Boston Scientific Corporation (BSX) Earnings Call Transcript & Summary

All right. Good morning, everybody. Thank you for joining. I'm Lee Hambright, U.S. Medical Device analyst at Bernstein. We are thrilled to host Mike Mahoney from Boston Scientific this morning. We're scheduled for a 50-minute fireside chat here. [Operator Instructions] So Mike, first of all, thanks so much for joining. Really appreciate the time today.

Pleasure, Lee. Can you hear me okay?

Can hear you fine. Thank you. So let's kick off. It's been a wild ride, of course, for all of us over the last 16 or 17 months. But Boston Scientific is off to a good start in 2021. You delivered a nice, clean beat and raise in the first quarter. Your stock's outperforming large-cap medtech.

Maybe could you please just kick us off with a few thoughts on the state of the business at BSC?

Yes. Good. Good morning. Thanks for having us again. It's really remarkable versus this time last year. Last year was a very difficult period for the company. We took a lot of actions to ensure free cash flow and the long-term health of the company and keep our employees engaged in a very difficult time. And it's almost really the opposite right now. It's -- the business momentum you saw in the first quarter was quite good. And the improved vaccination rate in the U.S. and parts of Europe and some parts of Asia really got the economy moving again and hospitals are much more -- busier. And during that time, we also made some smart portfolio changes or additions through some M&A activity, with 2 deals, with Preventice and Lumenis as well as stopping some programs that we felt would be dilutive to our growth and margins long term. So we're really in a much stronger position and super excited about the remainder of this year.

Excellent. For generalist investors, Boston Scientific can be a little bit intimidating. You've got a lot of products. And it can be hard to kind of boil the story down to a few things that matter. Maybe for the generalists in the audience, how do you explain what's different about Boston Scientific versus your medtech peers?

Yes. I think it's difficult if you try to understand every single product that we have, then I think it becomes confusing. But I think if you take it at a high level, we're an interventional medicine company. We're trying to disrupt oftentimes surgery and pharma, treat patients and get them out of the hospital, typically same day or 1 day, which is certainly with the grain of health care. And then from a financial standpoint, our brand has continued to be -- grow faster than our peer group, which we've done for most all years since I've been here, except during the COVID year. And improved margins consistently and drive double-digit EPS growth. So that's the financial brand that we continue to execute against. And then the portfolio itself. We have these major franchises. Many of them are category -- significant category leaders in their field, like endoscopy, urology, peripheral interventions, interventional oncology, where we have clear global leadership. And they have portfolios that are quite wide. So you don't have oftentimes a $1 billion product. We eventually will with WATCHMAN. But other than that, what you have are, for lack of better words, singles and doubles products in these large global franchises that have very strong leadership positions. Not on all of them, but many of them. And I think one thing the company does really well is we -- each quarter, each year, we continue to increase our -- the growth rate of our TAM-served market. We made difficult portfolio decisions. We've significantly decreased the weighting of CRM and drug-eluting stent in our business. And we're always seeking new innovation that complements our current portfolio and increases the growth profile of the company. And I think we've done that very well, and it shows in terms of the financial results if you take out the COVID year.

Great. Let's touch on COVID recovery a little bit. In Q1, you grew 3% over 2019 levels. And in Q2, you expect a bit of acceleration to around 4.5% off 2019 at the midpoint. Then in the second half, you're aiming for some acceleration even from there despite tougher comps in the second half of 2019. Any surprises so far? Maybe you can give us a sense for sort of what you're seeing out there.

Yes. No surprises. We saw improvement each month in the first quarter. We saw a slow January, slow first part of February, and then the business really improved quite a bit second half of February and significantly in March. As -- really primarily driven by U.S. overall as vaccination rates improve. And obviously, everyone reads the papers and understands what's going on, the U.S. is quite healthy right now. And so similar to our guidances, we're not going to update second quarter on the call here. But we're seeing strong momentum in the U.S. and improvements in Europe as vaccination rates improve there. And our China business is quite robust. Japan has been under some pressure with COVID. So there's pockets of COVID challenges, but those challenges seem to be reducing down each month as we go throughout the second quarter here. And so I think that's reflective in our guidance, where we said second quarter will be better than first quarter; and then second half, ideally be better, hopefully better than the -- certainly better than the first half.

Got it. So there's a lot of talk about backlogs of patients whose procedures have been deferred. I think some of your peers have worked backlog recovery scenarios actually into their guidance, while others are less willing to quantify their backlogs. How do you think about backlogs across your segments? Is the backlog simply upside to your 2021 guidance, or is it already baked in, to some extent?

Yes. I would say -- first of all, I would be in the category where it's very difficult to quantify. We spent a lot of time trying to do that across our businesses. Many of them are procedures, patients can't wait that long to have these procedures. And so I've seen questions where backlog will extend in 2022. We don't see that as a scenario for Boston, given our portfolio. So we have a difficult time quantifying that. We know hospitals are extremely busy right now. The outpatient clinics are extremely busy. And so further backlog would be, I would call it, upside to our -- the guidance that we provided. Whereas we feel very comfortable with the guidance we provided as the base business, excluding some prolonged or onetime backlog effect.

