point suggesting that, that is reasonably in the ballpark?

[Gary Ellis:]

Again, Bob, I'm not give any guidance on FY '12 as far as what our guidance would be right at this point in time. We haven't given any guidance previously for FY '12 and so I'm not at this point either. We'll do that in our Q4 earnings call. There were a lot of moving parts here in the quarter especially on the tax rate and the other income and expense has been complicated by this Puerto Rico excise tax issue. I think some of the things that you saw on the quarter, the retroactive, obviously, R&D credit et cetera, will be just based on the rate going forward. So it's not going to get catch-up, you'll just have it in the rate adjustment. So I think that there's nothing that occurred here in the quarter that necessarily changes my outlook for FY '12 and that's, Bob, the only thing I can tell you at this point in time. But we're not going to give any guidance at this level as far as what is appropriate for FY '12.

[Robert Hopkins:]

But then just to talk maybe a little more granularly about the tax rate going forward and how we should be thinking about that in light of all the moving parts, and the hedging gains and losses going forward, how should we should be thinking about that.

[Gary Ellis:]

Overall, from a standpoint on foreign exchange, Overall, right now, we see that relatively flat year-on-year. We've hedged for next year, a big portion of where we're at. We don't see a big headwind, we don't see a big benefit basically. We're hedged at rates that are relatively close to where we're at here in the current year. We're not completely hedged but where the rates are right now, I'd feel pretty comfortable that there's not a big change here. On the tax rate itself, as we indicated, our overall effective tax rate, ignoring this Puerto Rico tax issue right now, would've been more around the kind of in the 21% range and we think that's probably still going to be appropriate going forward. But again, this Puerto Rico excise tax thing will have an impact on probably reduced net effective tax rate as you look at it by about three percentage points as you go move ahead, because you're going to have $25 million to $30 million a quarter coming through the tax that's offsetting the other income and expense line item. So we have to go through the calculations and figure out, but my guess is we get into next year, you're going tax rates that -- effective tax rate that's closer to the high teens. And we'll give you more details beginning into year.

[William Hawkins:]

I want to just maybe add one comment, maybe just an inference of your previous question, Bob, in terms of just sort we're not going to give guidance on the outlook for next year, but I would just remind you that we do feel very good about kind of our new product portfolio. And as we get through the warning letters, the CRDM, with the Protecta, and now with MRI here in the U.S., we the think that that's going to be established. A lot of the new products that we've just now launched, the Endurant, the AF, are off to a very good start, so we're excited about the CoreValve. I mean, there is just a lot in the pipeline and the Neuro side as well as we get to the warning letter and InterStim valve. I mean, we're making the tough decisions in the restructuring to position ourselves to deliver profitable growth, and we feel that we've got a good pipeline that's going to enable us to accelerate growth for next year.

[Operator:]

Your next question comes from the line of David Lewis with Morgan Stanley.

[David Lewis:]

Gary, just a quick follow-up on the restructuring. I know you're not giving details but as we think about this conceptually, should we be thinking about this restructuring as largely dropping through to the bottom line and being accretive to earnings or there are significant chunks of reinvestment that we may be missing?

[Gary Ellis:]

Well, again, from our perspective, obviously, a lot of this will go to the bottom line. We do this as we focus -- we don't think about these costs necessary dropping to bottom line. We're taking a look at our entire cost structure and say, "What investments do we need to make?" "What kind of profitability or improvement do we need to have and where do we need to see the leverage occurring?" And then we'd back into where we do think we have opportunities to reduce our overall infrastructure costs. So overall, what you could assume by doing these things that yes you will see more leverage in the P&L as we move forward. And so that will clearly impact and have a benefit dropping to the bottom line. But these continue to be activities that we take to make sure we're achieving our objectives on delivering the profits to our shareholders but also to ensure that we can make the investments to drive the growth in some of the markets that we've been talking about, both the emerging therapies and some of the emerging markets geographically. So it's a combination.

[David Lewis:]

And then, Bill, just one quick follow-up here on emerging markets. It looked like the emerging market business accelerated a little bit this quarter sequentially. So I wonder if that was stocking new products or entrants in new markets? And maybe you could share with us, given emerging market is becoming a much more substantial component of overall corporate growth, what we can think about in terms of sustainable growth rate for this emerging markets, maybe just the next few years?

