Boston Scientific Corporation (BSX) Earnings Call Transcript & Summary

Well, good morning, everyone, and welcome to day 3 of the Morgan Stanley healthcare conference 2020. My name is David Lewis, medical device analyst at Morgan Stanley, and thanks for your -- for joining us bright and early, earlier for me than for you on the East Coast. It's my pleasure to kind of kick off day 3 here with one of our large-cap companies, Boston Scientific. We have both their CEO, Michael Mahoney; as well as their CFO, Dan Brennan. Pleased to have you both this morning. And with that, we're ready for action.

So team, I thought we'd start off where I'd been starting off kind of all week and just talk about COVID-19 recovery, your thoughts and anything you're willing to share here post the quarter. How have month-on-month trends been here in the third quarter? Most of our companies have talked about kind of nice sequential month-on-month improvement. I just wondered if you could comment on what you see here since the second quarter here as we work into the back half of the year.

Good morning, David. Nice to see you. Sure. Thanks for having us on the call this morning. Dan Brennan is with us as well. So we outlined in the April call that we expected a strong improvement in the third quarter, with an aim to grow in the fourth quarter. And so we're sticking with that. Similar to your comments, we have seen a strong improvement in third quarter versus second quarter given the nature of our procedures and the excellent job hospitals have done of managing COVID while also managing through elective procedures. So we're very encouraged by the recovery and very much consistent with the guidance that we provided post our April call.

Okay. And we're kind of modeling something around, The Street is, kind of upper single-digit like declines. Your comfortability versus where The Street sits in the third quarter at sort of upper single-digit declines -- and our sense is, at this conference, maybe people can do a little better than that, maybe sort of low to mid-single digits. Any sense there on how you're trending ?

Yes, yes. We'll see. We won't give a -- our estimate of the third quarter in the call here, but we've seen a consistent monthly improvement since the down period in April, which is really encouraging, based on the recovery of hospitals as well as the -- complemented by a very rich portfolio and as some of the new launches begin to take traction. But we won't be providing actual estimate of third quarter on the call other than that -- it's going to be nicely better than the second quarter. And we, again, aim to grow into fourth quarter, is the goal.

Okay. Are you feeling any better about the dynamic of growing in the fourth quarter now, Mike, just based on what you've seen here in the third quarter?

I think it's too early to call. I think a lot of it still depends on the environment that we're in with COVID. The -- our commercial teams are very much doing their jobs in the field, working with the customers. We're starting to ramp up our clinical trials more. We're starting to see some improved traction with our product launches. But still, the environment, I think, is still heavily dependent on what happens in the fourth quarter with COVID. If things stay kind of more in check, which I don't know if in check's the right word, but maybe describe that as today, then the odds improve. If there's more flare-ups in a more significant way, then that would be, obviously, a headwind on the entire industry. So I think it's too early to call, to give you any certainty as to the projections because I think so much of it depends on what happens in the fourth quarter with COVID.

I totally understand. So very, very helpful kind of in the near term. If we just kind of move out longer term. Maybe, Dan, for you. We started to ask some of the management teams about 2021 versus 2019, and obviously, no one's giving formal guidance here. But I sort of looked at my model last night. In 2021, I'm kind of, I don't know, 11%, 12% above 2019, which some days I wake up and I feel like that looks like a conservative number. I wonder if just -- qualitatively, can you talk at all about how 2021 can look versus '19? A lot of investors are very fixed in on that metric. And even on the margin perspective, can you get back to low 70s like GMs in 2021?

Sure. Let me hit each one of those separately. And I think the first one really piggybacks on what Mike had said, which is it's a little too early to call 2021. We're certainly not going to give any numbers on that for revenue for next year. I think I would just go back and say what we've been successfully executing as a company is growing at the high end of our peer set, and that's our goal heading into 2021. Obviously, comps are going to be a little crazy for '20 and '21. So when you normalize the comps for COVID and all of the dust settles, I'd like to think we can still be one of the companies that grows at the high end of the peer range. So not a lot of detail on that, but I think appropriate for where we sit today. Relative to gross margin, we think by the end of this year, and we said this on our last call, that we should be approaching 70% as we get the factories back to more of a normal production level. And as you look at 2021, there'll be headwinds and tailwinds. You'll have headwinds in some COVID protocols we got to put into the manufacturing plants just to be a little bit careful there, and that adds cost. The China tender probably isn't our friend, obviously, in terms of margin. And we will have some mix with new products, some of the new products that we have that are more dilutive out of the gate, certainly not longer term. And then the tailwinds are the normal process of taking our stranded costs out of the system that we have and then growth in some of our higher-margin products within IC and MedSurg and DBS, SCS, things like that. So we'll see where that all sorts out. We're in the middle of our annual operating plan process right now, and we'll see where that all sorts out as we finalize that as well.

