EX-13 15 medtronic072487s1_ex13.htm INFORMATION REFERENCED UNDER PART II Exhibit 13 to Medtronic, Inc. Form 10-K for fiscal year ended April 27, 2007

Exhibit 13

Table of Contents

 

 






1



Table of Contents

Management’s Discussion and Analysis of Financial Condition and Results of Operations


Understanding Our Financial Information

 

The following discussion and analysis provides information management believes to be relevant to understanding the financial condition and results of operations of Medtronic, Inc. (Medtronic or the Company). You should read this discussion and analysis along with our consolidated financial statements and related Notes thereto as of April 27, 2007 and April 28, 2006 and for each of the three fiscal years ended April 27, 2007, April 28, 2006, and April 29, 2005.

 

Organization of Financial Information Management’s discussion and analysis, presented on pages 2 to 34 of this report, provides material historical and prospective disclosures designed to enable investors and other users to assess our financial condition and results of operations.

 

The consolidated financial statements are presented on pages 38 to 79 of this report, and include the consolidated statements of earnings, consolidated balance sheets, consolidated statements of shareholders’ equity, consolidated statements of cash flows and the related Notes, which are an integral part of the consolidated financial statements.

 

Financial Trends    Throughout this financial information, you will read about transactions or events that materially contribute to or reduce earnings and materially affect financial trends. We refer to these transactions and events as either special (such as asset impairments), restructuring, certain litigation, purchased in-process research and development (IPR&D) charges, or certain tax adjustments. These charges, or benefits, result from facts and circumstances that vary in frequency and/or impact to operations. While understanding these charges is important in understanding and evaluating financial trends, other transactions or events may also have a material impact on financial trends. A complete understanding of the special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments is necessary in order to estimate the likelihood that financial trends will continue. When discussing the special, restructuring, certain litigation, and IPR&D charges, we provide both pre- and post-tax amounts. The post-tax amounts reflect the tax benefit, if any, at the applicable statutory rates rather than our effective tax rates as these items are treated on a discrete basis.

 

Our fiscal year-end is the last Friday in April, and therefore, the total weeks in a fiscal year can fluctuate between fifty-two and fifty-three weeks. Fiscal years 2007, 2006, and 2005 consisted of fifty-two weeks.

 

Executive Level Overview

 

We are the global leader in medical technology, alleviating pain, restoring health, and extending life for millions of people around the world. During the fourth quarter of fiscal year 2007, we revised our operating segment reporting to separate Physio-Control from our Cardiac Rhythm Disease Management (CRDM) operating segment. As a result, we now function in eight operating segments, consisting of CRDM, Spinal and Navigation, Vascular, Neurological, Diabetes, Cardiac Surgery, ENT, and Physio-Control. The applicable information for fiscal years 2006 and 2005 has been reclassified to conform to the current presentation. Through these eight operating segments, we develop, manufacture, and market our medical devices in more than 120 countries worldwide while expanding patient access to our products. Our primary products include those for cardiac rhythm disorders, cardiovascular disease, neurological disorders, spinal conditions and musculoskeletal trauma, urological and digestive disorders, diabetes, and ear, nose, and throat conditions.

 

Net earnings for the fiscal year ended April 27, 2007 were $2.802 billion, a $255 million, or 10 percent, increase from net earnings of $2.547 billion for the fiscal year ended April 28, 2006. Diluted earnings per share were $2.41 and $2.09 for the fiscal years ended April 27, 2007 and April 28, 2006, respectively. Fiscal year 2007 net earnings include after-tax special, restructuring and certain litigation charges, and certain tax adjustments that reduced net earnings by $5 million and had no impact on diluted earnings per share. Fiscal year 2006 net earnings include after-tax special and IPR&D charges and certain tax adjustments that reduced net earnings by $136 million, or $0.11 per diluted share. See further discussion of these charges/benefits in the “Special, Restructuring, Certain Litigation, and IPR&D Charges, and Certain Tax Adjustments” section of this management’s discussion and analysis. The fiscal year 2007 increase in net earnings was driven primarily by net sales growth, a reduction in IPR&D charges, and increased interest income. Fiscal year 2007 net earnings were also impacted by our adoption of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123(R)), related to stock-based compensation. We adopted SFAS No. 123(R) using the modified-prospective method and in accordance with this method, we did not adjust our historical financial statements to reflect the impact of stock-based compensation. Total stock-based compensation expense recognized during fiscal year 2007 was $127 million after-tax.

 

2



Table of Contents

Net sales in fiscal year 2007 were $12.299 billion, an increase of 9 percent from the prior fiscal year. Foreign currency translation had a favorable impact on net sales of $166 million when compared to fiscal year 2006. The increase in the current year was led by solid worldwide sales growth in the Vascular, Diabetes, Spinal and Navigation, and Neurological businesses and exceptional growth outside the United States (U.S.), where seven of our eight operating segments had growth rates ranging from 16 percent to 32 percent. As illustrated in the table below, four of our eight operating segments had double digit growth rates worldwide.

 

 

 

Net Sales

 

 

 

 

 

Fiscal Year

 

 

 

 

 

2007

 

2006

 

FY07 vs. FY06
% Change

(dollars in millions)

 

 

 

 

 

 

 

 

 

CRDM

 

$

4,876

 

$

4,794

 

2

%

Spinal and Navigation

 

 

2,544

 

 

2,244

 

13

 

Vascular

 

 

1,205

 

 

940

 

28

 

Neurological

 

 

1,183

 

 

1,016

 

16

 

Diabetes

 

 

863

 

 

722

 

20

 

Cardiac Surgery

 

 

704

 

 

663

 

6

 

ENT

 

 

539

 

 

501

 

8

 

Physio-Control

 

 

385

 

 

412

 

(7

)

Total Net Sales

 

$

12,299

 

$

11,292

 

9

%

 

CRDM net sales increased 2 percent over the prior fiscal year to $4.876 billion driven by a 6 percent increase in net sales of pacing systems and a 1 percent decline in net sales of implantable cardioverter defibrillators (ICDs). The overall U.S. market for ICDs declined from the prior period, but strong sales outside the U.S. helped to partially offset these declines. Net sales for pacing systems increased 6 percent over the prior year, primarily due to the Adapta family of pacemakers, including the Adapta, Versa, and Sensia models, that were launched in the U.S. in fiscal year 2007. Spinal and Navigation net sales increased 13 percent over the prior fiscal year to $2.544 billion. The increase reflects strong growth across our portfolio of spinal surgery products including the INFUSE Bone Graft, the CD HORIZON LEGACY Spinal System family of products for thoracolumbar stabilization, our Minimal Access Spinal Technologies (MAST) family of products, and increased acceptance of the CAPSTONE and CRESCENT Vertebral Body Spacers. Vascular net sales increased 28 percent over the prior fiscal year to $1.205 billion. Vascular growth was driven by Coronary Vascular net sales which grew 31 percent, and by Endovascular/Peripheral sales which grew 20 percent over fiscal year 2006. The growth in Coronary Vascular was primarily a result of increased commercial availability outside the U.S. of the Endeavor drug-eluting stent (DES) and strong performance of bare metal stents, due to reduced penetration of drug-eluting stents in the U.S. and the launch of the MicroDriver in the U.S. and Japan. Neurological net sales increased 16 percent over fiscal year 2006 to $1.183 billion reflecting solid growth in several product lines including the RestoreADVANCED and PrimeADVANCED neurostimulation systems for pain management, continued strength of Activa Therapy for the treatment of movement disorders associated with advanced Parkinson’s disease and essential tremor, and InterStim Therapy for the treatment of overactive bladder and urinary incontinence. Diabetes net sales increased 20 percent over the prior fiscal year to $863 million. The sales increase reflects solid global growth of the Paradigm REAL-Time sensor-augmented insulin pump system and consumables used with our Paradigm family of pumps. On January 15, 2007, we voluntarily suspended U.S. shipments of Physio-Control products manufactured at our facility in Redmond, Washington in order to address quality system issues, which led to Physio-Control’s decline in sales. See our discussion of “Net Sales” by operating segment within this management’s discussion and analysis for more information on the results of each operating segment.

 

3



Table of Contents

While we continue to make substantial investments in the expansion of our existing product lines and the search for new innovative products, we have also focused heavily on carefully planned clinical trials, which lead to market expansion and enable further penetration of our life changing devices. Fiscal year 2007 research and development spending of $1.239 billion increased 11 percent in comparison to the prior fiscal year. Our research and development efforts are focused on maintaining leadership in each of the markets we serve to ensure that patients receive the most advanced and effective treatments possible. Research and development expenditures have supported improvements in existing products and enhanced methods to deliver and/or monitor those products.

 

Increased investment in our future is fortified by our continued strong cash flow generated from operations of $2.979 billion during fiscal year 2007 and our $6.082 billion in cash, short-term debt securities, and long-term debt securities as of April 27, 2007. We may use our cash flow from operations to invest in research and development, fund certain strategic acquisitions, and to participate in expanded clinical trials, which support regulatory approval of our products.

 

We remain committed to our Mission of developing lifesaving and life enhancing therapies to alleviate pain, restore health, and extend life. The diversity and depth of our current product offerings enable us to provide medical therapies to patients worldwide. We will work to improve patient access through well planned studies, which show the cost-effectiveness of our therapies and our alliance with patients, clinicians, regulators, and reimbursement agencies. Our investments in research and development, strategic acquisitions, expanded clinical trials, and infrastructure provide the foundation for our growth. We are confident in our ability to drive long-term shareholder value using the principles of our Mission, our strong product pipelines, and continued commitment to research and development.

 

Other Matters

 

On December 4, 2006, we announced our intention to pursue a spin-off of Physio-Control into an independent, publicly traded company. Physio-Control is our wholly-owned subsidiary that offers external defibrillators, emergency response systems, data management solutions, and support services used by hospitals and emergency response personnel. On January 15, 2007, we announced our voluntary suspension of U.S. shipments of Physio-Control products manufactured at our facility in Redmond, Washington in order to address quality system issues. We are currently in discussions with the U.S. Food and Drug Administration (FDA) regarding the corrective actions that need to be taken before shipping in the U.S. can resume. We have a dedicated team from across the Company working on the corrective actions necessary to address the quality system issues. The suspension of U.S. shipments in fiscal year 2007 did not have a material impact on our overall results. We expect the suspension of U.S. shipments to continue into the second half of fiscal year 2008. Following the resolution of these matters, we intend to continue to pursue the spin-off of Physio-Control.

 

Critical Accounting Estimates

 

We have adopted various accounting policies to prepare the consolidated financial statements in accordance with accounting principles generally accepted in the U.S. (U.S. GAAP). Our most significant accounting policies are disclosed in Note 1 to the consolidated financial statements.

 

The preparation of the consolidated financial statements, in conformity with U.S. GAAP, requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying Notes. Our estimates and assumptions, including those related to bad debts, inventories, intangible assets, property, plant and equipment, asset impairment, legal proceedings, IPR&D, warranty obligations, product liability, self-insurance, pension and post-retirement obligations, sales returns and discounts, stock-based compensation, and income tax reserves are updated as appropriate, which in most cases is at least quarterly. We base our estimates on historical experience, actuarial valuations, or various assumptions that are believed to be reasonable under the circumstances.

 

Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions about material matters that are uncertain at the time the accounting estimates are made and (2) material changes in the estimates are reasonably likely to occur from period to period. Our critical accounting estimates include the following:

 

4



Table of Contents

Legal Proceedings   We are involved in a number of legal actions involving both product liability and intellectual property disputes. The outcomes of these legal actions are not within our complete control and may not be known for prolonged periods of time. In some actions, the claimants seek damages, as well as other relief, including injunctions barring the sale of products that are the subject of the lawsuit, which, if granted, could require significant expenditures or result in lost revenues. In accordance with SFAS No. 5, “Accounting for Contingencies,” we record a liability in our consolidated financial statements for these actions when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate, the minimum amount of the range is accrued. If a loss is possible, but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed in Note 15 to the consolidated financial statements. In most cases, significant judgment is required to estimate the amount and timing of a loss to be recorded. Our significant legal proceedings are discussed in Note 15 to the consolidated financial statements. While it is not possible to predict the outcome for the actions discussed and we believe that we have meritorious defenses against the matters detailed in Note 15 to the consolidated financial statements, it is possible that the outcomes of these legal matters could have a material adverse impact on our consolidated earnings, financial condition, or cash flows.

 

Tax Strategies   Our effective tax rate is based on income, statutory tax rates, and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our effective tax rate and evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are likely to be challenged and we may or may not prevail. We adjust these reserves in light of changing facts and circumstances, such as the progress of a tax audit. Our effective tax rate includes the impact of reserve provisions and changes to reserves that we consider appropriate. In the event there is a special, restructuring, certain litigation, or IPR&D charge, and/or certain tax adjustments recognized in our operating results, the tax attributable to that item is separately calculated and recorded.

 

Tax regulations require certain items be included in the tax return at different times than when those items are required to be recorded in the consolidated financial statements. As a result, our effective tax rate reflected in our consolidated financial statements is different than that reported in our tax return. Some of these differences are permanent, such as expenses that are not deductible on our tax return, and some are timing differences, such as depreciation expense. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax return in future years for which we have already recorded the tax benefit in our consolidated statements of earnings. We establish valuation allowances for our deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in our consolidated financial statements for which payment has been deferred or expense has already been taken as a deduction on our tax return, but has not yet been recognized as an expense in our consolidated statements of earnings.

 

The company’s overall tax rate including the tax impact on special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments has resulted in an effective tax rate of 20.3 percent for fiscal year 2007. Excluding the impact of these items, our operational and tax strategies have resulted in a non-GAAP nominal tax rate of 24.5 percent versus the U.S. statutory rate of 35.0 percent. The non-GAAP nominal tax rate is defined as the income tax (benefit) provision as a percentage of taxable income, excluding special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments. An increase in our nominal tax rate of 1 percent would result in an additional income tax provision for the fiscal year ended April 27, 2007 of approximately $37 million. See discussion of the tax rate in the “Income Taxes” section of this management’s discussion and analysis.

 

Valuation of IPR&D, Goodwill and Other Intangible Assets    When we acquire a company, the purchase price is allocated, as applicable, between IPR&D, other identifiable intangible assets, net tangible assets, and goodwill as required by U.S. GAAP. IPR&D is defined as the value assigned to those projects for which the related products have not received regulatory approval and have no alternative future use. Determining the portion of the purchase price allocated to IPR&D and other intangible assets requires us to make significant estimates. The amount of the purchase price allocated to IPR&D and other intangible assets is determined by estimating the future cash flows of each project or technology and discounting the net cash flows back to their present values. The discount rate used is determined at the time of acquisition in accordance with accepted valuation methods. For IPR&D, these methodologies include consideration of the risk of the project not achieving commercial feasibility.

 

5



Table of Contents

Goodwill represents the excess of the aggregate purchase price over the fair value of net assets, including IPR&D, of the acquired businesses. Goodwill is tested for impairment annually, or more frequently if changes in circumstance or the occurrence of events suggest that the carrying amount may be impaired. The test for impairment requires us to make several estimates about fair value, most of which are based on projected future cash flows. Our estimates associated with the goodwill impairment tests are considered critical due to the amount of goodwill recorded on our consolidated balance sheets and the judgment required in determining fair value amounts, including projected future cash flows. Goodwill was $4.327 billion and $4.346 billion as of April 27, 2007 and April 28, 2006, respectively.

 

Other intangible assets consist primarily of purchased technology, patents, and trademarks and are amortized using the straight-line or accelerated basis, as appropriate, over their estimated useful lives, ranging from 3 to 20 years. As of April 27, 2007, all of our intangible assets are definite lived and amortized on a straight-line basis. We review these intangible assets for impairment annually or as changes in circumstance or the occurrence of events suggest the remaining value may not be recoverable. Other intangible assets, net of accumulated amortization, were $1.433 billion and $1.592 billion as of April 27, 2007 and April 28, 2006, respectively.

 

Stock-Based Compensation   Effective April 29, 2006, we adopted the provisions of, and account for stock-based compensation in accordance with SFAS No. 123(R). Under the fair value recognition provisions of SFAS No. 123(R), we measure stock-based compensation cost at the grant date based on the fair value of the award and recognize the compensation expense over the requisite service period, which is generally the vesting period. We elected the modified-prospective method of adopting SFAS No. 123(R), under which prior periods are not retroactively revised. Estimated stock-based compensation expense for the non-vested portion of awards granted prior to the effective date is being recognized over the remaining service period using the compensation cost estimated for the SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), pro forma disclosures. Total stock-based compensation expense recognized during the fiscal year ended April 27, 2007 was $127 million after-tax ($185 million pre-tax). See Note 11 to the consolidated financial statements for further information regarding our stock-based compensation programs.

 

We use the Black-Scholes option pricing model (Black-Scholes model) to determine the fair value of stock options as of the grant date. The fair value of stock options under the Black-Scholes model requires management to make assumptions regarding projected employee stock option exercise behaviors, risk-free interest rate, volatility of our stock price and expected dividends.

 

We analyze historical employee stock option exercise and termination data to estimate the expected life assumption. We believe that historical data currently represents the best estimate of the expected life of a new employee option. We also stratify our employee population based upon distinctive exercise behavior patterns. The risk-free interest rate we use is based on the yield, on the grant date, of a zero-coupon U.S. Treasury bond whose maturity period equals or approximates the option’s expected term. Beginning in the third quarter of fiscal year 2007 we began to calculate the expected volatility using a blended volatility, combining the historical volatility and an implied volatility. Implied volatility is based on market traded options of the Company’s common stock. Prior to the third quarter of fiscal year 2007, we calculated the expected volatility based solely on historical volatility. The dividend yield rate used is calculated by dividing our annual dividend, based on the most recent quarterly dividend rate, by the closing stock price on the grant date. The amount of stock-based compensation expense we recognize during a period is based on the portion of the awards that are ultimately expected to vest. We estimate pre-vesting option forfeitures at the time of grant by analyzing historical data and revise those estimates in subsequent periods if actual forfeitures differ from those estimates.

 

If factors change and we employ different assumptions for estimating stock-based compensation expense in future periods or if we decide to use a different valuation model, the expense associated with new awards in future periods may differ significantly from what we have recorded in the current period related to historical awards and could materially affect our net earnings and diluted earnings per share of a future period.

 

There is a risk that our estimates of the fair values of our stock-based awards on the grant dates as determined using the Black-Scholes model may bear little resemblance to the actual values realized upon the exercise or forfeiture of those stock-based awards in the future. Some employee stock options may expire without value, or only realize minimal intrinsic value, as compared to the fair values originally estimated on the grant date and recognized in our financial statements. Alternatively, some employee stock options may realize significantly more value than the fair values originally estimated on the grant date and recognized in our financial statements.

