Good morning. My name is Darla, and I will be your conference operator today. At this time, I would like to welcome everyone to Medtronic First Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
I would now like to turn the conference over to Ryan Weistmanning. Please go ahead.
Great. Thank you, Darla. Good morning, and welcome to Medtronic's Q1 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 Q1, which ended on July 28, 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 as well as details related to our patient care, nutritional insufficiency and DVT divestiture to Cardinal Health. 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 Q1 of fiscal year 20 17 and rates and ranges are given on a constant currency basis. Finally, other than as noted, our EPS growth and guidance does not include any changes or charges or gains that would be recorded as non GAAP adjustments to earnings during the fiscal year. These adjustment details can be found in the reconciliation tables included with our earnings press release.
With that, I'm now pleased to turn the call over to Medtronic Chairman and Chief Executive Officer, Omar Ishraff. Omar?
Good morning, and thank you, Ryan, and thank you to everyone for joining us. This morning, we reported 1st quarter revenue of 7 point $4,000,000,000 representing growth of 4%. Non GAAP diluted earnings per share were $1.12 growing at 11%. Our results this quarter reflect the strength of our underlying businesses and the stable growth of our markets as well as the diversification benefit of our groups and regions. While a temporary sensor supply constraint and an IT disruption affected 1st quarter revenue growth, we continue to drive operating margin expansion.
This margin improvement combined with the previously communicated tax benefit this quarter translated into strong earnings leverage. And looking ahead, we have now entered a period of clear acceleration in our innovation cycle, and we expect to see increasing revenue momentum from several important new product launches over the balance of the fiscal year. Before discussing the details of the meaningful progress we're making in each of our growth strategies, let me briefly cover 2 specific issues that affected our Q1 performance. In our diabetes group, we're experiencing strong demand around the world for our new diabetes technology. This demand is a direct result of our differentiated strategy to move toward fully closed loop systems, which utilize our algorithms and CGM sensors to automate insulin dosing.
We launched the MiniMed 640 gs in international markets in 2015 and the world's first hybrid closed loop system, the MiniMed 670 gs with Guardian Sensor Tree in the U. S. In June. These advancements have increased our installed base and market share, resulting in a large increase in CGM demand, above our already high expectations. To put it in perspective, in just the past 10 quarters since launching the 640 gs, our overall sensor unit demand has more than doubled.
The increased demand is largely for the new highly accurate generation of sensors, the enhanced in light in international markets and the Guardian Sensor 3 in the U. S. And has temporarily outstripped our production capacity. We accelerated plans to increase sensor production capacity last year, but these lines are not expected to be ready for commercial production until our Q4, at which time we expect to have the capacity needed to meet the rapidly growing sensor demand. Until then, we have to prioritize sensor fulfillment toward our installed base of customers.
In the short term, this leaves less available for higher revenue generating new patient system sales. It is also important to note that our priority access program, necessitated by the early approval of the 670 gs, which allowed customers to purchase a 630 gs and then swap it for a 670 gs once available for a small fee, has been very successful with close to 32,000 enrollees exceeding our original expectations. However, because we only recognize a small portion of deferred revenue when exchanging the pumps, the program currently affects both revenue and margins. We expect to complete fulfillment to our priority access customers later this fall. Toward the end of the fiscal year, we expect our diabetes group to be in a position to capitalize on its differentiated innovation in the marketplace, with stronger revenue and profit growth, not only from increasing sales of our leading insulin pump technology, but also ongoing sensor annuity revenue.
Next, let me update you on the IT system disruption that occurred in June. As we communicated over the course of the quarter publicly, including an 8 ks and 10 ks filings, we experienced a global disruption to an IT system on June 19 that affected our ability to process, ship and manufacture orders globally. During the days following, we mobilized resources as quickly as possible to not only identify the underlying issue, but also put in corrective measures to restore the system. As a result, our system was subsequently and fully operational later that week. After the system had been fully restored, we engaged Ernst and Young to conduct an independent root cause analysis in partnership with our own technology experts and our vendor partners.
The independent analysis concluded that the root cause was due to inadvertent human error, which caused a misconfiguration within certain data storage systems and resulted in our IT system becoming inoperable. Both our internal analysis and the independent analysis found no evidence of external actor involvement, data exposure or compromise in this event. Based on our internal findings and that of we are taking appropriate actions to prevent this type of event from happening again, including, but not limited to, improvements aimed at IT network design, hardware and software systems enhancements, operating processes and execution and governance. While the IT disruption did have some impact on our overall performance for the quarter, it was not material to our quarterly revenue or earnings per share. We continue to deliver mid single digit revenue growth and double digit EPS growth in line with our long term expectations.
This event could have had a more significant impact in the quarter, if not for the outstanding work and commitment of our employees around the world and the understanding and the partnership of our customers. Our team rose to the occasion to ensure product was available to customers and patients during the disruption and then work tirelessly to fulfill backlogs that built up during the event. This resilience and around the clock commitment of our Medtronic team made all the difference and ultimately allowed us to return to normal operations expeditiously and effectively. There is no longer any outstanding backlog associated with this event and our IT system is operating normally. We are pleased to put this event behind this.
Now let's discuss each of our growth strategies, therapy innovation, globalization and economic value. In therapy innovation, we are seeing strong adoption of our innovative new products across all of our business groups. In our cardiac and vascular group, which grew 6%, we are leveraging the breadth of our products and services as well as our strong positions in important rapidly expanding markets to drive sustainable growth. In the Q1, transcatheter valves, AF ablation, LVADs, transcatheter pacing systems, insertable diagnostics, atherectomy and drug coated balloons all contributed to CVG's strong performance. In TAVR, we delivered growth in the high 30s in both the U.
S. And international markets. And looking ahead, our recent U. S. FDA approval for intermediate risk and global rollout of our EVOLUPRO valve to drive continued TAVR growth.
In coronary, we gained drug eluting stent share with our recently approved Resolute tonics in both the U. S. And Japan, and we expect this product to increasingly drive meaningful coronary growth as we go through the fiscal year. Next, our minimally invasive therapies group grew 3% or 5% adjusting for the divested businesses that will no longer be part of our reported results starting in the Q2. We admit syndicated growth in our Surgical Solutions division driven by new products in advanced energy and advanced stapling.
