EX-13 21 medtronic082604s1_ex13.htm Exhibit 13 to Medtronic, Inc. Form 10-K for fiscal year ended April 25, 2008

Exhibit 13

 

Table of Contents

 









1

 


 

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 25, 2008 and April 27, 2007 and for each of the three fiscal years ended April 25, 2008, April 27, 2007, and April 28, 2006.

 

Organization of Financial Information Management’s discussion and analysis, presented on pages 2 to 31 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 34 to 77 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, and 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.

 

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 2008, 2007, and 2006 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 first quarter of fiscal year 2008, we revised our operating segment reporting to combine our former Vascular and Cardiac Surgery businesses into the new CardioVascular operating segment. Additionally, the Navigation business was separated from Spinal for most of fiscal year 2008 and was reported as part of a stand-alone segment named Corporate Technologies and New Ventures. In the fourth quarter of fiscal year 2008, the decision was made to include the Navigation business as a component of the Ear, Nose and Throat (ENT) segment, which was renamed Surgical Technologies to reflect the expanding scope and focus of this business. As a result, the Company now functions in seven operating segments, consisting of Cardiac Rhythm Disease Management (CRDM), Spinal, CardioVascular, Neuromodulation, Diabetes, Surgical Technologies, and Physio-Control. The applicable information for fiscal years 2007 and 2006 has been reclassified to conform to the current presentation.

 

Through these seven operating segments, we develop, manufacture, and market our medical devices in more than 120 countries. 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.

 

On November 2, 2007, we consummated our $4.203 billion acquisition of Kyphon Inc. (Kyphon) and it became our wholly owned subsidiary. Kyphon develops and markets medical devices designed to restore and preserve spinal function using minimally invasive technology. Kyphon’s primary products are used in balloon kyphoplasty for the treatment of spinal compression fractures caused by osteoporosis or cancer, and in the interspinous process decompression (IPD) procedure for treating the symptoms of lumbar spinal stenosis. It is expected that the acquisition of Kyphon will add to the growth of our existing Spinal business by extending its product offerings into some of the fastest growing product segments of the spine market, enabling us to provide physicians with a broader range of therapies for use at all stages of the care continuum. For the fiscal year ended April 25, 2008, Kyphon contributed $298 million of revenue to the Spinal business. See the “Acquisitions” section of this management’s discussion and analysis for further information.

 

2

 



Net earnings for the fiscal year ended April 25, 2008 were $2.231 billion, a $571 million, or 20 percent, decrease from net earnings of $2.802 billion for the fiscal year ended April 27, 2007. Diluted earnings per share were $1.95 and $2.41 for the fiscal years ended April 25, 2008 and April 27, 2007, respectively. Fiscal year 2008 net earnings include after-tax special, restructuring, IPR&D and certain litigation charges that decreased net earnings by $742 million and had a $0.65 impact on diluted earnings per share. Fiscal year 2007 net earnings include after-tax special, restructuring and certain litigation charges, and certain tax adjustments that increased net earnings by $5 million and had no net impact on diluted earnings per 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 2008 special, restructuring, IPR&D and certain litigation charges more than offset the positive earnings growth from core operations.

 

 

 

Net Sales

 

 

 

 

 

Fiscal Year

 

 

 

 

 

2008

 

2007

 

% Change

(dollars in millions)

 

 

 

 

 

 

 

 

 

Cardiac Rhythm Disease Management

 

$

4,963

 

$

4,876

 

2

%

Spinal

 

 

2,982

 

 

2,417

 

23

 

CardioVascular

 

 

2,131

 

 

1,909

 

12

 

Neuromodulation

 

 

1,311

 

 

1,183

 

11

 

Diabetes

 

 

1,019

 

 

863

 

18

 

Surgical Technologies

 

 

780

 

 

666

 

17

 

Physio-Control

 

 

329

 

 

385

 

(15

Total Net Sales

 

$

13,515

 

$

12,299

 

10

%

 

Net sales in fiscal year 2008 were $13.515 billion, an increase of 10 percent from the prior fiscal year. Foreign currency translation had a favorable impact of $400 million on net sales when compared to fiscal year 2007. The net sales increase in the current fiscal year was fortified by the addition of Kyphon to our Spinal business and led by organic double digit sales growth in the CardioVascular, Diabetes, Neuromodulation, and Surgical Technologies businesses. Growth outside the United States (U.S.) was also especially strong, where six of our seven operating segments had strong double digit growth rates. See our discussion in the “Net Sales” section of this management’s discussion and analysis for more information on the results of our significant operating segments.

 

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 innovative research and development.

 

Other Matters

 

On October 15, 2007, we announced the voluntary suspension of worldwide distribution of Sprint Fidelis (Fidelis) leads because of the potential for lead fractures at higher than anticipated rates. Leads are sophisticated “wires” that connect an electronic pulse generator to the heart and are the pathway for therapy delivery between the device and heart. The Fidelis leads are applicable to therapy delivery in defibrillators only, including implantable cardioverter defibrillators (ICDs) and cardiac resynchronization therapy – defibrillators (CRT-Ds). The decision to voluntarily suspend the worldwide distribution of the Fidelis lead was based on a variety of factors that, when viewed together, indicated a voluntary suspension was the appropriate action. Based on Medtronic’s extensive performance data, Fidelis lead viability was trending lower than Medtronic’s Sprint Quattro (Quattro) lead at 30 months after implant (97.7 percent Fidelis vs. 99.1 percent Quattro). This difference was not considered statistically significant; however, if the current lead fracture rates remain constant, it could become significant over time. We believed that given this performance trend, this suspension of worldwide distribution was in the patients’ best interests.

 

When we ceased selling Fidelis leads and asked customers to return their unused product, Fidelis leads represented approximately 75 percent of our high power lead manufacturing output with our Quattro leads representing the other 25 percent. We successfully transitioned our manufacturing back to the production of Quattro leads and, by the end of the third quarter of fiscal year 2008, had re-established sufficient internal inventory levels to meet customer demand. Even though we quickly re-established our internal inventory levels, we believe we missed selling opportunities in the second, third and fourth quarters of fiscal year 2008 due to the voluntary suspension of worldwide distribution of Fidelis leads, the lack of a single coil lead, and the lack of an approved lead in Japan for most of the third quarter of fiscal year 2008. In January 2008, we were able to begin selling our Quattro lead in Japan after receiving both regulatory and reimbursement approvals.

 

3

 



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. However, shortly thereafter, in January 2007, we announced a voluntary suspension of U.S. shipments of Physio-Control products manufactured at our facility in Redmond, Washington in order to address quality system issues. In the months following the suspension of U.S. shipments, we worked diligently with the U.S. Food and Drug Administration (FDA) to address the quality system issues and resumed limited shipments to critical need customers. As a result of the work performed to date, on April 28, 2008, we announced that we had reached an agreement on a consent decree with the FDA regarding quality system improvements for our external defibrillator products. The agreement was filed on April 25, 2008 in the U.S. District Court for the Western District of Washington and was approved by the court on May 9, 2008. The agreement addresses issues raised by the FDA during inspections regarding Physio-Control’s quality system processes and outlines the actions Physio-Control must take in order to resume unrestricted distribution of our external defibrillators. Following the resolution of the quality system issues, we intend to pursue the spin-off of Physio-Control.

 

Critical Accounting Estimates

 

We have adopted various accounting policies to prepare our 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 our 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, stock-based compensation, sales returns and discounts, valuation of equity and debt securities, 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:

 

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, that could require significant expenditures or result in lost revenues. In accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 5, “Accounting for Contingencies,” (SFAS No. 5) 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 than any other, 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 most of the matters discussed in Note 15 to the consolidated financial statements, we believe it is possible that costs associated with them could have a material adverse impact on our consolidated earnings, financial position or cash flows on any one interim or annual period. With the exception of the Cordis, Marquis, and Kyphon matters, negative outcomes for the balance of the litigation matters discussed in Note 15 to the consolidated financial statements are not considered probable or cannot be reasonably estimated.

 

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. 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 that we may or may not prevail. These reserves are established and adjusted in accordance with the principles of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN No. 48). Under this Interpretation, if we determine that a tax position is more likely than not of being sustained upon audit, based solely on the technical merits of the position, we recognize the benefit. We measure the benefit by determining the amount that is greater than 50 percent likely of being realized upon settlement. We presume that all tax positions will be examined by a taxing authority with full knowledge of all relevant information. We regularly monitor our tax positions and FIN No. 48 tax liabilities. We reevaluate the technical merits of our tax positions and recognize an uncertain tax benefit, or derecognize a previously recorded tax benefit, when (i) there is a completion of a tax audit, (ii) there is a change in applicable tax law including a tax case or legislative guidance, or (iii) there is an expiration of the statute of limitations. Significant judgment is required in accounting for tax reserves. Although we believe that we have adequately provided for liabilities resulting from tax assessments by taxing authorities, positions taken by these tax authorities could have a material impact on our effective tax rate in future periods.

 

4

 



 

In the event there is a special, restructuring, certain litigation and/or IPR&D charge recognized in our operating results, the tax cost or benefit attributable to that item is separately calculated and recorded. Because the effective rate can be significantly impacted by these discrete items that take place in the period, we often refer to our tax rate using both the effective rate and the non-GAAP nominal tax rate. The non-GAAP nominal tax rate is defined as the income tax provision as a percentage of taxable income, excluding special, restructuring, certain litigation, and IPR&D charges. We believe that this resulting non-GAAP financial measure provides useful information to investors because it excludes the effect of these discrete items so that investors can compare our recurring results over multiple periods.

 

Tax regulations require certain items to 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 returns. Some of these differences are permanent, such as expenses that are not deductible on our tax return, and some are temporary differences, such as depreciation expense. Temporary 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 has resulted in an effective tax rate of 22.7 percent for fiscal year 2008. Excluding the impact of these items, our operational and tax strategies have resulted in a non-GAAP nominal tax rate of 21.0 percent versus the U.S. statutory rate of 35.0 percent. An increase in our nominal tax rate of 1.0 percent would result in an additional income tax provision for the fiscal year ended April 25, 2008 of approximately $38 million. See discussion of the tax rate in the “Income Taxes” section of the 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.

 

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 circumstances 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 $7.519 billion and $4.327 billion as of April 25, 2008 and April 27, 2007, respectively.

 

Other intangible assets consist primarily of purchased technology, patents, and trademarks and are amortized using the straight-line or accelerated method, as appropriate, over their estimated useful lives, ranging from 3 to 20 years. As of April 25, 2008, 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 $2.193 billion and $1.433 billion as of April 25, 2008 and April 27, 2007, respectively.

 

5

 


 

Net Sales

 

The table below illustrates net sales by product line and operating segment for fiscal years 2008, 2007, and 2006:

 

 

 

 

Net Sales

 

 

 

Net Sales

 

 

 

 

 

Fiscal year

 

 

 

Fiscal year

 

 

 

 

(dollars in millions)

 

2008

 

2007

 

%
Change

 

2007

 

2006

 

%
Change

 

Pacing Systems

 

$

2,008

 

$

1,895

 

6

%

$

1,895

 

$

1,795

 

6

%

Defibrillation Systems

 

 

2,897

 

 

2,917

 

(1

)

 

2,917

 

 

2,932

 

(1

Other

 

 

58

 

 

64

 

(9

)

 

64

 

 

67

 

(4

)

CARDIAC RHYTHM DISEASE MANAGEMENT

 

 

4,963

 

 

4,876

 

2

 

 

4,876

 

 

4,794

 

2

 

Core Spinal

 

 

1,869

 

 

1,713

 

9

 

 

1,713

 

 

1,566

 

9

 

Biologics

 

 

815

 

 

704

 

16

 

 

704

 

 

570

 

24

 

Kyphon

 

 

298

 

 

 

N/A

 

 

 

 

 

N/A

 

SPINAL

 

 

2,982

 

 

2,417

 

23

 

 

2,417

 

 

2,136

 

13

 

Coronary Stents

 

 

710

 

 

560

 

27

 

 

560

 

 

366

 

53

 

Other Coronary/Peripheral

 

 

408

 

 

386

 

6

 

 

386

 

 

357

 

8

 

Endovascular

 

 

285

 

 

259

 

10

 

 

259

 

 

216

 

20

 

Revascularization and Surgical Therapies

 

 

431

 

 

417

 

3

 

 

417

 

 

401

 

4

 

Structural Heart Disease

 

 

297

 

 

287

 

3

 

 

287

 

 

263

 

9

 

CARDIOVASCULAR

 

 

2,131

 

 

1,909

 

12

 

 

1,909

 

 

1,603

 

19

 

Neuro Implantables

 

 

1,069

 

 

962

 

11

 

 

962

 

 

833

 

15

 

Gastroenterology and Urology

 

 

242

 

 

221

 

10

 

 

221

 

 

183

 

21

 

NEUROMODULATION

 

 

1,311

 

 

1,183

 

11

 

 

1,183

 

 

1,016

 

16

 

DIABETES

 

 

1,019

 

 

863

 

18

 

 

863

 

 

722

 

20

 

Core ENT

 

 

323

 

 

278

 

16

 

 

278

 

 

266

 

5

 

Neurologic Technologies

 

 

298

 

 

261

 

14

 

 

261

 

 

235

 

11

 

Navigation

 

 

159

 

 

127

 

25

 

 

127

 

 

108

 

18

 

SURGICAL TECHNOLOGIES

 

 

780

 

 

666

 

17

 

 

666

 

 

609

 

9

 

PHYSIO-CONTROL

 

 

329

 

 

385

 

(15

)

 

385

 

 

412

 

(7

) 

TOTAL

 

$

13,515

 

$

12,299

 

10

%

$

12,299

 

$

11,292

 

9

%

 

In fiscal years 2008 and 2007, net sales were favorably impacted by foreign currency translation of $400 million and $166 million, respectively. 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 8 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, insertable cardiac monitors, and information systems for the management of patients with our devices. CRDM fiscal year 2008 net sales grew by 2 percent from the prior fiscal year to $4.963 billion. Foreign currency translation had a favorable impact on net sales of approximately $160 million when compared to the prior fiscal year.

