Ladies and gentlemen, thank you for standing by, and welcome to the Medtronic Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. And after the speakers' remarks, there will be a question and answer session. Thank you. I will now turn the conference over to Mr.
Ryan Weispfenning.
Great. Thank you, Crystal. Good morning and welcome to Medtronic's Q2 conference call and webcast. During the next hour, Omar Ishrak, Medtronic Chairman and Chief Executive Officer and Karen Parkhill, Medtronic Chief Financial Officer, will provide comments on the results of our Q2, which ended on October 27, 2017. After our prepared remarks, we'll be happy to take your questions.
First, a few logistical comments. Earlier this morning, we issued a press release containing our financial statements and a revenue by division summary. We also issued an earnings presentation that provides additional details on our performance and outlook. During this earnings call, many of the statements made may be considered forward looking statements, and actual results might differ materially from those projected in any forward looking statement. Additional information concerning factors that could cause actual results to differ is contained in our periodic reports and other filings that we make with the SEC, and we do not undertake to update any forward looking statement.
In addition, the reconciliations of any non GAAP financial measures are available on our website, investorrelations. Medtronic.com. Unless we say otherwise, references to quarterly results increasing or decreasing are in comparison to the Q2 of fiscal year interest efficiency divestiture as well as the impact of foreign currency. These adjustment details can be found in the reconciliation tables included with our earnings press release. Finally, other than as noted, our EPS growth and guidance does not include any charges or gains that would be reported as non GAAP adjustments to earnings during the fiscal year.
With that, I'm now pleased to turn the call over to Medtronic Chairman and Chief Executive Officer, Omar Ishrak. Omar?
Good morning, and thank you, Ryan, and thank you to everyone for joining us. This morning, we reported 2nd quarter financial results, including revenue of $7,100,000,000 non GAAP diluted earnings per share were $1.07 growing 2% or 5% after adjusting for the approximate 3% $0.03 impact from Hurricane Maria. These financial results are very encouraging when considered in the context of a quarter in which we faced 3 hurricanes and the California wildfires. Hurricane Maria, in particular, significantly affected our manufacturing operations in Puerto Rico. The lives of thousands of our employees were affected by these natural disasters, and yet the resiliency, dedication and persistence of our team to overcome these challenges was remarkable.
Against this backdrop, which resulted in not only a quantifiable impact to our quarter, but also an unquantifiable impact from the disruption to our teams. We delivered 3% comparable constant currency revenue growth of 4%, excluding the direct impact from Hurricane Maria. Our performance continues to be driven by our growth strategies of therapy innovation, globalization and economic value. In therapy innovation, as I noted last quarter, we have entered a period of clear acceleration in our innovation cycle. We're seeing increased revenue momentum from several important new product launches, which we expect will continue into the second half of the fiscal year.
In Q2, organic growth in our cardiac and vascular group was 6%, a sequential improvement of approximately 3.40 basis points and the main driver of our total company organic growth acceleration. Overall, CVG grew 7% year over year, leveraging the breadth of its products and services, as well as its strong positions in important rapidly expanding markets to drive sustainable growth. In CRHF, which grew in the mid single digits, we are maintaining market share in the core pacing, ICD and CRT product lines, while creating new markets that are meaningfully enhancing our weighted average market growth. This past quarter, combined revenue from our high growth CRHF product lines, representing about onethree of our CRHF business, grew organically in the mid-20s. Specifically, these product lines included our infection control, diagnostics, transcatheter pacemakers, AF Solutions and Mechanical Circulatory Support Systems.
Similarly, our CSH business is shifting its revenue mix toward higher growth transcatheter valve market, which now represents about a third of total CSH revenues. In TAVR, we delivered low-40s growth in the U. S. And high-30s growth in international markets, as we see both strong adoption around the world for our recently introduced Evolut Pro Valve as well as expansion into additional U. S.
TAVR centers and U. S. Share capture resulting from our new intermediate risk indication. In coronary, our DES product line returned to growth as we gained low to mid single digits points of market share sequentially in both the U. S.
And Japan, driven by the recent launch of our Resolute On X in these markets. Next, our minimal invasive therapies group grew 2%, less than initially expected given the impact of Hurricane Maria. In surgical innovations, our 4% growth was driven by new products in Advanced Stapling and Advanced Energy. In Advanced Stapling, growth was driven by our Endo Stapling specialty reloads with CryStaple technology as well as Signia, a new single handed powered surgical stapling system that provides surgeons with real time feedback during surgery. And in advanced energy, we experienced strong growth as we continue to roll out new ligature instruments in our ValleyLab FT10 energy platform.
These innovations are providing momentum to the transition from open surgical procedures to minimally invasive surgery, or MIS, resulting in better patient outcomes and lower health care costs. As we look ahead, we see the opportunity to expand the availability of MIS procedures through the use of our surgical robot platform. The development team continues to drive toward 1st in human use by the end of this fiscal year. We look forward to offering a more comprehensive value proposition to our customers across all key surgical areas, open surgery, traditional MIS, robotic surgery and services. Next, our restorative therapies group grew 2% this quarter, less than initially expected given the impact Hurricane Maria.
Our Brain Therapies division had a very strong quarter with 13% growth. This was driven by high 20s growth in neurovascular with strength across the entire stroke portfolio and mid teens growth in neurosurgery. Our spine division declined 1%, a reflection of the hurricane impact as well as a continued modest deceleration in the global spine market. Excluding the impact of Hurricane Maria, our core spine business performed better than the market. We attribute this to the ongoing success of our speed to scale product launch initiative as well as our surgical synergy strategy, which combines our enabling technologies such as imaging, navigation, power systems, nerve monitoring and now Mazor Robotics with our spine implants to deliver integrated procedures.
In fact, the combination of our enabling technologies, which are reported in our neurosurgery business with our spine revenue, resulted in 2% growth in Q2. We believe this is an indication of our overall growth in spine procedures and a more relevant comparison of our spine results against several of our competitors. Our pain therapies division recently received FDA approval and CE mark for our Intelli spinal cord stimulator. While the initial rollout was affected by Hurricane Maria, the product has been received positively by our customers, and we do expect Intelis to reverse the declines we've been experiencing for several quarters in the pain stim business. And finally, the FDA lifted its distribution requirements in our implantable drug pump this last month and its warning letter earlier this month.