In advanced energy, we continue to roll out the new Ligashore instruments in our ValleyLab FD10 energy platform. In advanced stapling, our endo stapling specialty reloads with Tri Staple technology are driving growth. We also continue to roll out Signia, our new single handed powered surgical stapling system that provides surgeons with real time feedback during surgery. These innovations are providing momentum to the transition from open surgical procedures to minimally invasive procedures or MIS, resulting in better patient outcomes and lower health care costs. At the end of this fiscal year, we intend to further our goal of moving procedures from open to MIS with the first in human use of our surgical robot platform.
We look forward to bringing a more comprehensive value proposition to our customers across all key surgical areas, open surgery, traditional MIS, robotic surgery and services. Our Restorative Therapies group grew 2% this quarter and within RTG, our spine division grew 1%. We estimate that both the U. S. And global spine markets have slowed modestly.
However, we continue to gain market share, which we attribute to the success of our speed to scale new product launch initiative. We also continue to gain market traction with our surgical synergy strategy, growing the number of customer contracts that combine our spine implants with capital equipment for imaging, navigation and powered surgical instrumentation sold by neurosurgery business. Our Brain Therapies division grew 7%, driven by high teens growth in neurovascular and high single digit growth in neurosurgery. Brain therapies continues to see traction from our recently launched StealthStation S8 surgical navigation system and strong low-30s growth of our solitaire family of revascularization devices for acute ischemic stroke. Turning to diabetes.
While revenue growth declined 1% given the reasons mentioned earlier, we gained global durable pump and consumables share, driven by significant clinician and customer demand for our first six for our 6 series pumps. CGM revenue grew in the low 20s, including growth of nearly 50% in international markets, driven by demand for our sensor augmented pumps and improved sensors. The Guardian Sensor Trees coming off our production line consistently demonstrate a MARD, which is a measure of sensor accuracy of 10.4% in a real world setting, in line with the performance we saw in the pivotal studies, but with a much larger sample size. Next, let's turn to our globalization growth strategy. Emerging markets grew 12%, in line with our long term double digit growth expectations as we continue to expand access to our products and services around the world.
Our consistent emerging markets performance continues to benefit from geographic diversification with strong results across the globe. Latin America grew 16% with double digit growth in Brazil, Mexico, Chile and Argentina. We had continued strong results in China, growing above the market with 12% growth as we continue to consistently perform in a complex environment that we believe will become one of our largest markets. Southeast Asia delivered 12% growth with Vietnam, Indonesia and Thailand all delivering robust results. In the Middle East, we grew 12% as we begin to see recovery in the region.
In particular, Saudi Arabia grew in the mid-30s, our Q1 of growth in 6 quarters as customer inventory levels appear to have normalized and hospitals have begun to purchase again. Let's turn now to our 3rd growth strategy, economic value. We continue to see success in our hospital solutions business, which grew double digits as we are now managing cath labs and operating rooms for nearly 140 customers around the world, including our first in Mexico. We're also seeing strong growth in our TYRX value based program for infection control and implantable devices, more than doubling the accounts under contract in the quarter to 325. Now approximately 10% of our U.
S. CRHF implantables revenue is covered under a TYRX related value based healthcare risk sharing arrangement. In diabetes, we were pleased to announce a new outcomes based agreement with Aetna, where a component of our pump reimbursement will now be successfully meeting clinical improvement thresholds. We're aggressively developing other unique value based healthcare solutions across each of our groups. While we are still early in this journey, we remain focused on leading the shift to healthcare payment systems that reward value and improve patient outcomes over volume.
As always, we expect to do this in a way that benefits patients and healthcare systems as well as our shareholders. Before turning the call over to Karen, I'd like to highlight that we closed our transaction with Cardinal Health at the beginning of the 2nd fiscal quarter, divesting a portion of our patient monitoring and recovery division. We expect this transaction to have a positive impact on our revenue growth rates and margins with modest near term earnings solution. We remain committed to the disciplined portfolio management and capital deployment that balances return to shareholders with reinvestment in internal and external opportunities that are aligned with our growth strategies and are expected to drive strong financial returns. With that, let me ask Karen to take you through a discussion of our Q1 financials and outlook for the remainder of the fiscal year.
Karen?
Karen? Thank you, Omar. As Omar mentioned, our first quarter revenue of $7,390,000,000 represented an approximate 3% as reported and approximately 4% on a constant currency basis. Foreign currency had a negative $33,000,000 impact on 1st quarter revenue And tuck in acquisitions completed almost a year ago contributed approximately 140 basis points to revenue growth, driven in part by the benefits gained from Medtronic ownership. Our revenue fell just shy of 4% growth by approximately $30,000,000 on a total of $7,400,000,000 When we updated our guidance in July, we expected our revenue would be slightly higher, but the IT disruption caused a unique dynamic affecting our visibility through quarter end as we worked to clear the order backlog, including higher than expected sensor demand in diabetes.
And as you know, given the buying patterns of our customers, we tend to have a larger amount of sales in the last few weeks of every quarter in some of our businesses. Importantly, as Omar mentioned, the IT system disruption is behind us and we are seeing strong demand for our new technologies, giving us confidence in our revenue expectations for the remainder of the year. In the quarter, we delivered continued operating margin expansion and strong EPS leverage. GAAP diluted earnings per share were $0.74 Non GAAP was 1.12 dollars After adjusting for the $0.02 negative impact from foreign currency, non GAAP diluted EPS grew 11%. Our operating margin for the quarter was 26.9% on a constant currency basis, representing a year over year improvement of 50 basis points.
With the impact of currency included, our 1st quarter non GAAP operating margin also improved, increasing 10 basis points year over year. Taking into account currency and the acquisitions that we have done in the past year, our operating margin improvement on an organic basis was approximately 70 basis points in the quarter. The operating margin improvement was driven by efficiencies as we continue to deliver on our Covidien synergies. This was partially offset by purposeful investments we are making in sales and marketing in the first half of the fiscal year to support new product launches. Net other expense, which is included in our operating margin, was $66,000,000 compared to $39,000,000 in the prior year and negatively affected our operating margin improvement by 30 basis points.