Got it. We've also heard maybe some stories about physicians who are a little tired after the COVID year, maybe want to take a little break, go on vacation with their families. You probably haven't pulled your -- all of your customers to check their vacation plans. But what are you seeing out there in terms of how busy hospitals are?

So this is more of a U.S. comment. They're certainly quite busy. I've been in the field quite a bit. We don't anticipate any type of unusual vacation activity from the physician community than normal. Many of our businesses which are more outpatient-oriented, they're highly motivated to do the procedures, given the impact they took last year. And so we don't -- we're not seeing a physician shortage at this point or an issue with them not being able to fulfill patient needs. I know that they're extremely busy. But we don't see any extraordinary onetime vacation impact from the doctors.

Great. All right. So you've guided to 2% to 5% organic growth off 2019 levels for this year, which implies you could be growing 6%-plus off 2019 levels in the second half, potentially. And you've reiterated your goal to grow at the top -- grow the top line at the high end of the peer group, around 6% to 8% longer term. Consensus is closer to the high end of those ranges for 2021 and for '22 and '23. Or can you talk a little bit about your outlook for the business and comment on kind of where expectations have landed?

Sure. As I mentioned before, we're quite pleased with the progress in most all markets, except there's some slowness in pockets in Europe and some pockets in Asia Pac. And so as we mentioned, we think the business will continue to get stronger throughout the year based on the COVID recovery and our portfolio launches. So we're quite comfortable with the guidance that we provided. We're going to continue to execute. And we'll give our results at the end of July, but we're very comfortable with the guidance that we provided for '21. And we'll have our Investor Day coming up in September. And we've always stated our goal is to continue to grow faster than our peer group, in that 6% to 8% range, and improve margins and drive double-digit EPS growth. And we have a lot of excellent product launches that we can talk about it that will fuel -- continue to fuel '21 and beyond. But overall, I'd say we're quite comfortable with the ranges that we've given so far.

Great. From a consensus expectation standpoint, sometimes, it feels like consensus sort of floats up toward the higher end of your ranges. I wonder, how do you think about balancing a bullish view of the opportunities that lie in front of you with kind of managing expectations at the same time?

I think we can only control so much. So we try to -- we had a few hiccups in terms of our guidance in '19. But in general, over the many years, we've been pretty good about delivering on our guidance commitments and so forth. So that will -- that's the trend we want to continue in '21 and beyond. We can't always control where consensus is. I'm glad that the analyst community is as excited about the company as we are. And they should be, given the pipeline that we have. And the execution that we saw in first quarter and -- that we laid out for guidance. So no, I don't lose sleep over where the consensus is at this point. And we're just focused on growing the company and expanding into the emerging markets and integrating acquisitions and motivating our employees. So I don't have any other comments there.

Great. You mentioned integrating acquisitions. So tuck-in M&A has been a major contributor to the company's pivot into higher-growth medtech markets during your tenure. Investors, I think, were encouraged to see you get back out there with Preventice and Lumenis this year. What lessons have you learned in terms of when it makes more sense to build or buy a given technology or capability?

Yes. So we really try to map this out pretty well, in terms of what we want to do organically, what we'd like to do through our VC portfolio and what would make more sense to do through M&A. And our organic development drives the bulk of the revenue growth and EBITDA of the company. And you've seen lots of great organic work: in neuromod, our organically grown spinal cord simulation platforms and brain stimulation; what we've done with PI with all the drug-eluting technologies; what we do with single-use scopes. So you can go on and on about that. And then oftentimes, we see -- oftentimes, there are adjacencies that we want to add to the portfolio to drive commercial leverage and improve gross margins and expand the call point within that physician area. And we'll often do that through M&A. So urology is probably the best example there. We were primarily a stone company when I first joined the company, about a $500 million U.S. business. Now it's a global business. Now we've expanded with Lumenis, where we'll be the market share leader once that closes in laser technology, which is critical to our StoneSmart platform. Expanded into men's health, expanded into SpaceOAR oncology and others. So oftentimes, we use the M&A for adjacencies that really are technologies that are not in our sweet spot to bring into the company. And then we use our VC portfolio more often than not for, I would say, riskier bets. Usually early stage companies, quite early. Some of them work great, some of them don't work. And we use that, obviously, because the companies are very early stage, they'd be very dilutive to the P&L. We try to put ourselves in a position early to have a meaningful stake in those companies. And if they come through, then we acquire them.

Got it. How do you think about return on investment from those tuck-in deals? I mean, do you need the tuck-in M&A to keep you in that 6% to 8% growth range, going forward?