 

6



Table of Contents

Net Sales

The table below illustrates net sales by product line and operating segment for fiscal years 2007, 2006, and 2005:

 

 

 

Net Sales

 

 

 

Net Sales

 

 

 

 

 

Fiscal year

 

 

 

Fiscal year

 

 

 

(dollars in millions)

 

2007

 

2006

 

%
Change

 

2006

 

2005

 

%
Change

 

Low Power Pacing

 

$

1,895

 

$

1,795

 

6

%

$

1,795

 

$

1,756

 

2

%

High Power Defibrillation

 

 

2,917

 

 

2,932

 

(1

)

 

2,932

 

 

2,379

 

23

 

Other

 

 

64

 

 

67

 

(4

)

 

67

 

 

68

 

(1

)

CARDIAC RHYTHM DISEASE MANAGEMENT

 

 

4,876

 

 

4,794

 

2

 

 

4,794

 

 

4,203

 

14

 

Spinal Instrumentation

 

 

1,721

 

 

1,566

 

10

 

 

1,566

 

 

1,372

 

14

 

Spinal Biologics

 

 

696

 

 

570

 

22

 

 

570

 

 

413

 

38

 

Navigation

 

 

127

 

 

108

 

18

 

 

108

 

 

99

 

9

 

SPINAL & NAVIGATION

 

 

2,544

 

 

2,244

 

13

 

 

2,244

 

 

1,884

 

19

 

Coronary Stents

 

 

560

 

 

366

 

53

 

 

366

 

 

317

 

15

 

Other Coronary

 

 

358

 

 

334

 

7

 

 

334

 

 

308

 

8

 

Endovascular/Peripheral

 

 

287

 

 

240

 

20

 

 

240

 

 

226

 

6

 

VASCULAR

 

 

1,205

 

 

940

 

28

 

 

940

 

 

851

 

10

 

Neurological Implantables

 

 

962

 

 

833

 

15

 

 

833

 

 

739

 

13

 

Gastroenterology & Urology

 

 

221

 

 

183

 

21

 

 

183

 

 

188

 

(3

)

NEUROLOGICAL

 

 

1,183

 

 

1,016

 

16

 

 

1,016

 

 

927

 

10

 

DIABETES

 

 

863

 

 

722

 

20

 

 

722

 

 

649

 

11

 

Valves

 

 

250

 

 

229

 

9

 

 

229

 

 

230

 

 

Perfusion

 

 

334

 

 

321

 

4

 

 

321

 

 

327

 

(2

)

Cardiac Surgery Technologies

 

 

120

 

 

113

 

6

 

 

113

 

 

112

 

1

 

CARDIAC SURGERY

 

 

704

 

 

663

 

6

 

 

663

 

 

669

 

(1

)

Core ENT

 

 

278

 

 

266

 

5

 

 

266

 

 

241

 

10

 

Neurologic Technologies

 

 

261

 

 

235

 

11

 

 

235

 

 

218

 

8

 

EAR, NOSE, & THROAT (ENT)

 

 

539

 

 

501

 

8

 

 

501

 

 

459

 

9

 

PHYSIO-CONTROL

 

 

385

 

 

412

 

(7

)

 

412

 

 

413

 

 

TOTAL

 

$

12,299

 

$

11,292

 

9

%

$

11,292

 

$

10,055

 

12

%

 

The primary exchange rate movements that impact our consolidated net sales growth are the U.S. dollar as compared to the Euro and the Japanese Yen. The impact of foreign currency fluctuations on net sales is not indicative of the impact on net earnings due to the offsetting foreign currency impact on operating costs and expenses and our hedging activities. See the “Market Risk” section of this management’s discussion and analysis and Note 5 to the consolidated financial statements for further details on foreign currency instruments and our related risk management strategies.

 

Forward-looking statements are subject to risk factors (see “Risk Factors” set forth in our Form 10-K).

 

Cardiac Rhythm Disease Management CRDM products consist primarily of pacemakers, implantable defibrillators, leads, ablation products, electrophysiology catheters, and information systems for the management of patients with our devices. CRDM fiscal year 2007 net sales grew by 2 percent from the prior fiscal year to $4.876 billion. Foreign currency translation had a favorable impact on net sales of approximately $70 million when compared to the prior fiscal year. CRDM net sales increased despite a challenging U.S. market for ICDs, and fiscal year 2007 highlights include the following:

 

7



Table of Contents

 

 

Implantable defibrillator net sales of $2.917 billion for fiscal year 2007 decreased 1 percent as compared to fiscal year 2006. This minimal decrease is the result of sales declines in the U.S., offset by strong sales growth outside the U.S. Net sales from ICDs in the U.S. were $2.082 billion, a decrease of 9 percent. The decrease in U.S. ICD net sales in fiscal year 2007 is primarily the result of a decline in the U.S. ICD market. Outside the U.S., net sales from ICDs were $835 million, an increase of 29 percent over the prior fiscal year, driven by the Virtuoso ICD and the Concerto cardiac resynchronization therapy-defibrillator (CRT-D). Both of these devices feature Conexus wireless technology which allows for remote transfer of patient data and enables communication remotely between the implanted device and programmer at the time of implant, during follow-up in a clinician’s office, or remotely using a patient home monitor.

 

 

 

Pacing system net sales for fiscal year 2007 increased by 6 percent over the prior fiscal year to $1.895 billion. The increase in the current fiscal year is attributable primarily to increased market share in a pacing market that experienced low single digit growth. Instrumental in the increase in sales over fiscal year 2006 was the Adapta family of pacemakers, including the Adapta, Versa, and Sensia models, which were launched in the U.S. in the second quarter of fiscal year 2007 and experienced a full year of sales outside the U.S. This new family of pacemakers incorporates an array of automatic features to help physicians improve pacing therapy and streamline the patient follow-up process, potentially minimizing the amount of time spent in a physician’s office. Adapta offers Managed Ventricular Pacing, or MVP, which is an atrial based pacing mode that significantly reduces unnecessary pacing in the right ventricle while providing the safety of a dual chamber backup if necessary. Clinical studies have suggested that reducing this unnecessary pacing in the right ventricle decreases the risk of developing heart failure and atrial fibrillation, a potentially life-threatening irregular heartbeat.

 

 

 

Fiscal year 2007 implantable defibrillator and pacing system sales also benefited from the continued acceptance of the Medtronic CareLink Service. The Medtronic CareLink Service enables clinicians to review data about implanted cardiac devices in real time and access stored patient and device diagnostics through a secure Internet website. The data, which is comparable to information provided during an in-clinic device follow-up, provides the patient’s medical team with a comprehensive view of how the device and patient’s heart are operating. Today, over 120,000 implant patients are being monitored through Medtronic’s CareLink Service in the U.S., up from approximately 70,000 implant patients being monitored a year ago.

 

CRDM fiscal year 2006 net sales grew by 14 percent from the prior fiscal year to $4.794 billion. Foreign currency translation had an unfavorable impact on net sales of approximately $50 million when compared to the prior fiscal year. While the increase in CRDM net sales was solid across most product lines, fiscal year 2006 highlights include the following:

 

 

 

Implantable defibrillator net sales for fiscal year 2006 increased 23 percent over the prior fiscal year to $2.932 billion. This increase was driven by strong demand for the Maximo and EnTrust families of ICDs, and continued market acceptance of the InSync Maximo and InSync Sentry CRT-Ds. EnTrust ICDs were released in the U.S. in June 2005, and offer anti-tachycardia pacing during charging, a feature designed to stop fast, dangerous heartbeats as it prepares to deliver a shock if needed. InSync Sentry was the world’s first implantable medical device offering automatic fluid status monitoring in the chest area encompassing the heart and lungs. Both the InSync Maximo and InSync Sentry provide sequential biventricular pacing, which optimizes the beating of the heart and bloodflow throughout the body. In addition, growth was aided by continued strong performance of our Sprint Fidelis leads, which were first released in fiscal year 2005. The strong market acceptance of these products reflects CRDM’s continued product innovation as well as an overall expansion of the tachyarrhythmia and heart failure markets due to increasing clinical data that supports the uses of these devices for certain patient populations. Net sales of implantable defibrillators for fiscal year 2006 also benefited from one key competitor being out of the ICD market for a portion of the fiscal year due to quality concerns with its product. The negative publicity associated with these quality concerns softened the ICD market growth in the latter half of fiscal year 2006. Market share gains in defibrillator sales worldwide partially offset the impact of the slower market growth.

 

 

8



Table of Contents

 

 

Pacing system net sales for fiscal year 2006 increased by 2 percent over the prior fiscal year to $1.795 billion. The fiscal year 2006 increase was attributable primarily to increased market share in an otherwise flat growth pacing market, as physicians continue to focus more on the ICD and CRT-D marketplace. Instrumental in the year over year increase in sales was the introduction of the EnRhythm pacemaker, which was released in the U.S. in May 2005, and the Adapta pacemaker family, introduced in certain markets outside of the U.S. in the third quarter of fiscal year 2006. The EnRhythm and Adapta pacemakers both offer MVP.

 

 

 

Fiscal year 2006 implantable defibrillator and pacing system sales also benefited from the continued acceptance of the Medtronic CareLink Service. As of the end of fiscal year 2006, over 70,000 implant patients were being monitored through Medtronic’s CareLink Service in the U.S. and Canada up from 35,000 implant patients being monitored in the prior fiscal year.

 

Looking ahead, we expect our CRDM operating segment should benefit from the following:

 

 

 

Continued acceptance and increased account penetration of the Concerto CRT-D and Virtuoso ICD. These are our first devices with Conexus wireless telemetry, enabling remote communication between the implanted device and programmer in a clinician’s office and at implant, or between the device and a patient home monitor.

 

 

 

Continued acceptance of the Adapta family of pacemakers, including the Adapta, Versa, and Sensia models. Fiscal year 2008 will benefit from having the Adapta family of pacemakers available in the U.S. for a full fiscal year.

 

 

 

Continued expansion of the Medtronic CareLink Service, available on both the pacing and ICD platforms in the U.S., Canada, and Western Europe. The Medtronic CareLink Service continues to drive physician preference for our products. As of the end of fiscal year 2007, more than 1,400 clinics were monitoring patients in the U.S and we continue to expand this network.  In June 2007, we launched the Medtronic CareLink Service throughout Europe, which should facilitate the doctor-patient interaction outside the U.S. by offering more convenience, which should increase follow-up compliance.

 

 

 

A return to growth in the U.S. ICD market and continued strong growth outside the U.S. We believe the worldwide market is still significantly under-penetrated, and our investments to expand the physician referral network, enhance clinical evidence, and develop technologies that promote the ease of use and care will drive increased usage of defibrillator therapies.

 

Spinal and Navigation   Spinal and Navigation products include thoracolumbar, cervical, and interbody spinal devices, bone growth substitutes, and surgical navigation tools. Spinal and Navigation net sales for fiscal year 2007 increased by 13 percent from the prior fiscal year to $2.544 billion. Foreign currency translation of $9 million had a favorable impact on net sales when compared to the prior fiscal year. Spinal net sales for fiscal year 2007 increased 13 percent from the prior fiscal year to $2.417 billion driven by solid growth across our entire portfolio of product offerings. Spinal Instrumentation net sales were $1.721 billion, a 10 percent increase over the prior fiscal year, based on continual acceptance of our CD HORIZON LEGACY Spinal System family of products, strong growth in our minimal access technology platforms, and an increase in dynamic stabilization product sales outside of the U.S., led by the DIAM System. The CD HORIZON LEGACY Spinal System is the most comprehensive system on the market today, and is designed to provide procedural solutions for degenerative, deformity, or trauma applications using color coded implants and ergonomic instrumentation. CD HORIZON SEXTANT II, a percutaneous lumbar fixation system with minimal access technologies that reduce procedural steps, was the main driver of the growth in the minimal access technology portfolio. Other revenue growth drivers in Spinal Instrumentation were CAPSTONE and CRESCENT Vertebral Body Spacers which are minimal access devices and techniques designed to replace and restore vertebral height, and the VERTEX Max Reconstruction System which is used to stabilize the complex junction between the flexible cervical and rigid thoracic spine. Biologics net sales were $696 million in fiscal year 2007, a 22 percent increase over the prior year, based on continued strong acceptance of INFUSE Bone Graft. INFUSE Bone Graft contains a recombinant human bone morphogenetic protein, or rhBMP-2, that induces the body to grow its own bone, eliminating the need for a painful second surgery to harvest bone from elsewhere in the body. In addition to the Spinal approval for INFUSE Bone Graft received in fiscal year 2003, since fiscal year 2005 we have had FDA approval to use INFUSE Bone Graft for the treatment of certain types of acute, open fractures of the tibial shaft, and late in fiscal year 2007 we received FDA approval for the use of INFUSE Bone Graft for certain oral maxillofacial and dental regenerative bone grafting procedures. In the Spinal market, the trend has been that small companies continue to increase their presence in the U.S., putting pressure on the market. Navigation net sales for fiscal year 2007 increased 18 percent from the prior fiscal year to $127 million based on strong sales of the PoleStar N20, an intra-operative Magnetic Resonance Image (iMRI)-Guidance System and O-arm Imaging System, a multi-dimensional surgical imaging platform that is optimized for use in spine and orthopedic surgery.

 

9



Table of Contents

Spinal and Navigation net sales for fiscal year 2006 increased by 19 percent from the prior fiscal year to $2.244 billion. Foreign currency translation had an unfavorable impact on net sales of $11 million when compared to the prior fiscal year. Spinal net sales for fiscal year 2006 increased 20 percent from the prior fiscal year to $2.136 billion. While this increase reflected solid growth across our portfolio of product offerings, Biologics net sales were $570 million, a 38 percent increase over the prior year, based on continued strong acceptance of INFUSE Bone Graft. Since late fiscal year 2005, we have had the right to market Wyeth’s InductOs Bone Graft, the European equivalent of the INFUSE Bone Graft, for use in spinal fusion in European markets. Other products showing steady growth include our CD HORIZON LEGACY Spinal System family of products for thoracolumbar stabilization, our MAST family of products, our cervical stabilization family of products including the VERTEX Max Reconstruction System and MYSTIQUE Resorbable Graft Containment Plating System and the CAPSTONE Vertebral Body Spacer. Released in fiscal year 2005, the CAPSTONE Vertebral Body Spacer is designed to replace and restore the height of all or part of a vertebral body (the weight bearing portion of the vertebra) that has been removed for the treatment of a tumor or fracture. Navigation net sales for fiscal year 2006 increased by 9 percent from the prior fiscal year. Navigation net sales growth was primarily the result of continued strong sales of the StealthStation TRIA and the PoleStar N20 surgical navigation equipment.

 

Looking ahead, we expect our Spinal and Navigation operating segment should benefit from the following:

 

 

Continued acceptance of the CD HORIZON LEGACY 5.5, the VERTEX Max Reconstruction System, and the CD HORIZON SEXTANT I System in Japan and Western Europe.

 

 

 

 

Continued acceptance of the INFUSE Bone Graft for spinal fusion and certain types of acute, open tibia fractures and the expansion of indications for INFUSE Bone Graft. In late fiscal year 2007, we launched INFUSE Bone Graft for use in certain oral maxillofacial and dental regenerative bone grafting procedures.

 

 

 

 

Continued acceptance of our dynamic stabilization products outside the U.S., including the DIAM System, MAVERICK Lumbar Artificial Disc, and PRESTIGE LP Cervical Disc Systems.

 

 

 

 

Future acceptance in the U.S. of the PRESTIGE Cervical Disc System, which an FDA advisory panel unanimously voted to recommend approval of in September 2006. The PRESTIGE Cervical Disc System is the first in a portfolio of artificial discs designed to serve patients suffering from severe degenerative disc disease, while maintaining motion in a patient’s cervical spine. U.S. FDA approval is anticipated in the first quarter of fiscal year 2008. 

 

 

 

 

Acceptance of Synergy Experience StealthStation System, a combination of Navigational Procedure Solutions and MAST techniques, which can allow less invasive procedures, smaller incisions, and less radiation.

 

Vascular   Vascular products consist of coronary, endovascular, and peripheral stents and related delivery systems, stent graft systems, distal embolic protection systems and a broad line of balloon angioplasty catheters, guide catheters, guidewires, diagnostic catheters, and accessories. Vascular net sales for fiscal year 2007 increased 28 percent from the prior fiscal year to $1.205 billion. Foreign currency translation of $32 million had a favorable impact on net sales when compared to the prior fiscal year. Coronary Vascular net sales increased 31 percent in comparison to the prior fiscal year to $918 million. The growth in Coronary Vascular net sales was primarily a result of the commercial availability of Endeavor DES outside the U.S. for a full fiscal year and further acceptance of the Driver family of bare metal stents. Endeavor DES, which generated revenue of $300 million in fiscal year 2007, is now commercially released in over 100 countries outside the U.S. and continues to benefit from favorable safety and efficacy data, along with its ease of delivery. We recognized revenue of $260 million in fiscal year 2007 from the Driver family of bare metal stents, which experienced strong growth in the U.S. as a result of reduced penetration of drug-eluting stents in the U.S. marketplace. The Driver bare metal stent is a cobalt-chromium coronary stent which has thinner struts and provides greater maneuverability in placing the stent. Net sales of Other Coronary products, including balloons, guides, and guide wires grew 7 percent over the prior year. Endovascular/Peripheral fiscal year 2007 net sales grew 20 percent when compared to the prior fiscal year. Growth in the endovascular business was driven by the fourth quarter of fiscal year 2006 successful U.S. launch of the market-leading AneuRx AAAdvantage Stent Graft System, which is used to treat abdominal aortic aneurysms (AAA), and increased sales of the Valiant Thoracic Stent Graft System outside the U.S. The Valiant Thoracic Stent Graft System is a next-generation stent graft used for the minimally invasive repair of the thoracic aorta, the body’s largest artery, for several disease states including aneurysms, penetrating ulcers, acute or chronic dissections, and contained or traumatic ruptures. The Valiant Thoracic Stent Graft System received CE Mark approval in Europe in March 2005.

 

10



Table of Contents

Vascular net sales for fiscal year 2006 increased 10 percent from the prior fiscal year to $940 million. Foreign currency translation had an unfavorable impact on net sales of $24 million when compared to the prior fiscal year. Coronary Vascular net sales increased 12 percent in comparison to the prior fiscal year. The growth in Coronary Vascular net sales was primarily a result of the second quarter of fiscal year 2006 release of our Endeavor DES in approximately 85 markets outside the U.S., and the worldwide strong performance in our Other Coronary products, including balloons and guidewires. Endeavor DES sales grew to $138 million during fiscal year 2006, while stent sales in the U.S. were only $24 million of the total worldwide stent sales of $366 million. Endovascular net sales increased 9 percent in comparison to the prior fiscal year. Endovascular results were primarily a result of solid performance of the Talent Thoracic Stent Graft System outside the U.S., which is used to treat AAA, and the Valiant Thoracic Stent Graft System outside the U.S.

