UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
ý | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended January 25, 2013 |
Commission File Number 1-7707
MEDTRONIC, INC. | |
(Exact name of registrant as specified in its charter) | |
Minnesota | 41-0793183 |
(State of incorporation) | (I.R.S. Employer Identification No.) |
710 Medtronic Parkway
Minneapolis, Minnesota 55432
(Address of principal executive offices) (Zip Code)
(763) 514-4000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ý No o
Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x | Accelerated filer o | |
Non-accelerated filer o | Smaller Reporting Company o | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No ý
Shares of common stock, $.10 par value, outstanding on March 1, 2013: 1,013,805,980
TABLE OF CONTENTS
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6. | ||||
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
MEDTRONIC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three months ended | Nine months ended | ||||||||||||||
January 25, 2013 | January 27, 2012 | January 25, 2013 | January 27, 2012 | ||||||||||||
(in millions, except per share data) | |||||||||||||||
Net sales | $ | 4,027 | $ | 3,918 | $ | 12,130 | $ | 11,887 | |||||||
Costs and expenses: | |||||||||||||||
Cost of products sold | 999 | 931 | 2,992 | 2,842 | |||||||||||
Research and development expense | 376 | 364 | 1,148 | 1,097 | |||||||||||
Selling, general, and administrative expense | 1,401 | 1,371 | 4,223 | 4,161 | |||||||||||
Certain litigation charges, net | — | — | 245 | — | |||||||||||
Acquisition-related items | (55 | ) | 15 | (44 | ) | (1 | ) | ||||||||
Amortization of intangible assets | 88 | 84 | 247 | 255 | |||||||||||
Other expense, net | 17 | 67 | 119 | 316 | |||||||||||
Interest expense, net | 46 | 33 | 103 | 103 | |||||||||||
Total costs and expenses | 2,872 | 2,865 | 9,033 | 8,773 | |||||||||||
Earnings from continuing operations before income taxes | 1,155 | 1,053 | 3,097 | 3,114 | |||||||||||
Provision for income taxes | 167 | 208 | 599 | 587 | |||||||||||
Earnings from continuing operations | 988 | 845 | 2,498 | 2,527 | |||||||||||
Discontinued operations, net of tax: | |||||||||||||||
Earnings from operations of Physio-Control | — | 15 | — | 32 | |||||||||||
Physio-Control divestiture-related costs | — | (9 | ) | — | (17 | ) | |||||||||
Deferred income tax benefit on sale | — | 84 | — | 84 | |||||||||||
Earnings from discontinued operations | — | 90 | — | 99 | |||||||||||
Net earnings | $ | 988 | $ | 935 | $ | 2,498 | $ | 2,626 | |||||||
Basic earnings per share: | |||||||||||||||
Earnings from continuing operations | $ | 0.98 | $ | 0.80 | $ | 2.45 | $ | 2.39 | |||||||
Net earnings | $ | 0.98 | $ | 0.89 | $ | 2.45 | $ | 2.48 | |||||||
Diluted earnings per share: | |||||||||||||||
Earnings from continuing operations | $ | 0.97 | $ | 0.80 | $ | 2.43 | $ | 2.37 | |||||||
Net earnings | $ | 0.97 | $ | 0.88 | $ | 2.43 | $ | 2.47 | |||||||
Basic weighted average shares outstanding | 1,012.5 | 1,054.4 | 1,020.7 | 1,058.5 | |||||||||||
Diluted weighted average shares outstanding | 1,021.0 | 1,060.2 | 1,028.7 | 1,064.1 | |||||||||||
Cash dividends declared per common share | $ | 0.2600 | $ | 0.2425 | $ | 0.7800 | $ | 0.7275 | |||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
1
MEDTRONIC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended | Nine months ended | ||||||||||||||
January 25, 2013 | January 27, 2012 | January 25, 2013 | January 27, 2012 | ||||||||||||
(in millions) | |||||||||||||||
Net earnings | $ | 988 | $ | 935 | $ | 2,498 | $ | 2,626 | |||||||
Other comprehensive income/(loss), net of tax: | |||||||||||||||
Unrealized gain/(loss) on investments, net of tax expense/(benefit) of $(19), $(89), $(15), and $(61), respectively | (33 | ) | (150 | ) | (26 | ) | (102 | ) | |||||||
Translation adjustment | 40 | (85 | ) | 13 | (168 | ) | |||||||||
Net change in retirement obligations, net of tax expense of $7, $6, $26, and $18, respectively | 10 | 15 | 45 | 38 | |||||||||||
Unrealized gain/(loss) on derivatives, net of tax expense/(benefit) of $(2), $59, $(18), and $106, respectively | (5 | ) | 101 | (31 | ) | 181 | |||||||||
Other comprehensive income/(loss) | 12 | (119 | ) | 1 | (51 | ) | |||||||||
Comprehensive income | $ | 1,000 | $ | 816 | $ | 2,499 | $ | 2,575 | |||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
2
MEDTRONIC, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
January 25, 2013 | April 27, 2012 | ||||||
(in millions, except per share data) | |||||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 1,298 | $ | 1,248 | |||
Short-term investments | 1,166 | 1,344 | |||||
Accounts receivable, less allowances of $106 and $100, respectively | 3,532 | 3,808 | |||||
Inventories | 1,889 | 1,800 | |||||
Deferred tax assets, net | 564 | 640 | |||||
Prepaid expenses and other current assets | 712 | 675 | |||||
Total current assets | 9,161 | 9,515 | |||||
Property, plant, and equipment | 6,136 | 5,796 | |||||
Accumulated depreciation | (3,634 | ) | (3,323 | ) | |||
Property, plant, and equipment, net | 2,502 | 2,473 | |||||
Goodwill | 10,341 | 9,934 | |||||
Other intangible assets, net | 2,758 | 2,647 | |||||
Long-term investments | 9,321 | 7,705 | |||||
Long-term deferred tax assets, net | 484 | 504 | |||||
Other assets | 382 | 305 | |||||
Total assets | $ | 34,949 | $ | 33,083 | |||
LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||
Current liabilities: | |||||||
Short-term borrowings | $ | 4,104 | $ | 3,274 | |||
Accounts payable | 569 | 565 | |||||
Accrued compensation | 864 | 912 | |||||
Accrued income taxes | 207 | 65 | |||||
Deferred tax liabilities, net | 10 | 33 | |||||
Other accrued expenses | 1,204 | 1,008 | |||||
Total current liabilities | 6,958 | 5,857 | |||||
Long-term debt | 7,314 | 7,359 | |||||
Long-term accrued compensation and retirement benefits | 838 | 759 | |||||
Long-term accrued income taxes | 1,002 | 1,005 | |||||
Long-term deferred tax liabilities, net | 639 | 611 | |||||
Other long-term liabilities | 362 | 379 | |||||
Total liabilities | 17,113 | 15,970 | |||||
Commitments and contingencies (Notes 4 and 19) | |||||||
Shareholders’ equity: | |||||||
Preferred stock— par value $1.00 | — | — | |||||
Common stock— par value $0.10 | 101 | 104 | |||||
Retained earnings | 18,207 | 17,482 | |||||
Accumulated other comprehensive loss | (472 | ) | (473 | ) | |||
Total shareholders’ equity | 17,836 | 17,113 | |||||
Total liabilities and shareholders’ equity | $ | 34,949 | $ | 33,083 | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
MEDTRONIC, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) | |||||||
Nine months ended | |||||||
January 25, 2013 | January 27, 2012 | ||||||
(in millions) | |||||||
Operating Activities: | |||||||
Net earnings | $ | 2,498 | $ | 2,626 | |||
Adjustments to reconcile net earnings to net cash provided by operating activities: | |||||||
Depreciation and amortization | 610 | 633 | |||||
Amortization of discount on senior convertible notes | 69 | 63 | |||||
Acquisition-related items | (67 | ) | 32 | ||||
Provision for doubtful accounts | 34 | 49 | |||||
Deferred income taxes | 39 | (181 | ) | ||||
Stock-based compensation | 119 | 124 | |||||
Change in operating assets and liabilities, net of effect of acquisitions: | |||||||
Accounts receivable, net | 255 | (124 | ) | ||||
Inventories | (58 | ) | (202 | ) | |||
Accounts payable and accrued liabilities | (25 | ) | 74 | ||||
Other operating assets and liabilities | 68 | 571 | |||||
Certain litigation charges, net | 245 | — | |||||
Certain litigation payments | (91 | ) | (239 | ) | |||
Net cash provided by operating activities | 3,696 | 3,426 | |||||
Investing Activities: | |||||||
Acquisitions, net of cash acquired | (820 | ) | (556 | ) | |||
Additions to property, plant, and equipment | (336 | ) | (374 | ) | |||
Purchases of marketable securities | (7,746 | ) | (5,714 | ) | |||
Sales and maturities of marketable securities | 6,396 | 4,495 | |||||
Other investing activities, net | (4 | ) | (32 | ) | |||
Net cash used in investing activities | (2,510 | ) | (2,181 | ) | |||
Financing Activities: | |||||||
Acquisition-related contingent consideration | (17 | ) | (62 | ) | |||
Change in short-term borrowings, net | (9 | ) | 197 | ||||
Repayment of short-term borrowings (maturities greater than 90 days) | (1,850 | ) | (2,500 | ) | |||
Proceeds from short-term borrowings (maturities greater than 90 days) | 2,625 | 2,525 | |||||
Payments on long-term debt | (10 | ) | (24 | ) | |||
Dividends to shareholders | (797 | ) | (769 | ) | |||
Issuance of common stock | 158 | 67 | |||||
Repurchase of common stock | (1,247 | ) | (780 | ) | |||
Net cash used in financing activities | (1,147) | (1,346) | |||||
Effect of exchange rate changes on cash and cash equivalents | 11 | (91 | ) | ||||
Net change in cash and cash equivalents | 50 | (192 | ) | ||||
Cash and cash equivalents at beginning of period | 1,248 | 1,382 | |||||
Cash and cash equivalents at end of period | $ | 1,298 | $ | 1,190 | |||
Supplemental Cash Flow Information | |||||||
Cash paid for: | |||||||
Income taxes | $ | 422 | $ | 226 | |||
Interest | 226 | 197 | |||||
4
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 – Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S.) (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a fair presentation of results of operations, financial condition, and cash flows in conformity with U.S. GAAP. In the opinion of management, the condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the results of Medtronic, Inc. and its subsidiaries (Medtronic or the Company) for the periods presented. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Actual results could materially differ from these estimates. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended April 27, 2012.