The warning letter had affected not only our pain therapies division, but also our Brain Modulation and Pelvic Health businesses. Turning to diabetes. Revenue growth declined 2%, better than what we had anticipated due to the strong demand from patients willing to purchase the MiniMed 670 gs pump ahead of the prepared CGM sensors. Although sensor supply constraints hampered overall growth, our ability to meet increasing patient demand has improved, and our sensor capacity expansion plans are on track. Last month, J and J announced that they were exiting the insulin pump market, and we were pleased that they selected us as their partner of choice to facilitate the transition of their NMS patients.
While the majority of the approximately 90,000 existing Animas patients are currently under warranty, we are actively working to ensure their smooth transition to Medtronic should they elect to do so. Looking ahead, we expect diabetes revenue growth to increase in the 3rd fiscal quarter now that we've finished shipping pumps for our priority access program and then continue to accelerate when we complete our sensor capacity expansion plans in the 4th fiscal quarter. In addition, our diabetes innovation pipeline remains robust across all three of its divisions. We are preparing for the international launch of the 670 gs and the U. S.
Launch of our standalone CGM system Guardian Connect with SugarIQ, both later this fiscal year and our new professional CGM iPro3 in FY2019. Next, let's turn to our globalization growth strategy. Emerging markets again grew 12% this quarter, in line with our long term double digit growth expectations as we continue to expand access to our products and services around the world. Latin America grew 18%, with Brazil, our highest market in the region, growing in the mid-20s. We continue to drive our channel optimization strategy in Latin America, expanding our direct operations.
In the Middle East and Africa, we grew 13% as recovery in the region continues with strong growth in Saudi Arabia and Turkey. Southeast Asia grew 12% with strength in spine, brain therapies and coronary and structural heart divisions. Greater China also grew 12% with high teens growth in RTG, mid teens growth in MITG and low double digit growth in CVG. We've been outperforming the China market now for the past few years and believe we can continue this momentum over the coming quarters. Let's turn now to our 3rd growth strategy, economic value.
As mentioned previously, we are seeing strong growth in our KYRX value based program for infection control in implantable devices, nearly tripling the accounts under contract in the quarter to over 900 hospitals. This past quarter, over 20% of our U. S. CRHF and QuantiVose revenue was covered under a TYRX related value based healthcare arrangement that links total payment to patient infection outcomes. In the past two quarters, we have rolled out additional value based programs in CVG, linking payment to improve patient outcomes that result directly from our innovative therapies.
Specifically, as part of these programs, a portion of our payment is tied to reducing reinterventions when using our AF ablation, AAA and DCB therapies and reducing rehospitalizations when using our ICD, CRT and AF ablation technologies. We're aggressively developing other unique value based solutions across each of our groups and regions. We remain focused on leading the shift to healthcare payment systems that reward value and improve patient outcomes over volume. We're increasingly partnering with additional stakeholders in the healthcare value chain as we believe medical technology has a key role to play in delivering better outcomes while improving efficiency for healthcare systems. As always, we expect to do this in a way that benefits patients and healthcare systems as well as our shareholders.
With that, let me ask Karen to now take you through a discussion of our Q2 financials and outlook for the remainder of the fiscal year. Karen?
Thank you. As Omar mentioned, our 2nd quarter revenue of $7,050,000,000 represented a 4% decrease as reported and growth of approximately 3.4% on a comparable constant currency basis or 4.3% when further adjusting for Hurricane Maria. Foreign currency had a positive $35,000,000 impact on 2nd quarter revenue, and tuck in acquisitions contributed approximately 30 basis points to revenue growth. While all 4 of our groups had some level of manufacturing in Puerto Rico, The direct financial impact of Hurricane Maria was limited to MITG and RTG. As Omar mentioned, through the hard work and determination of many colleagues, we utilized alternate manufacturing sites, directed field inventory movement, and ultimately were able to restore operations more quickly than anticipated.
GAAP diluted earnings per share were 1.4 $8 Non GAAP was 1 $0.07 After adjusting for the divestiture, the $0.01 positive impact from foreign currency and $0.03 negative impact from Hurricane Maria, non GAAP diluted EPS grew 5%. The operating margin for the quarter was 26.6 percent on a comparable constant currency basis, representing a year over year decline of 100 basis points. As expected, our operating margin declined in the quarter as we supported new product launches and experienced the temporary impact of lighter revenue in our diabetes group. In addition, the infusion set recall in diabetes and impact of Hurricane Maria further affected our 2nd quarter operating margins. Despite the net decline, we continue to deliver on our Covidien synergies and expect to reach our goal of delivering $850,000,000 of synergies this fiscal year.
As we have mentioned in the past, we expect to continue our focus on margin improvement even after delivery of the synergies and intend to provide detail on those ongoing activities in the near future. Non GAAP net other expense, which is included in our operating margin, was $96,000,000 compared to $65,000,000 in the prior year and negatively affected our operating margin by 20 basis points on a comparable constant currency basis. The change was impacted by increased expense related to our currency hedging program as well as a prior year gain from our equity investment in hardware. Looking ahead, we expect net other expense to be approximately $75,000,000 per quarter, including approximately $20,000,000 to $30,000,000 net per quarter related to our currency hedging program based on recent exchange rates. Our non GAAP nominal tax rate was 15%, better than initially expected given the year to date impact of our recent divestiture on our annual tax rate.
We now expect our tax rate to be between 15% 16% for the remainder of the year. 2nd quarter average daily shares outstanding on a diluted basis were 1,366,000,000 shares. We repurchased a net $568,000,000 of our ordinary shares in the 2nd quarter. As we enter the second half of the fiscal year, we continue to expect shares to stay roughly flat. Combining our share repurchase activities with the $622,000,000 we paid in dividends in the 2nd quarter, our total payout ratio was 82% on non GAAP net income and 59% on GAAP net income.