The increase in net other expense was due in part to foreign exchange re measurement and our hedging program, which combined were a $5,000,000 loss in the quarter versus a $4,000,000 gain in the prior year. Looking ahead, we expect net other expense to be approximately $110,000,000 per quarter and slightly higher than that in the second quarter. This includes approximately $30,000,000 to $40,000,000 per quarter of hedging expense based on recent exchange rates. Below the operating profit line, net interest expense was $194,000,000 slightly less than our original expectations as income earned on our cash investments helped to offset debt expense. Looking ahead, we expect net interest expense to be approximately $180,000,000 to $200,000,000 a quarter.
Our non GAAP nominal tax rate was 13% and benefited from $47,000,000 in operational tax adjustments that became evident and were communicated late in the quarter. Excluding these adjustments, our non GAAP nominal tax rate would have been 15.7 percent, in line with our expectation between 15.5% 16.5% for the remainder of the year. 1st quarter average daily shares outstanding on a diluted basis were 1,376,000,000 shares. We repurchased a net $1,100,000,000 of our ordinary shares in the Q1, executing the annual return commitment to shareholders, concluding our incremental $5,000,000,000 commitment announced in January 2016 and pulling forward some of our incremental $1,000,000,000 repurchase commitment from our divestiture to Cardinal Health given our lower stock price. We expect shares to continue to come down in Q2 and then stay roughly flat for the remainder of the year, given our tendency to purchase shares earlier in the fiscal year.
In June, we increased our cash dividend by 7%, making this our 40th consecutive year delivering a dividend increase. Combining our share repurchase activity the $625,000,000 we paid in dividends in the Q1, our total payout ratio was 111% on non GAAP net income and 169 percent on GAAP net income. Keep in mind, our payout ratio is elevated as we tend to to reiterate our annual guidance and update it with the completion of our divestiture to Cardinal Health, which occurred at the start of our Q2. For fiscal year 2018, we expect comparable constant currency revenue growth to be in the range of 4% to 5%, which removes the divested revenue from the second, third and fourth quarters of fiscal year 2017 as well as the impact of currency. On a comparable basis, the divestiture is expected to result in more than a 30 basis point improvement given the partial year impact to our fiscal 2018 revenue growth.
This translates into a full year annualized recurring growth rate benefit of approximately 50 basis points as highlighted previously. While we recognize the divestiture as a positive impact to our guidance range, the current supply constraint in diabetes will continue to impact growth in that business until later this fiscal year. Looking at revenue growth by our business groups. For CVG, quarterly growth rates have typically between 4% and 7% in recent years. Given the strength of its near term pipeline and easing prior year comparisons, we now expect CVG to grow in the upper half of its historical range for the full fiscal year.
We expect CVG's growth to be strong in the second and third quarters before facing a difficult comparison in the 4th quarter. MITG has typically reported growth rates between 3% 4%, excluding the impact of acquisitions and the divestiture is expected to increase growth by about a point. In fiscal 2018, given the partial year impact of the divestiture and lower growth in the Q1, we now expect MITG to grow in the range of 3.5% to 4.5%. For RTG, quarterly growth has typically been in the 3% to 5% range in recent years. Spine market, we now expect full fiscal year growth for RTG to be at the low end of this historical range.
Finally, in our diabetes group, historical growth before the recent market disruptions was typically in the high single digits to low double digits. With the impact of the temporary supply constraint, we now expect diabetes to grow in the range of 1% to 4% this fiscal year with improvement in the second half as we fulfill the new 670 gs to non priority access customers in the 3rd quarter and increase our sensor supply in the 4th quarter. While the growth acceleration has been delayed by a few quarters, we expect to enter fiscal year 2019 with ultimate strong double digit growth in diabetes. Looking at the Q2, we would expect to be in the lower half of our annual revenue growth range on a comparable constant currency basis, with accelerating growth in CVG, offset by a decline in diabetes in the high single digits. Diabetes revenue is expected to temporarily decline sequentially before improving in the back half of the year for two reasons.
First, we expect less deferred revenue recognition in the 2nd quarter from our priority access program as more pump shipments associated with this after we fulfill the priority access customers, we anticipate that new sales will be muted until we can ultimately fulfill sensors with pumps. Only a limited amount of patients are likely to be willing to purchase a pump and wait for the sensors. With regard to operating margin, we expect solid improvement in the fiscal year with greater strength in the back half. We expect our gross margin on a comparable constant currency basis to be flat for the year with modest pricing pressure offset by operating improvement. SG and A as a percent of revenue is expected to improve, particularly in the back half of the year as we continue to execute on margin expansion opportunities in enabling functions, transition to centers of excellence and optimize our distribution channel.
With respect to earnings, we continue to expect fiscal '18 non GAAP diluted earnings per share to grow in the range of 9% to 10% on a comparable constant currency basis. For the Q2, we would expect temporary year over year declines in our growth and operating margins, leading to EPS growth flat to slightly up, all on a comparable constant currency basis, given the continued investments we are making to support product launches, the impact of temporary revenue declines in diabetes and the operational tax benefits we received in the prior year that are not expected to repeat. However, we continue to expect EPS growth and operating margin expansion to accelerate in the back half of the fiscal year. While the impact from currency is fluid and therefore not something we forecast, if recent exchange rates, which include €1.18 and €109 remained stable for the fiscal year, our full year revenue would be positively affected by approximately $380,000,000 to $480,000,000 including an approximate $25,000,000 to $75,000,000 tailwind in the 2nd quarter. Full year EPS would be affected by approximately negative 0 0 0.03 of approximately $0.00 to $0.02 in the 2nd quarter.
Finally, regarding free cash flow, we continue to expect it to grow in the high single digits compounded annually from fiscal 2016 to 2018, albeit now on a comparable basis given the divestiture. To compare, you should adjust for items that are considered part of the divestiture net proceeds like tax and transaction costs that affect free cash flow. These are expected to be approximately $400,000,000 this fiscal year and $200,000,000 next year. In addition, you should adjust for the loss of free cash flow generated by the divested businesses, was approximately $100,000,000 per quarter. Without these adjustments, free cash flow is expected to grow in the low single digits compounded annually from fiscal year 2016 to 2018.