 

Looking ahead, we expect our Vascular operating segment should benefit from the following:

 

 

 

Continued acceptance in fiscal year 2008 of the Endeavor DES in currently available markets. Updated results from the ENDEAVOR I, II, and III clinical trials were presented at EuroPCR in May 2007. The clinical results for Endeavor DES have demonstrated excellent safety, sustained efficacy, low clinical event rates, and lack of late stent thrombosis.

 

 

 

Future acceptance of Endeavor Sprint. In May 2007, we received European CE Mark approval and launched the Endeavor Sprint in Europe. This product includes the proven Endeavor DES but provides even better delivery and trackability through enhancements and new technology we have leveraged from our successful Sprinter angioplasty balloon. This stent provides physicians with improved lesion access in tortuous vasculature, increased confidence in a successful outcome, greater ease-of-use, and reduced procedure time.

 

 

 

Our anticipated entry into the U.S. drug-eluting stent market. The final module of the Endeavor DES pre-market approval (PMA) was submitted in November 2006. The FDA has indicated that it will require nine month data from the ENDEAVOR IV clinical trial and the FDA has scheduled manufacturing site audits in our facilities in the U.S. and Ireland. We expect an FDA panel meeting in September or October of 2007, and anticipate FDA approval and U.S. launch of Endeavor DES in the second half of calendar year 2007.

 

 

 

CE Mark approval and the international launch of Endeavor Resolute in the third quarter of fiscal year 2008. Endeavor Resolute is a next-generation drug-eluting stent with Biolinx, a proprietary biocompatible polymer that is designed to address the special needs of patients who have complex medical conditions and is engineered to match the duration of drug delivery with the longer healing duration often required by these patients.

 

 

 

Continued net sales growth of the AneuRx AAAdvantage Stent Graft System and Valiant Thoracic Stent Graft System in the U.S and outside the U.S., respectively. The Valiant Thoracic Stent Graft System contains the Xcelerant Delivery System, which is designed to provide physicians with a smooth, controlled, and trackable delivery platform.

 

Neurological   Neurological products consist of therapeutic and diagnostic devices, including implantable neurostimulation systems, implantable drug administration devices, and urology and gastroenterology products. Neurological net sales for fiscal year 2007 increased 16 percent from the prior fiscal year to $1.183 billion. Foreign currency translation of $16 million had a favorable impact on net sales when compared to the prior fiscal year. The increase in sales was driven by strong growth of both Neurological Implantables and Gastroenterology and Urology sales. Net sales from Neurological Implantables were $962 million, an increase of 15 percent over the prior period. The growth in Neurological Implantables was driven by key products including the RestoreADVANCED and PrimeADVANCED neurostimulation systems for pain management and Activa Therapy for the treatment of movement disorders associated with advanced Parkinson’s disease and essential tremor. Fiscal year 2007 revenue for Neurological Implantables also benefited from increased sales of our Synchromed II drug delivery pump. Net sales of Gastroenterology and Urology products increased 21 percent over fiscal year 2006 to $221 million. The growth in Gastroenterology and Urology was led by sales of our InterStim product line for the treatment of overactive bladder and urinary incontinence and our Prostiva product line for the treatment of an enlarged prostate. The InterStim II was launched in the second quarter of fiscal year 2007, and the smaller design has been widely accepted.

 

11



Table of Contents

Neurological net sales for fiscal year 2006 increased 10 percent from the prior fiscal year to $1.016 billion. Foreign currency had an unfavorable impact on net sales of $11 million when compared to the prior fiscal year. The increase in Neurological net sales reflected solid growth in several product lines including the Restore Rechargeable Neurostimulation System for pain management, which benefited from the introduction of our Single Stretch-Coil Extension that enabled physicians to convert patients with existing neurostimulators to the new rechargeable technology. The Restore System, our first fully rechargeable neurostimulation system, was launched in late fiscal year 2005. The Restore System is indicated to manage chronic, difficult-to-treat pain in the trunk and/or multiple limbs that is associated with failed back syndrome, post laminectomy pain, unsuccessful disc surgery, or degenerative disc disease. Sales growth was also driven by continued strength of Activa Therapy for the treatment of movement disorders associated with advanced Parkinson’s disease and essential tremor, as well as InterStim Therapy for the treatment of overactive bladder and urinary incontinence. The increase in Neurological net sales was partially offset by a decrease in sales of our Gastroenterology/Urology diagnostics product line as a result of supplier issues.

 

Looking ahead, we expect our Neurological operating segment should benefit from the following:

 

 

 

Continued acceptance of the RestoreADVANCED rechargeable neurostimulation system for pain management that provides increased power without compromising device longevity. Additionally, the anticipated launch of the RestoreULTRA, our next generation rechargeable neurostimulator with advanced programming capabilities and longer recharge intervals, is expected to help drive future sales. The RestoreULTRA is expected to launch in the second half of fiscal year 2008. Additionally, our new surgical lead, the Specify 5-6-5 with Durable Electrode Technology, received FDA approval in June 2007. The Specify 5-6-5 surgical lead offers exclusive advantages and electrode programming patterns when used with our neurostimulators.

 

 

 

Continued acceptance of our Activa Therapy for the treatment of Parkinson’s disease and essential tremor. We continue to educate neurologists and the patient population of the benefits that our Activa Therapy offers them. The New England Journal of Medicine recently published a study that confirmed the advantages of Activa deep brain stimulation for the treatment of dystonia, and the journal Neurology published a study that supports earlier treatment of Parkinson’s disease with Activa deep brain stimulation.

 

 

 

Continued acceptance of InterStim II for overactive bladder and urinary incontinence. Interstim II is a smaller, next-generation device that adds a new implantable neurostimulator, a new improved patient programmer, and upgraded software.

 

The Neurological business may experience slower growth in comparison to prior years as the diagnostics product line is being divested. This divestiture should be complete by the end of the first quarter of fiscal year 2008. The diagnostics product line generated net sales of $67 million in fiscal year 2007.

 

Diabetes   Diabetes products consist of external insulin pumps and related consumables, continuous glucose monitoring systems, and subcutaneous glucose sensors. Diabetes net sales in fiscal year 2007 increased 20 percent over the prior fiscal year to $863 million. Foreign currency translation of $13 million had a favorable impact on net sales when compared to the prior fiscal year. External pump sales for fiscal year 2007 were $389 million, representing growth of 32 percent over the prior fiscal year. This increase reflects strong worldwide market acceptance of the Paradigm REAL-Time sensor-augmented pump system that integrates continuous glucose monitoring and insulin pump functionality. Sales of consumables during fiscal year 2007 were $425 million, an increase of 10 percent.

 

Diabetes net sales in fiscal year 2006 increased 11 percent over the prior fiscal year to $722 million. Foreign currency translation had an unfavorable impact on net sales of $6 million when compared to the prior fiscal year. The sales increase reflected continued global growth of the Paradigm family of insulin pumps and related consumables. The Paradigm family of insulin pumps offers increased customization of the insulin dosage based on patient specific information and enhanced information management capabilities.

 

Looking ahead, we expect our Diabetes operating segment should benefit from the following:

 

 

 

Continued acceptance of the Paradigm REAL-Time sensor-augmented pump system, which integrates continuous glucose monitoring and insulin pump functionality.

 

 

 

Continued acceptance of the Guardian REAL-Time Continuous Glucose Monitoring System for diabetes management. The Guardian REAL-Time System is a stand alone glucose monitoring system that provides patients with real-time glucose trend graphs and predictive alarms informing them when their glucose levels become too high or too low, enabling better management of diabetes.

 

 

12



Table of Contents

 

 

Continued acceptance of the MiniLink REAL-Time Transmitter, our next generation sensor transmitter which received FDA approval in the third quarter of fiscal year 2007. The MiniLink REAL-Time Transmitter significantly improves patient comfort as the transmitter has no cable and is about one third the size of the previous version. The MiniLink REAL-Time Transmitter is rechargeable and can be used with the Paradigm REAL-Time System, as well as the Guardian REAL-Time System.

 

 

 

Continued acceptance of the pediatric versions of our Guardian REAL-Time and Paradigm REAL-Time Systems. In March 2007, we received FDA approval to market the systems specifically designed for ages 7 through 17. The Guardian REAL-Time System is clinically proven to help patients monitor and better control their diabetes.

 

Cardiac Surgery   Cardiac Surgery products consist of products for the repair and replacement of heart valves, perfusion systems, positioning and stabilization systems for beating heart surgery, surgical accessories, and surgical ablation products. Cardiac Surgery net sales for fiscal year 2007 increased 6 percent as compared to the prior fiscal year to $704 million. Foreign currency translation of $11 million had a favorable impact on net sales when compared to the prior fiscal year. The primary drivers for the increase in net sales during the year were the Valves and Perfusion businesses, which grew net sales by 9 percent and 4 percent, respectively, as compared to fiscal year 2006. The Valves business growth was led by tissue valves, which increased 10 percent as compared to the prior fiscal year. Key components of the tissue valve growth were sales of the Mosaic and Mosaic Ultra tissue valves, which incorporate several design features to facilitate implantation and improve hemodynamics, as well as sales of the Melody Transcatheter Pulmonary Valve and Ensemble Transcatheter Delivery System outside the U.S. Growth in the Perfusion business was led by sales outside the U.S., specifically the cardiopulmonary and cannulae product lines.

 

Cardiac Surgery net sales for fiscal year 2006 decreased 1 percent as compared to the prior fiscal year to $663 million. Foreign currency translation had an unfavorable impact on net sales of $7 million when compared to the prior fiscal year. Excluding the negative impact of currency, the performance of Cardiac Surgery was flat with the prior year, indicative of a market showing little to no growth. Cardiac Surgery Technologies enjoyed modest growth during fiscal year 2006, led by our Cardioblate BP2 (Bipolar) Surgical Ablation System, which offers surgeons the unique ability to perform an irrigated surgical ablation procedure.

 

Looking ahead, we expect our Cardiac Surgery operating segment should benefit from the following:

 

 

 

Continued acceptance of our Mosaic and Mosaic Ultra tissue valves. These two tissue valves have been shown to preserve the structure and function found in a natural aortic valve.

 

 

 

Further acceptance of the Melody Transcatheter Pulmonary Valve and Ensemble Transcatheter Delivery System, which received CE Mark approval for commercial sale in October 2006. A feasibility study to evaluate the use of the Medtronic Melody Transcatheter Pulmonary Valve and Ensemble Transcatheter Delivery System in the U.S. was initiated in February 2007, with the first U.S. patient being implanted. This technology provides a catheter-based approach to pulmonic valve replacement for patients with congenital heart defects, with the goal of reducing the number of open-heart surgeries required during the patient’s lifetime.

 

ENT   ENT operating segment consists of ear, nose, and throat related products (Core ENT) and neurologic technology-related products (Neurologic Technologies) including powered tissue-removal systems and other microendoscopy instruments, implantable devices, nerve monitoring systems, disposable fluid-control products, image-guided surgery systems, a Ménière’s disease therapy device, hydrocephalus shunt devices, external drainage systems, cranial fixation devices, neuroendoscopes, and dura repair products. ENT net sales for fiscal year 2007 increased by 8 percent over the prior fiscal year to $539 million. Foreign currency translation of $6 million had a favorable impact on net sales when compared to the prior fiscal year. Core ENT net sales grew 5 percent to $278 million in fiscal year 2007 led by continued physician acceptance of the Straightshot M4 Microdebrider and the NIM-Response 2.0 Nerve Integrity Monitor. Net sales within Core ENT were impacted by the loss of revenue from our tonometry product line, which was sold in the third quarter of fiscal year 2006. Neurologic Technologies net sales grew 11 percent to $261 million in fiscal year 2007. The primary drivers of growth in Neurologic Technologies were continued acceptance of high-speed powered surgical drill systems, including the EHS Stylus system and the Strata valve used in the treatment of hydrocephalus. The Strata valve is an adjustable flow control valve in which the resistance properties of the valve can be changed non-invasively by the caregiver. The valve is designed to minimize overdrainage of cerebrospinal fluid and maintain intraventricular pressure within a normal physiologic range, regardless of patient position.

 

13



Table of Contents

ENT net sales for fiscal year 2006 increased by 9 percent over the prior fiscal year to $501 million. Foreign currency translation had an unfavorable impact on net sales of $3 million when compared to the prior fiscal year. Core ENT related product net sales grew 10 percent to $266 million in fiscal year 2006. The primary drivers of the increase in Core ENT related product net sales were continued physician acceptance of the Straightshot M4 Microdebrider, the NIM-Response 2.0 Nerve Integrity Monitor, and image guided surgery systems. Neurologic Technologies net sales grew 8 percent to $235 million in fiscal year 2006. The primary drivers of growth in Neurologic Technologies were continued acceptance of the EHS Stylus powered surgical drill system and the Strata valve.

 

Looking ahead, we expect our ENT operating segment should benefit from the following:

 

 

 

Continued adoption of power systems for sinus procedures as well as continued adoption of nerve monitoring for ENT and thyroid procedures.

 

 

 

Continued development of the normal pressure hydrocephalus market, resulting in increased sales of our shunt products, including the Strata valve.

 

 

 

Continued acceptance of our Legend high-speed drill systems, electric bone mill, and Durepair dura substitute.

 

Physio-Control Physio-Control offers external defibrillation and emergency response systems, data management solutions, and support services used by hospitals and emergency response personnel. Physio-Control fiscal year 2007 net sales decreased 7 percent from the prior fiscal year to $385 million. Foreign currency translation of $9 million had a favorable impact on net sales when compared to the prior fiscal year. The decrease in sales was caused by our January 15, 2007 voluntary suspension of U.S. shipments of Physio-Control products manufactured at our facility in Redmond, Washington in order to address quality system issues. The U.S. suspension led to a 20 percent reduction in U.S. sales which was partially offset by 19 percent growth in sales outside the U.S. driven by continued market acceptance of the LIFEPAK CR Plus defibrillator, an automated external defibrillator designed for both the commercial and consumer market. See further discussion related to the U.S. suspension of shipments in the “Other Matters” section of this management’s discussion and analysis.

 

Physio-Control fiscal year 2006 net sales were essentially flat as compared to the prior fiscal year at $412 million. Foreign currency translation of $5 million had an unfavorable impact on net sales when compared to the prior fiscal year. Our results were flat as a result of supplier issues which negatively impacted our operations in the second and third quarters of fiscal year 2006, but growth accelerated in the fourth quarter as supplier issues were corrected. We also experienced continued acceptance of the LIFEPAK CR Plus defibrillator and the LIFEPAK 20 defibrillator, an external defibrillator for use by both first responders and professionals in a hospital or clinical setting.

 

14



Table of Contents

Looking ahead, we expect our Physio-Control operating segment should benefit from the following:

 

 

 

Our anticipated return to the U.S. market in fiscal year 2008. We look forward to returning to strong growth in the U.S. once we have agreed with the FDA on a correction to the quality system issues.

 

 

 

The continued market acceptance outside the U.S. of our LIFEPAK family of automated external defibrillators.

 

Continued net sales growth in all operating segments is contingent on our ability to gain further market share, penetrate existing markets, develop new products, improve existing products, and develop new markets.

 

Costs and Expenses

 

The following is a summary of major costs and expenses as a percent of net sales:

 

 

Fiscal Year

 

 

 

2007

 

2006

 

2005

 

Cost of products sold

 

25.8

%

24.9

%

24.3

%

Research and development expense

 

10.1

 

9.9

 

9.5

 

Selling, general and administrative expense

 

33.8

 

32.4

 

32.0

 

Special charges

 

0.8

 

0.9

 

 

Restructuring charges

 

0.2

 

 

 

Certain litigation charges

 

0.3

 

 

6.5

 

IPR&D charges

 

 

3.2

 

 

Other expense, net

 

1.7

 

1.5

 

2.9

 

Interest income, net

 

(1.3

)

(0.8

)

(0.4

)

 

Cost of Products Sold   Fiscal year 2007 cost of products sold as a percent of net sales increased 0.9 of a percentage point from fiscal year 2006 to 25.8 percent. The increase in cost of products sold as a percentage of net sales was due to 0.1 of a percentage point increase for the recognition of $15 million of incremental stock-based compensation expense in fiscal year 2007, 0.2 of a percentage point increase for unfavorable manufacturing variances, and 0.9 of a percentage point increase relating to geographic and product mix shifts. The product mix impact was the result of decreased sales of higher margin ICDs in the U.S. and increased sales of INFUSE Bone Graft and certain tissue products in our Spinal business which have margins that are below our average gross margins. These increases were offset by 0.3 of a percentage point of favorable foreign currency adjustments. We expect cost of products sold, as a percentage of revenue, to continue in the 24.0 percent to 25.0 percent range.

 

Fiscal year 2006 cost of products sold as a percent of net sales increased 0.6 of a percentage point from fiscal year 2005 to 24.9 percent. The increase in cost of products sold as a percentage of net sales was driven by two main components. Unfavorable foreign currency translation reduced gross margin by 0.2 of a percentage point and product mix reduced gross margin by 0.4 of a percentage point. The product mix impact was the result of increased sales of INFUSE Bone Graft and certain tissue products in our Spinal business which have margins that are below our average margins, and strong sales of ICDs outside the U.S. which have lower gross margins than ICDs in the U.S.

 

Research and Development   We continue to invest heavily in the future by spending aggressively on research and development efforts. Research and development spending was $1.239 billion in fiscal year 2007 representing 10.1 percent of net sales, an increase of 0.2 of a percentage point over fiscal year 2006. The 0.2 of a percentage point increase over the prior year was the result of the recognition of $31 million of incremental stock-based compensation expense in fiscal year 2007. Excluding the incremental stock-based compensation expense, research and development expense was flat as a percentage of sales as compared to fiscal year 2006, but on a gross basis increased $95 million, or 9.0 percent as compared to the prior fiscal year. We remain committed to developing technological enhancements and new indications for existing products and new, less invasive, technologies to address unmet medical needs. That commitment leads to our initiation and participation in numerous clinical trials in every fiscal year. Furthermore, we expect our development activities to help reduce patient care costs and the length of hospital stays in the future.