 

6

 


 

Defibrillation Systems net sales of $2.897 billion for fiscal year 2008 decreased 1 percent as compared to fiscal year 2007. The decrease in net sales is the result of sales declines in the U.S., offset by sales growth outside the U.S. Global sales were driven by the Virtuoso ICD and the Concerto 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. Net sales from Defibrillation Systems in the U.S. were $1.955 billion, a decrease of 6 percent in comparison to the prior year. The decrease in U.S. Defibrillation Systems net sales in fiscal year 2008 is primarily the result of the suspension of worldwide distribution of the Fidelis lead. See the discussion in the “Other Matters” section of this management’s discussion and analysis for further information on the suspension of worldwide distribution of the Fidelis lead. Although the U.S. Defibrillation Systems market appears to have stabilized from the impact of the Fidelis lead issue, in the fourth quarter of fiscal year 2008 the rebound was not enough to offset the negative impact that the Fidelis lead issue had in the second and third quarters of fiscal year 2008. Outside the U.S., net sales from Defibrillation Systems were $942 million, an increase of 13 percent over the prior fiscal year. This growth is partially driven by favorable foreign currency translation as compared to the prior year, but is principally the result of strong market acceptance of the Virtuoso ICD and Concerto CRT-D. Outside the U.S. net sales were also impacted by the Fidelis lead issue. In particular, for most of the third quarter, we did not have an approved high power lead on the market in Japan, and as of the close of the fourth quarter we still do not have an approved single coil lead, which is a more popular lead design in certain Western European markets.

 

Pacing Systems net sales for fiscal year 2008 increased by 6 percent over the prior fiscal year to $2.008 billion. The increase in the current fiscal year is attributable primarily to continued worldwide acceptance of 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 have been available outside the U.S. since late fiscal year 2006. The Adapta 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 may decrease the risk of developing heart failure and atrial fibrillation, a potentially life-threatening irregular heartbeat. Net sales from Pacing Systems in the U.S. were $940 million, an increase of 1 percent. The revenue growth in the U.S. was slowed in the second and third quarters of fiscal year 2008 by the suspension of worldwide distribution of the Fidelis lead, as our field organization focused their efforts on serving Fidelis customers and patients. Outside the U.S., net sales from Pacing Systems were $1.068 billion, an increase of 11 percent over the prior fiscal year due primarily to foreign currency translation which had an $86 million favorable impact on net sales outside the U.S.

 

Fiscal year 2008 Defibrillation and Pacing Systems 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 250,000 patients are being monitored through Medtronic’s CareLink Service worldwide, up from approximately 124,000 patients being monitored a year ago.

 

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.

 

Defibrillation Systems net sales of $2.917 billion for fiscal year 2007 decreased 1 percent as compared to fiscal year 2006. This slight decrease was the result of sales declines in the U.S., offset by strong sales growth outside the U.S. Net sales from Defibrillation Systems in the U.S. were $2.082 billion, a decrease of 9 percent. The decrease in U.S. Defibrillation Systems net sales in fiscal year 2007 was primarily the result of a decline in the U.S. ICD market. Outside the U.S., net sales from Defibrillation Systems were $835 million, an increase of 29 percent over the prior fiscal year, driven by the Virtuoso ICD and the Concerto CRT-D.

 

Pacing Systems net sales for fiscal year 2007 increased by 6 percent over fiscal year 2006 to $1.895 billion. The increase was 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.

 

7

 


 

Fiscal year 2007 Defibrillation and Pacing Systems sales also benefited from the continued acceptance of the Medtronic CareLink Service, as over 124,000 patients were being monitored through Medtronic’s CareLink Service worldwide, up from approximately 70,000 patients being monitored a year ago.

 

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

 

 

The future acceptance upon launch of our new Vision 3D portfolio, which will comprise a full line of ICDs, CRT-Ds, pacemakers and cardiac resynchronization therapy-pacemakers (CRT-Ps) to address the needs of patients with arrhythmias, heart failure and those at risk of sudden cardiac arrest. The Secura ICD and the Consulta CRT-D, the portfolio’s first ICD and CRT-D devices, are expected to be commercially available in the coming months. Vision 3D is our first generation device with a common platform across ICDs, CRT-Ds and pacing systems. Additionally, these products provide enhanced follow-up and automaticity features and create meaningful manufacturing synergies. We will continue to develop our industry leading product portfolio to meet the medical needs of our patients.

 

 

The future acceptance of our single coil Quattro lead, which we expect to launch in markets around the world in the first quarter of fiscal year 2009. Some physicians prefer a single coil lead, particularly physicians in certain Western European countries. We believe the future availability of this product will help us to further recover from the impact of the Fidelis lead issue.

 

 

Continued acceptance of the Adapta family of pacemakers, including the Adapta, Versa, and Sensia models.

 

 

Continued expansion of the Medtronic CareLink Service, available on both the Pacing and Defibrillator platforms in the U.S., Canada, and Western Europe, and beginning in the fourth quarter of fiscal year 2008, on a pilot basis in Japan and Australia. We believe Medtronic CareLink Service continues to drive physician preference for our products.

 

 

The future launch and acceptance of the EnRhythm MRI SureScan pacing system (EnRhythm MRI). EnRhythm MRI will be the first pacemaker system to be developed and tested specifically for safe use in Magnetic Resonance Imaging (MRI) machines under specified scanning conditions. EnRhythm MRI is designed to address and mitigate interactions between the pacing system and the magnetic resonance environment.

 

Our growth in CRDM has been and will continue to be contingent upon continued market growth and our ability to maintain our market position.

 

Spinal Spinal products include thoracolumbar, cervical, and interbody spinal devices, bone growth substitutes, and devices for vertebral compression fractures and spinal stenosis. Spinal net sales for fiscal year 2008 increased by 23 percent from the prior fiscal year to $2.982 billion. Foreign currency translation had a favorable impact on net sales of $44 million when compared to the prior fiscal year. The growth in fiscal year 2008 was primarily driven by the November 2, 2007 close of the acquisition of Kyphon, which generated revenue of $298 million during the fiscal year.

 

Core Spinal net sales for fiscal year 2008 were $1.869 billion, an increase of 9 percent from the prior fiscal year. Growth in the period was primarily based on continued acceptance of our products for the thoracolumbar and cervical sections of the spine. Net sales in fiscal year 2008 were hampered by the trend of small companies increasing their presence and placing pressure on the Core Spinal market. Today, there are over 200 small physician owned companies competing in the marketplace. Thoracolumbar net sales growth for fiscal year 2008 was driven by net sales of the CD HORIZON LEGACY family of products (CD HORIZON) and the CAPSTONE Vertebral Body Spacer (CAPSTONE) outside the U.S., net sales of the VERTE-STACK CRESCENT Vertebral Body Spacer (CRESCENT) for thoracolumbar stabilization in the U.S., and worldwide net sales growth of the Lumbar Dynamic platform of products. CD HORIZON 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. The CAPSTONE and CRESCENT are minimal access devices and techniques designed to replace and restore vertebral height in the thoracolumbar spine. The growth of our Lumbar Dynamic platform of products, which allow some range in motion as compared to our fixed stabilization devices, was driven by demand for our PEEK Rod System in the U.S. and DIAM System outside the U.S. The growth in net sales in our cervical products during the fiscal year was led by the continued acceptance of the VERTEX Max Reconstruction System for cervical stabilization outside the U.S.

 

Biologics net sales for fiscal year 2008 increased 16 percent from the prior fiscal year to $815 million. This increase was primarily driven by continued strong acceptance of INFUSE Bone Graft in the U.S. 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 FDA approval for use of INFUSE Bone Graft for spinal fusion, we received FDA approval to use INFUSE Bone Graft for the treatment of certain types of acute, open fractures of the tibial shaft in fiscal year 2005, and for certain oral maxillofacial and dental regenerative bone grafting procedures late in fiscal year 2007. Additionally, although on a smaller base, we have continued to experience strong fiscal year 2008 growth in the sales of InductOs Bone Graft, the outside the U.S. equivalent of INFUSE Bone Graft.

 

8

 


 

Kyphon, which was acquired on November 2, 2007, had net sales of $298 million for fiscal year 2008 that were driven by continued acceptance of balloon kyphoplasty procedures for treating vertebral compression fractures and acceptance of Kyphon’s interspinous products for treating lumbar spinal stenosis. Balloon kyphoplasty, using Kyphon instruments, is presently used primarily by spine specialists, including orthopedic surgeons and neurosurgeons, interventional radiologists and interventional neuroradiologists, who repair compression fractures of the spine through minimally invasive spine surgeries. Kyphon’s interspinous products for treating lumbar spinal stenosis include the commercially available X-STOP IPD technology available in both the U.S. and outside the U.S. and Aperius PercLID available outside the U.S.

 

Spinal net sales for fiscal year 2007 increased by 13 percent from the prior fiscal year to $2.417 billion, driven by solid growth across our entire portfolio of product offerings. Foreign currency translation had a favorable impact of $7 million on net sales when compared to the prior fiscal year. Core Spinal net sales were $1.713 billion, a 9 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. 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 Core Spinal were CAPSTONE and CRESCENT, 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 $704 million in fiscal year 2007, a 24 percent increase over the prior year, based on continued strong acceptance of INFUSE Bone Graft. 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.

 

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

 

 

Continued acceptance of our products for stabilization of the thoracolumbar and cervical sections of the spine, including the CD HORIZON LEGACY 5.5 and the VERTEX Max Reconstruction System.

 

 

Continued acceptance of the INFUSE Bone Graft for spinal fusion and certain types of acute, open tibia fractures.

 

 

Future launch of the extra small and double extra small INFUSE kits for use in Spinal and oral maxillofacial procedures. We received FDA approval to market these two smaller kit sizes in April 2008, and they are expected to be available for clinical use in June 2008. These smaller kits should help to continue the strong growth that we have experienced to date by expanding the potential user population.

 

 

Continued growth in the acceptance of our PRESTIGE Cervical Disc System for dynamic stabilization, which received FDA approval on July 16, 2007 and was launched in the U.S. at the end of the first quarter of fiscal year 2008. We continue to train surgeons in the use of this product, and are encouraged by the steady progress we are making with reimbursement agencies for coverage.

 

 

Continued acceptance of our Lumbar dynamic platform of products including the PEEK Rod System in the U.S. and the DIAM System outside the U.S. combined with continued acceptance of Kyphon’s X-Stop IPD system and the Aperius PercLID, for the treatment of mild to moderate lumbar spinal stenosis.

 

 

Continued acceptance of the Kyphon instruments for use in balloon kyphoplasty. The acquisition of Kyphon is expected to add to the growth of our existing Spinal business by extending our product offerings into some of the fastest growing product segments of the spine market, enabling us to provide physicians with a broader range of therapies for use at all stages of the care continuum.

 

CardioVascular   CardioVascular products consist of coronary and peripheral stents and related delivery systems, endovascular stent graft systems, heart valve replacement technologies and tissue ablation systems, and open heart and coronary bypass grafting surgical products. CardioVascular net sales for fiscal year 2008 increased 12 percent from the prior fiscal year to $2.131 billion. Foreign currency translation had a favorable impact of $101 million on net sales when compared to the prior fiscal year.

 

9

 



Coronary Stent and Other Coronary/Peripheral net sales increased 18 percent in comparison to the prior fiscal year to $1.118 billion. The growth in Coronary Stent and Other Coronary/Peripheral net sales was primarily a result of the successful launch of the Endeavor drug-eluting stent (Endeavor) in the U.S., strong sales of Endeavor and the Endeavor Resolute drug-eluting stent (Endeavor Resolute) outside the U.S., and continued acceptance of the Driver family of bare metal stents. Although the market for stents and drug-eluting stents has declined, Endeavor and Endeavor Resolute continue to benefit from favorable safety and efficacy data, along with their ease of delivery. Endeavor, which was commercially released in the U.S. in February 2008, generated net sales of $81 million. Outside the U.S., Endeavor and Endeavor Resolute generated net sales of $337 million in fiscal year 2008, an increase of 12 percent over the prior year. Endeavor Resolute received CE Mark approval in October 2007 and is currently available in more than 100 countries. We also recognized net sales of $292 million in fiscal year 2008 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, which is also the base stent used in Endeavor and Endeavor Resolute, is a cobalt-chromium coronary stent which has thinner struts and provides greater maneuverability in placing the stent.

 

Endovascular fiscal year 2008 net sales grew 10 percent when compared to the prior fiscal year. Growth in the Endovascular business was driven in part by net sales of the Talent AAA Stent Graft System and 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. Net sales in the U.S. decreased in fiscal year 2008 as compared to the prior fiscal year as a result of a voluntary field action on the AneuRx AAAdvantage Stent Graft System that required physician and patient notification of a product packaging issue. As of the end of the fiscal year, both of these issues have been corrected and we expect to return to growth in the U.S. market.

 

Revascularization and Surgical Therapies net sales for fiscal year 2008 were $431 million, an increase of 3 percent in comparison to the prior fiscal year. The increase is the result of net sales growth outside the U.S., which increased 13 percent primarily from sales of our cannulae and beating heart products. The strong growth outside the U.S. was partially offset by a decrease in net sales in the U.S.

 

Structural Heart Disease net sales grew 3 percent in comparison to the prior fiscal year to $297 million. The increase in net sales for the fiscal year was driven by net sales outside the U.S., which offset slightly negative growth in the U.S. Net sales growth outside the U.S. was driven by sales of our Mosaic and Mosaic Ultra tissue values and our Melody Transcatheter Pulmonary Valve and Ensemble Transcatheter Delivery System. The growth outside the U.S. was tempered by the suspension of sales of the Advantage mechanical heart valve in the first quarter of fiscal year 2008. The Advantage valve was reintroduced to the market during the third quarter of fiscal year 2008. The Mosaic and Mosaic Ultra tissue valves incorporate several design features to facilitate implantation and improve durability. The Melody Transcatheter Pulmonary Valve and Ensemble Transcatheter Delivery System provide a catheter-based approach to pulmonic valve replacement for patients with congenital heart defects, with the goal of reducing the invasiveness and risk associated with pulmonic valve replacement.

 

CardioVascular net sales for fiscal year 2007 increased 19 percent from the prior fiscal year to $1.909 billion. Foreign currency translation had a favorable impact of $43 million on net sales when compared to the prior fiscal year.

 

Coronary Stent and Other Coronary/Peripheral net sales for fiscal year 2007 increased 31 percent in comparison to the prior fiscal year to $946 million. The growth in Coronary Stent and Other Coronary/Peripheral net sales was primarily a result of the commercial availability of Endeavor outside the U.S. for a full fiscal year and further acceptance of the Driver family of bare metal stents. Endeavor, which generated revenue of $300 million in fiscal year 2007, was then commercially released in over 100 countries outside the U.S. 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.

 

Endovascular fiscal year 2007 net sales grew 20 percent when compared to the prior fiscal year. Growth in the Endovascular business was driven by the 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.

 

Revascularization and Surgical Therapies net sales for fiscal year 2007 were $417 million, an increase of 4 percent in comparison to the prior fiscal year, led by net sales of our cannulae and cardiopulmonary products outside the U.S.