Now I will turn the call back to Omar.
Thanks, Karen. And looking ahead to the remainder of our fiscal year, we have confidence in our guidance and visibility into the acceleration in our innovation cycle as we see momentum coming from several new product launches this fiscal year. And let me remind you of a few of them. In CVG, we now have intermediate risk approval in TAVR and are launching our new Evolut profile. We're also in the early stages of market launch for our new Resolute On X drug eluting stent, our micro transcatheter pacing system and our MR conditional quadripolar CRT pacemakers in our largest global markets.
As we enter the back half of the fiscal year, we expect to launch HVAD destination therapy and our next generation Azure wireless pacemaker family in the U. S. Well as the impact Admiral drug coated balloon in Japan. In MITG, as I mentioned earlier, we're launching our Signia powered surgical stapling system and gearing up to release our surgical robot platform later this year. In RTG, our product refresh and spine continues, and we're preparing to launch our Solera Voyager 5.56.0 fixation system.
We're also seeing great StealthStation S8 navigation system and our continued partnership with Mazar and their Mazar X system. And in our diabetes group, in addition to ramping up the 670 gs hybrid closed loop launch, we are also preparing to launch our standalone CGM system, Guardian Connect in the U. S. Later this year, which will be combined with our SugarIQ app that utilizes IBM Watson Cognitive Computing. Let's now open the phone lines for Q and A.
In addition to Karen, I've asked Mike Coyle, President of CVG Brian Hanson, President of MITG Jeff Martha, President of RTG and Hooman Hakami, President of our diabetes group to join us. We want to try to get to as many people as possible. If you have additional questions, please contact Ryan and our Investor Relations team after the call. Operator, first question please.
Your first question comes from the line of Mike Weinstein with JPMorgan.
Thank you guys and good morning everybody. I wanted to start with 2 questions. So first, there appear to be somewhat conflicting statements and I understand part of it is legality on the impact of the computer outage. So can you try and quantify it because obviously there's a comment in your prepared remarks as well as a press release that says that it was not material. So can you try and quantify what the impact was this quarter?
And then second, obviously, it's going to be a better focus on the diabetes business and the step down to the outlook for the year. So can you just spend a little bit more time on what's going on with the sensors and why now we're looking at a eventually a backlog all the way out to the fiscal Q4 versus previously fall? Thanks.
Yes. Let me quickly address the diabetes one and then I'll let Karen address the IT system question. From diabetes, look, what's happened is the our success rate with our products, which all have now sensor to management, has actually been very high, not only with the 670 gs here in the U. S, but also with the 640 gs, which we launched in Europe roughly 2 years ago. And that plus the Guardian Connect in Europe has really gained traction.
And what's happened is the demand for the sensor really grows by multiple factors compared to just pump revenue because for every pump you need to supply sensors for the whole year in an ongoing basis. And so when you do that demand equation, that number comes to be a very large number. And although we're accelerating plans to add a new line, it just takes a little longer than one would want. I think that's all I can say that the attachment rates are much higher than previously envisaged that even a short while ago we were planning. The number of customers who want the priority access for 670 gs is also significantly higher than we were expecting.
All of this leads to a multiplication of the number of sensors that are required. And when you do the math, it just comes to a very large number, which which just couldn't fulfill immediately. But having said that, these are all things that are in our control and we plan. We are pretty confident that by the end of the year, we'll be diabetes will be able to take advantage of these new products, which actually we've been driving to and are pretty revolutionary in their own right. So Karen, do you want to say something on the IT?
Yes. On the IT outage, very difficult to separate and quantify the impact related to the outage. We did say that it is not material to the Q1 revenue or earnings per share. So very difficult to quantify beyond that.
Okay. And all right, so just two follow ups. So one on the sensor side, it appears part of the problem is that as you're moving to a lower MARD, it's harder to manufacture the sensors. We all are aware of that. But it just sounds like the yields aren't as good and that the reliability in terms of the life of the sensors isn't as good.
So you're having to include an extra sensor in the packets that you're shipping out. So can you comment on that? And then just the other follow-up is the change in the MITG guidance, the increase was less than we were expecting posted divestiture. And that part looks like to a weaker performance in general surgery this quarter. So could you just comment on the MITG business?
In fact, I'm saying why didn't guidance move up more there given the divestiture? And why was general surgery weak? Thanks. And I'll let him jump
Okay. First of all, with the diabetes, it is not an issue of yield at all. The yield is perfectly good and in line with our expectations and the number of sensors that are required are the standard number of sensors that we expect for patients to cycle through. So that is really not the issue at all. We're extremely confident in our manufacturing, the process, the yields, resulting in much more accurate sensor performance.
And this is purely an issue of acquiring capital equipment that needs to be approved by the FDA and put in place. And when that happens, we will release sensor capacity. This has got nothing to do with any yield differential of any sort or need for cycle these sensors any quicker than is normally expected. Function of increased
demand, not manufacturing output or manufacturing a function of increased demand, not manufacturing output or manufacturing performance. And maybe 2 statistics to keep in mind. You heard in the commentary, our installed base demand for sensors in Europe was 50%, five-zero percent. We were expecting growth in Europe, but 50% was more sensor utilization than what we were expecting. The second that you heard from the commentary is that there were 32,000 priority access patients that signed up.
That was a 30% increase versus what we expected. So this is purely a function of increased demand, not as Omar pointed out of anything to do with yields or lower MARD. Our MARDs are great. Our yields are totally in line with expectation. It's just our ability to meet demand and this is a temporary thing.
Keep in mind that our diabetes patients on the 640 gs do not need to use the sensor attached, but they are choosing to use it more and more often because of the accuracy with that sensor. And that is one of the reasons that the demand was higher than we originally anticipated. In regard to MITG, we do expect revenue growth for the year now to be 3.5% to 4.5% and that does include the positive impact of the divestiture for the partial year of about 30 basis points. On a full year basis, we would expect that to be about 50 basis points. So we are increasing our guidance in that business line.