Before turning the call back to Omar, I would like to reiterate our annual revenue and EPS growth guidance. Unless specified, all of my guidance comments are comparable constant currency. For the full fiscal year, we continue to expect revenue growth to be in the range of 4% to 5%. This would imply second half growth of approximately 4.5% to 6.5%, a range we would expect for both the 3rd and the 4th quarters. Looking at full year revenue growth by our business group, given the strength of its new products, we continue to expect CVG to grow in the range of 5.5% to 7%, with growth weighted to the Q3 due to more favorable prior year comparisons.
For MITG, we now expect growth to be in the range of 3% to 3.5%, given the lower growth in the first half due in part to Hurricane Maria. This implies accelerated second half growth of 3.5% to 4.5% which is consistent with our prior guidance range. We continue to expect RTG to grow approximately 3%, balancing the impact of Hurricane Maria and a spine market that is flat to slightly down with continued strength in brain therapies. Finally, in our diabetes group, we expect growth to significantly improve in the second half, given the completion of the priority access program as well as an expected increase in sensor supply by the 4th quarter, resulting in mid to high single digit growth for the full year. Regarding margins for the remainder of the year, we expect our gross margin to be roughly flat year over year and our operating margin to reflect significant improvement in the 3rd and stronger improvement of over 100 basis points in the 4th quarter.
With respect to earnings, we continue to expect non GAAP diluted earnings per share to grow in the range of 9% to 10%. As I have previously noted, we expect EPS growth to accelerate in the back half of the fiscal year and would expect Q3 EPS growth to be at the midpoint to upper end of the annual 9% to 10% range. While the impact from currency is fluid and therefore not something we forecast, if recent exchange rates remain stable for the full fiscal year, our full year revenue would be positively affected by approximately $275,000,000 to 375,000,000 dollars including an approximate $155,000,000 to $175,000,000 tailwind in the 3rd quarter. Our 3rd and 4th quarter operating margins would be negatively affected by approximately 50 to 100 basis points with the 4th quarter impact greater than the 3rd. And our full year EPS would be affected by approximately negative 0.02 dollars including a positive impact of approximately 0 point 0 $1 in the 3rd quarter.
Keep in mind, the effect of FX on revenue, margin and EPS can differ due to the magnitude of the year over year change in expense related to our currency hedging program along with the timing difference of FX and cost of goods sold reflecting inventory turns on our balance sheet. Regarding free cash flow, we continue to expect it to grow in the high single digits compounded annually from fiscal year 2016 to 2018 on a comparable basis given the divestiture, which removes the tax and transaction costs as well as the loss of free cash flow generated by the divested businesses. Lastly, while we intend to give our fiscal year 'nineteen guidance on our Q4 earnings call in May, I know that many of you are starting to think about your forward models. At this point, I would encourage you to keep in mind our longer term mid single digit revenue growth outlook as well as our long range plans to continue to drive operating margin expansion. While CVG is expected to ease back into mid single digit growth next fiscal year given prior year comparisons, we are expecting MITG and RTG to grow in the mid single digits and diabetes to deliver double digit growth.
We intend to give our fiscal year 'nineteen growth guidance on a comparable basis that excludes the impact of the divestiture from the Q1 of fiscal year 'eighteen and has the effect of lowering the base revenue by approximately $550,000,000 and EPS by approximately 0 point 0 $7 It is also worth noting that if current exchange rates remain stable through next year, we would expect a positive impact to revenue up to $100,000,000 and a slightly positive impact on EPS. Now, I will return the call back to Omar.
Thanks, Karen. And I'd like to conclude by noting that I realize that our shareholders are expecting consistent execution and reliable results from Medtronic. Know that your management team and Board expect the same. Over the past few quarters, our performance has been affected by some extraordinary events, which have masked the improving overall fundamentals of our business. That said, we aspire to be a company that can manage through even extraordinary events, similar to those that we have recently faced.
So we are keenly focused on solid execution as well as leveraging our diversification and scale around the world to deliver dependable results for our shareholders. Let's now open the phone lines for Q and A. In addition to Karen, I have Mike Coyle, President of CVG Brian Hanson, President of MITG Jeff Martha, President of RTG and Hooman Hakimi, President of our diabetes group to join us. We want to try to get to as many questions as possible, so please help us by limiting yourself to only one question and if necessary a related follow-up. If you have additional questions, please contact Ryan and our Investor Relations team after the call.
So with that, operator, first question please.
And our first question comes from the line of Mike Weinstein
with JPMorgan. Omar, first off, let me before I get the question, let me just say, I know how tough this quarter was in Puerto Rico and Santa Rosa. And just congratulations on good work that you did on behalf of all your employees that were impacted by both the hurricanes and the fires because I know it was significant. Let me get to 2 questions and I'll do one question and then do a follow-up. The first question is just on the growth outlook for the second half.
If I try and adjust for all the different activity, you effectively did 3% organic growth in the first half of the fiscal year adjusted for the hurricanes. You did 4% this quarter adjusted for the hurricanes. You're guiding to 4.5% to 6.5% in the second half of the year, and that's organic. There's no acquisition contribution. And that's despite what is a tougher comp in the back half of the year for the overall Medtronic.
So besides diabetes accelerating, which I think we can all see, can you just talk about the rest of the business and what gives you confidence in the overall Medtronic acceleration despite those comps?
I think, let's go through this group by group. I think they're almost all product driven on a basis of emerging market growth that continues to grow in the double digits and we're seeing that pretty consistently and non U. S. Developed market growth around 5% or so that we've been delivering. So if you take the U.
S, which is really the recipient of most of our new products, CVG has the most exciting portfolio here with the CorValveVeloPro currently launching in the U. S. And Europe, the intermediate risk indication for TAVR, the HVAD destination therapy as well as the micro leadless pacemaker, I think these are the key drivers for accelerated growth in CVG, like we mentioned earlier. And we're pretty confident given the momentum that we've seen in the just concluded quarter that this will continue. Now in the other groups too, we're seeing continued improvement and you'll see a tick up in growth in all of them and you mentioned diabetes yourself.