If I say to you -- Dan, gross margin, there could be some headwinds into 2021. You just mentioned some of them, and obviously, new products could be on a different trajectory because of COVID. Yet, some of the companies are starting to talk about middle of the income statement leverage sort of in a post-COVID world. We've seen some restructurings out of certain corporations. I have to imagine you've got to find some pennies available in the middle of the income statement. Can they be used to offset gross margin pressure if there is any? Or are you more inclined to reinvest that money back into the business?

No, I think that's spot on, David. I mean, I think -- and we've proven that as a team over the last few years, that it's all about making trade-offs within different areas of the P&L. You're going to have quarters and years where gross margin is humming and you need to invest in SG&A. You're going to have quarters and years where it's a bit of a flip. So as we head into 2021, I think we'll do what we always do, examine all the areas of the P&L, make the trade-offs in investments, make the trade-offs between those areas of specific lines of the P&L and look to continue the margin expansion journey. Specific to, I think, your commentary around SG&A, there's headwinds and tailwinds within there as well. I mean obviously, the travel and entertainment world is a lot different than it was 6 to 9 months ago. So I would envision we'll spend a lot less in 2021 there. The other side of that is we're now needing to invest in digital and omnichannel and virtual training capabilities, which we're doing very significantly. And I think that's going to pay dividends not only for '21 but well beyond that. So again, back to headwinds and tailwinds within that line, we'll have to look and see how that shapes out as we go through the fall.

Okay. Cool. In spec pharma -- the spec pharma divestiture, our model says, if that would happen, that's kind of $0.08 to $0.09. That's probably not the kind of thing you can offset. If that were to happen, that probably just is kind of a onetime dynamic for '21. That's the question for you. And then for Mike, at some point, I know you don't want to have that asset potentially long term. But is there a point at which the valuation is not interesting enough to kind of get over your return threshold and you say, "You know what, it's a below cost of capital sale. We're just going to keep the downside?"

Yes. On the first part, we're obviously not going to comment on any potential sale and just reiterate what we've consistently said. It's a noncore asset. It does operate very separately within our structure, and we'll continue to evaluate strategic options.

Okay. Enough said there. Okay. I think that covers earnings for next year. Mike, I want to kind of start back with you. I mean this management team has created a dramatic amount of value over the last, call it, 6, 7, 8 years. One of the comments that come up during COVID, besides the equity offering and things of that nature, was just what happened in 2019. A lot of investors who called me who want to own Boston Scientific here on the recovery said 2019 was not the best execution year for the business. Given the benefit of hindsight, Mike, what happened in 2019, just given the performance on a per quarter basis versus guidance?

Sure. Yes. So we do have a high bar for the company. We obviously want to deliver against our commitments. If you look back at '19, that seems like a long time ago, we did deliver, I think, 7.3% organic growth. Obvious -- organic -- I can't remember what the operational number was, 1 point or 2 likely higher than that, but 7.3% operational. So there was some slight growth in '19 organically over '18. But we probably had at least -- probably had about 150 basis points of onetime headwinds. And like any plan, we always plan on headwinds, but we had kind of a series of onetimers that we didn't expect: the paclitaxel challenges, which are now getting better; the mesh recall; there were sterilization issues. So there was a kind of a flurry of onetimers that, in hindsight, maybe we could have provided a slightly wider range. But that probably impacted 100, 150 basis points. So overall, it's still a good year, 7.3% organic. We improved margins. We delivered double-digit EPS, which is really what we say. We say we're going to grow faster than the peer group, we're going to improve margins, we'll deliver double-digit EPS. So we did all of that. We also took down a lot of risk with some of our contingent liabilities in the legal front to free up our -- better use of free cash flow. So overall, we also advanced the portfolio. There were some maybe less than great, stellar performance versus some of the projections. But overall, I think it was a good year, but we had an unusual amount of onetimers, I would say, in the year.

Okay. So great. Idiosyncratic risk, there's no structural dynamics that you see kind of coming out of '19 that we should be concerned about as we head into '21?

No. Again, I think we grew at the higher end of the peer group at 7.3% organic, continued our margin improvement and double-digit EPS while investing at the high end of our peer group in R&D for our portfolio for the future. So not our best year, but certainly not a bad year.

So we talked about this in the earnings call as well. We talked about the 6% to 9% number for Boston Scientific. Can you get back to that range? Obviously, as Dan mentioned, '21 is going to be kind of a wonky year. Let's just take -- forget '21, it's a wonky year. If we go underlying '21 or go into '22, I mean, how confident are you this business can get back to that 6% to 9% zone?