 

15



Table of Contents

Research and development spending was $1.113 billion in fiscal year 2006. This level of spending represented 9.9 percent of net sales, an increase of 0.4 of a percentage point over fiscal year 2005. The increase was a result of our commitment to developing technological enhancements and new indications for existing products and new, less invasive, technologies to address unmet medical needs.

 

In addition to our investment in research and development, we continue to access new technologies in areas served by our existing businesses, as well as in new areas, through acquisitions, licensing agreements, alliances, and certain strategic equity investments.

 

Selling, General and Administrative   Fiscal year 2007 selling, general and administrative expense as a percentage of net sales increased by 1.4 percentage points from fiscal year 2006 to 33.8 percent. The recognition of incremental stock-based compensation expense of $104 million drove 0.9 of a percentage point of the overall increase. The remaining increase in selling, general and administrative expense for fiscal year 2007 was due to expenses associated with our previously communicated investment in our marketing campaign for CRDM, the expansion of our sales forces across all businesses, especially in the Vascular business as we prepare for the U.S. launch of Endeavor DES, and costs associated with our global information technology system implementation. These increases were offset by our continual cost control measures across all of our businesses and attempts to leverage the general and administrative expense categories.

 

Fiscal year 2006 selling, general and administrative expense as a percentage of net sales increased by 0.4 of a percentage point from fiscal year 2005 to 32.4 percent. The increase in selling, general and administrative expense as a percentage of net sales primarily related to our continued investment in expanding our sales organization, increased spending on our global enterprise resource planning (ERP) infrastructure, and the compensation expenses associated with our record revenues and strong earnings. These increases were partially offset by continued cost control measures across all of our businesses.

 






16



Table of Contents

Special, Restructuring, Certain Litigation, and IPR&D Charges, and Certain Tax Adjustments We believe that in order to properly understand our short-term and long-term financial trends, investors may find it useful to consider the impact of special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments. Special charges (such as asset impairment charges), restructuring charges, certain litigation charges in connection with either settlements or judgments from material litigation, IPR&D charges, and certain tax adjustments recorded during the previous three fiscal years are as follows:

 

 

 

Fiscal Year

 

 

 

2007

 

2006

 

2005

 

(dollars in millions, except per share data)

 

 

 

 

 

 

 

 

 

 

Special charges:

 

 

 

 

 

 

 

 

 

 

Asset impairment charges (net of $39 tax)

 

$

59

 

$

 

$

 

Medtronic Foundation donation (net of $34 tax)

 

 

 

 

66

 

 

 

Total special charges

 

 

59

 

 

66

 

 

 

Restructuring charges (net of $11 tax)

 

 

25

 

 

 

 

 

Certain litigation charges (net of $0 and $236 tax, respectively)

 

 

40

 

 

 

 

418

 

IPR&D charges (net of $69 tax)

 

 

 

 

295

 

 

 

Tax benefit from the reversal of tax reserves

 

 

(129

 

(225

 

 

Tax impact for the repatriation of foreign earnings

 

 

 

 

 

 

49

 

Total special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments, after-tax

 

$

(5

$

136

 

$

467

 

 

 

 

 

 

 

 

 

 

 

 

Per Diluted Share Data:

 

 

 

 

 

 

 

 

 

 

Special charges

 

$

0.05

 

$

0.05

 

$

 

Restructuring charges

 

 

0.02

 

 

 

 

 

Certain litigation charges

 

 

0.04

 

 

 

 

0.34

 

IPR&D

 

 

 

 

0.24

 

 

 

Tax benefit from the reversal of tax reserves

 

 

(0.11

)

 

(0.18

)

 

 

Tax impact for the repatriation of foreign earnings

 

 

 

 

 

0.04

 

Total Per Diluted Share

 

$

 

$

0.11

 

$

0.38

 

 

Special Charges In fiscal year 2007 we concluded two intangible assets were impaired due to inadequate clinical results and the resulting delays in product development. As a result, in the fourth quarter of fiscal year 2007 we recorded a $59 million after-tax ($98 million pre-tax) special charge related to the impairments of intangible assets stemming from the July 1, 2005 acquisition of Transneuronix, Inc. (TNI) and the November 1, 2004 acquisition of Angiolink Corporation (Angiolink). TNI focused on the development of an implantable gastric stimulator to treat obesity. Angiolink focused on the development of wound closure devices for vascular procedures.

 

In fiscal year 2006, we recorded a $66 million after-tax ($100 million pre-tax) charitable donation to The Medtronic Foundation, which is a related party non-profit organization. The donation to The Medtronic Foundation was paid in the second quarter of fiscal year 2006.

 

There were no special charges in fiscal year 2005.

 

Restructuring Charges In fiscal year 2007, we recorded a $25 million ($36 million pre-tax) restructuring charge, which consisted of employee termination costs of $20 million ($28 million pre-tax) and asset write-downs of $5 million ($8 million pre-tax). These initiatives began in the fourth quarter of fiscal year 2007 and are designed to drive manufacturing efficiencies in our Vascular business, downsize our Physio-Control business due to our voluntary suspension of U.S. shipments, and rebalance resources within our CRDM business in response to current market dynamics. The employee termination costs consist of severance and the associated costs of continued medical benefits, and outplacement services. We have identified approximately 900 positions for elimination which will be achieved through early retirement packages offered to employees, voluntary separations, and involuntary separations, as necessary. Of the positions identified for elimination, 196 have been eliminated as of April 27, 2007. The asset write-downs consist of a $4 million after-tax charge for inventory write-downs, and a $1 million after-tax charge for asset write-downs. The inventory and asset write-downs were recorded within cost of products sold in the consolidated statement of earnings.

 

17



Table of Contents

The restructuring initiatives, which are scheduled to be completed by the end of fiscal year 2008, are expected to produce annualized operating savings of approximately $125 million. These savings will arise mostly from reduced compensation expense.

 

In the first quarter of fiscal year 2008 we expect to incur additional charges related to our restructuring initiatives that began in the fourth quarter of fiscal year 2007. Part of the additional expense is anticipated from increased retirement benefits in our defined benefit pension plans provided to those employees that elect early retirement. Additionally, we will recognize added expense associated with compensation provided to select employees whose employment terminates with the Company in the first quarter of fiscal year 2008 as part of the restructuring. These incremental costs were not accrued in fiscal year 2007 because they had not yet been communicated to the impacted employees.

 

There were no restructuring charges in fiscal years 2006 and 2005.

 

Certain Litigation Charges During fiscal year 2007, we recorded a certain litigation charge of $40 million related to a settlement agreement with the United States Department of Justice which requires the government to obtain dismissal of two qui tam civil suits pending against us, and is conditioned upon such dismissal being obtained. The two suits were based upon allegations about certain sales and marketing practices in the Spinal business. The settlement agreement reflects our assertion that the Company and its current employees have not engaged in any wrongdoing or illegal activity.

 

There were no certain litigation charges in fiscal year 2006.

 

In fiscal year 2005, we recorded after-tax certain litigation charges of $418 million ($654 million pre-tax). The largest of the charges, in the amount of $550 million pre-tax, occurred in the fourth quarter and related to costs for the settlement of all outstanding litigation and disputes with Gary Michelson, M.D. and Karlin Technology, Inc. (Michelson). The agreement reached with Michelson required a total cash payment of $1.350 billion for the settlement of all ongoing litigation and the purchase of a portfolio of more than 100 issued U.S. patents, over 110 pending U.S. patent applications and numerous foreign counterparts to these patents and patent applications. The $550 million was assigned to past damages between the parties and was recorded as an expense in fiscal year 2005. The remaining consideration, including $3 million of direct acquisition costs, was allocated between $628 million of acquired technology based intangible assets and $175 million of IPR&D that was expensed on the date of acquisition (May 18, 2005). Also, in the fourth quarter of fiscal year 2005, we recorded a pre-tax charge of $80 million resulting from a final arbitration award for breach of contract damages related to a March 2002 agreement between us and ETEX Corporation (ETEX). The $80 million included $64 million in damages, interest, and partial legal fees and the forgiveness of an existing $17 million note owed to us by ETEX. In the third quarter of fiscal year 2005, we recorded a pre-tax charge of $24 million related to the DePuy/AcroMed litigation. The jury found that the thoracolumbar multiaxial screw design of Medtronic Sofamor Danek, Inc. (MSD), which MSD no longer sells in the U.S., infringed patents held by DePuy/AcroMed under the doctrine of equivalents. In February 2005, the Court entered judgment against MSD in the amount of $24 million, which included prejudgment interest. Given the judgment entered by the Court and our conclusion that the incurrence of such an expense was both probable and could be reasonably estimated under SFAS No. 5 at that point and time, we recorded a $24 million charge related to this judgment. MSD has appealed the jury’s verdict and intends to continue to contest the charges vigorously. In fiscal year 2007, we paid the outstanding Depuy/AcroMed judgment and interest under protest.

 

18



Table of Contents

IPR&D Charges There were no IPR&D charges for fiscal year 2007.

 

During the first quarter of fiscal year 2006, we acquired TNI. At the date of the acquisition, $169 million of the purchase price was expensed as IPR&D related to a product being developed for the treatment of obesity by stimulation of the stomach that had not yet reached technological feasibility and had no future alternative use.

 

During the first quarter of fiscal year 2006, we acquired substantially all of the spine-related intellectual property and related contracts, rights, and tangible materials owned by Michelson. At the date of acquisition, $175 million of the purchase price was expensed as IPR&D related to spinal technology based devices that had not yet reached technological feasibility and which had no future alternative use. The patents pertain to novel spinal technology and techniques that have the potential for future patentable commercial products in the area of spinal surgery.

 

On July 27, 2005, we also entered into a royalty bearing, non-exclusive patent cross-licensing agreement with NeuroPace, Inc. On the date of the agreement, $20 million was expensed as IPR&D related to the licensed technology since technological feasibility of the project had not yet been reached and it had no future alternative use. This licensed technology is expected to enhance our ability to further develop and expand our therapies for neurological disorders.

 

There were no IPR&D charges recorded in fiscal year 2005.

 

We are responsible for the valuation of IPR&D charges. The values assigned to IPR&D are based on valuations that have been prepared using methodologies and valuation techniques consistent with those used by independent appraisers. All values were determined by identifying research projects in areas for which technological feasibility had not been established. Additionally, the values were determined by estimating the revenue and expenses associated with a project’s sales cycle and the amount of after-tax cash flows attributable to these projects. The future cash flows were discounted to present value utilizing an appropriate risk-adjusted rate of return. The rate of return included a factor that takes into account the uncertainty surrounding the successful development of the IPR&D.

 

At the time of acquisition, we expect all acquired IPR&D will reach technological feasibility, but there can be no assurance that the commercial viability of these products will actually be achieved. The nature of the efforts to develop the acquired technologies into commercially viable products consists principally of planning, designing and conducting clinical trials necessary to obtain regulatory approvals. The risks associated with achieving commercialization include, but are not limited to, delay or failure to obtain regulatory approvals to conduct clinical trials, delay or failure to obtain required market clearances, and patent litigation. If commercial viability were not achieved, we would likely look to other alternatives to provide these therapies.

 

See the “Acquisitions” section of this management’s discussion and analysis for detailed discussion of each material acquisition in fiscal years 2007 and 2006.

 

Certain Tax Adjustments In fiscal year 2007, we recorded a $129 million tax benefit associated with the reversal of excess tax accruals in connection with the settlement reached with the U.S. Internal Revenue Service (IRS) with respect to their review of our fiscal years 2003 and 2004 domestic income tax returns, the resolution of competent authority issues for fiscal years 1992 through 2000, and adjustments to the finalization of the fiscal year 2006 U.S. federal and state income tax returns. The $129 million tax benefit has been recorded in the provision for income taxes in the consolidated statement of earnings for fiscal year 2007.

 

In fiscal year 2006, we reversed excess tax accruals of $225 million associated with favorable agreements reached with the IRS involving the review of our fiscal years 1997 through 2002 domestic income tax returns. The $225 million tax benefit has been recorded in the provision for income taxes in the consolidated statement of earnings for fiscal year 2006.

 

19



Table of Contents

During the fourth quarter of fiscal year 2006, we repatriated the entire amount eligible under the American Jobs Creation Act of 2004 (Jobs Creation Act), or $934 million. The amounts repatriated were used for “qualified expenditures” as defined under the Jobs Creation Act such as qualified research and development activities, construction of a new U.S. facility, and qualified selling and marketing activities. As of April 29, 2005, we had recorded a deferred tax liability of $49 million associated with our planned repatriation of these funds, and we included that amount in the table above and in provision for income taxes in the consolidated statements of earnings.

 

Other Expense, Net   Other expense, net includes intellectual property amortization expense, royalty income and expense, realized equity security gains and losses, realized foreign currency transaction and derivative gains and losses, and impairment charges on equity securities. In fiscal year 2007, net other expense was $212 million, an increase of $45 million from $167 million in fiscal year 2006. This change is partially due to currency hedges, which resulted in gains in fiscal year 2007 of $20 million versus gains in fiscal year 2006 of $92 million. Fiscal year 2007 was also positively impacted by $55 million due to the accelerated amortization of deferred income in connection with a product supply agreement in the Vascular business, where the other party elected not to exercise its option to extend the agreement.

 

Net other expense decreased from $291 million in fiscal year 2005 to $167 million in fiscal year 2006, a $124 million decrease. This decrease was primarily driven by a shift from a loss in fiscal year 2005 to a gain in fiscal year 2006 on foreign exchange contracts used to hedge results of operations. In fiscal year 2006, our gain on foreign exchange contracts was $92 million compared to a loss of $135 million in fiscal year 2005. During fiscal year 2006, the gains on the foreign exchange contracts were partially offset by $42 million of expense associated with impairments on equity securities and $86 million in increased royalty expense, primarily in our Vascular and Spinal businesses.

 

Interest Income, Net   In fiscal year 2007, net interest income was $154 million, an increase of $67 million from net interest income of $87 million in fiscal year 2006. The increase in net interest income in fiscal year 2007 as compared to fiscal year 2006 is a result of higher average cash and cash investment balances as compared to prior periods. Interest income continues to increase, as we have maintained our ability to generate rates of return on our investments that exceed the interest rates we are paying on our outstanding debt.

 

In fiscal year 2006, net interest income was $87 million, an increase of $42 million from net interest income of $45 million in fiscal year 2005. The increase in net interest income in fiscal year 2006 as compared to fiscal year 2005 was primarily a result of increased levels of interest-bearing investments and higher interest rates.

 






20



Table of Contents

Income Taxes

 

 

Fiscal Year

 

Percentage Point
Increase/(Decrease)

 

 

2007

 

2006

 

2005

 

FY07/06

 

FY06/05

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income tax

 

$

713

 

$

614

 

$

740

 

N/A

 

N/A

Effective tax rate

 

 

20.3

%

 

19.4

%

 

29.1

%

0.9

 

(9.7)

Impact of repatriation, special, restructuring, certain litigation,
and IPR&D charges, and certain tax adjustments

 

 

(4.2)

 

 

(6.6

)

 

0.1

 

(2.4)

 

6.7

Non-GAAP nominal tax rate (1)

 

 

24.5

%

 

26.0

%

 

29.0

%

(1.5)

 

(3.0)

_______________

(1)

Non-GAAP nominal tax rate is defined as the income tax (benefit) provision as a percentage of taxable income, excluding repatriation, special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments. We believe that the resulting non-GAAP financial measure provides useful information to investors because it excludes the effect of certain discrete items so that investors can compare our recurring results over multiple periods.

 

The effective tax rate of 20.3 percent increased by 0.9 of a percentage point from fiscal year 2006 to fiscal year 2007. This increase reflects the 1.5 percentage points decrease in the non-GAAP nominal tax rate and 2.4 percentage points increase from the special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments. The non-GAAP nominal tax rate decreased from 26.0 percent in fiscal year 2006 to 24.5 percent in fiscal year 2007 as a result of increased benefits from our international operations subject to tax rates lower than our U.S. statutory tax rates. The remaining 2.4 percentage points increase is largely due to a $129 million tax benefit recorded in fiscal year 2007 compared to the $225 million tax benefit recorded in fiscal year 2006. The $129 million tax benefit reflects the reversal of excess tax accruals in connection with the settlement reached with the IRS involving the review of our fiscal years 2003 and 2004 domestic tax returns, the resolution of competent authority issues for fiscal years 1992 through 2000, and adjustments to the finalization of the fiscal year 2006 U.S. federal and state income tax returns.

 

The effective tax rate of 19.4 percent decreased by 9.7 percentage points from fiscal year 2005 to fiscal year 2006. This decrease reflected the 3.0 percentage points decrease in the non-GAAP nominal tax rate and 6.7 percentage points decrease from the amounts repatriated under the Jobs Creation Act, special, certain litigation, and IPR&D charges, and certain tax adjustments. The non-GAAP nominal tax rate decreased from 29.0 percent in fiscal year 2005 to 26.0 percent in fiscal year 2006 as a result of increased benefits from our international operations subject to tax rates lower than our U.S. statutory tax rates. The remaining 6.7 percentage decrease is primarily due to a $225 million tax benefit associated with the favorable agreements reached with the IRS involving the review of our fiscal years 1997 through 2002 domestic tax returns offset by taxes provided for amounts repatriated under the Jobs Creation Act, special, certain litigation, and IPR&D charges. As a result of the agreements reached with the IRS, we made approximately $326 million in incremental tax payments during the third quarter of fiscal year 2006. These payments reduced accrued income taxes in the fiscal year 2006 consolidated balance sheet.

 

Tax audits associated with the allocation of income, and other complex issues, may require an extended period of time to resolve and may result in income tax adjustments if changes to our allocation are required between jurisdictions with different tax rates. Tax authorities periodically review our tax returns and propose adjustments to our tax filings. Tax years settled with the IRS remain open for foreign tax audits and competent authority proceedings. Competent authority proceedings are a means to resolve intercompany pricing disagreements between countries.

 

The IRS has finalized its audits with us for all years through fiscal year 1996. The IRS has issued its audit reports for fiscal years 1997 through 2004. We have resolved or reached agreement with the IRS on all significant issues for fiscal years 1997 through 2004, except for an issue related to the allocation of income between Medtronic, Inc., and its wholly owned subsidiary in Switzerland. The unresolved issues from the fiscal years 1997 through 2004 tax audits and tax positions taken by the IRS or foreign tax authorities, with respect to potential issues on future tax audits could have a material impact on our effective tax rate in future periods. We continue to believe that we have meritorious defenses for our tax filings and will vigorously defend them through litigation in the courts, if necessary. We believe we have provided for probable liabilities resulting from tax assessments by taxing authorities.