 

10

 


 

Structural Heart Disease net sales grew 9 percent in fiscal year 2007 in comparison to the prior fiscal year to $287 million. The increase in net sales for the fiscal year was driven by sales of our Mosaic and Mosaic Ultra tissue values as well as sales of the Melody Transcatheter Pulmonary Valve and Ensemble Transcatheter Delivery System outside the U.S.

 

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

 

 

Continued acceptance of Endeavor, which was launched in the U.S. market in February 2008. Endeavor is the first new drug-eluting stent approved for use in the U.S. market in over four years and offers a unique and beneficial safety and efficacy profile for treating patients with coronary artery disease. Additionally, we anticipate receiving regulatory approval and launching Endeavor in Japan in the second half of fiscal year 2009.

 

 

Continued acceptance of Endeavor Resolute in markets outside the U.S. Endeavor Resolute combines the proven drug and stent components of Endeavor with Biolinx, a proprietary biocompatible polymer specifically engineered for drug eluting stent use. Biolinx facilitates the elongation of Zotarolimus elution while providing excellent biocompatibility. The design goal of Endeavor Resolute is enhanced safety and efficacy in the most complex lesions and patients.

 

 

Continued acceptance of our Sprinter Legend Semicompliant Rapid Exchange Balloon Dilation Catheter for use in coronary angioplasty procedures. We received CE Mark approval and initiated a November 2007 launch in markets outside the U.S. The Sprinter Legend Balloon incorporates revolutionary Zerofold technology which enables an exceptionally low profile with no wrapped material and no balloon shoulders. This design assists our customers in addressing their most difficult technical challenges.

 

 

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 and enrollment was completed in September 2007.

 

 

Future acceptance of the Talent AAA Stent Graft System in the U.S. market and our anticipated entry into the U.S. and Japanese thoracic stent graft markets. The Talent AAA Stent Graft System received FDA approval in April 2008 and is anticipated to be commercially available in June 2008. We received FDA approval of the Talent Thoracic stent graft in June 2008, and we anticipate Japanese approval of the Talent Thoracic stent graft in the third quarter of fiscal year 2009.

 

 

Continued acceptance and sales growth outside the U.S. with future acceptance of our next generation Endurant AAA stent graft and continued acceptance of the Valiant Thoracic Stent Graft System. The first-in-human trial for the new Endurant AAA stent graft in Western Europe was completed in April 2008. We anticipate CE mark approval of the Endurant AAA stent graft in the second half of calendar year 2008.

 

Neuromodulation   Neuromodulation products consist of therapeutic and diagnostic devices, including implantable neurostimulation systems, implantable drug delivery devices, and urology and gastroenterology products. Neuromodulation net sales for fiscal year 2008 increased 11 percent from the prior fiscal year to $1.311 billion. Foreign currency translation had a favorable impact of $32 million on net sales when compared to the prior fiscal year. In the third quarter of fiscal year 2007, we divested our Urology diagnostics product line and in the first quarter of fiscal year 2008 we completed the divestiture of our Gastroenterology and Neurological diagnostics product lines. The loss of these product lines had a negative net sales growth impact of 4 percent for fiscal year 2008.

 

Neuro Implantables is comprised of two product lines: Pain Management and Movement Disorders. Net sales from Neuro Implantables for treating pain and movement disorders were $1.069 billion, an increase of 11 percent over the prior period. The growth was driven by key products in Pain Management including RestoreULTRA, RestoreADVANCED and PrimeADVANCED neurostimulation systems for pain management, our SynchroMed II drug delivery pump, and our surgical lead for spinal cord stimulation, the Specify 5-6-5. RestoreULTRA, which was launched in March 2008, is our next generation rechargeable neurostimulator with advanced programming capabilities and is the smallest and thinnest 16-electrode neurostimulator on the market. Movement Disorder revenue was driven by growth in worldwide net sales of Activa Deep Brain Stimulation (DBS) Therapy. Activa DBS Therapy is used for the treatment of common movement disorders including Parkinson’s disease, essential tremor and dystonia.

 

11

 


 

Net sales of Gastroenterology and Urology products increased 10 percent over fiscal year 2007 to $242 million. The growth in Gastroenterology and Urology was led by net sales of our InterStim II product, which experienced its first full fiscal year on the market, and was partially offset by the impact of the divestitures of the Gastroenterology and Urology diagnostic product lines. InterStim II for the treatment of overactive bladder and urinary incontinence was launched in the second quarter of fiscal year 2007, and the smaller design has been widely accepted.

 

Neuromodulation net sales for fiscal year 2007 increased 16 percent from the prior fiscal year to $1.183 billion. Foreign currency translation had a favorable impact of $16 million on net sales when compared to the prior fiscal year. The increase in sales was driven by strong growth of both Neuro Implantables and Gastroenterology and Urology sales.

 

Net sales from Neuro Implantables were $962 million, an increase of 15 percent over the prior period. The growth in Neuro Implantables was driven by key products including RestoreADVANCED, PrimeADVANCED and Activa DBS Therapy. Fiscal year 2007 revenue for Neuro 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 and our PROSTIVA product line for the treatment of an enlarged prostate.

 

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

 

 

Continued acceptance of RestoreULTRA, our next generation rechargeable neurostimulator with advanced programming capabilities and smaller device size, which was launched in the fourth quarter of fiscal year 2008. RestoreULTRA is the smallest and thinnest 16-electrode rechargeable neurostimulator on the market and offers an innovative patient programmer that gives patients the ability to customize their pain control.

 

 

Continued acceptance of our surgical lead, the Specify 5-6-5 with Durable Electrode Technology, which was launched in the first quarter of fiscal year 2008. The Specify 5-6-5 surgical lead offers exclusive advantages and electrode programming patterns when used with our neurostimulators. Additionally, we anticipate the launch of the Specify 2x8 surgical lead in the first half of fiscal year 2009.

 

 

Continued acceptance of our Activa DBS Therapy for the treatment of common movement disorders. We continue to educate neurologists and the patient population on the benefits that our Activa DBS Therapy offers them. Additionally, we look forward to the anticipated launch of Activa PC and RC, our next generation neurostimulators. Activa PC is a primary cell and Activa RC will be the therapy’s first rechargeable device. We anticipate launch of Activa RC in the second half of fiscal year 2009.

 

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 2008 increased 18 percent over the prior fiscal year to $1.019 billion. Foreign currency translation had a favorable impact of $29 million on net sales when compared to the prior fiscal year.

 

External pump sales for fiscal year 2008 were $448 million, representing growth of 15 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. The sales increase of 41 percent outside the U.S. was especially strong, driven by growth in the markets in which we recently launched the Paradigm Real-Time system. The strong growth outside the U.S. was offset by slowed growth in the U.S., as we experienced a modest slowdown in replacement business given the timing of upgrades to our latest technology. Net sales of Consumables, including glucose sensors and other monitoring equipment, during fiscal year 2008 were $571 million, an increase of 20 percent. Net sales of infusion sets outside the U.S., in correlation with our strong pump growth, fueled the growth in Consumables.

 

Diabetes net sales in fiscal year 2007 increased 20 percent over the prior fiscal year to $863 million. Foreign currency translation had a favorable impact of $13 million 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. Net sales of Consumables, including glucose monitoring system and sensor products and other equipment, during fiscal year 2007 were $474 million, an increase of 11 percent.

 

12

 


 

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

 

 

Continued acceptance from both physicians and patients 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 System, our personal-use Continuous Glucose Monitoring System (CGMS) 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.

 

 

Future acceptance and customer preference for Medtronic products due to the alliances with LifeScan, Inc. (LifeScan), a Johnson & Johnson company, and Bayer Diabetes Care (Bayer), a member of the Bayer group, which we announced on August 21, 2007. The alliances reached with Lifescan (for the U.S. market) and Bayer (for markets outside the U.S.) provide for the distribution and marketing of blood glucose meters that communicate with Medtronic’s insulin pumps. These alliances provide our customers an integrated solution for managing diabetes, thereby improving the quality of life and ease of use. We launched our co-developed blood glucose meters with Bayer and LifeScan in February 2008 and April 2008, respectively.

 

 

Improved reimbursement for insulin pumps in certain international markets and for continuous glucose monitoring in both the U.S. and certain international markets.

 

 

Completion of the first user evaluation of a partially-closed loop system in the United Kingdom and the Netherlands. The study represents the first time patients with diabetes have been able to use a low-glucose suspend feature, the development of which is considered by many in the industry to be a major advance towards a closed-loop diabetes management system.

 

Surgical Technologies   Surgical Technologies products are used to treat conditions of the ear, nose, and throat, and certain neurological disorders. Additionally, we manufacture and sell image-guided surgery systems. Our portfolio consists of powered tissue-removal systems and other microendoscopy instruments, implantable devices, nerve monitoring systems, disposable fluid-control products, a Ménière’s disease therapy device, hydrocephalus shunt devices, external drainage systems, cranial fixation devices, neuroendoscopes, dura repair products, and image-guided surgery systems. Surgical Technologies net sales for fiscal year 2008 increased by 17 percent over the prior fiscal year to $780 million. Foreign currency translation had a favorable impact of $20 million on net sales when compared to the prior fiscal year.

 

Core ENT net sales grew 16 percent to $323 million in fiscal year 2008 led by strong growth of sales outside the U.S. of the Straightshot M4 Microdebrider and endoscopy sales. In the U.S., there was an increase in net sales of our Image Guided Surgery Systems which was partially due to the launch of the Fusion EM IGS System for use in sinus surgical procedures. Fusion EM IGS is an electromagnetic-based image-guided surgery product that will avoid “line of sight constraints” of optical systems. Net sales of monitoring disposables also experienced strong worldwide growth.

 

Neurologic Technologies net sales grew 14 percent to $298 million in fiscal year 2008. The primary drivers of growth in Neurologic Technologies were continued acceptance of high-speed powered surgical drill systems, including the EHS Stylus system.

 

Navigation net sales for fiscal year 2008 increased 25 percent from the prior fiscal year to $159 million based on strong U.S. net sales of the O-arm Imaging Systems, a multi-dimensional surgical imaging platform that is optimized for use in spine and orthopedic surgery, and increased global service revenue.

 

Surgical Technologies net sales for fiscal year 2007 increased by 9 percent over the prior fiscal year to $666 million. Foreign currency translation had a favorable impact of $8 million 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 charged 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

 


 

Navigation net sales for fiscal year 2007 increased 18 percent from fiscal year 2006 to $127 million based on strong sales of the PoleStar N20, an intra-operative Magnetic Resonance Image (iMRI)-Guidance System and O-arm Imaging Systems.

 

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

 

 

Continued acceptance of our new FUSION EM IGS System that was launched in the U.S. in the third quarter of fiscal year 2008. 

 

 

Continued adoption of power systems outside the U.S. for sinus procedures, including the Straightshot M4 Microdebrider, as well as continued global 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, and continued acceptance of our Legend high-speed drill systems, electric bone mill, and Durepair dura substitute.

 

 

Continued acceptance of the O-arm Imaging System and future acceptance of the S7 Navigation System which we expect to release in fiscal year 2009.

 

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

 

 

 

2008

 

2007

 

2006

 

Cost of products sold

 

25.5

%

25.8

%

24.9

%

Research and development expense

 

9.4

 

10.1

 

9.9

 

Selling, general and administrative expense

 

34.8

 

33.8

 

32.4

 

Special charges

 

0.6

 

0.8

 

0.9

 

Restructuring charges

 

0.3

 

0.2

 

 

Certain litigation charges

 

2.7

 

0.3

 

 

IPR&D charges

 

2.9

 

 

3.2

 

Other expense, net

 

3.2

 

1.7

 

1.5

 

Interest income, net

 

(0.8

)

(1.3

)

(0.8

)

 

Cost of Products Sold   Cost of products sold was $3.446 billion in fiscal year 2008 representing 25.5 percent of net sales, a decrease of 0.3 of a percentage point from fiscal year 2007. The cost of products sold was positively impacted by 0.7 of a percentage point of favorable foreign currency translation and 0.3 of a percentage point for reduced product costs and favorable manufacturing variances. These decreases were offset by 0.3 of a percentage point associated with the impact of the $34 million fair value adjustment for the inventory acquired in the Kyphon acquisition and 0.4 of a percentage point of unfavorability for scrap and other product costs associated with the suspension of the worldwide distribution of the Fidelis lead and scrap costs at our Physio-Control business segment.

 

Cost of products sold was $3.168 billion in fiscal year 2007 representing 25.8 percent of net sales, an increase of 0.9 of a percentage point from fiscal year 2006. 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 translation.

 

Research and Development   Consistent with prior years, we continue to invest heavily in the future by spending aggressively on research and development efforts. Research and development spending was $1.275 billion in fiscal year 2008, representing 9.4 percent of net sales, a decrease of 0.7 of a percentage point from fiscal year 2007. While our fiscal year 2008 research and development spending increased over the prior fiscal year, our restructuring initiatives and our efforts to prioritize projects with the greatest potential for future growth have impacted the current year rate of spending.

 

14

 



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. 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 2008 selling, general and administrative expense as a percentage of net sales increased by 1.0 percentage point from fiscal year 2007 to 34.8 percent. The increase in selling, general and administrative expense for fiscal year 2008 was predominantly driven by the acquisition of Kyphon which increased selling, general, and administrative expense by 0.6 of a percentage point. The remainder of the increase was due to expenses associated with our previously communicated investment in selling and marketing activities related to the U.S. launches of the Prestige Cervical Disc System and Endeavor, and the continued implementation of our global information technology system, which included the full conversion of our U.S. distribution systems in the second quarter of fiscal year 2008. 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 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 CardioVascular business, 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.

 

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 (such as asset impairment charges), restructuring, certain litigation, and IPR&D charges, and certain tax adjustments recorded during the previous three fiscal years are as follows:

 

 

 

Fiscal Year

 

 

 

2008

 

2007

 

2006

 

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

Special charges:

 

 

 

 

 

 

 

 

 

 

Asset impairment charges

 

$

78

 

$

98

 

$

 

Medtronic Foundation donation

 

 

 

 

 

 

100

 

Total special charges

 

 

78

 

 

98

 

 

100

 

Restructuring charges

 

 

45

 

 

36

 

 

 

Certain litigation charges

 

 

366

 

 

40

 

 

 

IPR&D charges

 

 

390

 

 

 

 

364

 

Total special, restructuring, certain litigation, and IPR&D charges

 

 

879

 

 

174

 

 

464

 

Tax impact of special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments

 

 

(137

)

 

(179

)

 

(328

)

Total special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments, net of tax

 

$

742

 

$

(5

$

136

 

 

Special Charges In fiscal year 2008, we recorded a special charge related to the impairment of intangible assets associated with our benign prostatic hyperplasia, or enlarged prostate, product line purchased in fiscal year 2002. The development of the market, relative to our original assumptions, has changed as a result of the broad acceptance of a new line of drugs to treat the symptoms of an enlarged prostate. After analyzing the estimated future cash flows utilizing this technology, based on the market development, we determined that the carrying value of these intangible assets was impaired and a write-down of $78 million was necessary. See Note 2 to the consolidated financial statements for further discussion of this special charge.

