Wall Street is closely eyeing business efficiency at medical device maker Medtronic PLC, one year after the company transformed itself through a $50 billion acquisition and a decision to move to a lower-tax country.
Medtronic had $28.8 billion in sales during the year that ended in April, a personal-best for the Minnesota-run maker of heart devices and surgical tools. But the company missed key targets in its operating margin throughout the past year, and on Tuesday it revealed that it had missed its guidance of 31 percent operating margin for the year as a whole.
The margin was 30.3 percent; investors had been expecting 31.4 percent in the first full fiscal year since Medtronic acquired surgical supplier Covidien in January 2015.
"Medtronic missed consensus margin targets in both the first and third quarters, due in large part to (fluctuations in international currencies), so the sensitivity around margin gains and post-Covidien operating leverage is running high," JPMorgan Chase analyst Mike Weinstein wrote in a note to investors before Tuesday's results were known.
Medtronic stock dropped about 1.5 percent to $80.48 per share on Tuesday following the news on the company's operating margin, on a day when the wider market was flat. The stock is up nearly 5 percent since the closing of the Covidien deal and the related relocation of combined company headquarters to Ireland.
Outgoing Medtronic Chief Financial Officer Gary Ellis, on his last earnings call as CFO, said Tuesday that company officials have been surprised by investors' strong focus on operating margins.
Asked about the company's struggles of late to hit its operating margin goals, Ellis said his previous guidance on the operating margin was too narrow, in the context of a complex company like Medtronic.
"In hindsight, if we would have realized how much focus was going to be on the operating margin line, we probably clearly would have given a broader range," in an earnings call several months ago, Ellis said. "That was my mistake, we should not have done that, but we didn't realize the focus everyone is going to have on it."
Ellis reiterated that executives still "feel very good" about the goal of achieving $850 million in annual cost synergies in combining the Medtronic and Covidien.
Chief Executive Omar Ishrak said the operating margin during the most recent quarter was hurt by negative currency fluctuations for medical device inventories, one-time impacts like the acquisition of Italian renal care provider Bellco, and a higher-than-anticipated impact from "scrap and obsolescence" of devices.
Without those items, the company would have fallen within its operating margin target for the quarter, Ishrak said.
Despite the miss on its quarterly operating margin, Medtronic still beat Wall Street's expectations for its earnings. A lower-than-expected tax global rate of 14.6 percent, compared to consensus estimates cited by J.P. Morgan of 16.1 percent, added 2 cents to the company's earnings per share for the quarter.
Medtronic beat Street estimates by penny, turning in earnings of $1.27 per share.
"Irrespective of the unplanned impacts, Medtronic offset it and with lower tax, beat on EPS," Deutsche Bank analyst Kristen Stewart wrote in an investors note.
Medtronic said its profit for the three months ended April 29 rose 9 percent and executives forecast stronger growth in the next year. Sales rose 4 percent to $7.57 billion.
Executives said they expected per-share profit growth of at least 12 percent in the coming year with revenue growing in the mid-single-digit percent range.
Medtronic saw revenue grow in all four of its divisions in the quarter. Its biggest unit, cardiac and vascular devices, reported a 5 percent jump to $2.7 billion. The next-biggest unit, minimally invasive therapies, rose 3 percent to $2.5 billion.
The restorative therapies group increased by 1 percent to $1.9 billion after two of its divisions, surgical technologies and neurovascular devices, overcame sales declines in the neuromodulation and spine products divisions. The diabetes group grew by 6 percent to $496 million.
Company executives said there appeared to be small but notable growth in surgical volumes in the United States during the quarter, which analysts said was consistent with what they had been hearing in the broader market.
In the coming fiscal year, Medtronic executives said the key to hitting earnings targets will be to reach sales growth of 5 to 6 percent.
Medtronic announced per-share earnings guidance in the range of $4.60 to $4.70, implying growth of 12 percent to 16 percent after adjusting for the effect of translating foreign currency transactions to U.S. dollars. Before those figures were announced, Wall Street had been projecting $4.70.
"There are a lot of moving parts here," Ishrak told investors. "And so, we just wanted to be reasonable in our approach and that's the most accurate. It's not virtually conservative, nor is it a virtually aggressive kind of an estimate that we gave, it's a fairly broad range. And obviously we do our best to maximize performance."