[William Hawkins:]

Well, we said big picture, we think that we can see emerging markets becoming 20% of our mix for the next five years. I mean, it has been growing 20-plus percent for the last number of quarters if not number of years. Yes, that was a good quarter. China contributed approximately $30 billion of incremental revenue year-on-year, and it represents almost 3% of our total Medtronic revenue now. China is, again, we have said this for the last year or so, I mean, we've been making over the last several years big investments to take advantage of what we think -- we think that China will be a very strong market for years to come. India is a bit behind, but we're seeing very good growth rate in India. Latin America is doing very well. So it's really pretty balanced across many of the overall emerging markets. And so if you look at today, again, as I've said in my commentary, roughly 9% to 10% percent of our revenue has come out of the emerging markets and we expect that to almost double the next five years.

[David Lewis:]

And Bill, the emerging market segment remains at the level of corporate profitability or higher?

[William Hawkins:]

Yes. This is growing at a...

[Gary Ellis:]

Yes, but in overall profit margins, as we've said before, international and profit margins are basically the same as they are in the U.S. and emerging market is the same way. I mean, in total, they're basically consistent with where we're at across the company. Obviously, it will vary by market, but in general, the emerging markets have a profit margin that's very consistent with the corporate level.

[Operator:]

Your next question comes from the line of David Roman with Goldman Sachs.

[David Roman:]

Bill, I was hoping you could maybe extrapolate a little bit more on the new product launch. If you launch Solera in January and Spine business is, although, stable, we didn't see much of an improvement. Could you maybe help us understand the timing and pacing of when we should start to see a significant impact in the P&L from some the products you're launching? Maybe using -- if you look at pacing, for an example, I think this is the first quarter in several quarters where you're seeing growth out of Europe when you launched Revo, I think, over year ago. Is that the right thing to say, is it 12 months until we start to see traction and maybe you could just sort of take us through the launch timeline?

[William Hawkins:]

There's a bit of a flywheel effect here, particularly on the spine side, when you're making big investments in the capital to the instruments sets it's to get out there to drive the procedures and in we commented in the last quarter or so that we've been investing in the instrument sets and we're now getting those into the field, which are going to drive the procedures. And where we have the sets and where we are in the account, we're seeing very good growth. And so we are very optimistic that Solera is going to be a terrific product platform for us. But it's not just Solera, I mean, the TSH 3Dx [TSRH 3Dx], the VERTEX SELECT, as well as even some of the DLIF products. I mean, DLIF had a another very strong quarter, so we're very encouraged by the momentum that's building particularly on the spine side. On the pacing side, again, I want to make sure that people understand, there's a big difference in the U.S. and the o U.S. in terms of what the we think of the opportunity for Revel. I mean, Revel is doing well in the European markets. But remember, Revel is dual chamber only and in Europe the dual chamber is roughly 50%, a little bit less of the total market. In the U.S., dual chamber is 80% and the same thing for active fixation leads, which in Europe is roughly 50% in the U.S. active fixation which is what we have MRSA is 80%. I was in the field last week on Friday with a few of our reps and I can just tell you, there's tremendous excitement and enthusiasm about MRSA. I think it's a different opportunity here in the U.S. than what we've seen in markets outside U.S. and we're pretty bullish that this is going to be a product platform. As I made a comment, sort of like what we saw with the Activitrax years ago, this is going to enable us to gain real meaningful share.

[Gary Ellis:]

Just to add to Bill's comment. The only thing I would add to what he had said is the only thing you have to remember is we do see new technologies adopted quicker generally across the board in the U.S. And the reason that is to some extent is outside the U.S. especially in the European markets, you have these tenders and everything else that you have to get things to be a part of and just takes a little bit longer process to get the products into the marketplace and then really have an impact. But clearly in the U.S., we tend to see new products start off quicker, and back to Bill's point, we really do believe that specially with the MRI SureScan that, that clearly will be well received in this marketplace.

[David Roman:]

At this point, I know it's early in the launch to give us some sense as to directionally the relative pricing you were able to achieve on some of his new products and is price premium on new products sufficient to fully offset the impact of negative like-for-like pricing?