But in addition, in MITG, we have many product launches in FY 'eighteen, including our Signia powered stapler and reinforced reload instruments. And in RTG, our enabling technologies are really taking hold. We had good traction with our capital equipment in Q2 and we expect that to continue. We think specifically the StealthStation S8, which brings an advanced solution to neurosurgeons will enhance this quite a bit in upcoming quarters. So as you can see, Mike, this confidence in our growth is really driven by an acceleration of our innovation pipeline and we feel pretty good about it.
Okay. And then just my one follow-up. So, Kieran, can you just spend a minute on free cash flow? Your free cash flow through the first half of the year was $1,100,000,000 If I'm correct, your commentary about high single, upper single digit free cash flow growth from FY 'sixteen to FY 'eighteen would imply somewhere around $4,900,000,000 to $5,000,000,000 correct me if I'm wrong there, for FY 2018. So, 1, am I right on that?
And 2, can you just talk about cash flows and why they improved so meaningfully in the second half of the year?
Sure. For FY 'eighteen, you're approximately right. We would expect high single digit growth compounded annually from FY 'sixteen on a comparable basis. So slightly high, but you can do the math from FY 'sixteen with that growth rate. I would say on our free cash flow, know that we typically generate about a third of our free cash flow in the first half.
That's what we did last year, what we're seeing right now. So we do remain confident about our ability to continue to grow in the high single digits from FY 'sixteen compounded annually. There have been some effects in the first half that we outlined on our Q4 earnings call. We expected significant tax and legal settlements in FY 'eighteen. Most of that did occur in the first half of this fiscal year.
We also had some payments fall into the first half that were in the second half last year on a comparable basis. Specifically, a couple of $100,000,000 related to the timing of the pension plan contributions happened in Q2 of this year versus Q3 of the prior year. And we also had some additional tax payments this first half. And then keep in mind that the divestiture of our businesses also had an impact of cash flow with both divestiture related expenses and foregone cash related to divestiture.
And Karen, just so we have it, what is the FY 'sixteen free cash flow number that you're using, obviously, adjusted for the divestiture. Do you know that?
Yes. It is in the slide deck, and it is 4.2
percent of
free cash flow. And if you look at it on a comparable free cash flow basis, with the divestiture impact of about $100,000,000 a quarter, it nets to $3,900,000
Got you. Okay. Thank you.
Thanks, Mike. Next question?
Our next question comes from the line of David Lewis with Morgan Stanley.
Good morning. Just two questions for me. Maybe I'll start with Jeff on RTG. And Jeff, it's kind of a 2 part question RTG related to market growth rates versus your performance. So spine obviously doing worse from a market growth perspective, FCS doing better from a market growth perspective.
How do you think about the trends in those two businesses the next 2 to 4 quarters? And do you still think you can trend slightly above market in spine? And within TELUS, is the way to think about that getting back to market growth rates or just getting back to positive territory? And I have a quick one for Karen.
Yes. So thanks. I'll take the first the slide one first. I mean, although we definitely see a pullback in the market here over the last couple of quarters from, I'll call it, 2% to flat to slightly down, we still feel very confident about our ability to perform above that. And it comes from 2 things.
1, continued product launches under the and launching them at scale, which has worked for us over the last, I'd say 5 or 6 quarters. So betting on the product launches, making sure we have the appropriate sets, making sure we've done the appropriate training of our reps and the physicians and launching with Force. And that's really helped us. And as we move forward, the surgical synergies is really taking hold. So that's the combination of all of our enabling technology, power, navigation, robotics and that is having a halo effect and actually a tangible pull through effect on our implants.
We do a lot of equipment placements and that we've done over the last 2 or 3 quarters and that will continue out over the next year. And a year from now or so, we'll have actually technological ties between our implants and the Mazor robot. So we feel really good about where we are in spine. I'd like to see the market go up because we given our market share at globally at 30% or so that would help. But we feel good about our ability to continue to perform in both the market.
The other thing I'll point out is that, I think Omar mentioned it, is if you combine our enabling technologies with our implants, we're really growing. And that's how a lot of our competitors look like, Glovis, NuVasive, etcetera. That puts us about 2% growth. So we feel good. And then we have a high exposure to the global markets.
The global markets outside the U. S. Are growing 3 times as fast as the U. S. Markets and we have a pretty high exposure there and are doing well.
So overall spine, we feel good. I wish the market were growing a little faster though. And in pain stim, pain pumps and pain stim actually are experiencing a lot of acceleration here in the last quarter. Pain stem because of the launch of Intellus, we already had launched our evolved workflow and that does get us from mid single digit to high single digit declines to, I'd say, low to mid single digit growth, not quite growing at the market yet. I think that's going to take a little bit of time.
But we feel very good about for the next couple of quarters going forward here, low to mid single digit growth in pain stem. And then pain pumps with the lifting of the certificate of medical need that has really given that business a boost plus all of the products, enhancements that we've launched over the last couple of quarters, we can we're relaunching that product as it's kind of a new product, if you will, and that's picked up quite a bit of steam and now growing at like high single digits. So the pain business has really experienced a pretty rapid turnaround here in the last quarter.
And just thanks, Jeff. And then a quick one, Keri, on I appreciate the early comments you gave us on next year's guidance. Just in terms of thinking about that mid single digit corporate profile, how should we think about or what allotments did you make for various ex U. S. Pricing headwinds, whether they be China, India or the biannual Japan price cuts, was there allotments made in that sort of mid single digit range for those dynamics next year?
Yes. We continue to have pricing pressure across all of our businesses and geographies, and that is taken into consideration when we give our longer term guidance.
Okay. Thank you so much. Thanks, David.
We'll go to the next question, Crystal.
Our next question comes from the line of Bob Hopkins with Bank of America.
Thanks and good morning. Can you hear me okay?
Yes, we can. Hi Bob.
Great. Good morning. So two questions. I'll start with Karen, if okay. And to echo David's comments, I appreciate some of the early commentary on fiscal 2019 on both revenue growth and currency.
I'm just curious on the earnings front though for 2019, is there any reason not to expect that sort of 10% earnings growth in fiscal 2019 off of what I realize is a pro form a restated 20 18, that $0.07 you're talking about. But just curious if there's any reason not to expect that sort of 10% growth in fiscal 2019 off of that new base?