Thank you, Mike. Thank you, Mike. Can we get the next
question, Darla?
It's from David Lewis with Morgan Stanley.
Good morning. Just a couple of questions for me. The first is for Jeff and then maybe one for Omar. Jeff, I just want to talk about just RTG kind of broadly for a second. There's sort of a tale of 2 cities.
The CoreSpine numbers to us looked better actually. I wonder if you could talk about your share momentum in CoreSpine relative to what we've seen, which is industry weakness amongst most of your peers in spine. And then of course, offsetting that is SCS and DBS businesses, just based on product cycle innovation, are not doing as well. And when do you think those businesses can begin to stabilize and why? And then I had a quick follow-up.
Craig? Yes.
In the spine market, look, we have seen a little bit of softness this last quarter. We had the spine market growing like 1% to 2% historically. In the last two quarters, Q3 and Q4 for us, Medtronic, we were at 3% overall growth. We had the spine market. It's hard for us that we're triangulating.
We don't give market data for a couple more weeks. But based on what we can see, we have new market at relatively flat to maybe 0.5% growth. So that definitely had an impact on us this quarter, but we are still gaining share. And we think it's on the strength of, 1, our product releases and this whole methodology of launching them around speed to scale. And then our surgical synergies deals, which I think will build momentum as we get continue to expand our partnership with Mazor.
But right now, over 5.5% in the U. S. Of our core spine volume is tied in with these capital deals and that's a growing number. So the two factors that are driving the business, one is just product releases and we'll see that continue throughout the year. In the second half, we have a couple of new product releases coming and then launching in the speed to scale manner and then combining them with the capital equipment.
And that is obviously, when you look at visavis the other multinationals, we're performing quite a bit better. And on the pure plays, I mean, the gap is very it's narrowed dramatically. And as we move forward with introducing robotics into the portfolio with Mazor, I see us and plus our continued product launches and correspond, I feel good about where we are and I see positive momentum. But you're right, that's been offset by Pain Stim and DBS. And Pain Stim has been declining in that mid single digits, even a little higher over the last couple of quarters.
And the catalyst for change there is going to be INTELLUS, which we plan to launch in the back half of the calendar year. And INTELLUS will be the smallest implantable rechargeable system on the market, 40% smaller than our current one with a state of the art programmer. I mentioned it's rechargeable and it will be a faster recharge like 75% faster than our current. And it's upgradable and you're also able to download novel stim patterns and algorithms which we are investing in. And you combine that with our, evolved workflow that we launched a few quarters ago, which is definitely helping us.
I think that will stabilize that business. And again, we're continuing to invest in novel stim patterns, which this Intellis platform will be able to handle. And then DBS, that's going to take a little bit longer. I mean, we are funding that business in terms of our R and D, but it will be probably several quarters over a year before some of these new innovations come to market that we've talked about in terms of our new steerable leads, our new PC plus S system and then a very novel cranial mounted rechargeable system. So DBS is a little bit further out and then we see pain stim when the pelvis launch.
And the dynamic that's shifted is spine has gone up and pain stim has gone down. DVS was still performing. And this past quarter, it started to shrink a little bit as Boston got on the market in Europe with their MR compatible system. Okay.
Thanks, Jeff. My two follow ups. One for Brian. I don't know if I caught the specific answer in MITG. It did look on the margin.
There was a little core softness in MITG across some of the major segments. I don't know if there's anything you'd be willing to call out there. And then for Omar, now that you've closed the divestiture, can you just kind of level set us in terms of where we should be thinking about priorities of future free cash and the broader balance sheet, and most specifically as it relates to buyback after you complete the $5,000,000,000 program and then just M and A, how investors should be thinking about your priorities here, mid tier larger acquisitions or more smaller growth innovative deals? Thanks so
much. Yes.
From a margin perspective, in our business, I don't see anything. It was probably just a little bit of mix in the quarter. I don't see anything that would continue there. Just real quick too on general surgery and the question that was asked previously, it was a little lighter in the quarter likely due to surgical volumes. It reacts more to surgical volumes than our advanced energy business and our advanced business overall.
And so that's why we saw a little bit of weakness in general surgery versus what we've seen in the past. It is almost directly impacted by these surgical volumes and that was the reason for the softness.
And with respect to the questions for me, let me start with the acquisition strategy. Look, we remain focused on tuck in acquisitions today and they work for us. We've converted them into the ones that we've done. We're converting them quite smoothly into organic growth drivers for us over time. We're not really focused today on transformative M and A.
Remember, we're still in the last year of integration of Covidien. We just did a divestiture, the separation agreements that we've got to follow through. So we're focused on executing these big sort of bets in many ways have been made. And we continue to have a very disciplined approach to pursuing tuck in acquisitions and we intend to continue that approach. Over the long term, we'll continue to build value for shareholders and we'll look at opportunities that are accretive to margins and growth trajectories that support our strategic priorities.
I think Karen can comment a little bit on capital allocation perhaps on the
buyback side. Sure. As you've heard us talk about in the past, we're focused on paying back to our shareholders in the form of both dividends and share repurchases and that won't change. We're also focused on balancing that payback with continued reinvestment in our own business so that we can continue to grow that long term value of Medtronic.
Okay. Thank you, David.
Thank you, David. Darley, can we have the next question, please?
It's from the line of Bob Hopkins with Bank of America.
Thanks and good morning. Good morning. I just wanted to ask 2 questions that really sort of clarify the guidance maybe. And Karen, to start out, this is pretty simple math, but just to confirm, the new EPS guidance for fiscal 2018, including Cardinal, by my math, based on your disclosures, sums to about $4.75 to $4.80 Is that correct?
Yes. We don't comment directly on exact EPS guidance, but we do expect continue to expect 9% to 10% growth on the base of last year. So hopefully that's helpful.
Well, I'm just saying, like you give all the moving pieces in your disclosures, and I just wanted to make sure that we had that right. But I guess we'll we can follow-up offline on that. But our math summed around $4.75 to $4.80 And I guess the other EPS clarifying question that I had was that I'm just trying to reconcile the old guidance to the new guidance and understand maybe what has changed. I know you're now giving your growth targets off of pro form a numbers, but I mean your old guidance called for 9% to 10% underlying EPS growth on legacy Medtronic and then a $0.05 to $0.10 hit. And then you said Cardinal would be dilutive by $0.18 Those are the 3 sort of big pieces to your old guidance.