 

21



Table of Contents

Liquidity and Capital Resources

 

 

Fiscal Year

 

 

 

2007

 

2006

 

(dollars in millions)

 

 

 

 

 

 

 

Working capital

 

$

5,355

 

$

5,971

 

Current ratio*

 

 

3.1:1.0

 

 

2.4:1.0

 

Cash, cash equivalents, and short-term investments

 

$

3,078

 

$

6,101

 

Long-term investments in public and private debt securities**

 

 

3,004

 

 

767

 

Cash, cash equivalents, short-term investments, and long-term debt securities

 

 

6,082

 

 

6,868

 

Short-term borrowings and long-term debt

 

 

6,087

 

 

7,923

 

Net cash position***

 

$

(5

)

$

(1,055

_______________

*

Current ratio is the ratio of current assets to current liabilities.

**

Long-term investments include public and private debt securities with a maturity date greater than one year from the end of the period.

***

Net cash position is the sum of cash, cash equivalents, short-term investments, and long-term investments in debt securities less short-term borrowings and long-term debt.

 

The increase in our net cash position in fiscal year 2007 as compared to fiscal year 2006 primarily relates to income from operations and other cash proceeds offset by cash used for the retirement of $1.877 billion in debentures, capital expenditures, dividend payments, and share repurchases. See the “Summary of Cash Flows” section of this management’s discussion and analysis for further discussion of our cash uses and proceeds. The decrease in our working capital relates to our movement of cash into long-term investments from short-term investments in fiscal year 2007 to generate higher interest income offset by normal operating changes in other account balances.

 

At April 27, 2007 and April 28, 2006, $5.428 billion and $4.168 billion, respectively, of cash, cash equivalents, and short- and long-term debt securities were held by our non-U.S. subsidiaries. These funds are available for use by worldwide operations; however, if these funds are repatriated to the U.S. or used for U.S. operations, the amounts would be subject to U.S. tax.

 

We believe that our existing cash and investments, as well as our available unused lines of credit and commercial paper capacity of $2.440 billion, if needed, will satisfy our foreseeable working capital requirements for at least the next twelve months. However, we periodically consider various financing alternatives and may, from time to time, seek to take advantage of favorable interest rate environments or other market conditions.

 



22



Table of Contents

Summary of Cash Flows

 

 

Fiscal Year

 

 

 

2007

 

2006

 

2005

 

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

Cash provided by (used in):

 

 

 

 

 

 

 

 

 

 

Operating activities

 

$

2,979

 

$

2,220

 

$

2,824

 

Investing activities

 

 

(1,701

)

 

(2,867

)

 

(1,603

)

Financing activities

 

 

(3,011

)

 

1,304

 

 

(494

)

Effect of exchange rate changes on cash and cash equivalents

 

 

(5

)

 

105

 

 

(89

)

Net change in cash and cash equivalents

 

$

(1,738

$

762

 

$

638

 

 

Operating Activities

Our net cash provided by operating activities was $2.979 billion for the fiscal year ended April 27, 2007 compared to net cash provided by operating activities of $2.220 billion in the same period of the prior year. The $759 million increase in net cash provided by operating activities was primarily attributable to:

 

A $1.055 billion decrease in cash used for operating assets and liabilities, primarily driven by a $657 million change in accounts payable and accrued liabilities and changes in deferred taxes and a $233 million change in inventory

 

partially offset by:

 

The timing of other receipts and payments in the ordinary course of business

 

Our net cash provided by operating activities was $2.220 billion for the fiscal year ended April 28, 2006 compared to net cash provided by operating activities of $2.824 billion in the same period of the prior year. The $604 million decrease in net cash provided by operating activities was primarily attributable to:

 

A $612 million payment for previously settled and accrued litigation

 

 

 

 

A $326 million payment of previously accrued income taxes in conjunction with the settlement reached with the IRS

 

 

 

 

A $49 million payment of income taxes associated with our repatriation of foreign subsidiary income

 

 

 

 

A $778 million decrease related to the timing of payment on inventory and other operating costs

 

 

 

partially offset by:

 

The timing of other receipts and payments in the ordinary course of business

 

 

 

 

Investing Activities

Our net cash used in investing activities was $1.701 billion for the fiscal year ended April 27, 2007 compared to $2.867 billion used in investing activities for the fiscal year ended April 28, 2006. The $1.166 billion decrease in net cash used in investing activities was primarily attributable to:

 

A decrease of $993 million in cash used for acquisitions and purchase of intellectual property, as fiscal year 2006 included several acquisitions

 

 

 

 

A $495 million decrease in cash used to purchase marketable securities

 

 

 

partially offset by:

 

A $166 million increase in capital expenditures for property, plant, and equipment

 

 

23



Table of Contents

Our net cash used in investing activities was $2.867 billion for the fiscal year ended April 28, 2006 compared to $1.603 billion used in investing activities for the fiscal year ended April 29, 2005. The $1.264 billion increase in net cash used in investing activities was primarily attributable to:

 

A $1.004 billion increase in cash used for acquisitions and purchases of intellectual property, as fiscal year 2006 included several acquisitions

 

 

 

 

A $440 million increase in cash used to purchase marketable securities

 

 

 

partially offset by:

 

A $45 million decrease in capital expenditures for property, plant, and equipment and an increase of $131 million from other investing activities

 

Financing Activities

Our net cash used in financing activities was $3.011 billion for the fiscal year ended April 27, 2007, compared to net cash provided by financing activities of $1.304 billion for the fiscal year ended April 28, 2006. The $4.315 billion increase in net cash used in financing activities was primarily attributable to:

 

$1.877 billion in cash used to repurchase long-term debt as the bond holders put the Contingent Convertible Debentures to us in fiscal year 2007

 

 

 

 

A $5.428 billion decrease in proceeds from the issuance of long-term debt as we had issued $1.000 billion in Senior Notes and $4.400 billion of Senior Convertible Notes in the prior year

 

 

 

 

A $175 million decrease in proceeds from issuance of common stock and $1.075 billion decrease in proceeds from the sale of call options

 

partially offset by:

 

A $2.550 billion decline in cash used to repurchase common stock

 

 

 

 

A $517 million net reduction in sale of warrants

 

Our net cash provided by financing activities was $1.304 billion for the fiscal year ended April 28, 2006, compared to net cash used by financing activities of $494 million for the fiscal year ended April 29, 2005. The $1.798 billion increase in net cash provided by financing activities was primarily attributable to:

 

Proceeds of $5.428 billion from the issuance of long-term debt and $506 million from the issuance of stock in fiscal year 2006, increases of $5.428 billion and $172 million over fiscal year 2005, respectively

 

 

 

 

Proceeds of $517 million from the sale of warrants in fiscal year 2006

 

partially offset by:

 

Stock repurchases of  $3.589 billion, an increase of $3.078 billion from fiscal year 2005

 

 

 

 

Cash of $1.075 billion used to purchase call options in fiscal year 2006

 

 

24



Table of Contents

Off-Balance Sheet Arrangements and Long-Term Contractual Obligations

 

We acquire assets still in development, enter into research and development arrangements and sponsor certain clinical trials that often require milestone and/or royalty payments to a third-party, contingent upon the occurrence of certain future events. Milestone payments may be required contingent upon the successful achievement of an important point in the development life cycle of a product or upon certain pre-designated levels of achievement in clinical trials. In addition, if required by the arrangement, we may have to make royalty payments based on a percentage of sales related to the product under development or in the event that regulatory approval for marketing is obtained. In situations where we have no ability to influence the achievement of the milestone or otherwise avoid the payment, we have included those milestone or minimum royalty payments in the following table. However, the majority of these arrangements give us the discretion to unilaterally make the decision to stop development of a product or cease progress of a clinical trial, which would allow us to avoid making the contingent payments. Although we are unlikely to cease development if a device successfully achieves clinical testing objectives, these payments are not included in the table of contractual obligations because of the contingent nature of these payments and our ability to avoid them if we decided to pursue a different path of development or testing.

 

In the normal course of business, we periodically enter into agreements that require us to indemnify customers or suppliers for specific risks, such as claims for injury or property damage arising out of our products or the negligence of our personnel or claims alleging that our products infringe third-party patents or other intellectual property. Our maximum exposure under these indemnification provisions cannot be estimated, and we have not accrued any liabilities within our consolidated financial statements or included any indemnification provisions in our commitments table. Historically, we have not experienced significant losses on these types of indemnification obligations.

 

 






25



Table of Contents

We believe our off-balance sheet arrangements do not have a material current or anticipated future effect on our consolidated earnings, financial position or cash flows. Presented below is a summary of contractual obligations and other minimum commercial commitments. See Notes 5, 7 and 14 to the consolidated financial statements for additional information regarding foreign currency contracts, long-term debt and lease obligations, respectively.

 

 

 

Maturity by Fiscal Year

 

 

 

Total

 

2008

 

2009

 

2010

 

2011

 

2012

 

Thereafter

 

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual obligations related to off-balance sheet arrangements:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency contracts(1)

 

$

5,372

 

$

3,806

 

$

1,262

 

$

304

 

$

 

$

 

$

 

Operating leases(2)

 

 

193

 

 

68

 

 

53

 

 

33

 

 

13

 

 

5

 

 

21

 

Inventory purchases(3)

 

 

621

 

 

292

 

 

134

 

 

73

 

 

67

 

 

13

 

 

42

 

Commitments to fund minority investments/contingent acquisition consideration(4)

 

 

124

 

 

47

 

 

20

 

 

19

 

 

17

 

 

1

 

 

20

 

Interest payments(5)

 

 

652

 

 

116

 

 

115

 

 

115

 

 

106

 

 

64

 

 

136

 

Other(6)

 

 

383

 

 

241

 

 

40

 

 

31

 

 

23

 

 

14

 

 

34

 

Total

 

$

7,345

 

$

4,570

 

$

1,624

 

$

575

 

$

226

 

$

97

 

$

253

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual obligations reflected in the balance sheet:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term debt, excluding capital leases(7)

 

$

5,494

 

$

 

$

94

 

$

 

$

2,600

 

$

 

$

2,800

 

Capital leases(8)

 

 

89

 

 

5

 

 

12

 

 

14

 

 

17

 

 

18

 

 

23

 

Other(9)

 

 

12

 

 

12

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

5,595

 

$

17

 

$

106

 

$

14

 

$

2,617

 

$

18

 

$

2,823

 

_______________

(1)

As these obligations were entered into as hedges, the majority of these obligations will be offset by losses/gains on the related assets, liabilities and transactions being hedged.

(2)

Certain leases require us to pay real estate taxes, insurance, maintenance, and other operating expenses associated with the leased premises. These future costs are not included in the schedule above.

(3)

We have included inventory purchase commitments which are legally binding and specify minimum purchase quantities. These purchase commitments do not exceed our projected requirements and are in the normal course of business. These commitments do not include open purchase orders.

(4)

Certain commitments related to the funding of minority investments and/or previous acquisitions are contingent upon the achievement of certain product-related milestones and various other favorable operational conditions. While it is not certain if and/or when these payments will be made, the maturity dates included in this table reflect our best estimates.

(5)

Interest payments in the table above reflect the interest on our outstanding debt, including the $4.400 billion of Senior Convertible Notes, $1.000 billion of Senior Notes and $94 million of Contingent Convertible Debentures. The interest rate on each outstanding obligation varies and interest is payable semi-annually. The interest rate is 1.500 percent on the $2.200 billion Senior Convertible Notes due 2011 and 1.625 percent on the $2.200 billion Senior Convertible Notes due 2013, 4.375 percent on the $400 million of Senior Notes due 2010, 4.750 percent on the $600 million of Senior Notes due 2015, and 1.250 percent on the Contingent Convertible Debentures due 2021.

(6)

These obligations include commitments to replace our existing legacy enterprise resource systems, construction of our new CRDM campus, and certain research and development arrangements.

(7)

Long-term debt in the table above includes $4.400 billion Senior Convertible Notes issued in April 2006, $1.000 billion Senior Notes issued in September 2005 and $94 million related to our Contingent Convertible Debentures. In September 2006 we repurchased $1.877 billion of Contingent Convertible Debentures as a result of certain holders exercising their put options. The table above also includes the impact of the five year interest rate swap entered into in November 2005.

(8)

Capital lease obligations include a sale-leaseback agreement entered into in the fourth quarter of fiscal year 2006 whereby certain manufacturing equipment was sold and is being leased by us over a seven year period.

(9)

These obligations include royalty payments and a financing arrangement associated with our fiscal year 2002 acquisition of Kobayashi Pharmaceutical Co.’s interest in a joint venture it had formed with us in 1996 to distribute spinal products in Japan.

 

26



Table of Contents

Debt and Capital

 

In October 2005, our Board of Directors authorized the repurchase of up to 40 million shares of our common stock and in April 2006, the Board of Directors made a special authorization for us to repurchase up to 50 million shares in connection with the $4.400 billion Senior Convertible Note offering (see below for further discussion). Shares are repurchased from time to time to support our stock-based compensation programs and to take advantage of favorable market conditions. During fiscal years 2007 and 2006, we repurchased approximately 21.7 million shares and 68.9 million shares at an average price of $47.83 and $52.12, respectively. The amounts disclosed as repurchased for fiscal year 2007 include 544,224 shares that we obtained as part of the final settlement of the previously announced and executed accelerated share repurchase program. Excluding the shares obtained in the settlement of the accelerated share repurchase program, for fiscal year 2007 we repurchased 21.2 million shares at an average price of $49.06. As of April 27, 2007, we have approximately 15.1 million shares remaining under current buyback authorizations approved by the Board of Directors.

 

In June 2007, our Board of Directors authorized the repurchase of an additional 50 million shares of our common stock.

 

In April 2006, we issued $2.200 billion of 1.500 percent Senior Convertible Notes due 2011 and $2.200 billion of 1.625 percent Senior Convertible Notes due 2013, collectively the Senior Convertible Notes. The Senior Convertible Notes were issued at par and pay interest in cash semi-annually in arrears on April 15 and October 15 of each year. The Senior Convertible Notes are unsecured unsubordinated obligations and rank equally with all other unsecured and unsubordinated indebtedness. The Senior Convertible Notes have an initial conversion price of $56.14 per share. The Senior Convertible Notes may only be converted: (i) during any calendar quarter if the closing price of our common stock reaches 140 percent of the conversion price for 20 trading days during a specified period, or (ii) if specified distributions to holders of our common stock are made or specified corporate transactions occur, or (iii) during the last month prior to maturity of the applicable notes. Upon conversion, a holder would receive: (i) cash equal to the lesser of the principal amount of the note or the conversion value and (ii) to the extent the conversion value exceeds the principal amount of the note, shares of our common stock, cash, or a combination of common stock and cash, at our option. In addition, upon a change in control, as defined, the holders may require us to purchase for cash all or a portion of their notes for 100 percent of the principal amount of the notes plus accrued and unpaid interest, if any, plus a number of additional make-whole shares of our common stock, as set forth in the applicable indenture. The indentures under which the Senior Convertible Notes were issued contain customary covenants, all of which we remain in compliance as of April 27, 2007. A total of $2.500 billion of the net proceeds from these note issuances were used to repurchase common stock. In April 2007, pursuant to provisions in the indentures relating to the Company’s increase of its quarterly dividend to shareholders, the conversion rates for each of the Senior Convertible Notes changed from 17.8113 to 17.8315, which correspondingly changed the conversion price per share for each of the Senior Convertible Notes from $56.14 to $56.08. See Note 7 to the consolidated financial statements for further discussion of the accounting treatment.

 

Concurrent with the issuance of the Senior Convertible Notes, we purchased call options on our common stock in private transactions. The call options allow us to receive shares of our common stock and/or cash from counterparties equal to the amounts of common stock and/or cash related to the excess conversion value that we would pay to the holders of the Senior Convertible Notes upon conversion. These call options will terminate upon the earlier of the maturity dates of the related Senior Convertible Notes or the first day all of the related Senior Convertible Notes are no longer outstanding due to conversion or otherwise. The call options, which cost an aggregate $1.075 billion ($699 million net of tax benefit), were recorded as a reduction of shareholders’ equity. See Note 7 to the consolidated financial statements for further discussion of the accounting treatment.

 

In separate transactions, we sold warrants to issue shares of our common stock at an exercise price of $76.56 per share in private transactions. Pursuant to these transactions, warrants for 41 million shares of our common stock may be settled over a specified period beginning in July 2011 and warrants for 41 million shares of our common stock may be settled over a specified period beginning in July 2013 (the “settlement dates”). If the average price of our common stock during a defined period ending on or about the respective settlement dates exceeds the exercise price of the warrants, the warrants will be settled in shares of our common stock. Proceeds received from the issuance of the warrants totaled approximately $517 million and were recorded as an addition to shareholders’ equity. See Note 7 to the consolidated financial statements for further discussion of the accounting treatment. In April 2007, certain of the holders requested adjustment to the exercise price of the warrants from $76.56 to $76.47 pursuant to the provisions of the warrants relating to our payment of dividends to common shareholders.

 

In September 2005, we issued two tranches of Senior Notes with the aggregate face value of $1.000 billion. The first tranche consisted of $400 million of 4.375 percent Senior Notes due 2010 and the second tranche consisted of $600 million of 4.750 percent Senior Notes due 2015. Each tranche was issued at a discount which resulted in an effective interest rate of 4.433 percent and 4.760 percent for the five and ten year Senior Notes, respectively. Interest on each series of Senior Notes is payable semi-annually, on March 15 and September 15 of each year. The Senior Notes are unsecured unsubordinated obligations and rank equally with all other unsecured and unsubordinated indebtedness. The indentures under which the Senior Notes were issued contain customary covenants, all of which we remain in compliance with as of April 27, 2007. We used the net proceeds from the sale of the Senior Notes for repayment of a portion of our outstanding commercial paper.

 

27



Table of Contents

In November 2005, we entered into a five year interest rate swap agreement with a notional amount of $200 million. This interest rate swap agreement was designated as a fair value hedge of the changes in fair value of a portion of our fixed-rate $400 million Senior Notes due 2010. We pay variable interest equal to the three-month London Interbank Offered Rate (LIBOR) minus 55 basis points and we receive a fixed interest rate of 4.375 percent.

 

In September 2001, we completed a $2.013 billion private placement of 1.250 percent Contingent Convertible Debentures due September 2021 (Old Debentures). Interest is payable semi-annually. Each Old Debenture is convertible into shares of common stock at an initial conversion price of $61.81 per share; however, the Old Debentures are not convertible before their final maturity unless the closing price of our common stock reaches 110 percent of the conversion price for 20 trading days during a consecutive 30 trading day period. In September 2002 and 2004, as a result of certain holders of the Old Debentures exercising their put options, we repurchased $39 million and $1 million respectively, of the Old Debentures for cash.