 

15

 



In fiscal year 2007, we concluded two intangible assets were fully impaired due to inadequate clinical results and the resulting delays in product development. As a result, we recorded a $98 million 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. See Note 2 to the consolidated financial statements for further discussion of this special charge.

 

In fiscal year 2006, we recorded a $100 million 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. See Note 2 to the consolidated financial statements for further discussion of this special charge.

 

Restructuring Charges

 

Global Realignment Initiative

 

In fiscal year 2008, as part of a global realignment initiative, we recorded a $31 million restructuring charge, which consisted of employee termination costs of $27 million and asset write-downs of $4 million. This initiative began in the fourth quarter of fiscal year 2008 and focuses on shifting resources to those areas where we have the greatest opportunities for growth and streamlining operations to drive operating leverage. The global realignment initiative impacts most businesses and certain corporate functions. Within CRDM, we are reducing research and development infrastructure by closing a facility outside the U.S., reprioritizing research and development projects to focus on the core business and consolidating manufacturing operations to drive operating leverage. Within Spinal, we intend to reorganize and consolidate certain activities where Medtronic’s existing infrastructure, resources, and systems can be leveraged to obtain greater operational synergies. The global realignment initiative is also designed to further consolidate manufacturing of CardioVascular products, streamline distribution of products in select businesses and to reduce general and administrative costs in our corporate functions.

 

The asset write-downs were recorded within cost of products sold in the consolidated statement of earnings. The employee termination costs of $27 million consist of severance and the associated costs of continued medical benefits, and outplacement services.

 

This global realignment initiative will result in charges being recognized in both the fourth quarter of fiscal year 2008 and the first quarter of fiscal year 2009, and we expect that when complete, will eliminate approximately 1,100 positions. Restructuring charges were recognized in the fourth quarter of fiscal year 2008 for standard severance benefits to be provided to impacted positions identified prior to the close of the fiscal year. In the first quarter of fiscal year 2009 we will recognize additional restructuring charges associated with (i) enhanced severance benefits for positions, identified in the fourth quarter of fiscal year 2008, and (ii) standard and enhanced severance benefits provided for positions that were identified in the first quarter of fiscal year 2009. These incremental costs were not accrued in fiscal year 2008 because either the enhanced benefits had not yet been communicated to the impacted employees or the positions for elimination had not yet been identified. We anticipate that the additional expense that we will recognize in the first quarter of fiscal year 2009 related to the global realignment initiative will be in the range of $80 million to $105 million.

 

Of the 1,100 positions that will be eliminated as part of this initiative, 560 positions were identified for elimination in the fourth quarter of fiscal year 2008 and will be achieved through voluntary and involuntary separation. Of these 560 positions identified, the majority will be eliminated in fiscal year 2009. The restructuring initiatives related to the 560 employees identified in the fourth quarter of fiscal year 2008 are scheduled to be completed by the end of fiscal year 2009, and are expected to produce annualized operating savings of approximately $69 million. These savings will arise mostly from reduced compensation expense. See Note 3 to the consolidated financial statements for further discussion.

 

Fiscal Year 2007 Initiative

 

In fiscal year 2007, we recorded a $36 million restructuring charge, which consisted of employee termination costs of $28 million and asset write-downs of $8 million. These initiatives were designed to drive manufacturing efficiencies in our CardioVascular 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 market dynamics. The employee termination costs consist of severance and the associated costs of continued medical benefits, and outplacement services. The asset write-downs consist of a $5 million charge for inventory write-downs and a $3 million charge for non-inventory asset write-downs. The inventory and asset write-downs were recorded within cost of products sold in the consolidated statement of earnings.

 

16

 



As a continuation of our fiscal year 2007 initiatives, in the first quarter of fiscal year 2008 we incurred $14 million of incremental restructuring charges associated with compensation provided to employees whose employment terminated with the Company in the first quarter of fiscal year 2008. These incremental costs were not accrued in fiscal year 2007 because these benefits had not yet been communicated to the impacted employees. Included in the total $14 million restructuring charge is $4 million of incremental defined benefit pension and post-retirement related expense for those employees who accepted early retirement packages. For further discussion on the incremental defined benefit pension and post-retirement related expense, see Note 13 to the consolidated financial statements.

 

When the restructuring initiative began in fiscal year 2007, we identified approximately 900 positions for elimination which were achieved through early retirement packages offered to employees, voluntary separation, and involuntary separation, as necessary. As of April 25, 2008, the initiatives begun in the fourth quarter of fiscal year 2007 were substantially complete. This restructuring initiative produced annualized operating savings of approximately $125 million mostly from reduced compensation expense. See Note 3 to the consolidated financial statements for further discussion.

 

There were no restructuring charges in fiscal year 2006.

 

Certain Litigation Charges We classify material litigation reserves recognized as certain litigation charges.

 

During fiscal year 2008, we incurred certain litigation charges of $366 million. Of that amount, $123 million relates to the settlement of certain lawsuits relating to the Marquis line of ICDs and CRT-Ds that were subject to a field action announced on February 10, 2005. The remainder of the charge, $243 million, relates to an estimated reserve established for litigation with Cordis Corporation, a subsidiary of Johnson & Johnson. The Cordis litigation originated in October 1997 and pertains to a patent infringement claim on a previous generation of bare metal stents that are no longer on the market. We believe an unfavorable outcome in the Cordis matter is probable. In accordance with SFAS No. 5, we have recorded a $243 million reserve for estimated damages in this matter. See Notes 2 and 15 to the consolidated financial statements for further discussion of these certain litigation charges. In May 2008, we paid substantially all of the settlement for certain lawsuits relating to the Marquis line of ICDs and CRT-Ds.

 

During fiscal year 2007, we recorded a certain litigation charge of $40 million related to a settlement agreement with the U.S. 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.

 

IPR&D Charges During fiscal year 2008, we recorded $390 million of IPR&D charges of which $42 million related to the acquisition of NDI Medical, Inc., a development stage company, $290 million related to a technology acquired through the purchase of Kyphon, $20 million related to the purchase of intellectual property from Setagon, Inc., $25 million related to a milestone payment under the existing terms of a royalty bearing, non-exclusive patent cross-licensing agreement with NeuroPace, Inc., and $13 million was for unrelated purchases of certain intellectual property. These payments were expensed as IPR&D since technological feasibility of the underlying projects had not yet been reached and such technology has no future alternative use. See Note 4 to the consolidated financial statements for further discussion.

 

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

 

During fiscal year 2006, we recorded $364 million of IPR&D charges of which $169 million related to the acquisition of TNI, $175 million related to the acquisition of substantially all of the spine-related intellectual property and related contracts, rights, and tangible materials owned by Gary Michelson, M.D. and Karlin Technology, Inc. (Michelson), and $20 million related to a royalty bearing, non-exclusive patent cross-licensing agreement with NeuroPace, Inc. See Note 4 to the consolidated financial statements for further discussion.

 

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.

 

17

 



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 2008 and 2007.

 

Certain Tax Adjustments We classify the material recognition or derecognition of uncertain tax positions as certain tax adjustments. There were no certain tax adjustments in fiscal year 2008.

 

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 and the resolution of competent authority issues for fiscal years 1992 through 2000. The $129 million tax benefit was 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 was recorded in the provision for income taxes in the consolidated statement of earnings for fiscal year 2006.

 

See the “Income Taxes” section of this management’s discussion and analysis for further discussion of the certain tax adjustments.

 

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 2008, net other expense was $436 million, an increase of $224 million from $212 million in fiscal year 2007. This change is primarily due to currency hedges, which resulted in losses in fiscal year 2008 of $147 million versus gains in fiscal year 2007 of $20 million, and $46 million of amortization on intangible assets resulting from the Kyphon acquisition. Additionally, prior year other expense was offset by $55 million due to the accelerated amortization of deferred income in connection with a product supply agreement in the CardioVascular business, where the other party elected not to exercise its option to extend the agreement.

 

In fiscal year 2007, net other expense was $212 million, an increase of $45 million from $167 million in fiscal year 2006. This change was 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 CardioVascular business.

 

Interest Income, Net   Interest income, net includes interest earned on our investments, interest paid on our borrowings, amortization of debt issuance costs and the net realized gain or loss on sales of available for sale (AFS) debt securities. In fiscal year 2008, net interest income was $109 million, a decrease of $45 million from net interest income of $154 million in fiscal year 2007. The decrease in net interest income in fiscal year 2008 as compared to fiscal year 2007 is a result of the impact of the cash utilized to finance the Kyphon acquisition, increased borrowings outstanding and a decline in interest rates being received on our short- and long-term investments. The decrease was partially offset by recognition of $26 million in net gains on the sale of AFS debt securities.

 

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 was a result of higher average cash and cash investment balances as compared to prior periods. Interest income increased, as we maintained our ability to generate rates of return on our investments that exceeded the interest rates we were paying on our outstanding debt.

 

18

 



Income Taxes

 

 

 

Fiscal Year

 

Percentage Point
Increase/(Decrease)

 

 

2008

 

2007

 

2006

 

FY08/07

 

FY07/06

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income tax

 

$

654

 

$

713

 

$

614

 

N/A

 

N/A

Effective tax rate

 

 

22.7

%

 

20.3

%

 

19.4

%

2.4

 

0.9

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

 

 

1.7

 

 

(3.9)

 

 

(6.6

)

(5.6)

 

(2.7)

Non-GAAP nominal tax rate (1)

 

 

21.0

%

 

24.2

%

 

26.0

%

(3.2)

 

(1.8)

_______________

(1)

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. We believe that the resulting non-GAAP financial measure provides useful information to investors because it excludes the effect of these discrete items so that investors can compare our recurring results over multiple periods.

 

The effective tax rate of 22.7 percent increased by 2.4 percentage points from fiscal year 2007 to fiscal year 2008. This increase reflects the 5.6 percentage points increase from the tax impact of special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments partially offset by a 3.2 percentage points decrease in the non-GAAP nominal tax rate. The 5.6 percentage points increase is largely due to the non-deductible IPR&D charges incurred during fiscal year 2008 compared to the $129 million certain tax benefit recorded in fiscal year 2007 associated with the reversal of excess tax accruals in connection with the settlement reached with the IRS with respect to their review of our fiscal years 2003 and 2004 domestic income tax returns and the resolution of competent authority issues for fiscal years 1992 through 2000. The non-GAAP nominal tax rate decrease of 3.2 percentage points is mainly due to increased benefits from our international operations subject to tax rates lower than our U.S. statutory rates.

 

The fiscal year 2007 effective tax rate of 20.3 percent increased by 0.9 of a percentage point from fiscal year 2006. This increase reflects a 2.7 percentage points increase from the tax impact of special, restructuring, certain litigation, and IPR&D charges, and certain tax adjustments partially offset by a 1.8 percentage points decrease in the non-GAAP nominal tax rate. The 2.7 percentage points increase is largely due to the $129 million certain tax adjustment recorded in fiscal year 2007 compared to the $225 million certain tax adjustment recorded in fiscal year 2006 associated with favorable agreements reached with the IRS involving the review of our fiscal years 1997 through 2002 domestic income tax returns. The non-GAAP nominal tax rate decrease of 1.8 percentage points is mainly due to increased benefits from our international operations subject to tax rates lower than our U.S. statutory rate.

 

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. The IRS has settled its audits with us for all years through fiscal year 1996. Tax years settled with the IRS may remain open for foreign tax audits and competent authority proceedings. Competent authority proceedings are a means to resolve intercompany pricing disagreements between countries.

 

In August 2003, the IRS proposed adjustments arising out of its audit of the fiscal years 1997, 1998 and 1999 tax returns. We initiated a defense of these adjustments at the IRS appellate level, and in the second quarter of fiscal year 2006 we reached settlement on most, but not all matters. The remaining issue relates to the allocation of income between Medtronic, Inc., and its wholly owned subsidiary in Switzerland. On April 16, 2008, the IRS issued a statutory notice of deficiency with respect to this remaining issue. We intend to file a Petition with the U.S. Tax Court and vigorously defend our position.

 

In September 2005, the IRS issued its audit report for fiscal years 2000, 2001 and 2002. In addition, the IRS issued its audit report for fiscal years 2003 and 2004 in March 2007. We have reached agreement with the IRS on substantially all of the proposed adjustments for these fiscal years 2000 through 2004. The only item of significance that remains open for these years relates to the carryover impact of the allocation of income issue proposed for fiscal years 1997 through 1999.

 

The unresolved issue from the 1997 through 2004 tax audits, as well as tax positions taken by the IRS or foreign tax authorities during future tax audits, could have a material unfavorable 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, as necessary. We believe that we have adequately provided for probable liabilities resulting from tax assessments by taxing authorities.

 

19

 



Liquidity and Capital Resources

 

 

 

Fiscal Year

 

 

 

2008

 

2007

 

(dollars in millions)

 

 

 

 

 

 

 

Working capital

 

$

3,787

 

$

5,355

 

Current ratio*

 

 

2.1:1.0

 

 

3.1:1.0

 

Cash, cash equivalents, and short-term investments

 

$

1,613

 

$

3,078

 

Long-term investments in debt securities**

 

 

2,078

 

 

3,004

 

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

 

 

3,691

 

 

6,082

 

Short-term borrowings and long-term debt

 

 

6,956

 

 

6,087

 

Net cash position***

 

$

(3,265

)

$

(5

)

_______________

*

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

**

Long-term investments include 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.

 

We believe our liquidity remains strong as of April 25, 2008 and our strong balance sheet and liquidity provide us with flexibility in the future. We believe our existing cash and investments, future cash generated from operations, and available lines of credit and commercial paper capacity of $1.945 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. At April 25, 2008, our Standard and Poor’s Ratings Group and Moody’s Investors Service ratings remain unchanged as compared to the fiscal year ended April 27, 2007 with long-term debt ratings of AA- and A1, respectively, and strong short-term debt ratings of A-1+ and P-1.

 

The decrease in our net cash position in fiscal year 2008 as compared to fiscal year 2007 is primarily due to the acquisition of Kyphon which was consummated on November 2, 2007. The transaction was financed through a combination of $3.303 billion of cash on hand, the issuance of $600 million short-term commercial paper and borrowing $300 million through a new long-term unsecured revolving credit facility. For further information regarding the acquisition of Kyphon, see Note 4 to the consolidated financial statements. See the “Summary of Cash Flows” section of this management’s discussion and analysis for further discussion of our cash uses and proceeds.