Yes, Bob, we are currently working on our long range forecast and our annual plan for next year. So we'll give much better guidance in the normal time frame. But in the meantime, we clearly do continue to expect to drive that mid single digit revenue growth and significant operating margin expansion that should lead to very robust bottom line growth.
Okay. So I guess for my second question, Omar, I was wondering if you could make a comment on just what you're seeing in terms of medtech market growth rates generally, both in the United States and in emerging markets. And to some degree, this follows on the last question a little bit given the China pricing announcement on ICDs and stents. But Omar, could you just talk broadly about what the trends you're seeing currently in the U. S.
And emerging markets as it relates to just broadly speaking medtech market growth?
Let me start with emerging markets, Bob. Look, the growth in emerging markets continues and we're delivering in that in our diversified position across the major markets of China, Latin America, Middle East and Africa. These are big markets where we've got significant positions and are fairly well diversified. Given that backdrop, we see ourselves growing in the double digits in a sustained fashion in emerging markets, powered by markets that are pretty robust. Now there may be variations from year to year in these different markets as we've experienced, but we've also shown that those variations are manageable.
They're not that big. They still are close to that range. And the China market is perhaps going to be at sometime in the future the biggest market in med tech. And it is one that we expect to participate in, work with stakeholders there and are confident that we can continue our performance there of delivering double digit revenue growth. So emerging markets, we're pretty confident about and feel very good about our position to for sustained delivery.
The U. S, on one side, the overall markets outside of spine are the surgical volumes are basically the same around 1% to 2%, with small variations which we really don't want to try to forecast at that precision level. And the spine market, you just heard Jeff say, has got some pressure in the U. S. For a variety of reasons, probably elective procedures maybe being one of them.
But more importantly, the U. S. Market in the end is driven by new product introductions. And we've seen that and we're experiencing that right now. With our new product cycles that drives the U.
S. Market and that's the most significant impact that we see. So that's the way I see markets. I mean, not that different from what we've seen before. A lot we can influence ourselves by our own actions and that's what we're focused on doing.
Very helpful. Thank you.
Great. Thanks, Bob. Next question, Crystal.
Our next question comes from the line of Kristen Stewart with Deutsche Bank.
I was wondering If you could go over a little bit more specifically in the diabetes business, just what how you're feeling about the reacceleration, how confident you are? And then maybe just touch on what gives that confidence for next year to grow in the double digit range, just kind of the path forward to bringing some of the new supply onto the market for the sensors?
Sure. Yes, Kristen, I'd say, first, let's start with the back half of this year and then we can talk about FY 2019. I'd say the acceleration that we expect in the back half of the year is really driven by three things. The first one is that our sensor capacity plans are actually not only going according to plan, but slightly ahead of schedule. And so we anticipate that we're going to be in a position by the end of this fiscal year where our sensor capacity will allow us to meet all of the demand.
So that's one. So as we get that back up, we expect to see acceleration not only of sensor revenue, but also of pump revenue. The second one is the 670 gs and the real world performance of 670 gs as more of those systems get into the market. This is a system that now has 13,000 patients that are uploading their data into CareLink. And what's really encouraging, Kristen, is that what we're seeing even at these volumes is outcomes and performance that are very similar to what we saw in the pivotal trial for the FDA.
And so as those things really start to continue to take hold, I think both from a physician perspective and a patient perspective, we'll start to see traction. And then the 3rd dynamic for the back half of the year, which will also go into FY twenty nineteen is Animas and the transition of those patients to Medtronic. And then as we look forward into FY 2019, as Omar mentioned, there's a series of new product launches in addition to all of these dynamics that I just mentioned. Guardian Connect and our entry into the standalone sensor market, number 1, Eye Pro 3, which will be a new professional CGM for our Type 2 business. You combine all of these things and we feel good about the acceleration into the second half and also double digits for FY twenty nineteen.
Okay. So all you'll have full sensor supply, is that as of the fiscal 4th quarter? Is that a quarter ahead?
Correct. That's right. So we're going to ramp up and Q3 should be better than Q2. So we our capacity expansion plans will allow us to produce more sensors this quarter than we did last quarter. And then by Q4, we'll be in a position where we can meet all of the demand.
Okay, perfect. And then Karen, just a question for you. Can you maybe just go through the dynamics year over year of just kind of the gross margin, the puts and takes of those?
Sure. We do expect our gross margin to be relatively flat year over year FY 'seventeen to 'eighteen. And the real puts and takes are the fact that we see continued pricing pressure, but remain focused on driving expense reduction in our COGS line item.
Okay. And when you had mentioned for the full year, I think you had said with respect to the guidance for with respect to the hedges. Did you mean that that was going to be negative impact from hedges with FX for the Q3 or was that positive?
Yes. From an FX perspective, we talked about it on the operating margin perspective. And we said that our 3rd and 4th quarter operating margin would be negatively affected by 50 to 100 basis points, but the 4th quarter impact a little bit greater than the 3rd. And that's assuming rates remain constant to where they are today.
Okay, perfect. Thank you very much.
Great. Thanks, Kristen. Next question, Crystal. Thank
you. Our next question comes from the line of Larry Biegelsen with Wells Fargo.
Thanks for taking the question. One follow-up on China and one on robotics. So Omar, I just wanted to ask you directly about the proposed price cuts to drug eluting stents, hips and ICDs. We've heard the price cuts could be up to 40%, but offset by the 2 invoice policy. How are you thinking about those pending changes in China and the potential for other device categories to have similar cuts?
And then I had one follow-up on robotics.
Again, on China, look, let's not forget the size of that market. And access to health care for patients in China is a big priority for the government and a big priority for us. And we're working closely with the government to figure out the best way to optimize the distribution channels, which has many factors as you noted. And now there may be certain price regulations, but we're used to managing those. And we feel at the end that our ability to demonstrate value and our experience with value based models will give us the right pricing in those markets and the right trade off between price and volume as well as leaning out the cost in the distribution channel, working together with the government.
So there are many variables here. In the end, we feel pretty confident that we can maintain our performance in China through these dynamics, which will change over time. It's a big market and a lot of work has to be done. But through that, we feel that we've got a team in place and products in place and a focus in place through which we can continuously deliver.