On January 30, 2012, the Company completed its sale of Physio-Control. Beginning in the third quarter of fiscal year 2012, the results of operations, assets, and liabilities of the Physio-Control business, which were previously presented as a component of the Cardiac and Vascular Group operating segment, are classified as discontinued operations. All information in the following notes to the condensed consolidated financial statements includes only results from continuing operations (excluding Physio-Control) for all periods presented, unless otherwise noted. For further information regarding discontinued operations, see Note 3.
The Company’s fiscal years 2013, 2012, and 2011 will end or ended on April 26, 2013, April 27, 2012, and April 29, 2011, respectively.
Note 2 – New Accounting Pronouncements
Recently Adopted
In June 2011, and as subsequently amended in December 2011, the Financial Accounting Standards Board (FASB) issued final guidance on the presentation of comprehensive income. Under the newly issued guidance, net income and comprehensive income may only be presented either as one continuous statement or in two separate, but consecutive statements. The Company retrospectively adopted this guidance in the first quarter of fiscal year 2013, with comprehensive income shown as a separate statement immediately following the condensed consolidated statements of earnings. Since the new guidance only relates to presentation, its adoption did not impact the Company’s financial position, results of operations, or cash flows.
In September 2011, the FASB updated the accounting guidance related to annual and interim goodwill impairment testing. The updated accounting guidance allows entities to first assess qualitative factors before performing a quantitative assessment of the fair value of a reporting unit. If it is determined on the basis of qualitative factors that the fair value of the reporting unit is more likely than not less than the carrying amount, the existing quantitative impairment test is required. Otherwise, no further impairment testing is required. The Company adopted this guidance in the first quarter of fiscal year 2013. The adoption did not have a material impact on the Company’s consolidated financial statements.
Not Yet Adopted
In December 2011 and January 2013, the FASB issued new accounting guidance related to disclosures on offsetting assets and liabilities on the balance sheet. This newly issued accounting standard requires an entity to disclose both gross and net information about instruments and transactions eligible for offset in the balance sheet as well as instruments and transactions executed under a master netting or similar arrangement and was issued to enable users of financial statements to understand the effects or potential effects of those arrangements on its financial position. This accounting guidance is required to be applied retrospectively and is effective for the Company beginning in the first quarter of fiscal year 2014. Since the accounting guidance only impacts disclosure requirements, its adoption will not have a material impact on the Company’s consolidated financial statements.
In July 2012, the FASB updated the accounting guidance related to annual and interim indefinite-lived intangible asset impairment testing. The updated accounting guidance allows entities to first assess qualitative factors before performing a quantitative assessment of the fair value of indefinite-lived intangible assets. If it is determined on the basis of qualitative factors that the fair value of indefinite-lived intangible assets is more likely than not less than the carrying amount, the existing quantitative impairment test is required. Otherwise, no further impairment testing is required. The updated guidance is effective
5
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
for the Company beginning in the first quarter of fiscal year 2014 with early adoption permitted under certain circumstances. The Company will adopt this accounting guidance in the first quarter of fiscal year 2014 and does not expect it to have a material impact on the Company’s consolidated financial statements.
In February 2013, the FASB expanded the disclosure requirements with respect to changes in accumulated other comprehensive income (AOCI). Under this new guidance, companies will be required to disclose the amount of income (or loss) reclassified out of AOCI to each respective line item on the statements of earnings where net income is presented. The guidance allows companies to elect whether to disclose the reclassification either in the notes to the financial statements or
parenthetically on the face of the financial statements. This update is effective for the Company beginning in the fourth quarter of fiscal 2013. Since the accounting guidance only impacts disclosure requirements, its adoption will not have a material impact on the Company’s consolidated financial statements.
Note 3 – Discontinued Operations
Beginning in the third quarter of fiscal year 2012, the results of operations, assets, and liabilities of the Physio-Control business, which were previously presented as a component of the Cardiac and Vascular Group operating segment, are classified as discontinued operations.
On January 30, 2012, the Company completed the sale of the Physio-Control business to Bain Capital Partners, LLC. The Company sold $164 million in net assets and received $386 million in net cash, excluding potential earn-outs. Additionally, the Company entered into a Transition Services Agreement (TSA) with Physio-Control in which the Company is providing transition services to ensure continuity of operations for Physio-Control as it establishes stand-alone processes separate from Medtronic. The TSA requires the Company to continue to provide certain back-office support functions to Physio-Control in the areas of finance, facilities, human resources, customer service, IT, quality and regulatory, and operations. The timeframe for these services is expected to extend through the end of fiscal year 2013. The Company is being compensated for the services specified in the TSA. The Company records the income earned from the TSA in other expense, net in the condensed consolidated statements of earnings.
The following is a summary of the operating results of Physio-Control for discontinued operations for the three and nine months ended January 27, 2012:
Three months ended | Nine months ended | ||||||
(in millions) | January 27, 2012 | January 27, 2012 | |||||
Discontinued operations: | |||||||
Net sales | $ | 112 | $ | 323 | |||
Earnings from operations of Physio-Control | $ | 23 | $ | 48 | |||
Physio-Control divestiture-related costs | (12 | ) | (24 | ) | |||
Income tax expense | (5 | ) | (9 | ) | |||
Deferred income tax benefit on sale | 84 | 84 | |||||
Earnings from discontinued operations | $ | 90 | $ | 99 | |||
During the three and nine months ended January 27, 2012, the Company recorded an $84 million deferred income tax benefit in discontinued operations. In accordance with the authoritative guidance, the Company was required to establish a deferred tax asset on the difference between its tax and book basis in the shares of Physio-Control, up to the expected amount of the gain. In the fourth quarter of fiscal year 2012 the deferred income tax benefit was reversed upon finalization of the sale. Additionally, during the three months ended January 27, 2012, the Company recorded $12 million of Physio-Control divestiture-related costs in discontinued operations. During the nine months ended January 27, 2012, the Company reclassified $12 million of Physio-Control divestiture-related costs previously recorded in acquisition-related items within continuing operations on the condensed consolidated statements of earnings in the first and second quarters of fiscal year 2012 to discontinued operations. For further information on Physio-Control assets and liabilities sold, see Note 3 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended April 27, 2012.
Note 4 – Acquisitions and Acquisition-Related Items
The Company had various acquisitions and other acquisition-related activity during the first three quarters of fiscal years 2013 and 2012. Certain acquisitions were accounted for as business combinations as noted below. In accordance with authoritative guidance on business combination accounting, the assets and liabilities of the company acquired were recorded as of the acquisition date, at their respective fair values, and consolidated with the Company. The purchase price is recorded based on
6
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
estimates of the fair values of assets acquired and liabilities assumed. The pro forma impact of these acquisitions was not significant, individually or in the aggregate, to the results of the Company for the three and nine months ended January 25, 2013 or January 27, 2012. The results of operations related to each company acquired have been included in the Company’s consolidated statements of earnings since the date each company was acquired.