 

On January 24, 2005, we completed an exchange offer whereby holders of approximately $1.930 billion of the total principal amount of the Old Debentures exchanged their existing securities for an equal principal amount of 1.250 percent Contingent Convertible Debentures, Series B due 2021 (New Debentures), as described below. Following the completion of the exchange offer, we repurchased approximately $2 million of the Old Debentures for cash.

 

The terms of the New Debentures are consistent with the terms of the Old Debentures noted above, except that: (i) the New Debentures require us to settle all conversions for a combination of cash and shares of our common stock, if any, in lieu of only shares. Upon conversion of the New Debentures we will pay holders cash equal to the lesser of the principal amount of the New Debentures or their conversion value, and shares of our common stock to the extent the conversion value exceeds the principal amount of the New Debentures; and (ii) the New Debentures require us to pay only cash (in lieu of shares of our common stock or a combination of cash and shares of our common stock) when we repurchase the New Debentures at the option of the holder or when we repurchase the New Debentures in connection with a change of control.

 

In September 2006, as a result of certain holders of the New Debentures and Old Debentures exercising their put options, we repurchased $1.835 billion of the New Debentures for cash and $42 million of the Old Debentures for cash. We may be required to repurchase the remaining debentures at the option of the holders in September 2008, 2011 or 2016. Twelve months prior to the put options becoming exercisable, the remaining balance of the New Debentures and the Old Debentures will be classified as short-term borrowings. At each balance sheet date without a put option within the subsequent four quarters, the remaining balance will be classified as long-term debt. Accordingly, during the second quarter of fiscal year 2007, $93 million of New Debentures and $1 million of the Old Debentures were reclassified from short-term borrowings to long-term debt as a result of the September 2006 put option expiring. For put options exercised by the holders of the New Debentures and the Old Debentures, the purchase price is equal to the principal amount of the applicable debenture plus any accrued and unpaid interest thereon to the repurchase date. If the put option is exercised, we will pay holders the repurchase price solely in cash (or, for the Old Debentures, in cash or stock at our option). As of April 27, 2007, approximately $93 million aggregate principal amount of New Debentures remain outstanding and approximately $1 million aggregate principal amount of Old Debentures remain outstanding. We can redeem the debentures for cash at any time.

 

We maintain a commercial paper program that allows us to have a maximum of $2.250 billion in commercial paper outstanding, with maturities up to 364 days from the date of issuance. At April 27, 2007 and April 28, 2006, outstanding commercial paper totaled $249 million and $190 million, respectively. During fiscal years 2007 and 2006, the weighted average original maturity of the commercial paper outstanding was approximately 56 and 31 days, respectively, and the weighted average interest rate was 5.26 percent and 3.86 percent, respectively.

 

In connection with the issuance of the contingent convertible debentures, Senior Notes, Senior Convertible Notes and commercial paper, Standard and Poor’s Ratings Group and Moody’s Investors Service issued us strong long-term debt ratings of AA- and A1, respectively, and strong short-term debt ratings of A-1+ and P-1, respectively. These ratings remain unchanged from the same periods of the prior year.

 

We have existing lines of credit of approximately $2.433 billion with various banks at April 27, 2007. The existing lines of credit include a five-year $1.750 billion syndicated credit facility dated December 20, 2006 that will expire on December 20, 2011 (New Facility). This New Facility replaced two credit facilities: one for $1.000 billion which was scheduled to expire in January 2010, and a $750 million facility which was scheduled to expire in January 2007. The New Facility provides us with the ability to increase its capacity by an additional $500 million at any time during the life of the five-year term of the agreement. We can also request the extension of the New Facility maturity date for one additional year, at the first and second anniversary of the date of this facility. The New Facility provides backup funding for the commercial paper program and may also be used for general corporate purposes.

 

28



Table of Contents

Interest rates on these borrowings are determined by a pricing matrix, based on our long-term debt ratings, assigned by Standard and Poor’s Ratings Group and Moody’s Investors Service. Facility fees are payable on the credit facilities and are determined in the same manner as the interest rates. The agreements also contain other customary covenants, all of which we remain in compliance with as of April 27, 2007.

 

As of April 27, 2007, we have unused credit lines and commercial paper capacity of approximately $2.440 billion.

 

Acquisitions

 

During the fourth quarter of fiscal year 2007 we acquired manufacturing assets, know-how, and an exclusive license to intellectual property related to the manufacture and distribution of EndoSheath products from Vision–Sciences, Inc. (VSI), which was accounted for as a purchase of assets. The license acquired from VSI will expand our existing U.S. distribution rights of EndoSheath products to worldwide distribution rights. The EndoSheath is a sterile disposable sheath that fits over a fiberoptic endoscope preventing contamination of the scope during procedures and allowing reuse of the scope without further sterilization. The consideration paid was $27 million in cash which was primarily allocated to technology-based intangible assets with an estimated useful life of 10 years. The purchase price is subject to increases triggered by the achievement of certain milestones.

 

During the second quarter of fiscal year 2007, we acquired and/or licensed selected patents and patent applications owned by Dr. Eckhard Alt (Dr. Alt), or certain of his controlled companies in a series of transactions. In connection therewith, we also resolved all outstanding litigation and disputes with Dr. Alt and certain of his controlled companies. The agreements required the payment of total consideration of $75 million, $74 million of which was capitalized as technology based intangible assets that had an estimated useful life of 11 years at the time of acquisition. The acquired patents or licenses pertain to the cardiac rhythm disease management field and have both current application and potential for future patentable commercial products.

 

During the first quarter of fiscal year 2007, we acquired substantially all of the assets of Odin Medical Technologies, Ltd. (Odin), a privately held company. Prior to the acquisition, we had an equity investment in Odin, which was accounted for under the cost method of accounting. Odin focused on the manufacture of the PoleStar iMRI-Guidance System which we already exclusively distributed. We expect this acquisition to help further drive the acceptance of iMRI guidance in neurosurgery. The consideration for Odin was approximately $21 million, which included $6 million in upfront cash and a $2 million milestone payment. The $8 million in net cash paid resulted from the $21 million in consideration less the value of our prior investment in Odin and Odin’s existing cash balance. In connection with the acquisition of Odin, we acquired $9 million of technology-based intangible assets that had an estimated useful life of 12 years at the time of acquisition. Goodwill of $12 million related to the acquisition was assigned entirely to the Spinal and Navigation operating segment. This goodwill is deductible for tax purposes. The pro forma impact of Odin was not significant to our results for fiscal year 2007. The results of operations related to Odin have been included in our consolidated statements of earnings since the date of the acquisition.

 

During the second quarter of fiscal year 2006, we acquired all the outstanding stock of IGN, a privately held company. Prior to the acquisition, we had an equity investment in IGN, which was accounted for under the cost method of accounting. IGN specialized in precision navigation and delivery technologies for brain surgery. The IGN product line includes the NexFrame disposable, “frameless” sterotactic head frame, which is used in conjunction with image-guided surgery systems during deep brain stimulation. This acquisition complements our position in deep brain stimulation by offering instruments that simplify the procedure for surgeons and improve patient comfort during surgery. The total consideration for IGN was approximately $65 million, which included $58 million in net cash paid. The $58 million in net cash paid results from the $65 million in consideration less the value of our prior investment in IGN and IGN’s existing cash balance.

 

During the first quarter of fiscal year 2006, we acquired all of the outstanding stock of TNI, a privately held company. Prior to the acquisition, we had an equity investment in TNI, which was accounted for under the cost method of accounting. TNI focused on the treatment of obesity by stimulation of the stomach with an implantable gastric stimulator, known as the Transcend device. This acquisition was expected to complement the Company’s strategy to deliver therapeutic solutions for the worldwide challenges of obesity. The consideration for TNI was approximately $269 million, which included $227 million in net cash paid. The $227 million in net cash paid resulted from the $269 million in consideration less the value of our prior investment in TNI and TNI’s existing cash balance. The purchase price is subject to increases triggered by the achievement of certain milestones. As a result of the acquisition of TNI, we acquired $55 million of intangible assets of which $54 million were technology-based intangible assets that had an estimated useful life of 15 years at the time of acquisition and $169 million of IPR&D that was expensed on the date of acquisition related to a product being developed for the treatment of obesity by stimulation of the stomach that had not yet reached technological feasibility and for which no future alternative use had been identified. Goodwill of $51 million related to the acquisition was assigned entirely to the Neurological operating segment. This goodwill is not deductible for tax purposes. In fiscal year 2007, we recognized an impairment charge related to the intangible assets acquired from TNI. See discussion in the “Special, Restructuring, Certain Litigation, and IPR&D Charges, and Certain Tax Adjustments” section of this management’s discussion and analysis.

 

29



Table of Contents

The pro forma impact of the IGN and TNI acquisitions was not significant, individually or in the aggregate, to our results for the fiscal year ended April 28, 2006. Our fiscal year 2006 operating results included the results of TNI and IGN since their respective acquisition dates.

 

During the first quarter of fiscal year 2006, we acquired substantially all of the spine-related intellectual property and related contracts, rights, and tangible materials owned by Michelson and settled all outstanding litigation and disputes between Michelson and us. The acquired patents pertain to novel spinal technology and techniques that have both current application and the potential for future patentable commercial products. The agreement requires total consideration of $1.350 billion for the purchase of a portfolio of more than 100 issued U.S. patents, over 110 pending U.S. patent applications and numerous foreign counterparts to these patents and patent applications, and the settlement of all ongoing litigation. A value of $550 million was assigned to the settlement of past damages between the parties and was recorded as an expense in the fourth quarter of fiscal year 2005. The remaining consideration, including $3 million of direct acquisition costs, was allocated between $628 million of acquired technology based intangible assets that had a useful life of 17 years at the time of acquisition and $175 million of IPR&D that was expensed on the date of acquisition related to spinal technology based devices that had not yet reached technological feasibility and had no future alternative use. The patents pertain to novel spinal technology and techniques that have the potential for future patentable commercial products in the area of spinal surgery. During the first quarter of fiscal year 2006, we paid $1.320 billion and committed to three future installments of $10 million to be paid in May 2006, 2007, and 2008. The first two installments of $10 million were paid in May 2006 and 2007.

 

During the first quarter of fiscal year 2006, we also entered into a royalty bearing, non-exclusive patent cross-licensing agreement with NeuroPace, Inc. Under the terms of the agreement, the two companies cross-licensed patents and patent applications of neurological technology related to direct electrical stimulation or monitoring of the brain. On the date of the agreement, $20 million was expensed as IPR&D related to the licensed technology since technological feasibility of the project had not yet been reached and such technology had no future alternative use. This licensed technology is expected to enhance our ability to further develop and expand its therapies for neurological disorders.

 

New Accounting Pronouncements

 

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN No. 48), which is an interpretation of SFAS No. 109, “Accounting for Income Taxes” (SFAS No. 109). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on recognition, measurement, presentation, disclosure, and transition. FIN No. 48 is effective for us beginning with fiscal year 2008, with earlier adoption permitted. We are still evaluating the impact that the adoption of FIN No. 48 will have on the consolidated financial statements, but do not believe it will be material to the consolidated financial statements.

 

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (SFAS No. 158), which requires the recognition of an asset or liability for the funded status of defined benefit pension and other post-retirement benefit plans in the statement of financial position. The funded status of a defined benefit plan is measured as the difference between plan assets at fair value and the benefit obligation. For a defined benefit pension plan, the benefit obligation is the projected benefit obligation (PBO) for any other defined benefit post-retirement plan, such as a retiree health care plan, the benefit obligation is the accumulated post-retirement benefit obligation. The initial incremental recognition of the funded status under SFAS No. 158 of our defined pension and other post-retirement benefit plans, as well as subsequent changes in our funded status that are not included in net periodic benefit cost will be reflected in accumulated other comprehensive (loss)/income. As of April 27, 2007, the net unfunded status of our defined benefit plans was $(2) million and recognition of this status upon the adoption of SFAS No. 158 resulted in an after-tax charge to shareholders’ equity of $209 million. Amounts recognized in accumulated other comprehensive (loss)/income are adjusted as they are subsequently recognized as a component of net periodic benefit cost. The method of calculating net periodic benefit cost will not change from existing guidance. SFAS No. 158 also prescribes enhanced disclosures, including current and long-term components of plan assets and liabilities, as well as amounts recognized in accumulated other comprehensive (loss)/income that will subsequently be recognized as a component of net periodic benefit cost in the following year. See Note 13 to the consolidated financial statements for additional information.

 

The funded status recognition and certain disclosure provisions of SFAS No. 158 are effective for our fiscal year ended April 27, 2007. SFAS No. 158 also requires the consistent measurement of plan assets and benefit obligations as of the date of our fiscal year-end statement of financial position effective for our fiscal year ending April 25, 2008. A select number of our plans, including the U.S. plans, currently have a January 31 measurement date. This standard will require us to change, in fiscal year 2008, that measurement date to match the date of our fiscal year-end. We do not expect a material impact on the financial condition for those plans in which we have not adopted the requirement to measure the plan assets and benefit obligation as of the date of the balance sheet.

 

30



Table of Contents

Discussed above are the significant new accounting pronouncements. Information regarding all new accounting pronouncements is included in Note 1 to the consolidated financial statements.

 

Operations Outside the U.S.

 

The table below illustrates U.S. net sales versus net sales outside the U.S. for fiscal years 2007, 2006 and 2005:

 

 

 

Fiscal Year

 

 

 

2007

 

2006

 

2005

 

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

U.S. net sales

 

$

7,900

 

7,626

 

$

6,711

 

Non U.S. net sales

 

 

4,399

 

 

3,666

 

 

3,344

 

Total net sales

 

12,299

 

11,292

 

10,055

 

 

From fiscal year 2006 to fiscal year 2007, consolidated net sales in the U.S. grew 4 percent compared to 20 percent growth in net sales outside the U.S. The slower U.S. growth is primarily a result of declines in the overall ICD market in the U.S. and the voluntary suspension of U.S shipments of Physio-Control products from our Redmond, Washington facility. Outside the U.S. net sales growth was strong across all businesses and led by strong performance in Vascular and CRDM, and a favorable impact of foreign currency translation. Vascular net sales were led by market share gains with Endeavor DES. Increased sales of ICDs and pacemakers led the increase within our CRDM business.

 

From fiscal year 2005 to fiscal year 2006, consolidated net sales in the U.S. grew at 14 percent, or 4 percent faster than consolidated net sales outside the U.S., primarily as a result of the strong performance in both CRDM and Neurological operating segments and the negative impact of foreign currency translation. CRDM and Neurological sales increased approximately 15 percent and 12 percent, respectively, in the U.S. while sales of those products outside the U.S. grew 8 percent and 4 percent, respectively. The growth in the U.S. in CRDM during fiscal year 2006 was driven by the strong demand for implantable defibrillation systems.

 

Net sales outside the U.S. are accompanied by certain financial risks, such as collection of receivables, which typically have longer payment terms. Outstanding receivables from customers outside the U.S. totaled $1.456 billion at April 27, 2007, or 50 percent of total outstanding accounts receivable, and $1.179 billion at April 28, 2006, or 45 percent of total outstanding accounts receivable. The increase in the percentage of accounts receivable from customers outside the U.S. is primarily driven by increased sales volume outside the U.S. and the impact of foreign currency exchange rates.

 

Market Risk

 

Due to the global nature of our operations, we are subject to the exposures that arise from foreign currency exchange rate fluctuations. We manage these exposures using operational and economic hedges as well as derivative financial instruments. The primary currencies hedged are the Euro and the Japanese Yen.

 

Our objective in managing exposure to foreign currency fluctuations is to minimize earnings and cash flow volatility associated with foreign exchange rate changes. We enter into various contracts, principally forward contracts that change in value as foreign exchange rates change, to protect the value of existing foreign currency assets, liabilities, net investments, and probable commitments. The gains and losses on these contracts offset changes in the value of the related exposures. It is our policy to enter into foreign currency hedging transactions only to the extent true exposures exist; we do not enter into foreign currency transactions for speculative purposes.

 

We had foreign exchange derivative contracts outstanding in notional amounts of $5.372 billion and $1.561 billion at April 27, 2007 and April 28, 2006, respectively. The fair value of these contracts at April 27, 2007 was $125 million less than the original contract value. A sensitivity analysis of changes in the fair value of all foreign exchange derivative contracts at April 27, 2007 indicates that, if the U.S. dollar uniformly strengthened/weakened by 10 percent against all currencies, the fair value of these contracts would increase/decrease by $508 million, respectively. Any gains and losses on the fair value of derivative contracts would be largely offset by gains and losses on the underlying transactions. These offsetting gains and losses are not reflected in the above analysis.

 

We are also exposed to interest rate changes affecting principally our investments in interest rate sensitive instruments. A sensitivity analysis of the impact on our interest rate sensitive financial instruments of a hypothetical 10 percent change in short-term interest rates compared to interest rates at April 27, 2007 indicates that the fair value of these instruments would correspondingly change by $30 million.

 

31



Table of Contents

We have sold specific pools of trade receivables in Japan. During fiscal years 2007 and 2006 no trade receivables were sold, and in fiscal year 2005, we sold $146 million of our trade receivables to financial institutions in Japan. Additionally, we entered into agreements to sell specific pools of receivables in Italy in the amount of $37 million, $53 million, and $4 million in fiscal years 2007, 2006, and 2005, respectively. The discount cost related to the Japan and Italy sales was insignificant and recorded in interest income, net in the consolidated statements of earnings.

 

We lend certain fixed income securities to enhance our investment income. These lending activities are collateralized at an average rate of 102 percent, with the collateral determined based on the underlying securities and creditworthiness of the borrowers. The value of the securities on loan at April 27, 2007 and April 28, 2006 was $1.318 billion and $362 million, respectively.

 

Government Regulation and Other Considerations

 

Our medical devices are subject to regulation by numerous government agencies, including the FDA and comparable foreign agencies. To varying degrees, each of these agencies requires us to comply with laws and regulations governing the development, testing, manufacturing, labeling, marketing, and distribution of our medical devices.

 

Authorization to commercially distribute a new medical device in the U.S. is generally received in one of two ways. The first, known as the 510(k) process, requires us to demonstrate that our new medical device is substantially equivalent to a legally marketed medical device. In this process, we must submit data that supports our equivalence claim. If human clinical data is required, it must be gathered in compliance with FDA investigational device exemption regulations. We must receive an order from the FDA finding substantial equivalence to another legally marketed medical device before we can commercially distribute the new medical device. Modifications to cleared medical devices can be made without using the 510(k) process if the changes do not significantly affect safety or effectiveness. A very small number of our devices are exempt from 510(k) clearance requirements.