Very clear. And then on robotics, Omar, I heard your comments about doing first in man, I think in fiscal 2018, if I heard correctly. But my question is, are you still planning to launch in select international markets this year? And I think at the last analyst meeting, you said you expected your robotic program to contribute 50 to, I think, 150 basis points of growth in fiscal 2019, which I think at the time equated to about $50,000,000 to $150,000,000 in revenues. I guess the question is, are you still comfortable with that?
Thanks for taking the questions.
Thanks. I'll let Brian kind of answer the robotics question. Go ahead, Brian.
Yes, sure. Thanks for the question, Larry. We obviously have a pretty complex project on our hands with a lot of moving pieces and parts on the robotic system, quite literally actually, a lot of moving pieces and parts. And so there's always risk in slippage for launch. But at this point in time, we're sticking to the dates that we have committed to relative to launch timelines, which would be consistent with what you said, 1st in human at the end of this fiscal year and then full launch in FY 2019.
So we're pretty excited about it. And I would tell you just even going further beyond that, I probably feel more confident now about the robotic system than I have at any point in the past, the fact that we're going to have a viable and really competitive product. And I'll tell you why. We're already building our pilot systems off the production line. So we've already built and are continuing to build those pilot systems right off the production line.
We're well past any design development piece at this point. We're fully into verification and validation. And although there's a lot of work ahead of us, the work really is more associated with just time to retire the work. And the risk of a viable product is behind us. So we're not having a viable product is behind us.
So I feel very confident about where we are. I feel very confident we're going to have not just a viable product, but we continue to do surgeon feedback. And the feedback that we're getting from surgeons is that they're very excited about the technology that we have and I look forward to the launch.
Thanks, Brian. Sure.
Okay. Thanks, Larry. Next question please, Crystal.
Our next question comes from the line of Raj Denhoy with Jefferies.
Good morning. I wonder if I could just ask around the U. S. Growth in MITG, it was down 5%, but even after correcting for the hurricanes, it was still a negative result in the U. S.
And so I'm curious if that's a reflection of perhaps procedure volumes or something else happening now that we're seeing in that market?
Yes, Raj. So it's less around procedural volumes because where we see a lot of pressure in our business in Q2, one obviously was a result of some of the pressure that we saw because of the hurricanes, a lot of that concentrated on the surgical business. But even through that pressure, we saw pretty good strength in the surgical business overall. The real pressure came in the RGR business, which specifically the biggest piece of that, which is respiratory, but we had some really challenging comps from last year. As you probably remember, we had relaunched the PB-nine eighty in Q2.
Had real strength last year as a result of that and that carried through in Q3 and Q4. And as expected, we saw some challenging growth rates in Q2 as a result of that. But I don't see anything fundamentally in the procedures that we leverage to drive revenue that would be concerning for me.
Great. I'll leave it to one. Thanks.
Thanks, Raj.
Our next question comes from the line of Kayla Krom with William Blair.
Hey, guys. Thanks for taking my questions. So first, I guess, starting off on emerging market and just the strength that you guys saw in the quarter. Can you just speak a little bit more to the durability of that double digit performance? And I know you don't want to give too much color on fiscal 2019, but just high level and taking into account some of the anticipated headwinds you've mentioned.
Is it fair to assume that sort of growth continues in the next year?
This is first, let me take the emerging markets. Like I've said, we've demonstrated double digit performance in emerging markets almost on a quarterly basis now for, I don't know, 5 years. So we have every expectation that, that will continue because our position in these markets is only strengthening. And there's no question about the need. You just need to look at the math based on the population and the market requirement of our therapies and the need is clearly there.
We're working closely with different stakeholders. We continue to work closely with different stakeholders in these markets to create methods through which access is provided going beyond our products, working with the governments as well as private providers to facilitate training of physicians to creation of infrastructure as well as creating awareness for our therapies. So we're pretty confident that this double digit emerging market growth will continue given the size of that opportunity and given the diversification that we have across the different major emerging markets. I think the second question in terms of growth into next year, the color that we provided really goes down to our 3 growth strategies, built on a reliable and emerging market growth, coupled with our new product launches that will become more sort of uniform across our different groups, led by a strong recovery in diabetes, but also good improvement in both MITG and RTG like we mentioned. I think all of this put together gives us confidence that we can continue our mid single digit growth trajectory that's in our short and long term plans.
Great. That's helpful. And then I guess just in spine, I mean, clearly, you're continuing to put up solid growth in the biologics segment of your business and you're investing those incremental dollars in infused research. But I guess there's some question as to the value of biologics as more companies introduce porous or titanium technologies, that do require less biologics use. So I guess what's your view on that dynamic longer term?
Thank you.
Sure. Yes, good question. Look, I think there's a lot more research that needs to be done on the impact of the surface technologies in the porous surface edgings on some of the inter bodies. But we'll also participate in that market as well. We just launched we're just launching our first titanium porous cage.
And so we're watching it. I think though that to dismiss the use of some of the biologics is premature based on the results we've seen over the last decade. And we're so confident in that that we're investing $90,000,000 over the next several years in clinical research. We feel very good about it. But we are intrigued on the surface coatings and we're going
invest in that as well. But I think,
I think dismissing the biologics, the existing biologics is a little premature. And I think more of the questions are some of the new claims around stem cells and things like that, that was where the pressure is. That's what we're seeing. We're not seeing it, for example, on Infuse, if that's the question. We are hearing about it in some of the new stem cell related products that there is pushback from the payers.
But in terms of the existing biologics, we feel that we have proven track record and we're confident in that thus investing in more clinical data. And the forest technology is intriguing, but there's still a lot to prove on that.
Very helpful. Thank you.
Thanks, Kayla. Next question, Crystal.
Our next question comes from the line of Josh Jennings with Cowen.
Hi, good morning. Thanks for taking the questions. Just had a question for Mike Coyle. Congrats on the CVG performance in the quarter. Having some concerns about competitors' MRI safe ICD launches and for the CRM business specifically, it sounds like that competitive headwind was limited in the quarter.