And I'm just curious, could you help us understand what's changed with this new guidance? Obviously, we can see that FX has gotten better. But as I sum through all the math, it seems like something must have gotten a little bit worse, either the cardinal dilution or maybe the face business due to other income or diabetes. So I'm just trying to understand what's changed relative to the old guidance and the way you used to give it.
Sure, sure.
I would say that the biggest thing that's changed is in our diabetes business and the impact of the lower revenue growth until the end of the fiscal year given the demand and the supply constraints. And that guidance does ultimately have an impact through the P and L. And so that does also affect the bottom line. Beyond that, we do expect that to be offset by some better guidance in CVG than initially given, given the strength of that new pipeline. And on an EPS perspective, we do expect that the dilutive impact of the transaction is still at $0.18 on a net basis after taking into account the use of proceeds.
On a gross basis, when you're looking at the numbers that we provide to reset your base, on a gross basis, that translate into about $0.23 dilutive before taking into account the use of proceeds.
And do you have a number that quantifies the impact of the diabetes changing guidance for this particular quarter? What the impact was on organic growth?
Yes. I would say that, again, difficult to give you an exact dollar amount of the impact to the quarter of the demand and supply equation. But clearly, it did impact us to perform under what we had initially guided for the diabetes business last quarter.
Okay. Thank you very much.
Thanks. Thank you, Bob. Next question, Darla, please.
It's from the line of Kristen Stewart with Deutsche Bank.
Hi, guys. How are you?
Good, Kristen.
I've missed you all. Yes. I guess I have just a couple of more strategic questions. And I just want to clarify just on diabetes, it sounds like it's the demand is just more overwhelmingly positive. So has this changed your mind from a strategic perspective?
And sorry for the background, just in terms of wanting to change your thoughts on going more from a why not think about going more just to consumer basis and not going more the professional route?
Fard, this is for the central Yes.
So Kristen, hi, this is Hooman. Nice to hear your voice. Let me just touch on that. First of all, it is, as we talked about, purely a demand equation. And as you rightly pointed out, we have our nLIGHT 1 sensor, our nLIGHT enhanced sensor, our Guardian sensor 3, all of those are experiencing strong demand, which as Omar and Karen mentioned, we are working to fill the capacity in order to meet that demand.
It doesn't change our strategy overall, number 1. So strategically, actually, this increased demand means the strategy is working with respect to sensor augmented systems. And then as far as personal versus professional CGM, I would say 2 things. 1, as Karen and Omar alluded to in the commentary, we are still working with the FDA for the launch of our own personal CGM, which should hopefully happen this year. The Guardian Connect Sensor with SugarIQ, that's number 1.
And on top of that, we continue to go down the path within our non intensive Type 2 business to drive professional CGM more aggressively through primary care physicians. So we're pursuing all three of these angles and that's been the strategy and we will continue to drive that strategy.
Okay, of course. Awesome. And so with the FDA just getting new lines up, that's just what's causing more of the delay and causing the backup into the ad, not the I think you're pretty strong in saying, Omar, it's not the yield.
It's not the yield. It's not
the right way of products and just electronic and where you're positioned now.
Okay. Thanks, Kristen. First of all, this CMS you meant with the payment changes. The change is really that it's not mandatory anymore. I think there's general encouragement to move more towards value based payments.
And I think it's not only CMS, but the commercial payers are also looking at that dimension. At the end of the day, value based health care is around improving outcomes at a lower cost. And I think that trajectory is not going to change. I think there's good realization of that. I think operationalizing this requires granular work and we're in the middle of that and we are driving that partnering with both providers and payers and CMS in doing so as we come up with the right models.
So I would say that the change from the mandatory version is just that, it's not mandatory anymore. There's no real change in philosophy about the value of bundled payments and the importance of outcomes measurements. I think with respect to the industry, look, value based care is where the industry has got to move to. Consolidation gives you a capability to have a seat at the table. It gives you more assets to use to deliver value based health care because you probably need a variety of capabilities to do so.
But at the end of the day, innovation in this industry that's relevant for patients is never going to go away. And let's not confuse getting broader in some ways with lack of focus in specific physician partnerships and therefore driving innovation, which will then result in higher value. That's what MedTech does and that is not going to go away. I think the rest of that trumps Great. Okay.
Thank you. Thank you, Christian.
Next question please, Darla.
Your next question is from the line of Larry Biegelsen with Wells Fargo.
Hey, good morning, guys. Thanks for taking the question. Let me just follow-up on a question that was asked earlier about weak U. S. Surgical volumes and the spine market.
Overall, calendar Q2 was pretty mixed for the large cap medtech companies and with growth slowing. So I wanted to see if you guys could talk about why you think the U. S. Surgical volumes might have been weak, maybe any insight on trends in July August and why you think the spine market might be a little soft? And then I had a follow-up.
Thank you.
Yes. I think there's 2 things on that. First of all, always remember that the U. S. Market is driven by innovation cycles.
And as we go through innovation cycles, the underlying market is really dominated by these growth spikes that we get. And as we move into an accelerating phase of innovation, you will see our U. S. Performance go up accordingly. With respect to the underlying market, there's been a slight change, which is in the range of changes that have happened in the past.
And you're right, surgical volumes overall have been a little softer as have spinal volumes. A lot of this is to do with elective procedures, people backing away from those. I think that's the best that I can that we've seen that there's been an intentional conservatism, if you like, maybe a caution about elective procedures right now in the middle of the year. But again, it's within the range of movement of these markets over time. So it's not anything beyond that.
And I do think that innovation cycles are the ones that really move these markets much more dramatically. And I think as we go through this period of accelerating innovation, you're going to see that.
Any commentary on the spine softness? Is that also procedure related? And just for my follow-up, maybe, Mike, there's a couple of presentations coming up at ESC that it could impact your AFib business, Castle AF, as well as renal denervation, the SPIRAL Auth Med trial. Could you talk about the significance of those trials and any other color you might be able to add before the data? Thanks.