 

The second, more rigorous process, known as pre-market approval (PMA), requires us to independently demonstrate that the new medical device is safe and effective. We do this by collecting data, including human clinical data for the medical device. The FDA will authorize commercial release if it determines there is reasonable assurance that the medical device is safe and effective. This process is generally much more time-consuming and expensive than the 510(k) process.

 

Both before and after a product is commercially released, we have ongoing responsibilities under FDA regulations. The FDA reviews design and manufacturing practices, labeling and record keeping, and manufacturers’ required reports of adverse experience and other information to identify potential problems with marketed medical devices. We may be subject to periodic inspection by the FDA for compliance with the FDA’s good manufacturing practice regulations among other FDA requirements, such as restrictions on advertising and promotion. These regulations, also known as the Quality System Regulations, govern the methods used in, and the facilities and controls used for, the design, manufacture, packaging and servicing of all finished medical devices intended for human use. If the FDA were to conclude that we are not in compliance with applicable laws or regulations, or that any of our medical devices are ineffective or pose an unreasonable health risk, the FDA could ban such medical devices, detain or seize adulterated or misbranded medical devices, order a recall, repair, replacement, or refund of such devices, and require us to notify health professionals and others that the devices present unreasonable risks of substantial harm to the public health. The FDA may also impose operating restrictions, enjoin and restrain certain violations of applicable law pertaining to medical devices, and assess civil or criminal penalties against our officers, employees, or us. The FDA may also recommend prosecution to the Department of Justice.

 

The FDA, in cooperation with U.S. Customs and Border Protection (CBP), administers controls over the import of medical devices into the U.S. The CBP imposes its own regulatory requirements on the import of our products, including inspection and possible sanctions for noncompliance. The FDA also administers certain controls over the export of medical devices from the U.S. International sales of our medical devices that have not received FDA approval are subject to FDA export requirements. Each foreign country to which we export medical devices also subjects such medical devices to their own regulatory requirements. Frequently, we obtain regulatory approval for medical devices in foreign countries first because their regulatory approval is faster or simpler than that of the FDA. However, as a general matter, foreign regulatory requirements are becoming increasingly stringent.

 

In the European Union, a single regulatory approval process has been created, and approval is represented by the CE Mark. To obtain a CE Mark in the European Union, defined products must meet minimum standards of safety and quality (i.e., the essential requirements) and then comply with one or more of a selection of conformity routes. A Notified Body assesses the quality management systems of the manufacturer and the product conformity to the essential and other requirements within the Medical Device Directive. Medtronic is subject to inspection by Notified Bodies for compliance.

 

32



Table of Contents

To be sold in Japan, most medical devices must undergo thorough safety examinations and demonstrate medical efficacy before they are granted approval, or “shonin.” The Japanese government, through the Ministry of Health, Labour, and Welfare (MHLW), regulates medical devices under recently enacted revisions to the Pharmaceutical Affairs Law (PAL). Implementation of PAL and enforcement practices thereunder are evolving, and compliance guidance from MHLW is still in development. Consequently, companies continue to work on establishing improved systems for compliance with PAL. Penalties for a company’s noncompliance with PAL could be severe, including revocation or suspension of a company’s business license and criminal sanctions.

 

The process of obtaining approval to distribute medical products is costly and time-consuming in virtually all of the major markets where we sell medical devices. We cannot assure that any new medical devices we develop will be approved in a timely or cost-effective manner.

 

Federal and state laws protect the confidentiality of certain patient health information, including patient medical records, and restrict the use and disclosure of patient health information by healthcare providers. In particular, in April 2003, the U.S. Department of Health and Human Services (HHS) published patient privacy rules under the Health Insurance Portability and Accountability Act of 1996 (HIPAA privacy rule). The HIPAA privacy rule governs the use and disclosure of protected health information by “Covered Entities,” which are healthcare providers that submit electronic claims, health plans and healthcare clearinghouses. Other than our Diabetes operating segment and our health insurance plans, each of which is a Covered Entity, and the role representatives play in providing technical support to physicians while providing patient care, the HIPAA privacy rule affects us only indirectly. The patient data that we receive and analyze may include protected health information. We are committed to maintaining patients’ privacy and working with our customers and business partners in their HIPAA compliance efforts. The ongoing costs and impacts of assuring compliance with the HIPAA privacy rules are not material to our business.

 

Government and private sector initiatives to limit the growth of healthcare costs, including price regulation, competitive pricing, coverage and payment policies, and managed-care arrangements, are continuing in many countries where we do business, including the U.S. These changes are causing the marketplace to put increased emphasis on the delivery of more cost-effective medical devices. Government programs, including Medicare and Medicaid, private healthcare insurance, and managed-care plans have attempted to control costs by limiting the amount of reimbursement they will pay for particular procedures or treatments, and other mechanisms designed to constrain utilization and contain costs, including, for example, gainsharing, where a hospital agrees with physicians to share any realized cost savings resulting from the physicians’ collective change in practice patterns such as standardization of devices where medically appropriate. This has created an increasing level of price sensitivity among customers for our products. Some third-party payors must also approve coverage for new or innovative devices or therapies before they will reimburse healthcare providers who use the medical devices or therapies. Even though a new medical device may have been cleared for commercial distribution, we may find limited demand for the device until reimbursement approval has been obtained from governmental and private third-party payors. In addition, some private third-party payors require that certain procedures or that the use of certain products be authorized in advance as a condition of reimbursement. As a result of our manufacturing efficiencies and cost controls, we believe we are well-positioned to respond to changes resulting from the worldwide trend toward cost-containment; however, uncertainty remains as to the nature of any future legislation, making it difficult for us to predict the potential impact of cost-containment trends on future operating results.

 

The delivery of our devices is subject to regulation by HHS and comparable state and foreign agencies responsible for reimbursement and regulation of healthcare items and services. U.S. laws and regulations are imposed primarily in connection with the Medicare and Medicaid programs, as well as the government’s interest in regulating the quality and cost of healthcare. Foreign governments also impose regulations in connection with their healthcare reimbursement programs and the delivery of healthcare items and services.

 

Federal healthcare laws apply when we or customers submit claims for items or services that are reimbursed under Medicare, Medicaid or other federally-funded healthcare programs. The principal federal laws include: (1) the False Claims Act which prohibits the submission of false or otherwise improper claims for payment to a federally-funded health care program; (2) the Anti-Kickback Statute which prohibits offers to pay or receive remuneration of any kind for the purpose of inducing or rewarding referrals of items or services reimbursable by a Federal healthcare program; and (3) the Stark law which prohibits physicians from referring Medicare or Medicaid patients to an entity for the provision of certain designated health services if the physician (or a member of the physician’s immediate family) has a financial relationship with that entity. There are often similar state false claims, anti-kickback, and anti-self referral laws that apply to claims submitted under state Medicaid or state-funded healthcare programs.

 

The laws applicable to us are subject to evolving interpretations. If a governmental authority were to conclude that we are not in compliance with applicable laws and regulations, Medtronic, its officers and employees, could be subject to severe criminal and civil penalties including substantial penalties, fines and damages, and exclusion from participation as a supplier of product to beneficiaries covered by Medicare or Medicaid.

 

33



Table of Contents

We operate in an industry characterized by extensive patent litigation. Patent litigation can result in significant damage awards and injunctions that could prevent the manufacture and sale of affected products or result in significant royalty payments in order to continue selling the products. At any given time, we are generally involved as both a plaintiff and a defendant in a number of patent infringement actions. While it is not possible to predict the outcome of patent litigation incident to our business, we believe the costs associated with this type of litigation could generally have a material adverse impact on our consolidated results of operations, financial position or cash flows. See “Legal Proceedings” for additional information.

 

We operate in an industry susceptible to significant product liability claims. These claims may be brought by individuals seeking relief or by groups seeking to represent a class. In addition, product liability claims may be asserted against us in the future based on events we are not aware of at the present time.

 

We are also subject to various environmental laws and regulations both within and outside the U.S. Like other medical device companies, our operations involve the use of substances regulated under environmental laws, primarily manufacturing and sterilization processes. We do not expect that compliance with environmental protection laws will have a material impact on our consolidated results of operations, financial position, or cash flows.

 

We have elected to self-insure most of our insurable risks, including medical and dental costs, disability coverage, physical loss to property, business interruptions, workers’ compensation, comprehensive general, director and officer, and product liability. This decision was made based on conditions in the insurance marketplace that have led to increasingly higher levels of self-insurance retentions, increasing number of coverage limitations, and dramatically higher insurance premium rates. We continue to monitor the insurance marketplace to evaluate the value to us of obtaining insurance coverage in the future. Based on historical loss trends, we believe that our self-insurance program accruals will be adequate to cover future losses. Historical trends, however, may not be indicative of future losses. These losses could have a material adverse impact on our consolidated results of operations, financial position, or cash flows.

 

Cautionary Factors That May Affect Future Results

 

This Annual Report may include “forward-looking” statements. Forward-looking statements broadly involve our current expectations or forecasts of future results. Our forward-looking statements generally relate to our growth strategies, financial results, product development, regulatory approvals, competitive strengths, intellectual property rights, litigation, mergers and acquisitions, market acceptance of our products, accounting estimates, financing activities, ongoing contractual obligations, and sales efforts. Such statements can be identified by the use of terminology such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “intend,” “may,” “plan,” “possible,” “project,” “should,” “will” and similar words or expressions. One must carefully consider forward-looking statements and understand that such statements may be affected by inaccurate assumptions and may involve a variety of risks and uncertainties, known and unknown, including, among others, those discussed in the previous section, in the section entitled “Risk Factors” in our Form 10-K, as well as those related to competition in the medical device industry, reduction or interruption in our supply, quality problems and price decrease for our products and services, and international operations. Consequently, no forward-looking statement can be guaranteed and actual results may vary materially. We intend to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 regarding our forward-looking statements, and are including this sentence for the express purpose of enabling us to use the protections of the safe harbor with respect to all forward-looking statements.

 

We undertake no obligation to update any statement we make, but investors are advised to consult any further disclosures by us in our filings with the Securities and Exchange Commission, especially on Forms 10-K, 10-Q, and 8-K, in which we discuss in more detail various important factors that could cause actual results to differ from expected or historical results. In addition, actual results may differ materially from those anticipated due to a number of factors, including, among others, those discussed in the section entitled “Risk Factors” in our Form 10-K. It is not possible to foresee or identify all such factors. As such, investors should not consider any list of such factors to be an exhaustive statement of all risks, uncertainties, or potentially inaccurate assumptions.

 

34



Table of Contents

Reports of Management

 

Management’s Report on the Financial Statements

 

The management of Medtronic, Inc. is responsible for the integrity of the financial information presented in this Annual Report. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Where necessary, and as discussed under Critical Accounting Estimates on pages 4-6, the consolidated financial statements reflect estimates based on management’s judgment.

 

The consolidated financial statements have been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, who conducted their audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). The independent registered public accounting firm’s responsibility is to express an opinion that such financial statements present fairly, in all material respects, our financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States.

 

Management’s Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of April 27, 2007. Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of April 27, 2007 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.

 

/s/   Arthur D. Collins, Jr.

Arthur D. Collins, Jr.

Chairman of the Board and Chief Executive Officer

/s/   Gary L. Ellis

Gary L. Ellis

Senior Vice President and Chief Financial Officer

 



35



Table of Contents

Report of Independent Registered Public Accounting Firm

 

To the Shareholders and Board of Directors of Medtronic, Inc.:

 

We have completed integrated audits of Medtronic, Inc.’s April 27, 2007, April 28, 2006 and April 29, 2005 consolidated financial statements and of its internal control over financial reporting as of April 27, 2007, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

 

Consolidated Financial Statements

 

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, shareholders’ equity and cash flows present fairly, in all material respects, the financial position of Medtronic, Inc. and its subsidiaries (the Company) at April 27, 2007 and April 28, 2006, and the results of their operations and their cash flows for each of the three fiscal years in the period ended April 27, 2007 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As discussed in Note 1 to the consolidated financial statements, in 2007 the Company changed the manner in which it accounts for share-based compensation and defined benefit pension and other postretirement plans as a result of adopting the provisions of Statement of Financial Accounting Standard No. 123 (revised 2004), “Share-Based Payment” and of Statement of Financial Accounting Standard No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” respectively.

 

Internal Control over Financial Reporting

 

Also, in our opinion, management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that the Company maintained effective internal control over financial reporting as of April 27, 2007 based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of April 27, 2007, based on criteria established in Internal Control – Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

 

36



Table of Contents

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/   PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP

Minneapolis, Minnesota

June 21, 2007

 







37



Table of Contents

Medtronic, Inc.

Consolidated  Statements of Earnings

 

 

Fiscal Year

 

 

 

2007

 

2006

 

2005

 

(in millions, except per share data)

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

12,299

 

$

11,292

 

$

10,055

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

Cost of products sold

 

 

3,168

 

 

2,815

 

 

2,446

 

Research and development expense

 

 

1,239

 

 

1,113

 

 

951

 

Selling, general and administrative expense

 

 

4,153

 

 

3,659

 

 

3,214

 

Special charges

 

 

98

 

 

100

 

 

 

Restructuring charges

 

 

28

 

 

 

 

 

Certain litigation charges

 

 

40

 

 

 

 

654

 

Purchased in-process research and development (IPR&D) charges

 

 

 

 

364

 

 

 

Other expense, net

 

 

212

 

 

167

 

 

291

 

Interest income, net

 

 

(154

)

 

(87

)

 

(45

)

Total costs and expenses

 

 

8,784

 

 

8,131

 

 

7,511

 

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes

 

 

3,515

 

 

3,161

 

 

2,544

 

Provision for income taxes

 

 

713

 

 

614

 

 

740

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

2,802

 

$

2,547

 

$

1,804

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

Basic

 

$

2.44

 

$

2.11

 

$

1.49

 

Diluted

 

$

2.41

 

$

2.09

 

$

1.48

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

Basic

 

 

1,149.7

 

 

1,204.5

 

 

1,209.0

 

Diluted

 

 

1,161.8

 

 

1,217.3

 

 

1,220.8

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.44

 

$

0.39

 

$

0.34

 


See accompanying notes to the consolidated financial statements.

 



38



Table of Contents

Medtronic, Inc.

Consolidated  Balance Sheets

 

 

 

April 27,
2007

 

April 28,
2006

 

(in millions, except share and per share data)

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,256

 

$

2,994

 

Short-term investments

 

 

1,822

 

 

3,107

 

Accounts receivable, less allowances of $160 and $184, respectively

 

 

2,737

 

 

2,429

 

Inventories

 

 

1,215

 

 

1,177

 

Deferred tax assets, net

 

 

405

 

 

197

 

Prepaid expenses and other current assets

 

 

483

 

 

473

 

Total current assets

 

 

7,918

 

 

10,377

 

 

 

 

 

 

 

 

 

Property, plant and equipment, net

 

 

2,062

 

 

1,881

 

Goodwill

 

 

4,327

 

 

4,346

 

Other intangible assets, net

 

 

1,433

 

 

1,592

 

Long-term investments

 

 

3,203

 

 

957

 

Long-term deferred tax assets, net

 

 

204

 

 

 

Other assets

 

 

365

 

 

512

 

Total assets

 

$

19,512

 

$

19,665

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Short-term borrowings

 

$

509

 

$

2,437

 

Accounts payable

 

 

282

 

 

319

 

Accrued compensation

 

 

767

 

 

723

 

Accrued income taxes

 

 

350

 

 

461

 

Other accrued expenses

 

 

655

 

 

466

 

Total current liabilities

 

 

2,563

 

 

4,406

 

 

 

 

 

 

 

 

 

Long-term debt

 

 

5,578

 

 

5,486

 

Deferred tax liabilities, net

 

 

 

 

22

 

Long-term accrued compensation

 

 

264

 

 

189

 

Other long-term liabilities

 

 

130

 

 

179

 

Total liabilities

 

 

8,535

 

 

10,282

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Notes 7, 14 and 15)

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

Preferred stock-par value $1.00; 2.5 million shares authorized, none outstanding

 

 

 

 

 

Common stock-par value $0.10; 1.6 billion shares authorized, 1,143,407,452 and 1,155,237,090 shares issued and outstanding, respectively

 

 

114

 

 

116

 

Retained earnings

 

 

10,925

 

 

9,112

 

Accumulated other comprehensive (loss)/income

 

 

(62

 

155

 

Total shareholders’ equity

 

 

10,977

 

 

9,383

 

Total liabilities and shareholders’ equity

 

$

19,512

 

$

19,665

 


See accompanying notes to the consolidated financial statements.

 


39



Table of Contents

Medtronic, Inc.