Three and nine months ended January 25, 2013
China Kanghui Holdings
On November 1, 2012, the Company acquired China Kanghui Holdings (Kanghui). Kanghui is a Chinese manufacturer and distributor of orthopedic products in trauma, spine, and joint reconstruction. Total consideration for the transaction was approximately $816 million. The total value of the transaction, net of Kanghui’s cash, was approximately $797 million. Based upon the preliminary acquisition valuation, the Company acquired $288 million of technology-based intangible assets and $53 million of tradenames and customer-related intangible assets that had a weighted average estimated useful life of 11 years at the time of acquisition and $401 million of goodwill. Acquired goodwill is not deductible for tax purposes.
The Company accounted for the acquisition of Kanghui as a business combination. The purchase price allocation is based on estimates of the fair value of assets acquired and liabilities assumed. The preliminary purchase price has been allocated as follows:
(in millions) | |||
Current assets | $ | 110 | |
Property, plant, and equipment | 56 | ||
Intangible assets | 341 | ||
Goodwill | 401 | ||
Other assets | 10 | ||
Total assets acquired | 918 | ||
Current liabilities | 30 | ||
Long-term deferred tax liabilities, net | 71 | ||
Other long-term liabilities | 1 | ||
Total liabilities assumed | 102 | ||
Net assets acquired | $ | 816 | |
Acquisition-Related Items
During the three and nine months ended January 25, 2013, the Company recorded net gains from acquisition-related items of $55 million and $44 million, respectively, including gains of $70 million and $67 million, respectively, related to the change in fair value of contingent milestone payments associated with acquisitions subsequent to April 29, 2009. The change in fair value of contingent milestone payments is primarily related to the change in fair value of Ardian, Inc. contingent commercial milestone payments, which are based on annual revenue growth through fiscal year 2015, due to current slower commercial ramp in Europe. Additionally, during the three and nine months ended January 25, 2013, the Company incurred transaction costs of $10 million and $13 million, respectively, in connection with the acquisition of Kanghui and an IPR&D impairment charge of $5 million related to a technology recently acquired by the Structural Heart business. During the nine months ended January 25, 2013, the Company incurred $5 million of transaction costs related to the divestiture of the Physio-Control business.
Three and nine months ended January 27, 2012
Salient Surgical Technologies, Inc.
On August 31, 2011, the Company acquired Salient Surgical Technologies, Inc. (Salient). Salient develops and markets devices for haemostatic sealing of soft tissue and bone incorporating advanced energy technology. Salient’s devices are used in a variety of surgical procedures including orthopedic surgery, spine, open abdominal, and thoracic procedures. Total consideration for the transaction was approximately $497 million. Medtronic had previously invested in Salient and held an 8.9 percent ownership position in the company. Net of this ownership position, the transaction value was approximately $452 million. Based upon the acquisition valuation, the Company acquired $154 million of technology-based intangible assets that had an estimated useful life of 12 years at the time of acquisition, $44 million of in-process research and development (IPR&D), $49 million of net tangible liabilities, and $348 million of goodwill. The value attributable to IPR&D has been capitalized as an indefinite-lived
7
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
intangible asset. The IPR&D primarily relates to the future launch of Salient’s concentric wire product. Acquired goodwill is not deductible for tax purposes.
The Company accounted for the acquisition of Salient as a business combination. During the first quarter of fiscal year 2013, the Company recorded minor adjustments to other intangible assets, goodwill, and long-term deferred tax liabilities as a result of finalizing the valuation for fair value of intangible assets acquired. The Company recorded the identifiable assets acquired and liabilities assumed at fair value as follows:
(in millions) | |||
Current assets | $ | 20 | |
Property, plant, and equipment | 11 | ||
IPR&D | 44 | ||
Other intangible assets | 154 | ||
Goodwill | 348 | ||
Other assets | 1 | ||
Total assets acquired | 578 | ||
Current liabilities | 43 | ||
Long-term deferred tax liabilities, net | 38 | ||
Total liabilities assumed | 81 | ||
Net assets acquired | $ | 497 | |
PEAK Surgical, Inc.
On August 31, 2011, the Company acquired PEAK Surgical, Inc. (PEAK). PEAK develops and markets tissue dissection devices incorporating advanced energy technology. Total consideration for the transaction was approximately $113 million. Medtronic had previously invested in PEAK and held an 18.9 percent ownership position in the company. Net of this ownership position, the transaction value was approximately $96 million. Based upon the acquisition valuation, the Company acquired $74 million of technology-based intangible assets that had an estimated useful life of 12 years at the time of acquisition, $17 million of net tangible liabilities, and $56 million of goodwill. Acquired goodwill is not deductible for tax purposes.
The Company accounted for the acquisition of PEAK as a business combination. The Company recorded the identifiable assets acquired and liabilities assumed at fair value on the acquisition date as follows:
(in millions) | |||
Current assets | $ | 5 | |
Property, plant, and equipment | 5 | ||
Other intangible assets | 74 | ||
Goodwill | 56 | ||
Total assets acquired | 140 | ||
Current liabilities | 10 | ||
Long-term deferred tax liabilities, net | 17 | ||
Total liabilities assumed | 27 | ||
Net assets acquired | $ | 113 | |
Acquisition-Related Items
During the three and nine months ended January 27, 2012, the Company recorded net charges (net gain) from acquisition-related items of $15 million and $(1) million, respectively, including charges of $15 million and $32 million, respectively, related to the change in fair value of contingent consideration. Additionally, in connection with the acquisitions of Salient and PEAK, the Company recognized gains of $32 million and $6 million, respectively, during the nine months ended January 27, 2012 on its previously held investments. In connection with these acquisitions, the Company began to assess and formulate a plan for the elimination of duplicative positions and the termination of certain contractual obligations. As a result, the Company incurred approximately $5 million of certain acquisition-related costs, which include legal fees, severance costs, change in control costs, and contract termination costs.
8
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Contingent Consideration
Certain of the Company’s business combinations or purchases of intellectual property involve the potential for the payment of future contingent consideration upon the achievement of certain product development milestones and/or various other favorable operating conditions. Payment of the additional consideration is generally contingent on the acquired company reaching certain performance milestones, including attaining specified revenue levels or achieving product development targets. Contingent consideration is recorded at the estimated fair value of the contingent milestone payments on the acquisition date for all acquisitions subsequent to April 24, 2009. The fair value of the contingent milestone consideration is remeasured at the estimated fair value at each reporting period with the change in fair value recognized as income or expense within acquisition-related items in the condensed consolidated statements of earnings. The Company measures the initial liability and remeasures the liability on a recurring basis using Level 3 inputs as defined under authoritative guidance for fair value measurements. See Note 8 for further information regarding fair value measurements.
Contingent consideration liabilities are remeasured to fair value each reporting period using projected revenues, discount rates, probabilities of payment, and projected payment dates. Projected contingent payment amounts are discounted back to the current period using a discounted cash flow model. Projected revenues are based on the Company’s most recent internal operational budgets and long-range strategic plans. Increases (decreases) in projected revenues and probabilities of payment may result in higher (lower) fair value measurements. Increases (decreases) in discount rates and the projected time to payment may result in lower (higher) fair value measurements. Increases (decreases) in any of those inputs in isolation may result in a significantly lower (higher) fair value measurement.
The recurring Level 3 fair value measurements of the contingent consideration include the following significant unobservable inputs:
($ in millions) | Fair Value at January 25, 2013 | Valuation Technique | Unobservable Input | Range | ||||
Discount rate | 13% - 24% | |||||||
Revenue-based payments | $137 | Discounted cash flow | Probability of payment | 95% - 100% | ||||
Projected fiscal year of payment | 2013 - 2019 | |||||||
Discount rate | 5.9% | |||||||
Product development-based payments | $4 | Discounted cash flow | Probability of payment | 100% | ||||
Projected fiscal year of payment | 2016 | |||||||
At January 25, 2013, the estimated maximum potential amount of undiscounted future contingent consideration that the Company is expected to make associated with all completed business combinations or purchases of intellectual property prior to April 24, 2009 was approximately $223 million. The milestones associated with the contingent consideration must be reached in future periods ranging from fiscal years 2013 to 2018 in order for the consideration to be paid.