Larry, on the spine market, I just I do attribute it to what Omar was talking about those broader themes around elective procedures. A little more specifics, we can rule out a few things. I mean, we haven't seen we do have some visibility in the payers and we haven't seen any increased pushback from payers, any increase like declines of procedures because we do have a view some insight into that. We haven't seen that. And then just talking to physicians, we haven't seen any other significant catalysts.
They still seem pretty positive about the market. And so at this point, again, like I mentioned earlier, we will get more procedural insights in a couple of weeks because the market data is delayed a little bit, the data that we get. But at this point, we're attributing it to the broader elective procedure dynamics that Omar mentioned.
And then Larry, on the questions about the clinical trials to come up here at ESC for late breaking clinical trials. I don't have much to say in the Castle AF until we actually see the results there. Obviously, our franchises are doing very well in that particular area, both therapeutically with the cryoablation and continuing benefits from the fire and ice study as well as obviously continued growth in the insertable loop recorder market where frankly most of the growth that we see there is being dominated by its use in cryptogenic stroke and syncope. So we don't expect those to be particularly impacted, but we'll obviously wait and see what those data are. As it relates to the renal denervation, obviously, we've been working now for better part of 3 years to basically look at the application of that therapy.
We've changed the device obviously to the spiral device. We have changed where we are doing the application of energy to go more distillate to the renal artery. We have changed the patient population that we are studying based on the evidence that we saw of who responded and who didn't in the original HTN-three study. And we also have obviously now executed on a randomized clinical trial sham controlled for the both on med and off med arms. And what's going to be presented at EFC next week is the off med cohort patient cohort there.
So we think that's probably the purest look at the therapeutic value of renal denervation. There'll be a simultaneous publication for that and we'll discuss those results after they're actually presented at ESC.
Thanks for taking the questions guys.
Thank you, Larry. Next question please, Dara.
It's from the line of Glenn Novarro with RBC Capital Markets.
Hi, good morning guys. I just want to ask one more question on surgical volumes. So we get it, spine volumes in the U. S. Were slower in 2Q and there was some softness in general surgical trends in 2Q.
But can you give us your expectations for the second half of this calendar year? And the reason I'm asking is because one of the things we've heard is that these higher lower pre owned premium, higher deductible plans are starting to push more and more cases into the Q4 similar to what we see in knees and hips. So is that a possible explanation as to why we saw some softness in 2Q? And is that a reason for volumes to get stronger in the back end? So I'm just wanting your thoughts on that.
And then I just had a follow-up question for Mike Coyle.
Okay, Brian. Yes. So
what I would
tell you is that thinking in Q2, we get it's not a perfect science, by the way. And so if you look at the variables that would drive the lower surgical volumes in a quarter, it's very difficult to say what variable actually had the biggest impact. So I don't want to draw any conclusions there. What I know is that from our own field sales organization, from some of our key competitors that play into space in their general surgery type products, there was softness in the quarter. I don't want to read too much into that though because it's 1 quarter.
We have quarters that are up, quarters that are down. So, I'm not calling this a trend at all at this point. And I certainly wouldn't want to draw any conclusions to any strength that would be happening in the Q4 as a result of this. One other thing I would mention in our Advanced Surgical business, though we always look at surgical volumes, one of the key things we concentrate on is moving current procedures from open to MIS and that drives a lot of our growth. So we're dependent on surgical volumes, but not completely dependent on surgical volumes in that business.
Okay. And then, Mike, just 2 cardio questions. 1, maybe a little bit more color on what you're seeing in your core pacing business today, given Abbott is now launched in MRI safe pacer? And then you're bullish on your stent outlook over the next couple of quarters with the On X launch, but maybe talk about what's truly different about On X that could allow you to gain share in the stent market over the next, I don't know, 6 to 12 months? Thanks.
Sure. So on the pacing side, the market is very stable. We're seeing low single digit to actually mid single digit unit growth for initial implants. And obviously, we've seen some modest share loss to competitors as they've entered with MRI. But as now we have brought out Micra, both in the U.
S. And Europe, and it will be coming to Japan this quarter. We are obviously seeing recapture of especially the single chamber unit share at much higher prices, obviously, with the micro product. And as we head into the second half of this year, we will be releasing our next generation of pacing family, the Azure wireless Pacer family, both in Europe and in the United States. It's actually just been released in Europe and will be coming to the United States in the second half.
So we think we will actually get back into a share capture mode with that particular product. And then as it relates to the On X product, the feedback we've received from Europe and its early release here in the U. S. And also in Japan is that it's the most deliverable scent in the market that it has the widest range of sizes and widths of any product that it basically can go anywhere and has great visibility. And we have seen it drive market share for us meaningfully in Europe to the point where we essentially recovered everything that had been given up as competitors have come in with their products.
So we are looking for a similar dynamic here in the U. S. And in Japan. And so we think we've obviously begun to see that. We're seeking a price premium for the product, which makes it a little slower in its ramp in terms of having to get approvals and committees to go on contract.
But we are very encouraged with the feedback that we're receiving, and we expect it to be a growth driver for us for the rest of the year.
Okay, great. Thanks, Mike.
Thank you, Glenn. Next question, please.
It's from the line of Matt Taylor with Barclays.
Hi. Thank you for taking the question. I guess since it's the biggest change here, I just wanted to ask one follow-up on diabetes. As you're moving towards getting this new line up and running and adding that capacity, I guess, can you help us understand what the gating factors are in terms of predicting that conservatism in that guidance?
Yes. I think, look, the major variable here is just the FDA approval that we need for the capital equipment that's needed for the line. The rest of it is pretty straightforward. We're replicating a line that process that we know how to do. And there's some level of things out of our control is the FDA time cycle for approval.
It's not anything that's different from what we've got approved in the past and we expect this to go okay, but it is something that's out of our control. And I think that's the major factor in getting the line up. Is there anything else, Man?
No, that's exactly right. We know the equipment. We know the process. So bringing the equipment in, doing all of the qualifications, that's something we feel very comfortable with. Then there's obviously the variable of turning all of that over to the FDA and seeking their approval.