Consolidated  Statements of Shareholders’ Equity

 

 

 

Common
Shares

 

Common
Stock

 

Retained
Earnings

 

Accumulated
Other
Comprehensive (Loss)/Income

 

Receivable
from Employee
Stock
Ownership Plan

 

Total
Shareholders’
Equity

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance April 30, 2004

 

 

1,209

 

$

121

 

$

8,891

 

$

72

 

$

(7

)

$

9,077

 

Net earnings

 

 

 

 

 

 

1,804

 

 

 

 

 

 

1,804

 

Other comprehensive (loss)/income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss on investments

 

 

 

 

 

 

 

 

(16

)

 

 

 

(16

)

Translation adjustment

 

 

 

 

 

 

 

 

63

 

 

 

 

63

 

Minimum pension liability

 

 

 

 

 

 

 

 

(5

)

 

 

 

(5

)

Unrealized gain on foreign exchange derivatives

 

 

 

 

 

 

 

 

36

 

 

 

 

36

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,882

 

Dividends to shareholders

 

 

 

 

 

 

(405

)

 

 

 

 

 

(405

)

Issuance of common stock under stock purchase and award plans

 

 

11

 

 

1

 

 

338

 

 

 

 

 

 

339

 

Repurchase of common stock

 

 

(10

)

 

(1

)

 

(510

)

 

 

 

 

 

(511

)

Excess tax benefit from exercise of stock-based awards

 

 

 

 

 

 

61

 

 

 

 

 

 

61

 

Repayments from employee stock ownership plan

 

 

 

 

 

 

 

 

 

 

7

 

 

7

 

Balance April 29, 2005

 

 

1,210

 

$

121

 

$

10,179

 

$

150

 

$

 

$

10,450

 

Net earnings

 

 

 

 

 

 

2,547

 

 

 

 

 

 

2,547

 

Other comprehensive (loss)/income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on investments

 

 

 

 

 

 

 

 

1

 

 

 

 

1

 

Translation adjustment

 

 

 

 

 

 

 

 

(13

)

 

 

 

(13

)

Minimum pension liability

 

 

 

 

 

 

 

 

(9

)

 

 

 

(9

)

Unrealized gain on foreign exchange derivatives

 

 

 

 

 

 

 

 

26

 

 

 

 

26

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,552

 

Dividends to shareholders

 

 

 

 

 

 

(465

)

 

 

 

 

 

(465

)

Issuance of common stock under stock purchase and award plans

 

 

14

 

 

2

 

 

516

 

 

 

 

 

 

518

 

Repurchase of common stock

 

 

(69

)

 

(7

)

 

(3,582

)

 

 

 

 

 

(3,589

)

Excess tax benefit from exercise of stock-based awards

 

 

 

 

 

 

99

 

 

 

 

 

 

99

 

Purchased call options, net of tax benefit

 

 

 

 

 

 

(699

)

 

 

 

 

 

(699

)

Sale of warrants

 

 

 

 

 

 

517

 

 

 

 

 

 

517

 

Balance April 28, 2006

 

 

1,155

 

$

116

 

$

9,112

 

$

155

 

$

 

$

9,383

 

Net earnings

 

 

 

 

 

 

2,802

 

 

 

 

 

 

2,802

 

Other comprehensive (loss)/income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on investments

 

 

 

 

 

 

 

 

20

 

 

 

 

20

 

Translation adjustment

 

 

 

 

 

 

 

 

18

 

 

 

 

18

 

Minimum pension liability

 

 

 

 

 

 

 

 

24

 

 

 

 

24

 

Unrealized loss on foreign exchange derivatives

 

 

 

 

 

 

 

 

(70

 

 

 

(70

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,794

 

Dividends to shareholders

 

 

 

 

 

 

(504

)

 

 

 

 

 

(504

)

Issuance of common stock under stock purchase and award plans

 

 

10

 

 

1

 

 

330

 

 

 

 

 

 

331

 

Adjustment to adopt SFAS No. 158 (Note 1)

 

 

 

 

 

 

 

 

(209

)

 

 

 

(209

)

Repurchase of common stock

 

 

(22

)

 

(3

)

 

(1,036

)

 

 

 

 

 

(1,039

)

Excess tax benefit from exercise of stock-based awards

 

 

 

 

 

 

36

 

 

 

 

 

 

36

 

Stock-based compensation

 

 

 

 

 

 

185

 

 

 

 

 

 

185

 

Balance April 27, 2007

 

 

1,143

 

$

114

 

$

10,925

 

$

(62

)

$

 

$

10,977

 


See accompanying notes to the consolidated financial statements.

 

40



Table of Contents

Medtronic, Inc.

Consolidated  Statements of Cash Flows

 

 

 

Fiscal Year

 

 

 

2007

 

2006

 

2005

 

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

Operating Activities:

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

2,802

 

$

2,547

 

$

1,804

 

Adjustments to reconcile net earnings to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

583

 

 

544

 

 

463

 

Special charges

 

 

98

 

 

 

 

 

IPR&D charges

 

 

 

 

364

 

 

654

 

Provision for doubtful accounts

 

 

31

 

 

39

 

 

43

 

Stock-based compensation

 

 

185

 

 

25

 

 

19

 

Excess tax benefit from exercise of stock-based awards

 

 

(36

 

99

 

 

61

 

Deferred income taxes

 

 

(236

 

105

 

 

(143

Change in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(326

)

 

(217

)

 

(271

)

Inventories

 

 

(24

)

 

(257

)

 

(51

Prepaid expenses and other assets

 

 

(45

)

 

(86

)

 

(107

)

Accounts payable and accrued liabilities

 

 

17

 

 

(981

 

409

 

Other long-term liabilities

 

 

(70

 

38

 

 

(57

Net cash provided by operating activities

 

 

2,979

 

 

2,220

 

 

2,824

 

 

Investing Activities:

 

 

 

 

 

 

 

 

 

 

Acquisitions, net of cash acquired

 

 

(8

)

 

(285

)

 

(108

)

Purchase of intellectual property

 

 

(121

)

 

(837

)

 

(10

Additions to property, plant and equipment

 

 

(573

)

 

(407

)

 

(452

)

Purchases of marketable securities

 

 

(11,837

 

(8,065

)

 

(1,805

)

Sales and maturities of marketable securities

 

 

10,894

 

 

6,627

 

 

803

 

Other investing activities, net

 

 

(56

 

100

 

 

(31

Net cash used in investing activities

 

 

(1,701

)

 

(2,867

)

 

(1,603

)

 

Financing Activities:

 

 

 

 

 

 

 

 

 

 

Change in short-term borrowings, net

 

 

45

 

 

(18

 

90

 

Payments on long-term debt

 

 

(1,880

)

 

 

 

(2

Issuance of long-term debt

 

 

 

 

5,428

 

 

 

Purchase of call options

 

 

 

 

(1,075

 

 

Sale of warrants

 

 

 

 

517

 

 

 

Dividends to shareholders

 

 

(504

)

 

(465

)

 

(405

)

Repurchase of common stock

 

 

(1,039

)

 

(3,589

)

 

(511

)

Issuance of common stock

 

 

331

 

 

506

 

 

334

 

Excess tax benefit from exercise of stock-based awards

 

 

36

 

 

 

 

 

Net cash (used in) provided by financing activities

 

 

(3,011

 

1,304

 

 

(494

)

Effect of exchange rate changes on cash and cash equivalents

 

 

(5

 

105

 

 

(89

)

 

 

 

 

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

 

(1,738

 

762

 

 

638

 

Cash and cash equivalents at beginning of period

 

 

2,994

 

 

2,232

 

 

1,594

 

Cash and cash equivalents at end of period

 

$

1,256

 

$

2,994

 

$

2,232

 

 

Supplemental Cash Flow Information:

 

 

 

 

 

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

 

 

 

 

 

Income taxes

 

$

1,034

 

$

860

 

$

559

 

Interest

 

 

230

 

 

109

 

 

55

 

Supplemental Noncash Investing and Financing Activities:

 

 

 

 

 

 

 

 

 

 

Reclassification of debentures from short-term to long-term debt

 

$

94

 

$

 

$

1,973

 

Reclassification of debentures from long-term to short-term debt

 

 

 

 

1,971

 

 

 

 

See accompanying notes to the consolidated financial statements.

 

41



Table of Contents

Medtronic, Inc.

Notes to Consolidated Financial Statements  

(dollars in millions, except per share data)

 

1.

Summary of Significant Accounting Policies

 

Nature of Operations   Medtronic, Inc. (Medtronic or the Company) is the global leader in medical technology, alleviating pain, restoring health, and extending life for millions of people around the world. The Company provides innovative products and therapies for use by medical professionals to meet the healthcare needs of their patients. Primary products include those for cardiac rhythm disorders, cardiovascular disease, neurological disorders, spinal conditions and musculoskeletal trauma, urological and digestive disorders, diabetes, and ear, nose, and throat conditions.

 

The Company is headquartered in Minneapolis, Minnesota, and markets its products primarily through a direct sales force in the United States (U.S.) and a combination of direct sales representatives and independent distributors in international markets. The primary markets for products are the U.S., Western Europe, and Japan.

 

Principles of Consolidation   The consolidated financial statements include the accounts of Medtronic, Inc., and all of its subsidiaries. All significant intercompany transactions and accounts have been eliminated. The principles of Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” and Accounting Research Bulletin (ARB) No. 51, “Consolidated Financial Statements” are considered when determining whether an entity is subject to consolidation.

 

Fiscal Year-End   The Company utilizes a 52/53-week fiscal year, ending the last Friday in April. The Company’s fiscal years 2007, 2006, and 2005 ended on April 27, 2007, April 28, 2006, and April 29, 2005, respectively, all of which were 52-week years.

 

Use of Estimates   The preparation of the financial statements in conformity with accounting principles generally accepted in the U.S. (U.S. GAAP) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates.

 

Cash Equivalents   The Company considers highly liquid investments with maturities of three months or less from the date of purchase to be cash equivalents. These investments are carried at cost, which approximates fair value.

 

Investments   Investments in marketable equity securities and debt securities are classified and accounted for as available-for-sale (AFS) at April 27, 2007 and April 28, 2006. AFS debt securities are recorded at fair value in both short-term and long-term investments and AFS equity securities are recorded at fair value in long-term investments in the consolidated balance sheets. The change in fair value for AFS securities is recorded, net of taxes, as a component of accumulated other comprehensive (loss)/income in the consolidated balance sheets. Management determines the appropriate classification of its investments in debt and equity securities at the time of purchase and reevaluates such determinations at each balance sheet date.

 

Certain of the Company’s investments in equity securities are long-term, strategic investments in companies that are in varied stages of development. The Company accounts for these investments under the cost or the equity method of accounting, as appropriate. The valuation of equity securities accounted for under the cost method considers all available financial information related to the investee, including valuations based on recent third-party equity investments in the investee. If an unrealized loss for any investment is considered to be other-than-temporary, the loss will be recognized in the consolidated statements of earnings in the period the determination is made. Equity securities accounted for under the equity method are recorded at the amount of the Company’s investment and adjusted each period for the Company’s share of the investee’s income or loss and dividends paid. Equity securities accounted for under both the cost and equity methods are reviewed quarterly for changes in circumstance or the occurrence of events that suggest the Company’s investment may not be recoverable. See Note 5 for discussion of the gains and losses recognized on equity securities. As of both April 27, 2007 and April 28, 2006, the Company had $190 of equity securities, which are recorded as long-term investments in the consolidated balance sheets. Of these investments, $150 and $176, respectively, represent investments in companies that do not have quoted market prices.

 

42



Table of Contents

Accounts Receivable   The Company grants credit to customers in the normal course of business, but generally does not require collateral or any other security to support its receivables. The Company maintains an allowance for doubtful accounts for potential credit losses. Uncollectible accounts are written-off against the allowance when it is deemed that a customer account is uncollectible. The allowance for doubtful accounts was $160 at April 27, 2007 and $184 at April 28, 2006.

 

Inventories    Inventories are stated at the lower of cost or market, with cost determined on a first-in, first-out basis. Inventory balances are as follows:

 

 

 

April 27,
2007

 

April 28,
2006

 

Finished goods

 

$

753

 

$

736

 

Work in process

 

 

209

 

 

197

 

Raw materials

 

 

253

 

 

244

 

Total

 

$

1,215

 

$

1,177

 

 

Property, Plant and Equipment   Property, plant and equipment is stated at cost. Additions and improvements that extend the lives of the assets are capitalized while expenditures for repairs and maintenance are expensed as incurred. Depreciation is provided using the straight-line method over the estimated useful lives of the various assets. Property, plant and equipment balances and corresponding lives are as follows:

 

 

 

April 27,
2007

 

April 28,
2006

 

Lives
(in years)

Land and land improvements

 

$

95

 

$

92

 

Up to 20

Buildings and leasehold improvements

 

 

1,007

 

 

955

 

Up to 40

Equipment

 

 

2,784

 

 

2,513

 

3-7

Construction in progress

 

 

423

 

 

234

 

Subtotal

 

 

4,309

 

 

3,794

 

 

Less: Accumulated depreciation

 

 

(2,247

)

 

(1,913

)

 

Property, plant and equipment, net

 

$

2,062

 

$

1,881

 

 

 

Depreciation expense of $401, $369, and $335 was recognized in fiscal years 2007, 2006, and 2005, respectively.

 

Goodwill   Goodwill is the excess of purchase price of an acquired entity over the amounts assigned to assets acquired and liabilities assumed in a business combination. In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” goodwill is not amortized. Goodwill is tested for impairment annually and when an event occurs or circumstances change that would indicate the carrying amount may be impaired. Impairment testing for goodwill is done at a reporting unit level. An impairment loss is recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. The estimated fair value is determined using discounted future cash flows analysis. The Company completed its annual goodwill impairment test in the third quarter of fiscal years 2007, 2006, and 2005 and determined that no goodwill was impaired.

 

Intangible Assets   Intangible assets include patents, trademarks, and purchased technology. Intangible assets with a definite life are amortized on a straight-line or accelerated basis, as appropriate, with estimated useful lives ranging from 3 to 20 years. Intangible assets with a definite life are tested for impairment whenever events or circumstances indicate that a carrying amount of an asset (asset group) may not be recoverable. Impairment is calculated as the excess of the asset’s carrying value over its fair value. Fair value is generally determined using a discounted future cash flows analysis. As of April 27, 2007, all of the Company’s intangible assets are definite lived and amortized on a straight-line basis.

 

Warranty Obligation   The Company offers a warranty on various products. The Company estimates the costs that may be incurred under its warranties and records a liability in the amount of such costs at the time the product is sold. Factors that affect the Company’s warranty liability include the number of units sold, historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. The amount of the reserve recorded is equal to the costs to repair or otherwise satisfy the claim. The Company includes the covered costs associated with field actions, if any, in warranty expense.

 

43



Table of Contents

Changes in the Company’s product warranty obligations during the years ended April 27, 2007 and April 28, 2006 consisted of the following:

 

Balance April 29, 2005

 

$

43

 

Warranty claims provision

 

 

47

 

Settlements made

 

 

(49

)

 

 

 

 

 

Balance April 28, 2006

 

 

41

 

Warranty claims provision

 

 

27

 

Settlements made

 

 

(34

)

 

 

 

 

 

Balance April 27, 2007

 

$

34

 

 

Self-Insurance   It is the Company’s policy to self-insure the vast majority of its insurable risks including medical and dental costs, disability coverage, physical loss to property, business interruptions, workers’ compensation, comprehensive general, director and officer and product liability. Insurance coverage is obtained for those risks required to be insured by law or contract. A provision for losses under the self-insured program is recorded and revised quarterly. The Company uses claims data and historical experience, as applicable, to estimate liabilities associated with the exposures that the Company has self-insured. Based on historical loss trends, the Company believes that its self-insurance program accruals are adequate to cover future losses. Historical trends, however, may not be indicative of future losses. These losses could have a material adverse impact on the Company’s consolidated financial statements.

 

Retirement Benefit Plan Assumptions   The Company sponsors various retirement benefit plans, including defined benefit pension plans, defined contribution savings plans, post-retirement medical plans, and termination indemnity plans, covering substantially all U.S. employees and many employees outside the U.S. Pension benefit and post-retirement medical plan costs include assumptions for the discount rate, retirement age, compensation rate increases, and the expected return on plan assets. Post-retirement medical plan costs also incorporate healthcare cost trend rate assumptions.

 

Annually, the Company evaluates the discount rate, retirement age, compensation rate increases, expected return on plan assets and healthcare cost trend rates of its pension benefit and post-retirement medical plans. In evaluating these assumptions, many factors are considered, including an evaluation of assumptions made by other companies, historical assumptions compared to actual results, current market conditions, asset allocations, and the views of leading financial advisors and economists. In evaluating the expected retirement age assumption, the Company considers the retirement ages of past employees eligible for pension and medical benefits together with expectations of future retirement ages.

 

It is reasonably possible that changes in these assumptions will occur in the near term and, due to the uncertainties inherent in setting assumptions, the effect of such changes could be material to the Company’s consolidated financial statements. Refer to Note 13 for additional information regarding the Company’s retirement benefit plans.

 

Revenue Recognition   The Company sells its products primarily through a direct sales force in the U.S. and a combination of direct sales representatives and independent distributors in international markets. The Company recognizes revenue when title to the goods and risk of loss transfers to customers, provided there are no remaining performance obligations required of the Company or any matters requiring customer acceptance. In cases where the Company utilizes distributors or ships product directly to the end user, it recognizes revenue upon shipment provided all revenue recognition criteria have been met. A portion of the Company’s revenue is generated from inventory maintained at hospitals or with field representatives. For these products, revenue is recognized at the time that the product has been used or implanted. The Company records estimated sales returns, discounts, and rebates as a reduction of net sales in the same period revenue is recognized.

 

Research and Development   Research and development costs are expensed when incurred.

 

IPR&D   When the Company acquires another entity, the purchase price is allocated, as applicable, between IPR&D, other identifiable intangible assets, net tangible assets, and goodwill. The Company’s policy defines IPR&D as the value assigned to those projects for which the related products have not received regulatory approval and have no alternative future use. Determining the portion of the purchase price allocated to IPR&D requires the Company to make significant estimates. The amount of the purchase price allocated to IPR&D is determined by estimating the future cash flows of each project or technology and discounting the net cash flows back to their present values. The discount rate used is determined at the time of acquisition in accordance with accepted valuation methods. These methodologies include consideration of the risk of the project not achieving commercial feasibility.

 

44



Table of Contents

Other Expense, Net   Other expense, net includes intellectual property amortization expense, royalty income and expense, realized equity security gains and losses, realized foreign currency transaction and derivative gains and losses, and impairment charges on equity securities.

 

Stock-Based Compensation Our compensation programs include share-based payments. Beginning in fiscal year 2007, all awards under share-based payment programs are accounted for at fair value and these fair values are generally amortized on a straight-line basis over the vesting terms into cost of products sold, research and development expense, and selling, general and administrative expense in the consolidated statement of earnings, as appropriate. In fiscal year 2006 and earlier years, grants under share-based payment programs were accounted for using the intrinsic value method, which measured fair value based on the difference between the quoted market price of the stock and the exercise price on the date of grant. Refer to Note 11 for additional information.

 

Foreign Currency Translation   Assets and liabilities are translated to U.S. dollars at period-end exchange rates, and the resulting gains and losses arising from the translation of net assets located outside the U.S. are recorded as a cumulative translation adjustment, a component of accumulated other comprehensive (loss)/income in the consolidated balance sheets. Elements of the consolidated statements of earnings are translated at average exchange rates in effect during the period and foreign currency transaction gains and losses are included in other expense, net in the consolidated statements of earnings.

 

Comprehensive Income and Accumulated Other Comprehensive (Loss)/Income   In addition to net earnings, comprehensive income includes changes in foreign currency translation adjustments (including the change in current exchange rates, or spot rates, of net investment hedges), unrealized gains and losses on foreign exchange derivative contracts qualifying and designated as cash flow hedges, minimum pension liabilities, and unrealized gains and losses on AFS marketable securities. Comprehensive income in fiscal years 2007, 2006, and 2005 was $2,794, $2,552, and $1,882, respectively.

 

Presented below is a summary of activity for each component of accumulated other comprehensive (loss)/income for fiscal years 2007, 2006, and 2005:

 

 

 

Cumulative
Translation
Adjustments

 

Unrealized
Gain/(Loss) on
Foreign Exchange Derivatives

 

Minimum
Pension Liability
and SFAS No. 158
Adjustments

 

Unrealized
Gain/(Loss) on
Investments

 

Accumulated
Other
Comprehensive
(Loss)/Income

 

Balance April 30, 2004

 

$

127

 

$

(47

)

$

(10

)

$

1

 

$

72