The fair value of contingent milestone payments associated with acquisitions subsequent to April 24, 2009 was remeasured as of January 25, 2013 and April 27, 2012 at $141 million and $231 million, respectively. As of January 25, 2013, $122 million was reflected in other long-term liabilities and $19 million was reflected in other accrued expenses in the condensed consolidated balance sheet. As of April 27, 2012, $200 million was reflected in other long-term liabilities and $31 million was reflected in other accrued expenses in the condensed consolidated balance sheet. The portion of the milestone payments related to the acquisition date fair value of contingent consideration has been reported as financing activities in the condensed consolidated statements of cash flows. Amounts paid in excess of the original acquisition date fair value of contingent consideration have been reported as operating activities in the condensed consolidated statements of cash flows. The following table provides a reconciliation of the beginning and ending balances of contingent milestone payments associated with acquisitions subsequent to April 24, 2009 measured at fair value that used significant unobservable inputs (Level 3):
Three months ended | Nine months ended | ||||||||||||||
(in millions) | January 25, 2013 | January 27, 2012 | January 25, 2013 | January 27, 2012 | |||||||||||
Beginning Balance | $ | 213 | $ | 288 | $ | 231 | $ | 335 | |||||||
Purchase price contingent consideration | — | — | 5 | 2 | |||||||||||
Contingent milestone payments | (2 | ) | — | (28 | ) | (66 | ) | ||||||||
Change in fair value of contingent consideration | (70 | ) | 15 | (67 | ) | 32 | |||||||||
Ending Balance | $ | 141 | $ | 303 | $ | 141 | $ | 303 | |||||||
9
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 5 – Certain Litigation Charges, Net
The Company classifies material litigation reserves and gains recognized as certain litigation charges, net.
During the three months ended January 25, 2013, there were no certain litigation charges, net. During the nine months ended January 25, 2013, the Company recorded certain litigation charges, net of $245 million relating to probable and reasonably estimated damages resulting from patent litigation with Edwards Lifesciences, Inc. See Note 19 for additional information.
During the three and nine months ended January 27, 2012, there were no certain litigation charges, net.
Note 6 – Restructuring Charges
During the three and nine months ended January 25, 2013 and January 27, 2012, the Company did not incur any restructuring charges.
Fiscal Year 2012 Initiative
In the fourth quarter of fiscal year 2012, the Company recorded a $118 million restructuring charge, which consisted of employee termination costs of $66 million, asset write-downs of $9 million, contract termination costs of $30 million, and other related costs of $13 million. The fiscal year 2012 initiative was designed to reduce general, administrative, and indirect distribution costs in certain organizations within the Company while prioritizing investment in research and development, and sales and marketing in those organizations within the Company where faster growth is anticipated, such as emerging markets and new therapies.
In connection with the fiscal year 2012 initiative, as of the end of the fourth quarter of fiscal year 2012, the Company had identified approximately 1,000 positions for elimination to be achieved through involuntary and voluntary separation. Of the 1,000 positions identified in April 2012, approximately 600 positions have been eliminated as of January 25, 2013. The fiscal year 2012 initiative is scheduled to be substantially complete by the end of the fourth quarter of fiscal year 2013.
A summary of the activity related to the fiscal year 2012 initiative is presented below:
Fiscal Year 2012 Initiative | |||||||||||||||
(in millions) | Employee Termination Costs | Asset Write- downs | Other Costs | Total | |||||||||||
Balance as of April 29, 2011 | $ | — | $ | — | $ | — | $ | — | |||||||
Restructuring charges | 66 | 9 | 43 | 118 | |||||||||||
Payments/write-downs | (2 | ) | (9 | ) | (16 | ) | (27 | ) | |||||||
Balance as of April 27, 2012 | $ | 64 | $ | — | $ | 27 | $ | 91 | |||||||
Payments/write-downs | (26 | ) | — | (17 | ) | (43 | ) | ||||||||
Balance as of July 27, 2012 | $ | 38 | $ | — | $ | 10 | $ | 48 | |||||||
Payments/write-downs | (17 | ) | — | (4 | ) | (21 | ) | ||||||||
Balance as of October 26, 2012 | $ | 21 | $ | — | $ | 6 | $ | 27 | |||||||
Payments/write-downs | (5 | ) | — | (1 | ) | (6 | ) | ||||||||
Balance as of January 25, 2013 | $ | 16 | $ | — | $ | 5 | $ | 21 | |||||||
10
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 7 – Investments
The Company holds short-term and long-term investments, which consist primarily of marketable debt and equity securities.
Information regarding the Company’s short-term and long-term investments at January 25, 2013 is as follows:
(in millions) | Cost | Unrealized Gains | Unrealized Losses | Fair Value | |||||||||||
Available-for-sale securities: | |||||||||||||||
Corporate debt securities | $ | 4,171 | $ | 60 | $ | (7 | ) | $ | 4,224 | ||||||
Auction rate securities | 153 | — | (19 | ) | 134 | ||||||||||
Mortgage-backed securities | 1,050 | 8 | (8 | ) | 1,050 | ||||||||||
U.S. government and agency securities | 3,755 | 11 | (3 | ) | 3,763 | ||||||||||
Foreign government and agency securities | 34 | — | — | 34 | |||||||||||
Certificates of deposit | 6 | — | — | 6 | |||||||||||
Other asset-backed securities | 504 | 4 | — | 508 | |||||||||||
Marketable equity securities | 117 | 123 | (7 | ) | 233 | ||||||||||
Trading securities: | |||||||||||||||
Exchange-traded funds | 45 | 4 | — | 49 | |||||||||||
Cost method, equity method, and other investments | 486 | — | — | 486 | |||||||||||
Total short-term and long-term investments | $ | 10,321 | $ | 210 | $ | (44 | ) | $ | 10,487 | ||||||
Information regarding the Company’s short-term and long-term investments at April 27, 2012 is as follows:
(in millions) | Cost | Unrealized Gains | Unrealized Losses | Fair Value | |||||||||||
Available-for-sale securities: | |||||||||||||||
Corporate debt securities | $ | 3,501 | $ | 47 | $ | (7 | ) | $ | 3,541 | ||||||
Auction rate securities | 153 | — | (26 | ) | 127 | ||||||||||
Mortgage-backed securities | 840 | 9 | (10 | ) | 839 | ||||||||||
U.S. government and agency securities | 3,046 | 38 | — | 3,084 | |||||||||||
Foreign government and agency securities | 67 | — | — | 67 | |||||||||||
Certificates of deposit | 47 | — | — | 47 | |||||||||||
Other asset-backed securities | 535 | 3 | (1 | ) | 537 | ||||||||||
Marketable equity securities | 100 | 158 | (5 | ) | 253 | ||||||||||
Trading securities: | |||||||||||||||
Exchange-traded funds | 45 | 2 | (1 | ) | 46 | ||||||||||
Cost method, equity method, and other investments | 508 | — | — | 508 | |||||||||||
Total short-term and long-term investments | $ | 8,842 | $ | 257 | $ | (50 | ) | $ | 9,049 | ||||||
Information regarding the Company’s available-for-sale and trading securities at January 25, 2013 and April 27, 2012 is as follows:
January 25, 2013 | April 27, 2012 | ||||||||||||||
(in millions) | Short-term | Long-term | Short-term | Long-term | |||||||||||
Available-for-sale securities | $ | 1,166 | $ | 8,786 | $ | 1,344 | $ | 7,151 | |||||||
Trading securities | — | 49 | — | 46 | |||||||||||
Total | $ | 1,166 | $ | 8,835 | $ | 1,344 | $ | 7,197 | |||||||
11
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following tables show the gross unrealized losses and fair values of the Company’s available-for-sale securities that have been in a continuous unrealized loss position deemed to be temporary for less than 12 months and for more than 12 months, aggregated by investment category as of January 25, 2013 and April 27, 2012:
January 25, 2013 | |||||||||||||||
Less than 12 months | More than 12 months | ||||||||||||||
(in millions) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||
Corporate debt securities | $ | 1,038 | $ | (4 | ) | $ | 23 | $ | (3 | ) | |||||
Auction rate securities | — | — | 134 | (19 | ) | ||||||||||
Mortgage-backed securities | 459 | (3 | ) | 54 | (5 | ) | |||||||||
U.S. government and agency securities | 1,459 | (3 | ) | — | — | ||||||||||
Other asset-backed securities | 37 | — | 2 | — | |||||||||||
Marketable equity securities | 13 | (7 | ) | — | — | ||||||||||
Total | $ | 3,006 | $ | (17 | ) | $ | 213 | $ | (27 | ) | |||||
April 27, 2012 | |||||||||||||||
Less than 12 months | More than 12 months | ||||||||||||||
(in millions) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||
Corporate debt securities | $ | 664 | $ | (4 | ) | $ | 16 | $ | (3 | ) | |||||
Auction rate securities | — | — | 127 | (26 | ) | ||||||||||
Mortgage-backed securities | 218 | (2 | ) | 57 | (8 | ) | |||||||||
Other asset-backed securities | 55 | — | 9 | (1 | ) | ||||||||||
Marketable equity securities | 24 | (5 | ) | — | — | ||||||||||
Total | $ | 961 | $ | (11 | ) | $ | 209 | $ | (38 | ) | |||||
At January 25, 2013, the Company concluded that the unrealized losses associated with the available-for-sale securities detailed above were not other-than-temporary as the Company does not have the intent to sell, nor is it more likely than not that the Company will be required to sell, before recovery of the amortized cost basis.