[William Hawkins:]

On the pacing side, we do think that there's real value in this product and again we're only out there for a week and we are seeing that customers are rewarding us with a premium for this product. So anyway, we think that, that will offset, yes, the dynamics of kind of market growth and it will see that our growth will be positive with Revel .

[David Roman:]

And how about on the spine side?

[William Hawkins:]

Yes, the same thing. In the spine side, we're probably less of a premium on the Solera on a relative basis. But it's really, in this case, we're using Solera to actively go after market share.

[Operator:]

Your next question comes from the line of Joanne Wuensch with BMO Capital Markets.

[Joanne Wuensch:]

Is there any update on the FDA warning letter? You're starting to get one product approved but anything that you can share with us on that front?

[William Hawkins:]

Yes. We were encouraged that the FDA approved the MRI Safe. And I was actually in the FDA again last week, and again, I am consciously optimistic that we're going to see the warning letters get lifted and we'll be able to get these products on the market, as I said, a while ago sooner rather than later. But we've done -- we've completed all the follow-ups with the FDA. And we've been meeting with the FDA in a regular basis. And so again, I remain optimistic that this is going to happen sooner rather than later.

[Joanne Wuensch:]

And is there anything that you can broadly discuss on price? It sounds like in certain areas you're still seeing negative 3%, negative 4% type of price pressure, in other areas you're starting to get that back somewhat with differentiated products, but could you us a big picture view?

[William Hawkins:]

It's all about new products. And again, as a made a comment on the Revo MRI, I mean, we think that that's going to -- will enable us to bring the price back up. The same thing on Solera, less so -- but again, when we bring out new products, that's our opportunity to really sort of move the price back up. And so I mean, as we replenish -- as we continue to bring fourth new products that we've been investing in, that's going to help us to offset some of the price pressures.

[Joanne Wuensch:]

My final question has to do with spine. For a while now you've been talking about trying to get back to the market growth rate, albeit the market growth rate keeps going down or maybe stable, I'd like your view on that. Could you please comment now on how long you think it'll take for you to get back to a market growth rate?

[Gary Ellis:]

This is Gary. Again, from an overall, as I've mentioned, we think the market growth rate overall, has been stable the last three quarters, kind of an at 3% to 4% range. If you take a look at our Core Metal Constructs, we grew 2% this quarter. And as Bill mentioned with Solera and everything else, we think as we go through Q4 here and we enter into FY '12, we will be back to market growth.

[Operator:]

And your next question comes from the line of Derrick Sung with Sanford Bernstein.

[Derrick Sung:]

On Physio-Control, could you give us a sense, Gary, as to how the operating margins for that division compare relative to overall company average margins? And I guess, the question I'm getting to hear, is it reasonable to assume that this will be a pretty accretive transaction if sort of operating margins are well below company average?

[Gary Ellis:]

Overall, Physio-Control's gross margins and operating margins are probably some of the lower ones in company overall and clearly below the company's average, so that will be accretive from the standpoint of our overall margins. Again, the primary reason we've talked about the strategically divesting this business talked about even two or three years ago is, we just think actually Physio-Control, strategically, is not benefiting Medtronic as much as we would like to see with that business. But more importantly, we think that they alone being spun off or divested can do much better with themselves. It's just hard for them to -- because of those margin issues I just mentioned, it's hard for them to ever kind of compete against the investments we have to make. And so overall, we think this is better for them. It's better for the company in general. And we've talked about this. This has been a strategic decision that we've made a long time ago, but we want to get through the making sure the business was back and running effectively and it is. It's a nice business. But I think it'll be better if we divested from the company.

[Derrick Sung:]

And next year you're going to be anniversary-ing some of the reimbursement cuts in Japan. And I was wondering if you could kind of talk about which businesses might benefit most from that and overall from a company perspective, what's the level of impact that you would see on overall sort of company pricing next year?