Yes. If you try to neutralize all these comps, as you know, '21 will have easy comps, and '22, we may have tough comps. But if you try to neutralize for all that, really nothing's changed other than, obviously, with COVID, most companies, including Boston, have new capabilities as a result of COVID that we're doubling down on. As Dan said, the long-term travel impact and others is changing the way we do business, I think, for more productivity. The regulators have done a great job in Europe and U.S. on approving products. We've had some additional tailwinds with some recent reimbursement wins. So if you kind of neutralize for COVID, nothing has changed in the story. Our addressable served market growth continues to kind of be in the 5% to -- maybe 5% to 6% range based on the portfolio strategic shift we've had over the years where DBS and CRM become a smaller piece of our business each year, each quarter. And then we layer on the organic pipeline that we have and our flexibility to do some tuck-in M&A. So nothing's changed with the longer-term story in terms of the pipeline that we have, the growth we have, opportunities regionally. The balance sheet actually is better now than it was pre COVID. And so from that perspective, I think we exit COVID with more unique capabilities, slightly stronger balance sheet, less contingent liabilities and the same portfolio that we talked about pre COVID.

Okay. I think some investors looked at the secondary offering and your need to sort of stay active on M&A and venture and said maybe you're not as comfortable getting to 6% to 9% with the portfolio you have today. It sounds like you believe the portfolio that you have today can get you to that 6% to 9% number.

Yes, we do. We have a lot of confidence. We're just -- we're launching, we can go through some of the products, a lot of products right now than we will in 2021. And we've had a history -- BTG was a large deal that we did that was very strategic for us, and we think it's going exceptionally well. Very pleased that we did that. And since BTG, we've been quiet on the M&A front, except for our venture portfolio. So our venture portfolio primarily could lead to some tuck-in acquisitions over the next -- call it, within the next 18 months. And we're certainly looking at other opportunities that fill strategic needs and have the right return profile. So tuck-in M&A will continue to be part of our strategy, but the organic investments that we have with our pipeline are quite strong to deliver against that commitment.

Okay. So raising the equity was really about just making sure that you can maintain the same type of forward front portfolio, forward front action that you've had historically. It doesn't suggest to people that you need to urgently go out and do deals because you're feeling not as good about the core portfolio.

Yes, yes. Well, we did the equity raise. It was a bit of a different era with COVID. So we're concerned about that. And we didn't want to be, as you said, flat-footed on the defense over the next 18 months with our ability to leverage that venture portfolio and other opportunities. So we think it was the smart move for the company for the long term. And not in a big hurry to do it again, that's for sure, but we think it was the right move at the time for the company.

Mike, I've got this thesis that I don't think you agree with but I'm throwing out there anyway. But this dynamic that -- LOTUS was supposed to be a much bigger product in my mind, and maybe it's turned out to be. And my concern was that LOTUS may have resulted in a kind of a gap in the portfolio, and I guess that we've talked about this. I'm not sure you agree. But any concerns that LOTUS could have been a $400 million, $500 million, $600 million product, $700 million product and it's not, and that has sort of forced the company to sort of shift things around or it created a void in the RFP that has to be filled with M&A?

No, I think -- certainly, LOTUS will continue to be an important product for us. It's a significant market, as you know, and even small share gains are significant for us. And so LOTUS will continue to be an important growth driver for us, supported with our whole platform with ACURATE neo 2. But you also have other offsets. I would say our overall WATCHMAN performance is stronger than we ever anticipated to be. So -- and the performance of many of our other businesses, like a small one like DBS continues to do extremely well and exceeds our expectations. So overall, LOTUS remains a key growth driver for us. And we're not going to give you share estimates, but we're continuing to invest along those lines. We're starting to do more account openings. The reorder rate for existing users is quite high, and we're slowly being able to penetrate some new accounts with some new training. So LOTUS is important for us, but we have other tailwinds to support the company.

Okay. Last strategic question for me before we jump into some of these important products. Is -- Dan Starks said to me once, "I like Medtronic as a competitor." And I don't think he was being nice. So he -- you now have in Medtronic a new CEO that's talking about being front-footed. And frankly, he's doing some things like -- when I hear a company say, "We're going to restructure. We're going to get leaner. We're going to get decentralized," that's very much, in my mind, the Boston Scientific playbook. Is a more front-footed, decentralized Medtronic as a key competitor who now wants to do M&A deals when the prior CEO was really kind of shooing doing M&A -- is a more aggressive, decentralized Medtronic something that you should be concerned about at Boston Scientific?

Companies like that have always been good companies. I would say they are pretty front-footed when they bought Covidien. We know more about Covidien years ago. That's pretty front-footed. So I think we always have good competition, and that's actually healthy for the industry, it's actually healthy for Boston Scientific. But primarily, we invest most of our energy on our strategic portfolio, our go-to-market model. The culture of Boston Scientific, we think, is very unique and it's difficult to replicate. And we certainly wish -- we wish them well. But they've had very strong leaders in place for many generations, and that really hasn't impacted in a significant way our performance.

Okay. Very helpful. So you mentioned WATCHMAN, Mike, as being kind of an outsized driver. Clearly, it has. And I think you've said recently that WATCHMAN FLX could be sort of the biggest incremental dollar driver heading into '21. Is that on a kind of a gross or a net basis? I mean does that factor in some cannibalization of existing WATCHMAN users versus FLX? Or is that just a -- is that an incremental growth driver for the business? Do you think FLX is the biggest driver for '21?