But just wanted to hear if you had any updated thoughts on your competitive positioning and ability to defend the share gains you captured the last 2 years? And did you see any impact from those launches in October?
Yes, Josh, thanks for the
question. As you mentioned, those products were launched in mid to late September by both of our competitors. And so we now have 8 or 9 weeks of experience with the launches. And frankly, we have not seen a lot of impact on our unit share in the Highpower segment.
And I think there are
a number of reasons why that is true. The first is that the competitive offerings that they have are really not matching up to what we already have in the market. It's not just the 3 Tesla labeling that we have, but also they have very significant labeling restrictions on their product and workflow negatives when you try to implement to their labeling. And that obviously works to our advantage. But probably the bigger reason there hasn't been a meaningful detectable shift is that this really was just labeling expansion.
It's really the same products that they've been selling. And their field had done a good job, I think, of indicating to customers that when they got the approval for MRISAFE, that they would be able to basically perform MRIs on implants even before the approval, right. So that basically put them in a position where we never saw the kind of share shift that we saw in Brady where they had to there was a special lead and they had to wait until they had actual approval of the product before they could start selling it. So most of the share shift that we've seen from our product line has really come from features that are embedded in our devices that are highly differentiated, like our VIZI AF or the SmartShoc technology that we have or the adaptive and effective CRT features. And these features have not been matched up with the products that have come in from competitors.
So they represent 70% to 80% of our product mix. So we were not expecting to see a big major share shift away from us as MRI labeling came in from competitors and at least 8 or 9 weeks into the launch we have not seen that happen.
Great. Thanks. I'll stick to that one. Appreciate it.
Thanks, Josh. Next question, Crystal.
Our next question comes from the line of Isaac Ro with Goldman Sachs.
Good morning, guys. Thank you. Omar, just wondering if you could comment on your views for the overall healthcare utilization environment in elective procedures in particular. Just kind of curious what's baked into your outlook for the back half of the fiscal year. And the reason I ask is, the managed care and kind of provider community has struck, I would say, a little more cautious tone on the quarter to date trend here as we move into the end of the year.
And it seems like the device companies have been a little bit more constructive around their expectations for underlying trends. So if you could kind of maybe spend a minute reconciling that view a little bit on as to what you're seeing, that would be helpful.
Well, like I mentioned before, some of our procedures are acute procedures that are needed as almost on an emergency basis. And those procedures will continue and there's a demographic statistical need for that and we don't see that changing. And if anything, where the demographics may even increase slightly. But and then beyond that, you have core surgical procedures, like I said, some of which are elective, but most of it is required and there we are seeing a pretty steady performance in the marketplace. The spine area, which I think is probably because of the elective nature of some of those procedures, we've seen some pressure, but not completely out of line with what we've seen historically in different phases and one that we expect to stabilize going forward.
So from a procedural perspective, we don't really see that much change. Some shifts between the different areas that we're in, primarily, I think, driven by the elective nature of some of these procedures. I think overall, though, like I mentioned before and I want to emphasize, new product introductions in medtech in general drive the market far more than these shifts. And that's what's going to see us get the kind of accelerated growth that we are projecting into the second half and into next year.
Got it. Thank you. And then, Mike, maybe a follow-up for you on TAVR. Just curious what's baked into your outlook for the rest of the fiscal year in the U. S.
And Europe for that business? It's obviously done well the last couple of quarters here and competitive landscape does figure to shift again as we move into calendar 2018. So be interested in kind of how you're game planning for TAVR in the context of your guidance. Thank you.
We're obviously fairly early into the launch of EVOLU Pro both in Europe and in the United States. It really was the last quarter was really the 1st full quarter for that product. It's doing exceptionally well in terms of not only the improvements in lower perivalveolar leak rates, but the physicians are really being able to use that system to have lower pacemaker rates as well. So we really feel well positioned relative to our product line now obviously with both EVOLUDR and EVOLUPRO available to our customers. And obviously the intermediate risk approval in the United States allowed us to really access where the growth in the market is.
And now we're expanding centers to basically take advantage of that. And then obviously, the of the low to mid-20s. And obviously, we're in a share capture mode. We think our product lines are well positioned to compete against any new entrants that come into the marketplace. And obviously, we continue to invest in expanded indications for use, including low risk and looking at things like bicuspid indication.
So we think there's plenty of room for continued expansion.
Okay. Thank you, guys.
Thank you, Isaac. Next question please, Crystal.
Our next question comes from the line of Glenn Novarro with RBC Capital.
Hi, good morning. Question for Karen on tax reform. Medtronic's had an advantage versus competitors given its inverted status. So Karen, based on what you're seeing out of Washington DC and tax reform today, I wonder if you can give me some of your initial thoughts on reform. Does it what part of reform helps Medtronic?
Is there any part of reform that puts you at a disadvantage? Thank you.
Yes. Thanks for the question, Glenn. We are pleased that Congress is working on potential tax reform right now. We do continue to support reform in general, including the establishment of a territorial system and a lower U. S.
Corporate tax rate. As you know, the House has advanced its potential with the passage of a bill and the Senate has only just released last night its legislative draft. But we recognize that both houses need to reconcile their versions into bill and its impact if any to us, but the most positive impact of potential reform to us in the long term would be the ongoing Okay
Okay, great. I'll just leave it at that. Thanks.
Thank you, Glenn. Next question please, Crystal.
Our next question comes from the line of Matt Taylor with Barclays.
Hi, thanks for taking the question. Karen, I was wondering if you could talk a little bit about some of the things that impacted operating margin that you called out in the prepared remarks this quarter to help us quantify kind of the temporary impact of those product launch support programs and the hurricane? And then you alluded to beyond the Covidien synergies, some additional things that you can do on operating margin. Can you give us any clarity on what those are and if they're any different from what you laid out in the prior plan?
Sure. So we did talk about a margin decline that we had this quarter, and that was really driven by 4 things: the impact of lower revenue, lighter revenue in our diabetes business along with the impact of the hurricane as well as the infusion set recall in diabetes. And so going forward, we do expect to improve our operating margin, particularly this year in the back half, substantially more in the Q4. And that is really driven by the strength of revenue along with our continued focus on driving cost synergies and driving costs down where we can. Looking longer term, we do expect to continue to drive operating margin improvement as we've discussed in the past beyond the delivery of the Covidien synergies, increased use of shared services, increased use of shared services, continued focus on our enabling functions on a global basis, driving centers of excellence and improving our processes, etcetera.
