Growth in diabetes products lags, but Medtronic earnings solid

Medtronic could be making a lot more money from its diabetes business right now, but executives are confident they can ramp up manufacturing to address a supply shortfall for the Minnesota-run company's glucose sensors in the coming months.

Insulin pumps and sensors make up the smallest stand-alone product group at Medtronic, with less than $500 million in revenue, but the diabetes division had been expected to increase sales by as much as 12 percent this year.

Instead, as the company announced better than expected fiscal first quarter earnings on Tuesday, it pared diabetes guidance to 1-to-4 percent growth for its fiscal year ending in April 2018.

Demand for Medtronic's latest body-worn blood-glucose sensors has more than doubled in two years, which has "temporarily outstripped our production capacity," chief executive Omar Ishrak said during a quarterly earnings call Tuesday. "We accelerated plans to increase sensor production capacity last year, but these lines are not expected to be ready for commercial production until our fourth quarter," which ends in April.

Until then, the company is prioritizing its supply of sensors for customers who already have a Medtronic insulin pump that works with the sensor, which cuts into the supply of sensors available for high-revenue sales to new patients.

"Growth in the diabetes division was slower than expected in the quarter, noted Edward Jones research analyst John Boylan. "But once they can match supply with demand, which we think they will do over time, this will be long-forgotten," he said.

Medtronic shares dipped about 2 percent to $81.76 in trading Tuesday as investors digested a complex earnings announcement.

Overall, despite missing revenue targets for its fiscal first quarter ended July 28, Medtronic beat income expectations for the period as the companywide global tax rate declined. The company released overall financial guidance that was in line with previous announcements.

Medtronic told analysts it is also putting recent computer woes behind it. Ishrak said that a weeklong outage of a critical global system during the quarter had only a small financial impact on operations because company employees worked hard to fill the back orders that it created.

Ishrak told investors Tuesday that a third-party analysis of the issue confirmed the disruption was caused by "inadvertent human error," and there was no evidence of a data breach or any involvement from hackers outside the company.

"There is no longer any outstanding backlog associated with this event, and our IT system is operating normally," Ishrak said. "We are pleased to put this event behind us."

Costly outage

Leerink Partners analysts have estimated that the outage of a central system for manufacturing, ordering and fulfillment, along with a lower-than-anticipated sales in the diabetes division, created a roughly $70 million sales shortfall in the quarter.

Overall company revenue in the quarter increased 3 percent to $7.39 billion in the three months ended July 28, below Wall Street estimates for the earnings announcement. However, Medtronic beat earnings expectations by 4 cents per share, with adjusted diluted earnings of $1.12 per share. Adjusted net income climbed 6.7 percent to $1.54 billion, and the operating margin climbed half a percentage point, to 27 percent. Medtronic said its adjusted worldwide tax rate in the just-completed quarter was 13 percent, down from 15.7 percent in the same quarter last year.

In the largest sales group, cardiac and vascular devices, which includes machines that make hearts beat more regularly and effectively, sales increased 5 percent to $2.6 billion in the most recent quarter. The second-largest group, minimally invasive therapies, grew 3 percent to $2.5 billion.

Meanwhile sales of restorative devices for the brain and spine grew just 2 percent to $1.8 billion amid a larger "softness" in volumes of elective surgeries during the quarter. And sales of devices for diabetes management sank 1 percent to $449 million, as the company worked to fulfill a higher-than-expected demand for newer devices, particularly the new 670G pump that partly automates insulin delivery and a continuous glucose sensor worn on the body that analyzes a patient's blood levels in real time.

Looking ahead, Medtronic also reiterated its financial guidance for the fiscal year, which will end in April 2018.

Medtronic expects full-year revenue growth of 4 to 5 percent, and earnings per share growth of between 9 to 10 percent.

That includes changes following July's $6.1 billion sale of patient-care, deep vein thrombosis and nutritional insufficiency product lines to health care supplier Cardinal Health.

Overall Ishrak said the ongoing softness in elective surgeries at hospitals isn't dampening Medtronic's financial outlook.

"Product innovation ... is what really swings these markets. And we do think that for the right procedures, where there is real value that the patient can see and the physicians can see, the procedures will happen and they will grow when new innovation comes along. And we are in a period of accelerating that innovation, so we do expect our U.S. growth numbers to go up in the coming quarters," Ishrak said.

Joe Carlson • 612-673-4779