Activity related to the Company’s short-term and long-term investment portfolio is as follows:
Three months ended | |||||||||||||||
January 25, 2013 | January 27, 2012 | ||||||||||||||
(in millions) | Debt (a) | Equity (b) | Debt (a) | Equity (b) | |||||||||||
Proceeds from sales | $ | 1,506 | $ | 25 | $ | 1,486 | $ | 28 | |||||||
Gross realized gains | 9 | 16 | 21 | 17 | |||||||||||
Gross realized losses | (5 | ) | — | (6 | ) | — | |||||||||
Impairment losses recognized | — | — | (1 | ) | — | ||||||||||
Nine months ended | |||||||||||||||
January 25, 2013 | January 27, 2012 | ||||||||||||||
(in millions) | Debt (a) | Equity (b) | Debt (a) | Equity (b)(c) | |||||||||||
Proceeds from sales | $ | 6,306 | $ | 90 | $ | 4,453 | $ | 81 | |||||||
Gross realized gains | 51 | 52 | 45 | 72 | |||||||||||
Gross realized losses | (12 | ) | — | (13 | ) | — | |||||||||
Impairment losses recognized | — | (10 | ) | (2 | ) | (4 | ) | ||||||||
(a) Includes available-for-sale debt securities.
(b) Includes marketable equity securities, cost method, equity method, exchange-traded funds, and other investments.
(c) As a result of the Salient and PEAK acquisitions, the Company recognized a non-cash gain of $38 million during the nine months ended January 27, 2012 on its previously held minority investments.
12
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The total other-than-temporary impairment losses on available-for-sale debt securities for the three and nine months ended January 25, 2013 were not significant. The total other-than-temporary impairment losses on available-for-sale debt securities for the three and nine months ended January 27, 2012 were $2 million and $5 million, respectively, of which $1 million and $3 million, respectively, were recognized in other comprehensive income and less than $1 million and $2 million, respectively, were recognized in earnings. These charges relate to credit losses on certain mortgage-backed securities and other asset-backed securities. The amount of credit losses represents the difference between the present value of cash flows expected to be collected on these securities and the amortized cost. Based on the Company’s assessment of the credit quality of the underlying collateral and credit support available to each of the remaining securities in which invested, the Company believes it has recorded all necessary other-than-temporary impairments as the Company does not have the intent to sell, nor is it more likely than not that the Company will be required to sell, before recovery of the amortized cost.
The following tables show the credit loss portion of other-than-temporary impairments on debt securities held by the Company as of the dates indicated and the corresponding changes in such amounts:
Three months ended | |||||||
(in millions) | January 25, 2013 | January 27, 2012 | |||||
Beginning Balance | $ | 20 | $ | 20 | |||
Additional credit losses recognized on securities previously impaired | — | 1 | |||||
Credit losses recognized on securities previously not impaired | — | — | |||||
Reductions for securities sold during the period | (2 | ) | — | ||||
Ending Balance | $ | 18 | $ | 21 | |||
Nine months ended | |||||||
(in millions) | January 25, 2013 | January 27, 2012 | |||||
Beginning Balance | $ | 20 | $ | 20 | |||
Additional credit losses recognized on securities previously impaired | — | 1 | |||||
Credit losses recognized on securities previously not impaired | — | 1 | |||||
Reductions for securities sold during the period | (2 | ) | (1 | ) | |||
Ending Balance | $ | 18 | $ | 21 | |||
The January 25, 2013 balance of available-for-sale debt securities by contractual maturity is shown in the following table at fair value. Within the table, maturities of mortgage-backed securities have been allocated based upon timing of estimated cash flows, assuming no change in the current interest rate environment. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
(in millions) | January 25, 2013 | ||
Due in one year or less | $ | 1,681 | |
Due after one year through five years | 6,898 | ||
Due after five years through ten years | 1,010 | ||
Due after ten years | 130 | ||
Total debt securities | $ | 9,719 | |
As of January 25, 2013 and April 27, 2012, the aggregate carrying amount of equity and other securities without a quoted market price and accounted for using the cost or equity method was $486 million and $508 million, respectively. The total carrying value of these investments is reviewed quarterly for changes in circumstance or the occurrence of events that suggest the Company’s investment may not be recoverable. The fair value of cost or equity method investments is not adjusted if there are no identified events or changes in circumstances that may have a material adverse effect on the fair value of the investment.
Gains and losses realized on trading securities and available-for-sale debt securities are recorded in interest expense, net in the condensed consolidated statements of earnings. Gains and losses realized on marketable equity securities, cost method, equity method, and other investments are recorded in other expense, net in the condensed consolidated statements of earnings. In addition, unrealized gains and losses on available-for-sale debt securities are recorded in accumulated other comprehensive loss in the condensed consolidated balance sheets and unrealized gains and losses on trading securities are recorded in interest
13
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
expense, net in the condensed consolidated statements of earnings. Gains and losses from the sale of investments are calculated based on the specific identification method.
Note 8 – Fair Value Measurements
The Company follows the authoritative guidance on fair value measurements and disclosures, with respect to assets and liabilities that are measured at fair value on both a recurring and nonrecurring basis. Under this guidance, fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. The authoritative guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability developed based upon the best information available in the circumstances. The hierarchy is broken down into three levels. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). Descriptions of the three levels of the fair value hierarchy are discussed in Note 7 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended April 27, 2012.
See the section below titled Valuation Techniques for further discussion of how the Company determines fair value for financial assets and liabilities.
Assets and Liabilities That Are Measured at Fair Value on a Recurring Basis
The authoritative guidance is principally applied to financial assets and liabilities such as marketable equity securities and debt and equity securities that are classified and accounted for as trading, available-for-sale, and derivative instruments. Derivatives include cash flow hedges, freestanding derivative forward contracts, and interest rate swaps. These items are marked-to-market at each reporting period. The information in the following paragraphs and tables primarily addresses matters relative to these financial assets and liabilities.
The following tables provide information by level for assets and liabilities that are measured at fair value on a recurring basis:
Fair Value as of January 25, 2013 | Fair Value Measurements Using Inputs Considered as | ||||||||||||||
(in millions) | Level 1 | Level 2 | Level 3 | ||||||||||||
Assets: | |||||||||||||||
Corporate debt securities | $ | 4,224 | $ | — | $ | 4,214 | $ | 10 | |||||||
Auction rate securities | 134 | — | — | 134 | |||||||||||
Mortgage-backed securities | 1,050 | — | 1,024 | 26 | |||||||||||
U.S. government and agency securities | 3,763 | 1,953 | 1,810 | — | |||||||||||
Foreign government and agency securities | 34 | — | 34 | — | |||||||||||
Certificates of deposit | 6 | — | 6 | — | |||||||||||
Other asset-backed securities | 508 | — | 502 | 6 | |||||||||||
Marketable equity securities | 233 | 233 | — | — | |||||||||||
Exchange-traded funds | 49 | 49 | — | — | |||||||||||
Derivative assets | 284 | 116 | 168 | — | |||||||||||
Total assets | $ | 10,285 | $ | 2,351 | $ | 7,758 | $ | 176 | |||||||
Liabilities: | |||||||||||||||
Derivative liabilities | $ | 162 | $ | 88 | $ | 74 | $ | — | |||||||
Total liabilities | $ | 162 | $ | 88 | $ | 74 | $ | — | |||||||
14
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Fair Value as of April 27, 2012 | Fair Value Measurements Using Inputs Considered as | ||||||||||||||
(in millions) | Level 1 | Level 2 | Level 3 | ||||||||||||
Assets: | |||||||||||||||
Corporate debt securities | $ | 3,541 | $ | — | $ | 3,531 | $ | 10 | |||||||
Auction rate securities | 127 | — | — | 127 | |||||||||||
Mortgage-backed securities | 839 | — | 810 | 29 | |||||||||||
U.S. government and agency securities | 3,084 | 1,511 | 1,573 | — | |||||||||||
Foreign government and agency securities | 67 | — | 67 | — | |||||||||||
Certificates of deposit | 47 | — | 47 | — | |||||||||||
Other asset-backed securities | 537 | — | 531 | 6 | |||||||||||
Marketable equity securities | 253 | 253 | — | — | |||||||||||
Exchange-traded funds | 46 | 46 | — | — | |||||||||||
Derivative assets | 254 | 87 | 167 | — | |||||||||||
Total assets | $ | 8,795 | $ | 1,897 | $ | 6,726 | $ | 172 | |||||||
Liabilities: | |||||||||||||||
Derivative liabilities | $ | 82 | $ | 37 | $ | 45 | $ | — | |||||||
Total liabilities | $ | 82 | $ | 37 | $ | 45 | $ | — | |||||||
Valuation Techniques
Financial assets that are classified as Level 1 securities include highly liquid government bonds within U.S. government and agency securities, marketable equity securities, and exchange-traded funds for which quoted market prices are available. In addition, the Company has determined that foreign currency forward contracts will be included in Level 1 as these are valued using quoted market prices in active markets which have identical assets or liabilities.