 

We have future contractual obligations and other minimum commercial commitments that are entered into in the normal course of business. 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. See the “Off-Balance Sheet Arrangements and Long-Term Contractual Obligations” section of this management’s discussion and analysis for further information.

 

Notes 2 and 15 to the consolidated financial statements provide information regarding amounts we have accrued related to significant legal proceedings as well as information regarding the expected timing of payment. In accordance with SFAS No. 5, 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. In May 2008, we paid substantially all of the settlement for certain lawsuits relating to the Marquis line of ICDs and CRT-Ds. In June 2008, we paid the settlement amount for the Kyphon qui tam complaint, which we assumed in the acquisition of Kyphon.

 

At April 25, 2008 and April 27, 2007, $3.317 billion and $5.428 billion, respectively, of cash, cash equivalents, and short- and long-term debt securities were held by our non-U.S. subsidiaries. The reduction in this cash balance is the result of the use of cash by our non-U.S. subsidiaries in connection with the acquisition of Kyphon, partially offset by additional cash generated by our non-U.S. subsidiaries. These funds are available for use by worldwide operations; however, if these funds were to be repatriated to the U.S. or used for U.S. operations, the amounts would be subject to U.S. tax.

 

We have investments in marketable debt securities that are classified and accounted for as available-for-sale. Our debt securities include government securities, commercial paper, corporate bonds, bank certificates of deposit, and mortgage backed and other asset backed securities including auction rate securities. Market conditions during the third and fourth quarters of fiscal year 2008 and subsequent to our fiscal year-end continue to indicate significant uncertainty on the part of investors on the economic outlook for the U.S. and for financial institutions that have potential exposure to the sub-prime housing market. This uncertainty has created reduced liquidity across the fixed income investment market, including certain securities in which we have invested. As a result, some of our investments have experienced reduced liquidity including unsuccessful monthly auctions for our auction rate security holdings. During the third quarter of fiscal year 2008, we reclassified all of our auction rate fixed income securities, which had a cost basis of $198 million, from short-term investments to long-term investments on our consolidated balance sheet due to the fact that they are currently not trading, and current conditions in the general debt markets have reduced the likelihood that the securities will successfully auction within the next 12 months. Auction rate securities that did not successfully auction reset to the maximum rate as prescribed in the underlying indenture and all of our holdings continue to be current with their interest payments.

 

20

 



 

For the fiscal year ended April 25, 2008, we recognized a $3 million impairment loss on AFS debt securities. Based on our assessment of the credit quality of the underlying collateral and credit support available to each of the remaining securities in which we are invested, we believe no other-than-temporary impairment has occurred as we have the ability and the intent to hold these investments long enough to avoid realizing any significant loss. Additionally, if we required capital we believe we could liquidate the majority of our portfolio and incur no material impairment loss and we have capacity under our commercial paper program and lines of credit that we could access. As of April 25, 2008, we do not believe that we have material risk in our current portfolio of investments that would impact our financial condition or liquidity. For further information about the risks associated with our investments, see the “Market Risk” section and the section entitled “Risk Factors” in our Form 10-K.

 

Summary of Cash Flows

 

 

 

Fiscal Year

 

 

 

2008

 

2007

 

2006

 

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

Cash provided by (used in):

 

 

 

 

 

 

 

 

 

 

Operating activities

 

$

3,489

 

$

2,979

 

$

2,220

 

Investing activities

 

 

(2,790

)

 

(1,701

)

 

(2,867

)

Financing activities

 

 

(835

)

 

(3,011

)

 

1,304

 

Effect of exchange rate changes on cash and cash equivalents

 

 

(60

)

 

(5

)

 

105

 

Net change in cash and cash equivalents

 

$

(196

)

$

(1,738

$

762

 

 

Operating Activities Our net cash provided by operating activities was $3.489 billion for the fiscal year ended April 25, 2008 compared to net cash provided by operating activities of $2.979 billion in the same period of the prior year. The $510 million increase in net cash provided by operating activities was primarily attributable to a $442 million decrease in cash used for operating assets and liabilities. The decrease in cash used was led by our improved management of outstanding accounts receivable and inventory.

 

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. The decrease in cash used was led by our improved management of outstanding accounts receivable and inventory.

 

Investing Activities Our net cash used in investing activities was $2.790 billion for the fiscal year ended April 25, 2008 compared to $1.701 billion used in investing activities for the fiscal year ended April 27, 2007. The $1.089 billion increase in net cash used in investing activities was primarily attributable to the $4.185 billion increase in cash used for acquisitions and the purchase of intellectual property, principally the Kyphon acquisition, partially offset by $3.067 billion in incremental cash generated through the liquidation of marketable securities as compared to the prior year.

 

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 purchases of intellectual property, as fiscal year 2006 included several acquisitions and a $495 million decrease in cash used to purchase marketable securities. These decreases were partially offset by a $166 million increase in capital expenditures for property, plant, and equipment.

 

Financing Activities Our net cash used in financing activities was $835 million for the fiscal year ended April 25, 2008, compared to net cash used in financing activities of $3.011 billion for the fiscal year ended April 27, 2007. The $2.176 billion decrease in net cash used in financing activities was primarily attributable to the fact that in the prior year $1.877 billion in cash was used to repurchase long-term debt as the bond holders put the Contingent Convertible Debentures to us and in fiscal year 2008 we generated proceeds of $543 million from short-term borrowings and $300 million from the issuance of long-term debt. These cash inflows were offset by a $505 million increase in cash used for stock repurchases.

 

21

 



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 the following: a $1.877 billion increase 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, and a $517 million net reduction in the sale of warrants. These cash outflows were offset by a $2.550 billion decline in cash used to repurchase common stock and a $1.075 billion decrease in cash used in the purchase of call options.

 

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.

 

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 7, 8 and 14 to the consolidated financial statements for additional information regarding long-term debt, foreign currency contracts, and lease obligations, respectively.

 

In addition to the amounts shown in the following table, we have $455 million of unrecognized tax benefits recorded as long-term liabilities in long-term accrued incomes taxes on the April 25, 2008 consolidated balance sheet. However, we are uncertain as to if or when such amounts may be settled. The gross accrued interest and penalties related to these uncertain tax positions totaled $126 million at April 25, 2008.

 

 

 

Maturity by Fiscal Year

 

 

 

Total

 

2009

 

2010

 

2011

 

2012

 

2013

 

Thereafter

 

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual obligations related to off-balance sheet arrangements:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency contracts(1)

 

$

6,613

 

$

3,812

 

$

2,026

 

$

775

 

$

 

$

 

$

 

Operating leases(2)

 

 

261

 

 

88

 

 

59

 

 

35

 

 

19

 

 

29

 

 

31

 

Inventory purchases(3)

 

 

749

 

 

323

 

 

174

 

 

103

 

 

30

 

 

27

 

 

92

 

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

 

 

478

 

 

280

 

 

53

 

 

22

 

 

16

 

 

22

 

 

85

 

Interest payments(5)

 

 

558

 

 

124

 

 

124

 

 

111

 

 

64

 

 

64

 

 

71

 

Other(6)

 

 

210

 

 

44

 

 

45

 

 

32

 

 

15

 

 

5

 

 

69

 

Total

 

$

8,869

 

$

4,671

 

$

2,481

 

$

1,078

 

$

144

 

$

147

 

$

348

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual obligations reflected in the balance sheet:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term debt, excluding capital leases(7)

 

$

5,829

 

$

94

 

$

 

$

2,908

 

$

 

$

2,200

 

$

627

 

Capital leases(8)

 

 

78

 

 

11

 

 

13

 

 

16

 

 

17

 

 

20

 

 

1

 

Other(9)

 

 

11

 

 

10

 

 

 

 

1

 

 

 

 

 

 

 

Total

 

$

5,918

 

$

115

 

$

13

 

$

2,925

 

$

17

 

$

2,220

 

$

628

 

 

 

22

 



_______________

(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. These commitments also include amounts related to our agreement to form a joint venture with Shandong Weigao Group Medical Polymer Company Limited (Weigao), which was announced in December 2007, to market therapies in the spine and orthopedics sector throughout China. In addition, we agreed to acquire a 15 percent equity interest in Weigao for approximately $220 million. We expect to close the transaction in the first half of fiscal year 2009.

(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, $94 million of Contingent Convertible Debentures, and the $300 million Credit Agreement with the Bank of Tokyo-Mitsubishi UFJ, Ltd. The interest rate on each outstanding obligation varies and interest is payable semi-annually on the Senior Convertible Notes and the Contingent Convertible Debentures. 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. Interest on the $300 million Credit Agreement with the Bank of Tokyo-Mitsubishi UFJ, Ltd. due 2011 is variable and paid quarterly.

(6)

These obligations include 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, and the $300 million Credit Agreement with the Bank of Tokyo-Mitsubishi UFJ, Ltd. 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 and the eight year interest rate swap entered into in June 2007.

(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 primarily relate to the agreement with Michelson that settled all outstanding litigation and disputes between Michelson and the Company. See Note 4 to the consolidated financial statements for further discussion.

 

Debt and Capital

 

In October 2005 and June 2007, our Board of Directors authorized the repurchase of up to 40 million and 50 million shares of our common stock, respectively. In addition, in April 2006, the Board of Directors made a special authorization for the repurchase of 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 2008 and 2007, we repurchased approximately 30.7 million shares and 21.7 million shares at an average price of $50.28 and $47.83, 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 25, 2008, we have approximately 34.3 million shares remaining under current buyback authorizations approved by the Board of Directors.

 

23

 



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 with as of April 25, 2008. A total of $2.500 billion of the net proceeds from these note issuances were used to repurchase common stock. As of April 25, 2008, 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 is now 17.8715, which correspondingly changed the conversion price per share for each of the Senior Convertible Notes to $55.96. 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 2008, certain of the holders requested adjustment to the exercise price of the warrants from $76.47 to $76.30 pursuant to the anti-dilution 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 25, 2008. We used the net proceeds from the sale of the Senior Notes for repayment of a portion of our outstanding commercial paper.

 

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. The outstanding market value of this swap agreement was an $8 million unrealized gain at April 25, 2008. The unrealized gain of $8 million at April 25, 2008 is recorded in long-term debt with the offset recorded in other long-term assets on the consolidated balance sheets. There was no unrealized gain or loss at April 27, 2007.

 

In June 2007, we entered into an eight year interest rate swap agreement with a notional amount of $300 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 $600 million Senior Notes due 2015. We pay variable interest equal to the three-month LIBOR minus 90 basis points and we receive a fixed interest rate of 4.750 percent. The outstanding market value of this swap agreement was a $27 million unrealized gain at April 25, 2008. The unrealized gain of $27 million at April 25, 2008 is recorded in long-term debt with the offset recorded in other long-term assets on the consolidated balance sheets.

 

24

 



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 2008, $93 million of New Debentures and $1 million of the Old Debentures were reclassified from long-term debt to short-term borrowings due to the put option becoming exercisable in September 2008. 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 25, 2008, 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 25, 2008 and April 27, 2007, outstanding commercial paper totaled $874 million and $249 million, respectively. During fiscal years 2008 and 2007, the weighted average original maturity of the commercial paper outstanding was approximately 35 and 56 days, respectively, and the weighted average interest rate was 4.46 percent and 5.26 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.

 

On November 2, 2007, we entered into a new Credit Agreement (the “New Credit Agreement”) with the Bank of Tokyo-Mitsubishi UFJ, Ltd. (the “New Lender”). The New Credit Agreement provides for a $300 million unsecured revolving credit facility (the “New Facility”) maturing November 2, 2010. In addition to certain initial fees, we are obligated to pay a commitment fee based on the total revolving commitment. 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. The New Credit Agreement contains customary representations and warranties of the Company as well as affirmative covenants regarding the Company. Upon the occurrence of an event of default as defined under the New Credit Agreement, the New Lender could elect to declare all amounts outstanding under the New Facility to be immediately due and payable.

 

We have existing unsecured lines of credit of approximately $2.795 billion with various banks at April 25, 2008. 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 (Credit Facility). The Credit Facility provides backup funding for the commercial paper program and may also be used for general corporate purposes.

 

25

 



The Credit 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 Credit Facility maturity date for one additional year on December 20, 2008, the second anniversary of the date of this facility.

 

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 25, 2008.

 

As of April 25, 2008, we have unused credit lines and commercial paper capacity of approximately $1.945 billion.

 

Acquisitions

 

On April 15, 2008, we recorded an IPR&D charge of $42 million related to the acquisition of NDI Medical (NDI), a development stage company focused on commercially developing technology to stimulate the dorsal genital nerve as a means to treat urinary incontinence. Total consideration for NDI was approximately $42 million which included $39 million in cash and the forgiveness of $3 million of pre-existing loans provided to NDI. The acquisition will provide us with exclusive rights to develop and use NDI’s technology in the treatment of urinary urge incontinence. This payment was expensed as IPR&D since technological feasibility of the underlying projects had not yet been reached and such technology has no future alternative use.

 

On November 2, 2007, we consummated the acquisition of Kyphon and it became our wholly owned subsidiary. Kyphon develops and markets medical devices designed to restore and preserve spinal function using minimally invasive technology. Kyphon’s primary products are used in balloon kyphoplasty for the treatment of spinal compression fractures caused by osteoporosis or cancer, and in the IPD procedure for treating the symptoms of lumbar spinal stenosis. It is expected that the acquisition of Kyphon will add to the growth of our existing Spinal business by extending its product offerings into some of the fastest growing product segments of the spine market, enabling us to provide physicians with a broader range of therapies for use at all stages of the care continuum.

 

Under the terms of the agreement announced on July 27, 2007, Kyphon shareholders received $71 per share in cash for each share of Kyphon common stock they owned. Total consideration for the transaction was $4.203 billion which includes payments to Kyphon shareholders for the cancellation of outstanding shares, the assumption and settlement of existing Kyphon debt, and payment of direct acquisition costs. Total debt assumed relates to Kyphon’s obligations under existing credit and term loan facilities and outstanding senior convertible notes. As of the date of the transaction, the existing credit and term loan facilities were fully paid and terminated. The senior convertible notes were converted by the holders in the weeks following the close of the transaction and have been included in the total purchase consideration above. In addition, the total consideration includes the proceeds of unwinding the related convertible note hedges and cancellation and payment of the warrants to the hedge participants that were originally issued by Kyphon in February 2007.

 

The transaction was financed through a combination of $3.303 billion cash on hand, the issuance of $600 million short-term commercial paper and borrowing $300 million through a new long-term unsecured revolving credit facility.