So as Omar pointed out, that's the single biggest variable in this that has uncertainty around it. The other elements we feel very good
about. And just to make it clear, we have gotten approval for this kind of stuff from the FDA in the past without any issues. So there's nothing that's any different, but it is something that needs approval.
And just to follow-up on the presentation, I noticed that CRTDs actually declined low double digits this quarter. So I was curious if you could give us some color on that. I was a little surprised by the magnitude of that decline and if anything could change there going forward to improve that.
Yes. The decline that you're seeing in the CRTD is basically being driven by the U. S. And it is basically we are seeing low single digit declines in initial implants for CRTD. We're actually taking market share in the initial implants, but we're also now seeing sort of low double digit declines in replacements.
This is something we talked about a year ago in Q1 and Q2 as a competitor who had a major recall at the end of our Q2 and into Q3 and Q4 that obviously drove competitive replacements for us, which masked, if you will, that decline that's really being driven by the extending of battery life in the CRTD space. And that's what you're seeing sort of reflected in the numbers. The other major driver for that, which is temporary to the Q1 results, is that we saw a fairly significant destocking of hospital held inventory in the United States in Q1, where essentially the hospitals are looking not to hold as much inventory of product. And if they want to take it, they want significant discounts to restock that, which we've opted not to do. So that is more of a temporary issue that we think will not see this big of a magnitude of it going forward.
Great. Thanks a
lot for the color. Thank you.
Next question please, Carla.
It's from the line of Joanne Wuensch with BMO Capital Markets.
Thank you very much for taking my question. Can we shift a little bit to the land of robotics? You have a new surgical robot outside the United States this year and you mentioned Mazor in your comments. Could you please give us an update on your thinking about those two aspects of your portfolio?
I'll let Brian go first and then let Jeff talk about major.
I couldn't hear you very well. What was the question on the surgical robotic system?
Just an update on how you're thinking about that launch applications and differentiations and anything else that you could add to the color of as we all look towards it?
Well, obviously, we're pretty excited that we're in the fiscal year that we're going to get it in 1st human use. So that's positive. We're in the I would define as the pilot phase build right now and we're obviously working very diligently for verification, validation and also any things that we need to put together for regulatory submissions. So we're heading down the path, feel confident with what we have today. Obviously, with this complex of a product, a lot can happen in the V and V process, but we're feeling good about where we stand today.
And the strategy holds. It's the same that I've mentioned before. Our organization from a mission perspective is to move our patients from open surgery to MIS. This is another tool to ensure that we can do that. And we feel confident that once we launch this, we're going to be in a unique position to bring more value than any other company in the world.
We'll be able to fully service open surgical procedures, room. So we remain very confident in the product and we remain very confident in the overall strategy.
And then this is Jeff. On Mazor, as I think most people know, it's been it's public, it's out there is our relationship with them has a continuum, if you will, and we're in this phase of the relationship that is a lead sharing. And if we hit certain milestones and they hit certain milestones, we move to more of a distribution. And the initial phase has gone very well. It's tested the hypothesis that we believe robotics has a strong place in spine surgery, and it works well with our broader solutions around interoperative imaging and navigation.
And so we're very pleased with where the relationship is going, and I think we can talk more about this in the next quarter here in terms of moving towards distribution. In addition to that, a go forward look on tighter product integration with our navigation and interoperative imaging systems as well as our spine implant business, how this impacts their product roadmap as well. But the relationship continues to go well. It's growing. Our customers see a lot of value in it, not just the robot, but the robot, the Mazor X robot used in conjunction with our interoperative imaging system, the OAR2 as well as our navigation platform, the StealthStation.
Okay. Most of my other questions have been answered. Thank you very much.
Great. Thank you, Joanne. We'll take one more question please, Joe.
And your final question will be from Isaac Ro with Goldman Sachs.
Thanks for fitting me in guys. Appreciate it. I want to spend a minute talking about the nature of your relationship with hospitals. There are a couple of items here that have been brought upon that I thought are interesting. One was just the nature of surgical procedures.
And I'm wondering if you're seeing on volumes in spine and elsewhere in your business?
Look, we don't have any direct insight into that. We don't hear of that as a specific reason. And like I said, this range is within a fluctuation range that we've seen before. So we're taking it in that light. And like we mentioned earlier, elective procedures probably are down a little bit, but again in the range we've seen before.
And again, let me emphasize that product innovation in this market is what really swings these markets. And we do think that for the right procedures where there's real value that the patient can see and the physicians can see, the procedures that happen and they will grow when new innovation comes along. And we're in a period of accelerating that innovation. So we do expect our U. S.
Growth numbers to go up in the coming quarters, offset a little bit by the diabetes slowdown in the next quarter or so, because that's mostly almost all U. S. But really surgical procedures themselves, I think again are in the range of history of historical trends. And we expect our product innovation to positively impact those markets.
Okay. That's helpful. Maybe just from another direction. I think there was an earlier comment on the CRTD business with regards to hospital inventory. Are you seeing at a higher level any change in the way hospitals manage their inventory for your products?
I mean, it seems like, again, that customer group is a little bit stretched in terms of their financial health. And so just understanding how they're managing their cash flow and how that impacts you?
Well, no, I think their methodology for managing is more or less the same as it's always been. And you go through these cycles, again, in the range that we've seen before. And look, I hear too from hospitals, just in general that they're concerned about their business flow. But again, it's nothing that's more than what we've seen before and in that range. And for the right thing, they will do it.
But the buying patterns are in line with what we've seen, nothing dramatically different.
Okay. Thank you very much.
Thank you, Isaac. Okay. So with that, let me thank you all for your questions. And on behalf of the entire management team, I'd like to thank you again for your continued support and interest in Medtronic. We look forward to updating you on our progress on our Q2 earnings call, which we now anticipate holding on November 28, which is a week later than normal during the closing time needed as a result of the divestiture to Cardinal Health.
Thank you all and have a good day. Thanks.
Ladies and gentlemen, this concludes Medtronic's 1st quarter earnings conference call. You may now disconnect.