The valuation for most fixed maturity securities are classified as Level 2. Financial assets that are classified as Level 2 include corporate debt securities, U.S. government and agency securities, foreign government and agency securities, certificates of deposit, other asset-backed securities, and certain mortgage-backed securities whose value is determined using inputs that are observable in the market or can be derived principally from or corroborated by observable market data such as pricing for similar securities, recently executed transactions, cash flow models with yield curves, and benchmark securities. In addition, interest rate swaps are included in Level 2 as the Company uses inputs other than quoted prices that are observable for the asset. The Level 2 derivative instruments are primarily valued using standard calculations and models that use readily observable market data as their basis.
Financial assets are considered Level 3 when their fair values are determined using pricing models, discounted cash flow methodologies, or similar techniques, and at least one significant model assumption or input is unobservable. Level 3 financial assets also include certain investment securities for which there is limited market activity such that the determination of fair value requires significant judgment or estimation. Level 3 investment securities primarily include certain corporate debt securities, auction rate securities, certain mortgage-backed securities, and certain other asset-backed securities for which there was a decrease in the observability of market pricing for these investments. At January 25, 2013, with the exception of auction rate securities, these securities were valued using third-party pricing sources that incorporate transaction details such as contractual terms, maturity, timing, and amount of expected future cash flows, as well as assumptions about liquidity and credit valuation adjustments of market participants. The fair value of auction rate securities is estimated by the Company using a discounted cash flow model, which incorporates significant unobservable inputs. The significant unobservable inputs used in the fair value measurement of the Company’s auction rate securities are years to principal recovery and the illiquidity premium that is incorporated into the discount rate. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value of the securities. Additionally, the Company uses level 3 inputs in the measurement of contingent milestone payments and related liabilities for all acquisitions subsequent to April 24, 2009. See Note 4 for further information regarding contingent consideration.
15
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table represents the range of unobservable inputs utilized in the fair value measurement of auction rate securities classified as Level 3 as of January 25, 2013:
Valuation Technique | Unobservable Input | Range (Weighted Average) | |
Auction rate securities | Discounted cash flow | Years to principal recovery | 2 yrs - 12 yrs (3 yrs) |
Illiquidity premium | 6% | ||
The Company reviews the fair value hierarchy classification on a quarterly basis. Changes in the ability to observe valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy. The Company’s policy is to recognize transfers into and out of levels within the fair value hierarchy at the end of the fiscal quarter in which the actual event or change in circumstances that caused the transfer occurs. There were no significant transfers between Level 1, Level 2, or Level 3 during the three or nine months ended January 25, 2013 or January 27, 2012. When a determination is made to classify an asset or liability within Level 3, the determination is based upon the significance of the unobservable inputs to the overall fair value measurement. The following tables provide a reconciliation of the beginning and ending balances of items measured at fair value on a recurring basis that used significant unobservable inputs (Level 3) for the three and nine months ended January 25, 2013 and January 27, 2012:
Three months ended January 25, 2013 | |||||||||||||||||||
(in millions) | Total Level 3 Investments | Corporate debt securities | Auction rate securities | Mortgage- backed securities | Other asset- backed securities | ||||||||||||||
Balance as of October 26, 2012 | $ | 171 | $ | 10 | $ | 129 | $ | 27 | $ | 5 | |||||||||
Total unrealized gains/(losses) included in other comprehensive income | 5 | (1 | ) | 5 | — | 1 | |||||||||||||
Balance as of January 25, 2013 | $ | 176 | $ | 9 | $ | 134 | $ | 27 | $ | 6 | |||||||||
Three months ended January 27, 2012 | |||||||||||||||||||
(in millions) | Total Level 3 Investments | Corporate debt securities | Auction rate securities | Mortgage- backed securities | Other asset- backed securities | ||||||||||||||
Balance as of October 28, 2011 | $ | 174 | $ | 10 | $ | 127 | $ | 31 | $ | 6 | |||||||||
Total realized losses and other-than-temporary impairment losses included in earnings | (1 | ) | — | — | (1 | ) | — | ||||||||||||
Total unrealized gains/(losses) included in other comprehensive income | 6 | — | 6 | — | — | ||||||||||||||
Settlements | (1 | ) | — | — | (1 | ) | — | ||||||||||||
Balance as of January 27, 2012 | $ | 178 | $ | 10 | $ | 133 | $ | 29 | $ | 6 | |||||||||
Nine months ended January 25, 2013 | |||||||||||||||||||
(in millions) | Total Level 3 Investments | Corporate debt securities | Auction rate securities | Mortgage- backed securities | Other asset- backed securities | ||||||||||||||
Balance as of April 27, 2012 | $ | 172 | $ | 10 | $ | 127 | $ | 29 | $ | 6 | |||||||||
Total unrealized gains/(losses) included in other comprehensive income | 6 | (1 | ) | 7 | — | — | |||||||||||||
Settlements | (2 | ) | — | — | (2 | ) | — | ||||||||||||
Balance as of January 25, 2013 | $ | 176 | $ | 9 | $ | 134 | $ | 27 | $ | 6 | |||||||||
Nine months ended January 27, 2012 | |||||||||||||||||||
(in millions) | Total Level 3 Investments | Corporate debt securities | Auction rate securities | Mortgage- backed securities | Other asset- backed securities | ||||||||||||||
Balance as of April 29, 2011 | $ | 191 | $ | 17 | $ | 133 | $ | 35 | $ | 6 | |||||||||
Total realized losses and other-than-temporary impairment losses included in earnings | (3 | ) | (1 | ) | — | (1 | ) | (1 | ) | ||||||||||
Total unrealized gains/(losses) included in other comprehensive income | 1 | 1 | — | (1 | ) | 1 | |||||||||||||
Settlements | (11 | ) | (7 | ) | — | (4 | ) | — | |||||||||||
Balance as of January 27, 2012 | $ | 178 | $ | 10 | $ | 133 | $ | 29 | $ | 6 | |||||||||
16
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis
Non-financial assets such as equity and other securities that are accounted for using the cost or equity method, goodwill and IPR&D, intangible assets, and property, plant, and equipment are measured at fair value when there is an indicator of impairment and recorded at fair value only when an impairment is recognized.
The Company holds investments in equity and other securities that are accounted for using the cost or equity method, which are classified as long-term investments in the condensed consolidated balance sheets. The aggregate carrying amount of these investments was $486 million as of January 25, 2013 and $508 million as of April 27, 2012. These cost or equity method investments are measured at fair value on a nonrecurring basis. The fair value of the Company’s cost or equity method investments is not estimated if there are no identified events or changes in circumstance that may have a significant adverse effect on the fair value of these investments. The Company did not record any impairment charges related to cost method investments during the three months ended January 25, 2013 and January 27, 2012. During the nine months ended January 25, 2013 and January 27, 2012, the Company determined that the fair values of certain cost method investments were below their carrying values and that the carrying values of these investments were not expected to be recoverable within a reasonable period of time. As a result, the Company recognized $6 million and $4 million in impairment charges during the nine months ended January 25, 2013 and January 27, 2012, respectively. The impairment charges related to the cost method investments were recorded in other expense, net in the condensed consolidated statements of earnings. These investments fall within Level 3 of the fair value hierarchy, due to the use of significant unobservable inputs to determine fair value, as the investments are privately held entities without quoted market prices. To determine the fair value of these investments, the Company used all pertinent financial information that was available related to the entities, including financial statements and market participant valuations from recent and proposed equity offerings.