 

The results of operations related to Kyphon have been included in our consolidated statements of earnings since the date of the acquisition and include the full amortization of a $34 million inventory write-up recorded as part of the Kyphon acquisition accounting. The pro forma impact of Kyphon was significant to our results for fiscal year 2008. See Note 4 to the consolidated financial statements for the unaudited pro forma results of operations for fiscal years 2008 and 2007.

 

On November 1, 2007, we recorded an IPR&D charge of $20 million related to the acquisition of Setagon, Inc. (Setagon), a development stage company focused on commercially developing metallic nanoporous surface modification technology. The acquisition will provide us with exclusive rights to use and develop Setagon’s Controllable Elution Systems technology in the treatment of cardiovascular disease. Total consideration for Setagon was approximately $20 million in cash, subject to purchase price increases, which would be triggered by the achievement of certain milestones.

 

On June 25, 2007, we exercised a purchase option and acquired substantially all of the O-arm Imaging System (O-arm) assets of Breakaway Imaging, LLC (Breakaway), a privately held company. Prior to the acquisition, we had the exclusive rights to distribute and market the O-arm. The O-arm provides multi-dimensional surgical imaging for use in spinal and orthopedic surgical procedures. The acquisition is expected to bring the O-arm into a broad portfolio of image guided surgical solutions. Total consideration for Breakaway was approximately $26 million in cash, subject to purchase price increases, which would be triggered by the achievement of certain milestones. The pro forma impact of the acquisition of Breakaway was not significant to our results for fiscal year 2008 and 2007. The results of operations related to Breakaway have been included in our consolidated statement of earnings since the date of acquisition.

 

26

 



On March 26, 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 expanded 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.

 

On September 15, 2006, 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.

 

On July 25, 2006, 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. 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.

 

New Accounting Pronouncements

 

Information regarding 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 2008, 2007 and 2006:

 

 

 

Fiscal Year

 

 

 

2008

 

2007

 

2006

 

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

U.S. net sales

 

$

8,336

 

7,900

 

$

7,626

 

Non-U.S. net sales

 

 

5,179

 

 

4,399

 

 

3,666

 

Total net sales

 

13,515

 

12,299

 

11,292

 

 

From fiscal year 2007 to fiscal year 2008, consolidated net sales in the U.S. grew 6 percent compared to 18 percent growth in net sales outside the U.S. The slower U.S. growth is primarily a result of the voluntary suspension of the Fidelis lead 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 CardioVascular, Diabetes and CRDM, the benefit of the addition of Kyphon in Spinal, and a favorable impact of foreign currency translation which added 9 percentage points to the outside the U.S. growth rate. CardioVascular net sales were led by market share gains with Endeavor and Endeavor Resolute. Diabetes sales increased as a result of further acceptance of the paradigm Real Time System. Increased sales of Defibrillation Systems and Pacing Systems led the increase within our CRDM business.

 

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 CardioVascular and CRDM, and a favorable impact of foreign currency translation. CardioVascular net sales were led by market share gains with Endeavor. Increased sales of Defibrillation Systems and Pacing Systems led the increase within our CRDM business.

 

27

 



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 $1.800 billion at April 25, 2008, or 53 percent of total outstanding accounts receivable, and $1.456 billion at April 27, 2007, or 50 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 $6.613 billion and $5.372 billion at April 25, 2008 and April 27, 2007, respectively. The fair value of these contracts at April 25, 2008 was $441 million less than the original contract value. A sensitivity analysis of changes in the fair value of all foreign exchange derivative contracts at April 25, 2008 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 $654 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 25, 2008 indicates that the fair value of these instruments would correspondingly change by $21 million.

 

We have investments in marketable debt securities that are classified and accounted for as available-for-sale. Our debt securities include government securities, commercial paper, corporate bonds, bank certificates of deposit, and mortgage backed and other asset backed securities including auction rate securities. Market conditions during the third and fourth quarters of fiscal year 2008 and subsequent to our fiscal year-end continue to indicate significant uncertainty on the part of investors on the economic outlook for the U.S. and for financial institutions that have potential exposure to the sub-prime housing market. This uncertainty has created reduced liquidity across the fixed income investment market, including certain securities in which we have invested. As a result, some of our investments have experienced reduced liquidity including unsuccessful monthly auctions for our auction rate security holdings. During the third quarter of fiscal year 2008, we reclassified all of our auction rate fixed income securities, which had a cost basis of $198 million, from short-term investments to long-term investments on our consolidated balance sheet due to the fact that they are currently not trading, and current conditions in the general debt markets have reduced the likelihood that the securities will successfully auction within the next 12 months. Auction rate securities that did not successfully auction reset to the maximum rate as prescribed in the underlying indenture and all of our holdings continue to be current with their interest payments.

 

For the fiscal year ended April 25, 2008, we recognized a $3 million impairment loss on AFS debt securities. Based on our assessment of the credit quality of the underlying collateral and credit support available to each of the remaining securities in which we are invested, we believe no other-than-temporary impairment has occurred as we have the ability and the intent to hold these investments long enough to avoid realizing any significant loss. Additionally, if we required capital, we believe we could liquidate the majority of our portfolio and incur no material impairment loss and we have capacity under our commercial paper program and lines of credit that we could access. As of April 25, 2008, we do not believe that we have material risk in our current portfolio of investments that would impact our financial condition or liquidity. As of April 25, 2008, we have $70 million of gross unrealized losses on our aggregate investments of $2.631 billion; however, if market conditions continue to deteriorate further, some of these holdings may experience other-than-temporary impairment in the future. For further information about the liquidity risks associated with our investments, see the “Liquidity and Capital Resources” section and the section entitled “Risk Factors” in our Form 10-K.

 

28

 



We lend certain fixed income securities to enhance our investment income. These lending activities are collateralized at an average rate of 103 percent, with the collateral determined based on the underlying securities and creditworthiness of the borrowers. The value of the securities on loan at April 25, 2008 and April 27, 2007 was $610 million and $1.318 billion, 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 U.S. 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.

 

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 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.

 

29

 



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, or approved at all.

 

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) and, in April 2005, published security rules for protected health information. The HIPAA privacy and security rules govern the use, disclosure and security 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 where we operate as a Business Associate (which is anyone that performs a service on behalf of a Covered Entity involving the use or disclosure of protected health information and is not a member of the covered entity’s workforce), the HIPAA privacy and security rules only affect us 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 and security 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 healthcare 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; (3) tbe Stark law which prohibits physicians from referring Medicare or Medicaid patients to a provider that bills these programs 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 provider; and (4) healthcare fraud statutes that prohibit false statements and improper claims with any third-party payor. There are often similar state false claims, anti-kickback, anti-self referral and insurance fraud laws that apply to claims submitted under state Medicaid or state-funded or private healthcare benefit programs. In addition, the U.S. Federal Corrupt Practices Act can be used to prosecute companies in the U.S. for arrangements with physicians or other parties outside the U.S. if the physician or party is a government official of another country and the arrangement violates the law of that country.

 

The laws applicable to us are subject to change, and to evolving interpretations. If a governmental authority were to conclude that we are not in compliance with applicable laws and regulations, Medtronic and 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.

 

30

 



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 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 have a material adverse impact on our consolidated results of operations, financial position or cash flows. See Notes 2 and 15 to the consolidated financial statements 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. Forward-looking statements in this Annual Report include, but are not limited to, growth in our Spinal business related to the Kyphon acquisition and our intended reorganization and consolidation of certain activities; our intention to pursue the spin-off of Physio-Control; future launches of products and continued acceptance of products in our operating segments; the effectiveness of our development activities in reducing patient care costs; the elimination of certain positions related to the global realignment initiative; outcomes in our litigation matters; the continued strength of our balance sheet and liquidity; and the potential impact of our compliance with governmental regulations. 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, liquidity, decreasing prices, adverse regulatory action, litigation success, self-insurance, healthcare policy changes, 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.

 

31

 


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 4-5, 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 25, 2008. Our internal control over financial reporting as of April 25, 2008, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, who has also audited our consolidated financial statements.

 

/s/  William A. Hawkins

William A. Hawkins

President and Chief Executive Officer

 

/s/  Gary L. Ellis

Gary L. Ellis

Senior Vice President and Chief Financial Officer

 



32

 


 

Report of Independent Registered Public Accounting Firm

 

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

 

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 25, 2008 and April 27, 2007, and the results of their operations and their cash flows for each of the three fiscal years in the period ended April 25, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of April 25, 2008, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

As discussed in Note 12 to the consolidated financial statements, in 2008 the Company changed the manner in which it accounts for income taxes as a result of adopting the provisions of Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.” 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.

 

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 19, 2008

 

33

 


 

Medtronic, Inc.

Consolidated  Statements of Earnings

 

 

 

Fiscal Year

 

 

 

2008

 

2007

 

2006

 

(in millions, except per share data)

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

13,515

 

$

12,299

 

$

11,292

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

Cost of products sold

 

 

3,446

 

 

3,168

 

 

2,815

 

Research and development expense

 

 

1,275

 

 

1,239

 

 

1,113

 

Selling, general and administrative expense

 

 

4,707

 

 

4,153

 

 

3,659

 

Special charges

 

 

78

 

 

98

 

 

100

 

Restructuring charges

 

 

41

 

 

28

 

 

 

Certain litigation charges

 

 

366

 

 

40

 

 

 

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

 

 

390

 

 

 

 

364

 

Other expense, net

 

 

436

 

 

212

 

 

167

 

Interest income, net

 

 

(109

)

 

(154

)

 

(87

)

Total costs and expenses

 

 

10,630

 

 

8,784

 

 

8,131

 

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes

 

 

2,885

 

 

3,515

 

 

3,161

 

Provision for income taxes

 

 

654

 

 

713

 

 

614

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

2,231

 

$

2,802

 

$

2,547

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.97

 

$

2.44

 

$

2.11

 

Diluted

 

$

1.95

 

$

2.41

 

$

2.09

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

Basic

 

 

1,130.7

 

 

1,149.7

 

 

1,204.5

 

Diluted

 

 

1,142.1

 

 

1,161.8

 

 

1,217.3

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.50

 

$

0.44

 

$

0.39

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 




34

 


 

Medtronic, Inc.

Consolidated  Balance Sheets

 

 

 

April 25,
2008

 

April 27,
2007

 

(in millions, except share and per share data)

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,060

 

$

1,256

 

Short-term investments

 

 

553

 

 

1,822

 

Accounts receivable, less allowances of $99 and $160, respectively

 

 

3,287

 

 

2,737

 

Income tax receivable

 

 

73

 

 

 

Inventories

 

 

1,280

 

 

1,215

 

Deferred tax assets, net

 

 

600

 

 

405

 

Prepaid expenses and other current assets

 

 

469

 

 

483

 

Total current assets

 

 

7,322

 

 

7,918

 

 

 

 

 

 

 

 

 

Property, plant and equipment, net

 

 

2,221

 

 

2,062

 

Goodwill

 

 

7,519

 

 

4,327

 

Other intangible assets, net

 

 

2,193

 

 

1,433

 

Long-term investments

 

 

2,322

 

 

3,203

 

Long-term deferred tax assets, net

 

 

103

 

 

204

 

Other long-term assets

 

 

518

 

 

365

 

Total assets

 

$

22,198

 

$

19,512

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Short-term borrowings

 

$

1,154

 

$

509

 

Accounts payable

 

 

383

 

 

282

 

Accrued compensation

 

 

789

 

 

767

 

Accrued income taxes

 

 

 

 

350

 

Other accrued expenses

 

 

1,209

 

 

655

 

Total current liabilities

 

 

3,535

 

 

2,563

 

 

 

 

 

 

 

 

 

Long-term debt

 

 

5,802

 

 

5,578

 

Long-term accrued compensation and retirement benefits

 

 

304

 

 

264

 

Long-term accrued income taxes

 

 

519

 

 

 

Other long-term liabilities

 

 

502

 

 

130

 

Total liabilities

 

 

10,662

 

 

8,535

 

 

 

 

 

 

 

 

 

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, 1,124,926,775 and 1,143,407,452 shares issued and outstanding, respectively

 

 

112

 

 

114

 

Retained earnings

 

 

11,710

 

 

10,925

 

Accumulated other comprehensive loss

 

 

(286

)

 

(62

Total shareholders’ equity

 

 

11,536

 

 

10,977

 

Total liabilities and shareholders’ equity

 

$

22,198

 

$

19,512

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

35

 


 

Medtronic, Inc.

Consolidated  Statements of Shareholders’ Equity

 

 

 

Common
Shares

 

Common
Stock

 

Retained
Earnings

 

Accumulated
Other
Comprehensive (Loss)/Income

 

Total
Shareholders’
Equity

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance April 30, 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

 

Net earnings

 

 

 

 

 

 

2,231

 

 

 

 

2,231

 

Other comprehensive (loss)/income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss on investments

 

 

 

 

 

 

 

 

(47

)

 

(47

)

Translation adjustment

 

 

 

 

 

 

 

 

14

 

 

14

 

Net change in retirement obligations

 

 

 

 

 

 

 

 

37

 

 

37

 

Unrealized loss on foreign exchange derivatives

 

 

 

 

 

 

 

 

(211

)

 

(211

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,024

 

Dividends to shareholders

 

 

 

 

 

 

(565

)

 

 

 

(565

)

Issuance of common stock under stock purchase and award plans

 

 

13

 

 

1

 

 

402

 

 

 

 

403

 

Adjustment to deferred tax benefit recorded on adoption of SFAS No. 158

 

 

 

 

 

 

 

 

(17

)

 

(17

)

Repurchase of common stock

 

 

(31

)

 

(3

)

 

(1,541

)

 

 

 

(1,544

)

Excess tax benefit from exercise of stock-based awards

 

 

 

 

 

 

40

 

 

 

 

40

 

Stock-based compensation

 

 

 

 

 

 

217

 

 

 

 

217

 

Cumulative effect adjustment to retained earnings related to the adoption of FIN No. 48 (Note 12)

 

 

 

 

 

 

1

 

 

 

 

1

 

Balance April 25, 2008

 

 

1,125

 

$

112

 

$

11,710

 

$

(286

)

$

11,536

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

36

 


 

Medtronic, Inc.

