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Medtronic Inc. (MDT - Analyst Report) reported first-quarter fiscal 2014 earnings per share (EPS) of 93 cents, up 12% year over year. After taking into account certain one-time items, adjusted EPS was 88 cents, up 4% year over year and in line with the Zacks Consensus Estimate.

Revenues in the reported quarter were $4.083 billion, up 2% year over year (up 3% at constant exchange rates or CER). However, it remained below the Zacks Consensus Estimate of $4.112 billion.

Total sales grew 6% year over year (up 9% at CER) to $1.887 billion in the reported quarter . The international market generated 46% of total sales. Based on the company’s focus on emerging markets, revenues from these regions experienced continued growth momentum and increased 15% (same at CER) to $504 million. This region now represents 12% of the company’s total revenue.

Segment Details

Medtronic earns revenues from two major groups – the Cardiac & Vascular Group and the Restorative Therapies Group. The former encompasses the Cardiac Rhythm Disease Management (“CRDM”), Coronary, Structural Heart, and Endovascular businesses; while the latter includes the Spine, Neuromodulation, Diabetes, and Surgical Technologies businesses.

CRDM sales were flat year over year (up 2% at CER) to $1.193 billion. Revenues from Implantable Cardioverter Defibrillators (ICD) declined 2% at CER to $655 million. With the growing strength of the Advisa DR MRI (TM) SureScan (TM) pacing system in Japan, pacing system revenues increased 6% at CER to reach $474 million.

Coronary, Structural Heart and Endovascular recorded growth of 3% (to $435 million), 13% (to $313 million) and 7% (to $219 million), respectively, at CER. The company is benefiting from the sale of the drug eluting stent (“DES”), which grew 10% at CER driven by significant share gains of the Resolute Integrity drug-eluting stent worldwide.

While strong CoreValve transcatheter aortic heart valve sales in the international market led to growth in the Structural Heart business, Endovascular growth was based on the launch of Endurant II in Japan, solid Thoracic business and strong double-digit growth in Drug Eluting Balloons.

Spine revenues maintained the sluggish trend and fell 3% year over year (down 1% at CER) along with a decline in revenues from BMP (bone morphogenetic protein). At CER, revenues from Core Spinal grew 1% to $641 million.

Meanwhile, Surgical Technologies revenues were $361 million (up 11% year over year and up 13% at CER), while revenues at Neuromodulation were $428 million (up 2%, up 3% at CER) and at Diabetes were $369 million (up 1%, same at CER).

Margins

Gross margin during the reported quarter contracted 75 basis points (bps) to 74.9%. Operating margin contracted 124 bps year over year to 14.2%, with a 1% increase in selling, general and administrative expenses (to $1.416 billion), a 5.0% rise in research and development expenses (to $1.022 billion) and a 12.8% increase in Other expenses (to $44 million).

Guidance

Medtronic reiterated its outlook for fiscal 2014. The company expects full-year EPS in the range of $3.80−$3.85 (annualized growth of 6%−8%) on revenue growth of 3%−4% at CER. The current Zacks Consensus Estimate for EPS stands at $3.83 (on revenues of $16.936 billion) and remains within the guided range.

Our Take

Medtronic is off to a disappointing start for fiscal 2014 with the top line missing estimates. Although adjusted EPS remained in line with the Zacks Consensus Estimate, margin pressure remains a major concern.

However, we are encouraged with the signs of improvement in Medtronic’s core CRDM and pacing segments. We are also impressed with the several recent growth initiatives taken by Medtronic. Earlier this month, the company acquired privately held Cardiocom, a developer and provider of integrated telehealth and patient services chronic diseases management. The acquisition is an attempt by the company to rebuild itself as a health care service provider.

In this regard, we note that the challenging economic conditions, a competitive environment, pressure on core segments and larger-than-expected currency headwinds continue to remain major causes of concern for medical device majors like Boston Scientific (BSX - Analyst Report).

Currently, Medtronic retains a Zacks Rank #4 (Sell). Medical products companies such as Affymetrix Inc. (AFFX - Analyst Report) and Gilead Sciences Inc. (GILD - Analyst Report),  which carry a Zacks Rank #1 (Strong Buy), are expected to do well.

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