The Company reviews intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an intangible asset (asset group) may not be recoverable. The aggregate carrying amount of intangible assets, excluding IPR&D, was $2.392 billion as of January 25, 2013 and $2.277 billion as of April 27, 2012. When events or changes in circumstances indicate that the carrying amount of an intangible asset may not be recoverable, the Company calculates the excess of an intangible asset's carrying value over its undiscounted future cash flows. If the carrying value is not recoverable, an impairment loss is recorded based on the amount by which the carrying value exceeds the fair value. During the three months ended January 25, 2013 and January 27, 2012, the Company determined that a change in events and circumstances indicated that the carrying amount of certain intangible assets, representing less than five percent of the total aggregate carrying amount of intangible assets, may not be fully recoverable. During the three months ended January 25, 2013, the carrying amount of one intangible asset was less than the undiscounted future cash flows, therefore the Company assessed the asset's fair value and recorded an impairment of $2 million. The Company did not record any additional intangible asset impairments during the three or nine months ended January 25, 2013. The Company did not record any intangible asset impairments during the three or nine months ended January 27, 2012.
The Company assesses the impairment of goodwill and IPR&D annually in the third quarter and whenever events or changes in circumstances indicate that the carrying amount may be impaired. The aggregate carrying amount of goodwill was $10.341 billion as of January 25, 2013 and $9.934 billion as of April 27, 2012. The aggregate carrying amount of IPR&D was $366 million as of January 25, 2013 and $370 million as of April 27, 2012. During the three months ended January 25, 2013 and January 27, 2012, the Company performed its annual impairment reviews of goodwill and IPR&D. The goodwill impairment review requires the Company to make several estimates about fair value, most of which are based on projected future cash flows. The Company calculated the excess of each reporting unit's goodwill carrying value over its fair value utilizing a discounted future cash flow analysis. As a result of the analysis performed, the fair value of each reporting unit's goodwill was deemed to be greater than the carrying value. The Company did not record any goodwill impairments during the three and nine months ended January 25, 2013 or January 27, 2012. Similar to the goodwill impairment test, the IPR&D impairment test requires the Company to make several estimates about fair value, most of which are based on projected future cash flows. The Company calculated the excess of the IPR&D asset carrying values over their fair values utilizing a discounted future cash flow analysis. As a result of the analysis performed during the three months ended January 25, 2013, the fair value of IPR&D assets related to a technology recently acquired by the Structural Heart business was deemed to be less than the carrying value, resulting in a pre-tax impairment loss of $5 million that was recorded in acquisition-related items in the condensed consolidated statement of earnings. The Company did not record any additional IPR&D impairments during the nine months ended January 25, 2013. As a result of the analysis performed during the three months ended January 27, 2012, the fair value of each IPR&D asset was deemed to be greater than the carrying value, resulting in no IPR&D impairments during the three and nine months ended January 27, 2012. Due to the nature of IPR&D projects, the Company may experience delays or failures to obtain regulatory approvals to conduct clinical trials, failures of such clinical trials, delays or failures to obtain required market
17
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
clearances or other failures to achieve a commercially viable product, and as a result, may record impairment losses in the future.
The Company assesses the impairment of property, plant, and equipment whenever events or changes in circumstances indicate that the carrying amount of property, plant, and equipment assets may not be recoverable. The Company did not recognize any significant impairments of property, plant, and equipment during the three and nine months ended January 25, 2013 or January 27, 2012.
Financial Instruments Not Measured at Fair Value
The estimated fair value of the Company’s long-term debt, including the short-term portion, as of January 25, 2013 was $9.970 billion compared to a principal value of $9.126 billion, and as of April 27, 2012 was $9.965 billion compared to a principal value of $9.138 billion. Fair value was estimated using quoted market prices for the public registered senior notes and senior convertible notes, classified as Level 1 within the fair value hierarchy, and quoted market prices for similar instruments for the term loan on capital lease buyout, classified as Level 2 within the fair value hierarchy. The fair values and principal values consider the terms of the related debt and exclude the impacts of debt discounts and derivative/hedging activity.
Note 9 – Financing Arrangements
Senior Convertible Notes
In April 2006, the Company issued $2.200 billion of 1.625 percent Senior Convertible Notes due 2013 (2013 Senior Convertible Notes). The 2013 Senior Convertible Notes were issued at par and pay interest in cash semi-annually in arrears on April 15 and October 15 of each year. The 2013 Senior Convertible Notes are unsecured unsubordinated obligations and rank equally with all other unsecured and unsubordinated indebtedness.
Concurrent with the issuance of the 2013 Senior Convertible Notes, the Company purchased call options on its common stock in private transactions. The call options allow the Company to receive shares of the Company’s common stock and/or cash from counterparties equal to the amounts of common stock and/or cash related to the excess conversion value that it would pay to the holders of the 2013 Senior Convertible Notes upon conversion.
In separate transactions, the Company sold warrants to issue shares of the Company’s common stock at an exercise price of $76.56 per share in private transactions. Pursuant to these transactions, warrants for 41 million shares of the Company’s common stock may be settled over a specified period beginning in July 2013.
Based on existing guidance, the purchased call option contracts were recorded as a reduction of equity and the warrants were recorded as an addition to equity as of the trade date. Existing guidance states that a reporting entity shall not consider contracts to be derivative instruments if the contract issued or held by the reporting entity is both indexed to its own stock and classified in shareholders’ equity in its statement of financial position. The Company concluded that the purchased call options and sold warrants were indexed to its own stock and should be classified in shareholders’ equity and not separated as a derivative.
The Company accounted for the 2013 Senior Convertible Notes in accordance with the authoritative guidance for convertible debt, which requires the proceeds from the issuance of the 2013 Senior Convertible Notes to be allocated between a liability component (issued at a discount) and an equity component. The resulting debt discount is amortized over the period the 2013 Senior Convertible Notes are expected to be outstanding as additional non-cash interest expense.
The following table provides equity and debt information for the 2013 Senior Convertible Notes under the convertible debt guidance:
(in millions) | January 25, 2013 | April 27, 2012 | |||||
Carrying amount of the equity component | $ | 547 | $ | 547 | |||
Principal amount of the 2013 Senior Convertible Notes | $ | 2,200 | $ | 2,200 | |||
Unamortized discount | (20 | ) | (90 | ) | |||
Net carrying amount | $ | 2,180 | $ | 2,110 | |||
18
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
As of January 25, 2013, the unamortized balance of the debt discount will be amortized over the remaining life of the 2013 Senior Convertible Notes, which is approximately three months. The following tables provide interest rate and interest expense amounts related to the 2013 Senior Convertible Notes:
Three months ended | |||||||
(in millions, except interest rate) | January 25, 2013 | January 27, 2012 | |||||
Effective interest rate | 6.03 | % | 6.03 | % | |||
Interest cost related to contractual interest coupon | $ | 9 | $ | 9 | |||
Interest cost related to amortization of the discount | $ | 23 | $ | 22 | |||
Nine months ended | |||||||
(in millions, except interest rate) | January 25, 2013 | January 27, 2012 | |||||
Effective interest rate | 6.03 | % | 6.03 | % | |||
Interest cost related to contractual interest coupon | $ | 27 | $ | 27 | |||
Interest cost related to amortization of the discount | $ | 69 | $ | 65 | |||
Commercial Paper
The Company maintains a commercial paper program that allows the Company to have a maximum of $2.250 billion in commercial paper outstanding, with maturities up to 364 days from the date of issuance. As of January 25, 2013 and April 27, 2012, outstanding commercial paper totaled $1.635 billion and $950 million, respectively. During the three and nine months ended January 25, 2013, the weighted average original maturity of the commercial paper outstanding was approximately 104 days and 84 days, respectively, and the weighted average interest rate was 0.20 percent and 0.18 percent, respectively. The issuance of commercial paper reduces the amount of credit available under the Company’s existing lines of credit.
Bank Borrowings
Bank borrowings consist primarily of borrowings from non-U.S. banks at interest rates considered favorable by management and where natural hedges can be gained for foreign exchange purposes and borrowings from U.S. banks.