Consolidated  Statements of Cash Flows

 

 

 

Fiscal Year

 

 

 

2008

 

2007

 

2006

 

(in millions)

 

 

 

 

 

 

 

 

 

 

Operating Activities:

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

2,231

 

$

2,802

 

$

2,547

 

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

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

637

 

 

583

 

 

544

 

Special charges

 

 

78

 

 

98

 

 

 

IPR&D charges

 

 

390

 

 

 

 

364

 

Provision for doubtful accounts

 

 

31

 

 

31

 

 

39

 

Stock-based compensation

 

 

217

 

 

185

 

 

25

 

Excess tax benefit from exercise of stock-based awards

 

 

(40

)

 

(36

 

99

 

Deferred income taxes

 

 

(49

)

 

(236

 

105

 

Change in operating assets and liabilities, net of effect of acquisitions:

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(461

)

 

(326

)

 

(217

)

Inventories

 

 

30

 

 

(24

)

 

(257

)

Prepaid expenses and other assets

 

 

92

 

 

(45

)

 

(86

)

Accounts payable and accrued liabilities

 

 

61

 

 

17

 

 

(981

Other long-term liabilities

 

 

272

 

 

(70

 

38

 

Net cash provided by operating activities

 

 

3,489

 

 

2,979

 

 

2,220

 

 

 

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

 

 

 

 

Acquisitions, net of cash acquired

 

 

(4,221

)

 

(8

)

 

(285

)

Purchases of intellectual property

 

 

(93

)

 

(121

)

 

(837

)

Additions to property, plant and equipment

 

 

(513

)

 

(573

)

 

(407

)

Purchases of marketable securities

 

 

(6,433

)

 

(11,837

 

(8,065

)

Sales and maturities of marketable securities

 

 

8,557

 

 

10,894

 

 

6,627

 

Other investing activities, net

 

 

(87

)

 

(56

 

100

 

Net cash used in investing activities

 

 

(2,790

)

 

(1,701

)

 

(2,867

)

 

 

 

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

 

 

 

 

Change in short-term borrowings, net

 

 

543

 

 

45

 

 

(18

Payments on long-term debt

 

 

(12

)

 

(1,880

)

 

 

Issuance of long-term debt

 

 

300

 

 

 

 

5,428

 

Purchase of call options

 

 

 

 

 

 

(1,075

Sale of warrants

 

 

 

 

 

 

517

 

Dividends to shareholders

 

 

(565

)

 

(504

)

 

(465

)

Repurchase of common stock

 

 

(1,544

)

 

(1,039

)

 

(3,589

)

Issuance of common stock

 

 

403

 

 

331

 

 

506

 

Excess tax benefit from exercise of stock-based awards

 

 

40

 

 

36

 

 

 

Net cash (used in) provided by financing activities

 

 

(835

)

 

(3,011

 

1,304

 

Effect of exchange rate changes on cash and cash equivalents

 

 

(60

)

 

(5

 

105

 

 

 

 

 

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

 

(196

)

 

(1,738

 

762

 

Cash and cash equivalents at beginning of period

 

 

1,256

 

 

2,994

 

 

2,232

 

Cash and cash equivalents at end of period

 

$

1,060

 

$

1,256

 

$

2,994

 

 

 

 

 

 

 

 

 

 

 

 

Supplemental Cash Flow Information:

 

 

 

 

 

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

 

 

 

 

 

Income taxes

 

$

717

 

$

1,034

 

$

860

 

Interest

 

 

258

 

 

230

 

 

109

 

Supplemental noncash investing and financing activities:

 

 

 

 

 

 

 

 

 

 

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

 

$

 

$

94

 

$

 

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

 

 

94

 

 

 

 

1,971

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

37

 



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 2008, 2007, and 2006 ended on April 25, 2008, April 27, 2007, and April 28, 2006, 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 25, 2008 and April 27, 2007. 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 on 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 on 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 and other 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 and other 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 initially 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 and other securities.

 

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 $99 at April 25, 2008 and $160 at April 27, 2007.

 

38

 



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 25,
2008

 

April 27,
2007

 

Finished goods

 

$

784

 

$

753

 

Work in process

 

 

250

 

 

209

 

Raw materials

 

 

246

 

 

253

 

Total

 

$

1,280

 

$

1,215

 

 

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 25,
2008

 

April 27,
2007

 

Lives
(in years)

Land and land improvements

 

$

123

 

$

95

 

Up to 20

Buildings and leasehold improvements

 

 

1,240

 

 

1,007

 

Up to 40

Equipment

 

 

3,066

 

 

2,784

 

3-7

Construction in progress

 

 

314

 

 

423

 

Subtotal

 

 

4,743

 

 

4,309

 

 

Less: Accumulated depreciation

 

 

(2,522

)

 

(2,247

)

 

Property, plant and equipment, net

 

$

2,221

 

$

2,062

 

 

 

Depreciation expense of $417, $401, and $369 was recognized in fiscal years 2008, 2007, and 2006, 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 a discounted future cash flows analysis. The Company completed its annual goodwill impairment test in the third quarter of fiscal years 2008, 2007, and 2006 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 25, 2008, 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.

 




39

 


 

Changes in the Company’s product warranty obligations during the years ended April 25, 2008 and April 27, 2007 consisted of the following:

 

Balance April 28, 2006

 

$

41

 

Warranty claims provision

 

 

27

 

Settlements made

 

 

(34

)

 

 

 

 

 

Balance April 27, 2007

 

 

34

 

Warranty claims provision

 

 

22

 

Settlements made

 

 

(13

)

 

 

 

 

 

Balance April 25, 2008

 

$

43

 

 

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, post-retirement medical plans, defined contribution savings plans, and termination indemnity plans, covering substantially all U.S. employees and many employees outside the U.S. Pension benefit 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 include assumptions for the discount rate, retirement age, expected return on plan assets, and 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. Research and development costs include costs of all basic research activities as well as other research, engineering, and technical effort required to develop a new product or service or make significant improvement to an existing product or manufacturing process. Research and development costs also include pre-approval regulatory expenses.

 

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.

 

40

 


 

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 The Company’s compensation programs include share-based payments. Concurrent with the adoption of SFAS No. 123 (revised 2004), “Share Based Payment” (SFAS No. 123(R)), 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 on 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, defined benefit pension adjustments, and unrealized gains and losses on AFS marketable securities. Comprehensive income in fiscal years 2008, 2007, and 2006 was $2,024, $2,794, and $2,552, respectively.

 

Presented below is a summary of activity for each component of accumulated other comprehensive (loss)/income for fiscal years 2008, 2007, and 2006:

 

 

 

Unrealized
Gain/(Loss) on
Investments

 

Cumulative Translation Adjustments

 

Net Change in Retirement Obligations

 

Unrealized
(Loss)/Gain on
Foreign Exchange Derivatives

 

Accumulated
Other
Comprehensive
(Loss)/Income

 

Balance April 29, 2005

 

$

(15

$

190

 

$

(15

)

$

(11

)

$

150

 

Other comprehensive (loss)/income

 

 

1

 

 

(13

 

(9

)

 

26

 

 

5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance April 28, 2006

 

 

(14

 

177

 

 

(24

)

 

15

 

 

155

 

Other comprehensive (loss)/income

 

 

20

 

 

18

 

 

24

 

 

(70

)

 

(8

)

Adoption of SFAS No. 158

 

 

 

 

 

 

(209

)

 

 

 

(209

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance April 27, 2007

 

 

6

 

 

195

 

 

(209

)

 

(55

)

 

(62

)

Other comprehensive (loss)/income

 

 

(47

 

14

 

 

37

 

 

(211

 

(207

)

Adjustment to deferred tax benefit recorded on adoption of SFAS No. 158

 

 

 

 

 

 

(17

)

 

 

 

(17

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance April 25, 2008

 

$

(41

$

209

 

$

(189

)

$

(266

$

(286

)

 

Translation adjustments are not adjusted for income taxes as substantially all translation adjustments relate to permanent investments in non-U.S. subsidiaries. The tax (benefit)/expense on the unrealized (loss)/gain on derivatives in fiscal years 2008, 2007, and 2006 was $(132), $(38), and $14, respectively. The tax benefit on the minimum pension liability was $5 in fiscal year 2006. The minimum pension liability was eliminated at the end of fiscal year 2007 as a result of the Company’s adoption of 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). The tax benefit related to SFAS No. 158 was $17 and $92 in fiscal years 2008 and 2007, respectively. The tax expense/(benefit) on the unrealized gain/(loss) on investments in fiscal years 2008, 2007, and 2006 was $(26), $11 and $1, respectively.

 

41

 


 

Derivatives   SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (SFAS No. 133) as amended, requires companies to recognize all derivatives as assets and liabilities on the balance sheet and to measure the instruments at fair value through earnings unless the derivative qualifies as a hedge. If the derivative is a hedge, depending on the nature of the hedge and hedge effectiveness, changes in the fair value of the derivative will either be recorded currently through earnings or recognized in accumulated other comprehensive (loss)/income on the consolidated balance sheets until the hedged item is recognized in earnings upon settlement/termination. The changes in the fair value of the derivative will offset the change in fair value of the hedged asset, liability, net investment, or probable commitment. The Company evaluates hedge effectiveness at inception and on an ongoing basis. If a derivative is no longer expected to be highly effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is recorded in earnings.

 

The Company uses derivative instruments, primarily forward exchange contracts, to manage its exposure related to foreign exchange rate changes. The Company enters into contracts with major financial institutions that change in value as foreign exchange rates change. These contracts are designated either as cash flow hedges, net investment hedges, or freestanding derivatives. It is the Company’s policy to enter into forward exchange derivative contracts only to the extent true exposures exist; the Company does not enter into forward exchange derivative contracts for speculative purposes. Principal currencies hedged are the Euro and the Japanese Yen. All derivative instruments are recorded at fair value on the consolidated balance sheets, as a component of prepaid expenses and other current assets, other long-term assets, other accrued expenses, or other long-term liabilities depending upon the gain or loss position of the contract and contract maturity date.

 

Forward contracts designated as cash flow hedges are designed to hedge the variability of cash flows associated with forecasted transactions denominated in a foreign currency that will take place in the future. Changes in value of derivatives designated as cash flow hedges are recorded in accumulated other comprehensive (loss)/income on the consolidated balance sheets until earnings are affected by the variability of the underlying cash flows. At that time, the applicable amount of gain or loss from the derivative instrument, that is deferred in shareholders’ equity, is reclassified to earnings and is included in other expense, net or cost of products sold in the consolidated statements of earnings, depending on the underlying transaction that is being hedged.

 

The purpose of net investment hedges is to hedge the long-term investment (equity) in foreign operations. The gains and losses related to the change in the forward exchange rates of the net investment hedges are recorded currently in earnings as other expense, net. The gains and losses based on changes in the current exchange rates, or spot rates, are recorded as a cumulative translation adjustment, a component of accumulated other comprehensive (loss)/income on the consolidated balance sheets.

 

The Company uses forward exchange contracts to offset its exposure to the change in value of certain foreign currency denominated intercompany assets and liabilities. These forward exchange contracts are not designated as hedges, and therefore, changes in the value of these freestanding derivatives are recognized currently in earnings, thereby offsetting the current earnings effect of the related foreign currency denominated assets and liabilities.

 

In addition, the Company uses interest rate derivative instruments to manage its exposure to interest rate movements and to reduce borrowing costs by converting fixed-rate debt into floating-rate debt. The objective of the instruments is to more effectively balance the Company’s borrowing costs and interest rate risk. These derivative instruments are designated as fair value hedges under SFAS No. 133. Changes in the fair value of the derivative instrument are recorded in other expense, net, and are offset by gains or losses on the underlying debt instrument. Interest expense includes interest payments made or received under interest rate derivative instruments.

 

Earnings Per Share   Basic earnings per share is computed based on the weighted average number of common shares outstanding. Diluted earnings per share is computed based on the weighted average number of common shares outstanding increased by the number of additional shares that would have been outstanding had the potentially dilutive common shares been issued and reduced by the number of shares the Company could have repurchased from the proceeds from issuance of the potentially dilutive shares. Potentially dilutive shares of common stock include stock options and other stock-based awards granted under stock-based compensation plans and shares committed to be purchased under the employee stock purchase plan.

 

42

 


 

The table below sets forth the computation of basic and diluted earnings per share:

 

 

 

Fiscal Year

 

(shares in millions)

 

2008

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

2,231

 

$

2,802

 

$

2,547

 

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

 

Basic-weighted average shares outstanding

 

 

1,130.7

 

 

1,149.7

 

 

1,204.5

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

Employee stock options

 

 

9.7

 

 

9.9

 

 

10.4

 

Shares issuable upon conversion of Contingent Convertible Debentures

 

 

 

 

0.2

 

 

0.7

 

Other

 

 

1.7

 

 

2.0

 

 

1.7

 

Diluted-weighted average shares outstanding

 

 

1,142.1

 

 

1,161.8

 

 

1,217.3

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

1.97

 

$

2.44

 

$

2.11

 

Diluted earnings per share

 

$

1.95

 

$

2.41

 

$

2.09

 

 

The calculation of weighted average diluted shares outstanding excludes options for approximately 22 million, 35 million and 12 million common shares in fiscal years 2008, 2007 and 2006, respectively, as the exercise price of those options was greater than the average market price, resulting in an anti-dilutive effect on diluted earnings per share.

 

New Accounting Standards

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157). SFAS No. 157 establishes a framework for measuring fair value in accordance with generally accepted accounting principles, clarifies the definition of fair value within that framework and expands disclosures about fair value measurements. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, except for the measurement of share-based payments. SFAS No. 157 does not expand the use of fair value in any new circumstances. For certain types of financial instruments, SFAS No. 157 requires a limited form of retrospective transition, whereby the cumulative impact of the change in principle is recognized in the opening balance in retained earnings in the fiscal year of adoption. All other provisions of SFAS No. 157 will be applied prospectively. On February 12, 2008, the FASB issued FASB Staff Position (FSP) FAS 157-2, “Effective Date of FASB Statement No. 157” (FSP FAS 157-2). FSP FAS 157-2 defers the implementation of SFAS No. 157 for certain nonfinancial assets and nonfinancial liabilities. The remainder of SFAS No. 157 is effective, for the Company, beginning in the first quarter of fiscal year 2009. The aspects that have been deferred by FSP FAS 157-2 will be effective for the Company beginning in the first quarter of fiscal year 2010. The fiscal year 2009 adoption is not expected to have a material impact on the consolidated financial statements. The Company is currently evaluating the impact that FSP FAS 157-2 will have on the consolidated financial statements.

 

In September 2006, the FASB issued 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 healthcare plan, the benefit obligation is the accumulated post-retirement benefit obligation. The initial incremental recognition of the funded status under SFAS No. 158 of the Company’s defined pension and other post-retirement benefit plans, as well as subsequent changes in the Company’s funded status that are not included in net periodic benefit cost will be reflected in accumulated other comprehensive (loss)/income. As of April 25, 2008 and April 27, 2007, the net overfunded/(underfunded) status of the Company’s defined benefit plans was $90 and $(2), respectively, and recognition of this status upon the adoption of SFAS No. 158 resulted in an after-tax charge to shareholders’ equity of $209 in fiscal year 2007. 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 for additional information.