So we do continue to drive
do expect to continue to drive
margin expansion going forward.
Okay, great. Thanks for taking my question.
Thank you, Matt. Next question
please, Crystal.
Our next question comes from the line of Joanne Wuensch with BMO Capital Markets. Thank you
for taking the question. Can you tell us sort of or share with us philosophically how you think about guidance? I appreciate your verbiage in the prepared remarks regarding a view towards consistency. But as we think about the second half of the year and then your remarks going into next year, which is appreciated, How do you think about putting all of those pieces of the puzzle together?
Well, like we mentioned, we feel that we've got a set of businesses driven by our growth strategies of therapy innovation, of emerging market growth and drive towards value based healthcare, which helps us with pricing and some unique business models. You take all three of those things together across the spread of our businesses. We feel that we can deliver on the mid single digit growth. And I think we've demonstrated that. We've had issues in certain quarters for a variety of reasons and which we're not happy about.
But in general, on a yearly basis, we've certainly delivered that and we have every expectation that that will continue. And to do that this year, we need an acceleration in the second half, which we have line of sight to, given the new product launches and the dynamics that we see in our different businesses. So really it's as straightforward as that. We think our new products fuel this on a base of strong double digit emerging markets growth.
And just as a quick follow-up, of the new products, which of the 2 or 3 you really think are the drivers for the next 12 to 18 months? And then thank you. Yes.
It varies quite a bit as we go through the next 12 months, 12 to 18 months. But CVG in cardiovascular, we continue to have traction. And our core valve, EvoluPro and TAVR, in addition to the intermediate risk approval that we got, is driving both market growth as well as our own share position in the U. S. And across the world.
We're really excited about our HVAD destination therapy approval. I mean, that's a real game changer for us in that market and we're pleased with the success that we've seen with that product line. And then also repeating the Micra leadless pacemaker, which is the only leadless pacemaker that exists. And we continue to benefit from full CMS reimbursement for that product in the U. S.
And we're seeing very strong growth in that segment as well. So all three of those areas in CVG continue to grow in addition to the other product lines. So we're pretty confident that will go on. There will be dynamics through the different quarters as we go through the year. It will be higher earlier in the next 12 months rather than later in CVG.
But then that's supplemented by continued growth in MITG where we have a regular cadence of launches that we're seeing deliver successful results, specifically in surgical innovations, but the other businesses also are contributing. And in RTG, in addition to the capital equipment that we've talked about, like the StealthStation S8 and the ORM and to some degree, our partnership with Mazor in Robotics. We also have the Intellus platform that we should really look at, which is a big turnaround and take us towards positive growth in spinal cord stimulation. In addition to the removal of the warning letter and the consent decree requirements that were in place for the pain pump in that product line. And then finally, in diabetes, we've gone through a fairly difficult phase, mostly to do with our supply shortage in sensors, but very strong demand from patients for our highly differentiated technology.
And we're only in the beginning stages of the growth in diabetes with that kind of differentiated hybrid closed loop technology. And in addition to that, we're supplementing that with our Guardian Connect with SugarIQ product, which is a CGM product to be launched in the U. S. Sometime later this fiscal year, which is highly differentiated from anything that's available in the market. So you put all that together, we see that while the relative dynamics of the different businesses may vary quarter to quarter, overall, we've got enough diversification in our in the markets that we serve that we can maintain mid single digit growth.
I'll leave it there. Thank you very much.
Thank you, Joanne. We'll take one more question please, Crystal.
Our final question comes from the line of Chris Pasquale with Guggenheim.
Thanks. I appreciate you fitting me in. One for Omar and maybe Mike and then one quick one for Karen. Omar, you highlighted the expansion of value based contracts in CRM. Based on your estimates of the likely event rates under those contracts, what's the implied net impact on your pricing?
Is this a situation where you're effectively getting a price increase by taking risk off the hands of the hospital? And if so, can you quantify that?
Yes. I think a better way to look at that is to sort of we demonstrate the translation of the clinical value to economic value in the financials of the hospital. That's what we're doing. The clinical value is reduced reintervention rates, for example, for which we've got evidence. We're not just guessing this.
We've got clinical trial evidence that shows that. And that translated to the financials of a hospital is our value based health care program where the variables are highly technology driven or innovation driven. So there are a few other variables. Our technology we know through evidence in clinical trials create this improved clinical benefit, which we then translate to the hospital's financials as an economic benefit. And we think that through that indeed pricing is not only protected, but to some degree we would get enhanced overall pricing because in the end the hospital is better off financially with this new technology than without.
That's the essence of value based healthcare programs. And we've as the overall payment model changes, we're gaining a lot of experience as to how to create these contracts with providers in the existing fee for service model. As we translate more to a pay for value model, we think we'll be very well positioned to even broaden the scope of these business arrangements.
That's helpful. Thanks. And then Karen, you bought back a lot of stock in the first half of the year. I know a piece of that was sort of one time and tied to the PMR proceeds. But if I do the math on the free cash flow guidance and then add in the dividends in the back half of the year, it looks like you're on track to basically return 100 percent of free cash flow to shareholders for the 3rd straight year.
How sustainable is that as we look ahead to 2019?
Right. Our commitment on return to shareholders is greater than 50% of our actual free cash flow that we generate. And while we did use a portion of our divestiture proceeds to repurchase stock, which does elevate our return to shareholders this year. Going forward, we would expect to stick with that greater than 50% of free cash flow commitment.
Okay. So with that, let's close the call out. Thank you very much for all your questions. And on behalf of the entire management team, I would like to thank you again for your continued support and interest in Medtronic. And for those of you in the U.
S, I want to wish you and your families a very happy Thanksgiving. We look forward to updating you on our progress in our Q3 call, which we currently anticipate holding on Tuesday, February 20. Thank you all very much.
This concludes today's conference call. You may now disconnect.