Full article reprinted from "The Gray Sheet" - June 9, 2008
Medtronic is allocating an increasing share of R&D resources to its high-growth neuromodulation and diabetes care segments, at the expense of its larger but slower-growing cardiac rhythm disease management and cardiovascular care businesses.
While total R&D spending will remain at its current rate of about 10% of corporate sales, the planned shift in resource allocation relative to that of the past five years is meant to ensure that capital flows to the most promising opportunities, according to the company.
"We are taking more of an enterprise-wide approach on what we want to develop and ... how we allocate and track the resources we invest in R&D," Senior VP-Quality and Operations James Dallas said during the firm's June 2 analyst day meeting in New York.
Medtronic cites increasing regulatory burdens as a driving force behind its need to become more efficient in its R&D spending.
Senior VP-Strategy and Innovation Catherine Szyman explained that "the increasing need for clinical evidence and increasing scrutiny from a regulatory and quality perspective on our devices as they come to market" has led to increased spending on clinical trials as a percentage of the total R&D budget in recent years - from 10% of R&D in fiscal '03 to 17% in fiscal '08.
"As we look into the future, we believe that we're going to have to spend 20%-plus of our R&D investment on clinical trials to get the clinical evidence that we need to bring technologies to market," Szyman said. "So that means that we have to be more efficient with the remaining development dollars." Altogether, Medtronic expects to spend about $8 billion-$10 billion on device R&D over the next five years.
The plan, which includes targeting about 20% of R&D for "new market opportunities," is a key component of the firm's "One Medtronic" strategy. The strategy was articulated publicly for the first time at the meeting by CEO Bill Hawkins, though it encompasses certain previously disclosed organizational changes and financial targets (1"The Gray Sheet" May 5, 2008, p. 4).
"The 'One Medtronic' vision is a global mindset focused on achieving synergies and operating leverage both vertically and horizontally across all businesses and geographies," said Hawkins, who took over as CEO in 2007 (2"The Gray Sheet" March 5, 2007, p. 7).
The annual analyst meeting set a "positive tone," although the firm's financial targets remain "essentially unchanged," Wachovia analyst Larry Biegelsen said in a June 3 report. Based on the presentation, Medtronic "appears committed to setting achievable goals and focusing on disciplined capital deployment to shareholders and internal efforts."
Neuromodulation, Diabetes Units Are Fast Growers
Medtronic expects its neuromodulation business, with $1.3 billion in annual revenues, to grow at a 13%-15% annual rate over the next five years, while its $1 billion diabetes business will grow 12%-14% annually over the same period.
Key R&D projects in the neuro segment include deep brain stimulation (DBS) indications for treating depression and epilepsy. Near term plans include rolling out a DBS system "later this year" for obsessive compulsive disorder. Medtronic also expects to debut a U.S. bowel incontinence neurostimulator indication in fiscal 2010.
In the diabetes segment, Medtronic expects to introduce a new Paradigm insulin pump outside the United States this fiscal year as part of a "partial closed loop" artificial pancreas that can shut off insulin delivery under certain patient conditions. A fully "closed loop" system remains "the ultimate vision of our business," the firm said. Core development projects also include "tubeless" patch-based pumps and a hospital-based continuous glucose monitoring system.
Following a 14% increase in diabetes R&D spending last year, the segment is "making a big bet this coming year in increasing our R&D investment by 35% to push through what is arguably the most exciting new product portfolio in the company's history," remarked Christopher O'Connell, senior VP and president of the diabetes division.
Meanwhile, Medtronic's higher-profile, $5 billion cardiac rhythm disease management franchise is expected to grow at a 5%-7% rate, and its $2.1 billion cardiovascular business at 10%-14%.
Among the firm's other businesses, the company anticipates 10%-14% annual growth of its $3 billion spinal unit, and annual expansion of 10%-15% in its $800 million surgical technologies business. R&D allocation to the latter two segments will remain relatively steady compared with that of the last five years, according to the company.
Overall, Medtronic is forecasting organic corporate sales growth of 9%-11% annually through fiscal 2013. On May 20, Medtronic reported corporate sales for fiscal 2008 (ended April 25) of $13.5 billion, up 10% from last year (3"The Gray Sheet" May 26, 2008, p. 4).
On top of product innovation, including over 100 new product introductions slated for this year alone, geographic expansion remains a key part of Medtronic's strategy - particularly since the firm expects its overseas sales will continue the recent trend of growing faster than domestic revenues. Over the next five years, Medtronic projects its compound annual growth rate will be 10%-13% overseas and 8%-10% in the U.S.
"We have and will continue to invest in faster growing international markets ... Emerging markets like Brazil and Russia, India, China, South Korea, are just some of the more important, fast-growing markets in which we are investing," Dallas said.
Medtronic's overall strategic plan calls for boosting operating margins while trimming sales, general and administrative expenses to help increase profits.
For example, the firm expects to trim its "cost of goods sold" by 25%, or over $1 billion, by fiscal 2012 to help offset the effects of anticipated device pricing erosion, while still delivering earnings per share growth of 11%-14%.
The plan will allow Medtronic to generate about $20 billion-$22 billion in "free cash flow" over the next five years, with the intention to return a minimum of 40%-50% of that to shareholders each year in the form of dividends and share repurchases.
Hawkins noted that Medtronic will continue to seek potential "tuck in" acquisitions to leverage the firm's existing distribution capability. However, Medtronic does not currently see a need to do "larger, transformational, big" acquisitions, the exec concluded.
- Jon Dobson
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