 

43

 



The funded status recognition and certain disclosure provisions of SFAS No. 158 were effective for the Company’s 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 the Company’s fiscal year-end statement of financial position effective for the Company’s fiscal year ended April 24, 2009. A select number of the Company’s plans, including the U.S. plans, currently have a January 31 measurement date. This standard will require the Company to change, in fiscal year 2009, that measurement date to match the date of the Company’s fiscal year-end. The Company does not expect a material impact on the financial condition for those plans in which the Company has not adopted the requirement to measure the plan assets and benefit obligations as of the date of the balance sheet.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS No. 159). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 will be effective for the Company at the beginning of fiscal year 2009. The Company has not elected the fair value option for eligible items that existed as of April 26, 2008.

 

In June 2007, the Emerging Issues Task Force (EITF) reached a consensus on EITF Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services Received to Be Used in Future Research and Development Activities” (EITF No. 07-3). EITF No. 07-3 requires companies that are involved in research and development activities to defer nonrefundable advance payments for future research and development activities and to recognize those payments as goods and services are delivered. The Company will be required to assess on an ongoing basis whether or not the goods or services will be delivered and to expense the nonrefundable advance payments immediately if it is determined that delivery is unlikely. EITF No. 07-3 is effective for new arrangements entered into subsequent to April 25, 2008. The adoption of EITF No. 07-3 will not be material to the consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (SFAS No. 141(R)). SFAS No. 141(R) replaces SFAS No. 141, “Business Combinations.” SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interests in the acquiree and the goodwill acquired. Some of the key changes under SFAS No. 141(R) will impact the accounting treatment for certain specific acquisition related items including: (1) accounting for acquired in process research and development (IPR&D) as an indefinite-lived intangible asset until approved or discontinued rather than as an immediate expense; (2) expensing acquisition costs rather than adding them to the cost of an acquisition; (3) expensing restructuring costs in connection with an acquisition rather than adding them to the cost of an acquisition; (4) including the fair value of contingent consideration at the date of an acquisition in the cost of an acquisition; and (5) recording at the date of an acquisition the fair value of contingent liabilities that are more likely than not to occur. SFAS No. 141(R) also includes a substantial number of new disclosure requirements. SFAS No. 141(R) will be effective for the Company beginning fiscal year 2010 and must be applied prospectively to all new acquisitions closing on or after April 25, 2009. Early adoption of SFAS No. 141(R) is prohibited. SFAS No. 141(R) is expected to have a material impact on how the Company will identify, negotiate, and value future acquisitions and a material impact on how an acquisition will affect the Company’s consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (SFAS No. 160). SFAS No. 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method will significantly change the accounting for partial and/or step acquisitions. SFAS No. 160 will be effective for the Company in the first quarter of fiscal year 2010. The Company is currently evaluating the impact that the adoption of SFAS No. 160 will have, but does not believe it will be material to the consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” (SFAS No. 161) which will require increased disclosures about an entity’s strategies and objectives for using derivative instruments; the location and amounts of derivative instruments in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under SFAS No. 133; and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Certain disclosures will also be required with respect to derivative features that are credit risk-related. SFAS No. 161 is effective for the Company beginning in the fourth quarter of fiscal year 2009 but only requires the revised disclosures on a prospective basis. Since SFAS No. 161 requires only additional disclosures about the Company’s derivatives and hedging activities, the adoption of SFAS No. 161 will not affect the Company’s consolidated financial statements.

 

In May 2008, the FASB issued FSP APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (FSP APB 14-1). FSP APB 14-1 requires the proceeds from the issuance of such convertible debt instruments to be allocated between a liability component (issued at a discount) and an equity component. The resulting debt discount is amortized over the period the convertible debt is expected to be outstanding as additional non-cash interest expense. The change in accounting treatment is effective for the Company beginning in fiscal 2010, and will be applied retrospectively to prior periods. FSP APB 14-1 changes the accounting treatment for the Company’s $2,200 of 1.500 percent and $2,200 of 1.625 percent Senior Convertible Notes due in 2011 and 2013, respectively, which were issued in April 2006 and the $93 remaining balance of the Company’s Contingent Convertible Debentures due 2021. The Company is currently evaluating the impact of this new accounting treatment, which will result in an increase to non-cash interest expense reported in its historical financial statements. Based on a preliminary review, the Company believes historical diluted EPS would be impacted in the range of $0.06 to $0.10 per fiscal year.

 

44

 



2.

Special and Certain Litigation Charges

 

Special Charges

 

In fiscal year 2008, the Company recorded a special charge of $78 related to the impairment of intangible assets associated with its benign prostatic hyperplasia, or enlarged prostate, product line purchased in fiscal year 2002. The development of the market, relative to the Company’s original assumptions, has changed as a result of the broad acceptance of a new line of drugs to treat the symptoms of an enlarged prostate. After analyzing the estimated future cash flows utilizing this technology, based on the market development, the Company determined that the carrying value of these intangible assets was impaired and a write-down was necessary.

 

In fiscal year 2007, the Company concluded two intangible assets were fully impaired due to inadequate clinical results and the resulting delays in product development. As a result, the Company recorded a $98 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, the Company recorded a $100 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.

 

Certain Litigation Charges

 

The Company classifies material litigation reserves recognized as certain litigation charges. In fiscal year 2008, the Company incurred certain litigation charges of $366. Of that amount, $123 relates to the settlement of certain lawsuits relating to the Marquis line of implantable cardioverter defibrillators (ICDs) and cardiac resynchronization therapy-defibrillators (CRT-Ds) that were subject to a field action announced on February 10, 2005. The remainder of the charge, $243, relates to an estimated reserve established for litigation with Cordis Corporation (Cordis), a subsidiary of Johnson & Johnson (J&J). The Cordis litigation originated in October 1997 and pertains to a patent infringement claim on a previous generation of bare metal stents that are no longer on the market. See Note 15 for further discussion of these certain litigation charges. In May 2008, the Company paid substantially all of the settlement for certain lawsuits relating to the Marquis line of ICDs and CRT-Ds.

 

In fiscal year 2007, the Company reached a settlement agreement with the U.S. Department of Justice which requires the government to obtain dismissal of the two qui tam civil suits and is conditioned upon such dismissal being obtained. To resolve the matter, Medtronic has entered into a five-year corporate integrity agreement effective upon dismissal of the two suits that further strengthens its employee training and compliance systems surrounding sales and marketing practices. The settlement agreement also reflects Medtronic’s assertion that the Company and its current employees have not engaged in any wrongdoing or illegal activity. Medtronic also agreed to pay $40 pending dismissal of the related lawsuits.

 

There were no certain litigation charges in fiscal year 2006.

 

3.

Restructuring Charges

 

Global Realignment Initiative

 

In fiscal year 2008, as part of a global realignment initiative, the Company recorded a $31 restructuring charge, which consisted of employee termination costs of $27 and asset write-downs of $4. This initiative began in the fourth quarter of fiscal year 2008 and focuses on shifting resources to those areas where the Company has the greatest opportunities for growth and streamlining operations to drive operating leverage. The global realignment initiative impacts most businesses and certain corporate functions. Within the Company’s Cardiac Rhythm Disease Management (CRDM) business, the Company is reducing research and development infrastructure by closing a facility outside the U.S., reprioritizing research and development projects to focus on the core business and consolidating manufacturing operations to drive operating leverage. Within Spinal, the Company intends to reorganize and consolidate certain activities where Medtronic’s existing infrastructure, resources, and systems can be leveraged to obtain greater operational synergies. The global realignment initiative is also designed to further consolidate manufacturing of CardioVascular products, streamline distribution of products in select businesses and to reduce general and administrative costs in the Company’s corporate functions.

 

45

 


 

The asset write-downs were recorded within cost of products sold in the consolidated statement of earnings. The employee termination costs of $27 consist of severance and the associated costs of continued medical benefits, and outplacement services.

 

This global realignment initiative will result in charges being recognized in both the fourth quarter of fiscal year 2008 and the first quarter of fiscal year 2009, and the Company expects that when complete, will eliminate approximately 1,100 positions. Restructuring charges were recognized in the fourth quarter of fiscal year 2008 for standard severance benefits to be provided to impacted employees. In the first quarter of fiscal year 2009 the Company will recognize additional restructuring charges associated with (i) enhanced severance benefits for positions identified in the fourth quarter of fiscal year 2008, and (ii) standard and enhanced severance benefits provided for positions that were identified in the first quarter of fiscal year 2009. These incremental costs were not accrued in fiscal year 2008 because either the enhanced benefits had not yet been communicated to the impacted employees or the positions for elimination had not yet been identified.

 

Of the 1,100 positions that will be eliminated as part of this initiative, 560 positions were identified for elimination in the fourth quarter of fiscal year 2008 and will be achieved through voluntary and involuntary separation. Of these 560 positions identified, the majority will be eliminated in fiscal year 2009.

 

A summary of the activity related to the fiscal year 2008 global realignment initiative is presented below:

 

 

 

Global Realignment Initiative

 

 

 

Employee Termination Costs

 

Asset Write-downs

 

Total

 

Balance at April 27, 2007

 

$

 

$

 

$

 

Restructuring charges

 

 

27

 

 

4

 

 

31

 

Payments/write-downs

 

 

(2

)

 

(4

)

 

(6

)

Balance at April 25, 2008

 

$

25

 

$

 

$

25

 

 

Fiscal Year 2007 Initiative

 

In fiscal year 2007, the Company recorded a $36 restructuring charge, which consisted of employee termination costs of $28 and asset write-downs of $8. These initiatives were designed to drive manufacturing efficiencies in the Company’s CardioVascular business, downsize the Physio-Control business due to the Company’s voluntary suspension of U.S. shipments, and rebalance resources within the CRDM business in response to market dynamics. The employee termination costs consist of severance and the associated costs of continued medical benefits, and outplacement services. The asset write-downs consist of a $5 charge for inventory write-downs and a $3 charge for non-inventory asset write-downs. The inventory and non-inventory asset write-downs were recorded within cost of products sold in the consolidated statement of earnings.

 

As a continuation of the fiscal year 2007 initiatives, in the first quarter of fiscal year 2008 the Company incurred $14 of incremental restructuring charges associated with compensation provided to employees whose employment terminated with the Company in the first quarter of fiscal year 2008. These incremental costs were not accrued in fiscal year 2007 because these benefits had not yet been communicated to the impacted employees. Included in the total $14 restructuring charge is $4 of incremental defined benefit pension and post-retirement related expense for those employees who accepted early retirement packages. These costs are not included in the table summarizing restructuring costs below because they are associated with costs that are accounted for under the pension and postretirement rules. For further discussion on the incremental defined benefit pension and post-retirement related expense, see Note 13.

 

When the restructuring initiative began in fiscal year 2007, the Company identified approximately 900 positions for elimination which were achieved through early retirement packages offered to employees, voluntary separation, and involuntary separation, as necessary. As of April 25, 2008, the initiatives begun in the fourth quarter of fiscal year 2007 were substantially complete.

 

46

 


 

A summary of the activity related to the fiscal year 2007 initiative is presented below:

 

 

 

Fiscal Year 2007 Initiative

 

 

 

Employee Termination Costs

 

Asset Write-downs

 

Total

 

Balance at April 28, 2006

 

$

 

$

 

$

 

Restructuring charges

 

 

28

 

 

8

 

 

36

 

Payments/write-downs

 

 

(5

)

 

(8

)

 

(13

Balance at April 27, 2007

 

 

23

 

 

 

 

23

 

Restructuring charges

 

 

10

 

 

 

 

10

 

Payments

 

 

(33

)

 

 

 

(33

)

Balance at April 25, 2008

 

$

 

$

 

$

 

 

There were no restructuring charges in fiscal year 2006.

 

4.

Acquisitions and IPR&D Charges

 

When the Company acquires another company or a group of assets, 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. Goodwill represents the excess of the aggregate purchase price over the fair value of net assets, including IPR&D, of acquired businesses. The values assigned to IPR&D and other identifiable intangible assets are based on valuations that have been prepared using methodologies and valuation techniques consistent with those used by independent appraisers. These techniques include estimating the future cash flows of each project or technology and discounting the net cash flows back to their present values utilizing an appropriate risk-adjusted rate of return (discount rate). The discount rate used is determined at the time of the acquisition in accordance with accepted valuation methods. For IPR&D, these methodologies include consideration of the risk of the project not achieving commercial feasibility and include a factor that takes into account the uncertainty surrounding the successful development of the IPR&D.

 

At the time of acquisition, the Company expects 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 issuance, validity and litigation, if any. If commercial viability were not achieved, the Company would likely look to other alternatives to provide these therapies.

 

Fiscal Year 2008

 

Kyphon Acquisition

 

On November 2, 2007, the Company consummated the acquisition of Kyphon Inc. (Kyphon) and it became a wholly owned subsidiary of the Company. Kyphon develops and markets medical devices designed to restore and preserve spinal function using minimally invasive technology. Kyphon’s primary products are used in balloon kyphoplasty for the treatment of spinal compression fractures caused by osteoporosis or cancer, and in the interspinous process decompression procedure for treating the symptoms of lumbar spinal stenosis. It is expected that the acquisition of Kyphon will add to the growth of the Company’s existing Spinal business by extending its product offerings into some of the fastest growing product segments of the spine market, enabling the Company to provide physicians with a broader range of therapies for use at all stages of the care continuum.

 

Under the terms of the agreement announced on July 27, 2007, Kyphon shareholders received $71 per share in cash for each share of Kyphon common stock they owned. Total consideration for the transaction was approximately $4,203, which includes payments to Kyphon shareholders for the cancellation of outstanding shares, the assumption and settlement of existing Kyphon debt and payment of direct acquisition costs. Total debt assumed relates to Kyphon’s obligations under existing credit and term loan facilities and outstanding senior convertible notes. In addition, the total consideration includes the proceeds of unwinding the related convertible note hedges and cancellation and payment of the warrants to the hedge participants that were originally issued by Kyphon in February 2007. The transaction was financed through a combination of approximately $3,303 cash on hand, the issuance of $600 short-term commercial paper and borrowing $300 through a new long-term unsecured revolving credit facility.

 

47

 


 

The Company has accounted for the acquisition of Kyphon as a purchase under U.S. GAAP. Under the purchase method of accounting, the assets and liabilities of Kyphon were recorded as of the acquisition date, at their respective fair values, and consolidated with the Company. The break down of the purchase price of Kyphon is as follows:

 

 

 

 

 

Cash acquisition of Kyphon outstanding common stock

 

$

3,300

 

Cash settlement of vested stock-based awards

 

 

218

 

Debt assumed and settled

 

 

570