Lines of Credit
The Company has a $2.250 billion syndicated credit facility dated December 17, 2012 which expires on December 17, 2017 (Credit Facility). The Credit Facility provides the Company with the ability to increase its capacity by an additional $750 million at any time during the term of the agreement. The Company can also request a maximum of two one-year extensions of the Credit Facility maturity date, at each anniversary date of the Credit Facility. The Credit Facility provides backup funding for the commercial paper program, and therefore, the issuance of commercial paper reduces the amount of credit available under the committed lines of credit. The Credit Facility replaced the Company's four-year $2.250 billion syndicated credit facility which was scheduled to expire on December 9, 2014. As of January 25, 2013 and April 27, 2012, no amounts were outstanding on the committed lines of credit.
Interest rates are determined by a pricing matrix, based on the Company’s long-term debt ratings, assigned by Standard & Poor’s Ratings Services and Moody’s Investors Service. Facility fees are payable on the credit facilities and are determined in the same manner as the interest rates. The agreements also contain customary covenants, all of which the Company remains in compliance with as of January 25, 2013.
19
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Long-term debt consisted of the following:
(in millions, except interest rates) | Maturity by Fiscal Year | Payable as of January 25, 2013 | Payable as of April 27, 2012 | |||||||
4.500 percent five-year 2009 senior notes | 2014 | $ | 550 | $ | 550 | |||||
3.000 percent five-year 2010 senior notes | 2015 | 1,250 | 1,250 | |||||||
4.750 percent ten-year 2005 senior notes | 2016 | 600 | 600 | |||||||
2.625 percent five-year 2011 senior notes | 2016 | 500 | 500 | |||||||
5.600 percent ten-year 2009 senior notes | 2019 | 400 | 400 | |||||||
4.450 percent ten-year 2010 senior notes | 2020 | 1,250 | 1,250 | |||||||
4.125 percent ten-year 2011 senior notes | 2021 | 500 | 500 | |||||||
3.125 percent ten-year 2012 senior notes | 2022 | 675 | 675 | |||||||
6.500 percent thirty-year 2009 senior notes | 2039 | 300 | 300 | |||||||
5.550 percent thirty-year 2010 senior notes | 2040 | 500 | 500 | |||||||
4.500 percent thirty-year 2012 senior notes | 2042 | 400 | 400 | |||||||
Interest rate swaps | 2015 - 2022 | 168 | 167 | |||||||
Gains from interest rate swap terminations | - | 66 | 102 | |||||||
Capital lease obligations | 2014 - 2025 | 155 | 165 | |||||||
Total Long-Term Debt | $ | 7,314 | $ | 7,359 | ||||||
Senior Notes
The Company has outstanding unsecured senior obligations including those indicated as "senior notes" in the long-term debt table above (collectively, the Senior Notes). The Senior Notes rank equally with all other unsecured and unsubordinated indebtedness of the Company. The indentures under which the Senior Notes were issued contain customary covenants, all of which the Company remains in compliance with as of January 25, 2013. The Company used the net proceeds from the sale of the Senior Notes primarily for working capital and general corporate uses, which include the repayment of other indebtedness of the Company. For additional information regarding the terms of these agreements, refer to Note 9 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended April 27, 2012.
As of January 25, 2013, the Company had interest rate swap agreements designated as fair value hedges of certain underlying fixed rate obligations including the Company’s $1.250 billion 3.000 percent 2010 Senior Notes due 2015, $600 million 4.750 percent 2005 Senior Notes due 2015, the Company’s $500 million 2.625 percent 2011 Senior Notes due 2016, the Company’s $500 million 4.125 percent 2011 Senior Notes due 2021, and the Company’s $675 million 3.125 percent 2012 Senior Notes due 2022. For additional information regarding the interest rate swap agreements, refer to Note 10.
Note 10 – Derivatives and Foreign Exchange Risk Management
The Company uses operational and economic hedges, as well as currency exchange rate derivative contracts and interest rate derivative instruments to manage the impact of currency exchange and interest rate changes on earnings and cash flows. In order to minimize earnings and cash flow volatility resulting from currency exchange rate changes, the Company enters into derivative instruments, principally forward currency exchange rate contracts. These contracts are designed to hedge anticipated foreign currency transactions and changes in the value of specific assets, liabilities, and probable commitments. At inception of the forward contract, the derivative is designated as either a freestanding derivative or a cash flow hedge. The primary currencies of the derivative instruments are the Euro and the Japanese Yen. The Company does not enter into currency exchange rate derivative contracts for speculative purposes. The gross notional amount of all currency exchange rate derivative instruments outstanding at January 25, 2013 and April 27, 2012 was $6.610 billion and $5.136 billion, respectively. The aggregate currency exchange rate gains for the three and nine months ended January 25, 2013 were $17 million and $11 million, respectively. The aggregate currency exchange rate (losses) for the three and nine months ended January 27, 2012 were $(35) million and $(168) million, respectively. These gains/(losses) represent the net impact to the condensed consolidated statements of earnings for the derivative instruments presented below, offset by remeasurement gains/(losses) on foreign currency denominated assets and liabilities.
The information that follows explains the various types of derivatives and financial instruments used by the Company, how and why the Company uses such instruments, how such instruments are accounted for, and how such instruments impact the Company’s condensed consolidated balance sheets and statements of earnings.
20
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Freestanding Derivative Forward Contracts
Freestanding derivative forward contracts are used to offset the Company’s exposure to the change in value of specific foreign currency denominated assets and liabilities. These derivatives are not designated as hedges, and therefore, changes in the value of these forward contracts are recognized in earnings, thereby offsetting the current earnings effect of the related change in U.S. dollar value of foreign currency denominated assets and liabilities. The cash flows from these contracts are reported as operating activities in the condensed consolidated statements of cash flows. The gross notional amount of these contracts, not designated as hedging instruments, outstanding as of January 25, 2013 and April 27, 2012, was $1.662 billion and $2.039 billion, respectively.
The amount of (losses)/gains and location of the (losses)/gains in the condensed consolidated statements of earnings related to derivative instruments, not designated as hedging instruments, for the three and nine months ended January 25, 2013 and January 27, 2012 are as follows:
(in millions) | Three months ended | |||||||||
Derivatives Not Designated as Hedging Instruments | Location | January 25, 2013 | January 27, 2012 | |||||||
Foreign currency exchange rate contracts | Other expense, net | $ | (4 | ) | $ | 46 | ||||
(in millions) | Nine months ended | |||||||||
Derivatives Not Designated as Hedging Instruments | Location | January 25, 2013 | January 27, 2012 | |||||||
Foreign currency exchange rate contracts | Other expense, net | $ | (24 | ) | $ | 66 | ||||
Cash Flow Hedges
Foreign Currency Exchange Rate Risk
Forward contracts designated as cash flow hedges are designed to hedge the variability of cash flows associated with forecasted transactions denominated in a foreign currency that will take place in the future. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive loss and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. No gains or losses relating to ineffectiveness of cash flow hedges were recognized in earnings during the three and nine months ended January 25, 2013 or January 27, 2012. No components of the hedge contracts were excluded in the measurement of hedge ineffectiveness and no hedges were derecognized or discontinued during the three and nine months ended January 25, 2013 or January 27, 2012. The cash flows from these contracts are reported as operating activities in the condensed consolidated statements of cash flows. The gross notional amount of these contracts, designated as cash flow hedges, outstanding at January 25, 2013 and April 27, 2012, was $4.948 billion and $3.097 billion, respectively, and will mature within the subsequent three-year period.
21
MEDTRONIC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The amount of (losses)/gains and location of the (losses)/gains in the condensed consolidated statements of earnings and other comprehensive income (OCI) related to foreign currency exchange rate contract derivative instruments designated as cash flow hedges for the three and nine months ended January 25, 2013 and January 27, 2012 are as follows:
Three months ended January 25, 2013 | ||||||||||
Gross (Losses)/Gains Recognized in OCI on Effective Portion of Derivative | Effective Portion of (Losses)/Gains on Derivative Reclassified from Accumulated Other Comprehensive Loss into Income | |||||||||
(in millions) | ||||||||||
Derivatives in Cash Flow Hedging Relationships | Amount | Location | Amount | |||||||
Foreign currency exchange rate contracts | $ | (20 | ) | Other expense, net | $ | 22 | ||||
Cost of products sold | 4 | |||||||||
Total | $ | (20 | ) | $ | 26 | |||||
Three months ended January 27, 2012 | ||||||||||
Gross (Losses)/Gains Recognized in OCI on Effective Portion of Derivative | Effective Portion of (Losses)/Gains on Derivative Reclassified from Accumulated Other Comprehensive Loss into Income | |||||||||
(in millions) | ||||||||||
Derivatives in Cash Flow Hedging Relationships | Amount | Location | Amount | |||||||
Foreign currency exchange rate contracts | $ | 201 | Other expense, net | $ | (24 | ) | ||||
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