[Gary Ellis:]

Well, as you said, yes, we are, beginning of April, anniversary-ing against those Japan price cuts which were probably the most felt in CRDM and also on cardiovascular. In general, the entire Cardiac and Vascular business is probably where they had the biggest impact, but CRDM and then on the Cardiovascular side. So that will clearly benefit those two businesses because Japan, as we've seen all year, has been either flat to down primarily because of those ASP pressures and that will clearly help them as they go into next year. We won't have those tough comparisons that they'll be dealing with. Overall, on pricing pressures, as Bill mentioned, we've seen the pricing pressures being somewhat stable over the last several quarters. However, from our perspective, with these new products and the innovation, we think that will actually help minimize some of the pricing pressures we've seen. So going forward, we would expect to see not quite as dramatic pricing pressures as we probably saw this last year for Medtronic in general.

[Operator:]

The next question comes from the line of Rick Wise with Leerink.

[Frederick Wise:]

One, just on the Revo pacer. You had indicated that you think it's going to drive share. My impression is your share is already in the low 50s. Maybe help us think just what kind of dreams do you have for -- what impact on base share, and if you could talk a little bit about when your next-gen Revo is going to be launched in the U.S.? Have you filed it? Just a little perspective there.

[William Hawkins:]

So again I mentioned, the real addressable market for us is about 80% of the market because that's the dual chamber and active fixation. And I'm not going to give you a projection. The only thing I would say, Rick, is what I say to our people. I mean, why would you not want an MRI Safe pacemaker if it's available? I mean, given the fact that we know that roughly 70% of the people who get pacemakers are going to need an MRI Safe. So I just think and this is a different environment here, the whole issue of liability and everything else, I mean, the forces are in place that really draw the adoption of this kind of therapy. So I'm fairly bullish that this is going to be a real big opportunity for us.

[Frederick Wise:]

Turning to spine, you mentioned that pricing in the lateral fusion category is getting more competitive. Can you quantify that more specifically and maybe give us some perspective on what DLIF -- you said you gained share and it grew fast. I still feel like in the first quarter, I remember you grew 40%, last quarter 25%, a little perspective about this quarter?

[William Hawkins:]

It's in the same range. It's up 25% to 30%. So it's -- the DLIF is doing well and we're bringing on new instrument sets, which are going to, we think, even make more competitive. And on the pricing, we haven't seen major changes in the overall spine market. If you go back a few years ago, we saw price increases, and now we're in that flat to modestly down. But again, it's all predicated on bringing out new technologies. And with what we have in the pipeline, we're comfortable that we're going to be able to manage through this very well with Solera, with the TSRH 3Dx, with the VERTEX SELECT, with the T2 ALTITUDE, I mean, the whole product portfolio.

[Frederick Wise:]

And one last one, Gary, if I could on gross margin. Obviously, I understand why gross margins this quarter are the weakest we've seen in some time and you gave us the guidance for the fourth quarter. But recently the last quarter you were talking about 75.5% to 76%. What drives you to that upper end of the range as we look over not just the fourth quarter but directionally looking ahead? Is it this all these new products and the better ASPs, is that "all it is" or can help us understand what might move it higher over time?

[Gary Ellis:]

Well, again, what we would have said that the normal rate for Q3, for ongoing rate would be around 75.6% to 76% and that's the reason that we still feel comfortable. We're not saying we're going to increase our gross margins from where they're at, we just won't have the one-time items we have in this quarter. But overall, Rick, I would tell you that, yes, we think, as we mentioned during the call here, we do think that the new products will have an impact on stabilizing the gross margin and potentially giving us a little bit of an uptick because at the same time, we're coming out with these products, we continue to focus on taking product costs out. So if we can maintain pricing pressures and minimize those and take product cost out, obviously, that gives us the benefit. There's no question that we have things that are pushing it back a little bit the other way. Some of the acquisitions, the mix is such that their gross margins are quite as high as some of the other product lines. So it's a combination. There's a lot of moving parts in the gross margin overall. But what we're trying to get at is, really, on an ongoing basis, we think our gross margins still are running between 75.5% and 76% and we think we continue to maintain those as we go through the fourth quarter and we would hope as we get into the future years.

[William Hawkins:]

Okay. With that, just again, thank you for your interest in Medtronic, and especially for your support during my leadership tenure and wishing each one of you all the very best. Thanks a lot.

[Operator:]

This concludes Medtronic's Q3 Earnings Release Conference Call. You may now disconnect.