Now the tuck-in M&A really just -- it's kind of an anchor on that category leadership strategy that we have. And so if we layer on these adjacencies that are important to that position and drive innovation and uniqueness, then it makes that whole business stronger. That's the reason that we do it. It also helps in contracting capabilities. In terms of dollars spent, since I've been with the company, about 85% or so of the M&A dollars have been in more mature companies that have strong commercial presence already, where there's cost synergies; and about 15% of our dollars had been in very early stage, call it, riskier companies that it could have a big win or potentially not. But we feel like that's the right dollar balance. In terms of returns, we aim to get to our return on invested capital after year 3, is our goal. And we've had a pretty good track record of doing that.

Great. Some of your peers appear to be kind of taking a page from your playbook. They're talking about ramping up tuck-in M&A activity. At the same time, the medtech IPO market is healthier than it used to be. Are you starting to see a little bit more competition for those deals?

I would say there's -- it's always been competitive. We try to -- we have excellent leaders, excellent depth within our businesses. So they know those spaces extremely well. So they're able to understand the early trends in those businesses, to try to lay down VC bets earlier than most of our competitors because of the knowledge they have and the empowerment that they have to do that and the process that we have. So I think that's difficult to replicate. Some of the large consolidation that's occurred over the past 5 years have actually created fewer potential competitors, they may be bigger, but fewer in terms of numbers. So that's actually been helpful. Some of the public markets' frothiness has made it more difficult for some targets we potentially would like to acquire because the financials just don't make sense. But we always keep those types of companies in the bullpen potentially for the future. And so this year, we've done 2 acquisitions. Preventice is closed. Lumenis will close in the second half of this year. And we'll likely see us do 1 or 2 others. So that's a pretty normal pace for us. And it's always competitive, you always want to do smart deals, but we have a pretty savvy team and we have a pretty good playbook there.

Great. Let's touch on operating margins. You've improved operating margins significantly during your tenure, driven mostly by COGS efficiencies. Going forward, it sounds like you see considerable opportunity to drive operating expense efficiencies. You've talked about getting back to 26% operating margin in the back half of this year and then driving towards 30% over time. I'm sure we'll learn more about the expected kind of pace of margin expansion at your Investor Day later this year. But broadly speaking, what will drive kind of the next leg of BSC's margin expansion story?

Yes. So again, pre-COVID, we had a very consistent March, as you mentioned, in our operating income margin, and we feel like that will be the case. We're really gaining back. Our goal is, as you said, this year, to get back to that 26%-ish range as you look at kind of jumping off point in 2021, and so -- in terms of what we expect the second half of the year. And then we'd anticipate growing, call it, on average, 50 basis points a year. Some years, it may be more, some years maybe less, but we anticipate kind of a minimum of 50 basis point operating margin improvement per year going forward. And you combine that with the strong growth that we anticipate, our ability to deploy our free cash flow now is significantly better in '21 and the future than it's been over the past 5 years. So it's a big difference there. But really, that's how we look at it.

Got it. Can you consistently kind of grow above peers on an organic basis and have best-in-class margins? Or do you see some trade-offs there?

Well, if we just had WATCHMAN only, yes. I would say that isn't -- so that's very -- that's difficult to do, to do both of those. To be -- have the best-in-class growth rate and the best-in-class margin profile, unless you had a very, very narrow portfolio potentially. So with our portfolio, I think we've shown, through many years, ex-COVID year, that we can grow at sometimes at the high end of our peer group, but typically faster than our peers. You look at pre-COVID, we kind of grew organically 7.5% for 3 years in a row pre-COVID. And we guided to 6% to 8%, ex-COVID. So we feel quite comfortable with that range. And we've had a consistent track record of improving margins. And back to your question there, on the gross margin side, in terms of how we get there, on the gross margin front, we took that drop-down during COVID to recline back our gross margins to where they used to be. And that's what we anticipate, getting back to that kind of 71%, 72%-ish level. And we do see some upside opportunities in SG&A. Our SG&A is higher than many of our peers, and R&D is at the high end of our peer group. So we do see opportunities there. We've globalized our R&D group significantly more than we have in the past to drive more efficiencies, with engineering capabilities in China, India, Costa Rica, all our digital capabilities. So we do see opportunity for productivity in SG&A and R&D to support that margin improvement going forward. But we're not marching to -- if we can drive more margin improvement in a particular year, we certainly will, but we always want to fuel the growth of the company. And so we feel like the right balance has been to continue to grow faster than our peers, most of them, and improve margins as we continue to scale the business consistently. And we're not trying to claw it all back in one year, which is possible. But you could -- by doing that, you're oftentimes starving critical growth opportunities that you have for the long term. So we don't think that's the right long-term way to do things.

Got it. Anything post-COVID that creates an opportunity for real savings or maybe an inflection in operating margin? Or do you think we'll kind of go back to the way we were doing business before?

Yes. Our hope is that we don't go back. Meetings like this, quite frankly, are super-efficient this way. So we've invested -- we've tripled our digital investment over the past 18 months, with all things related to physician education, internal training capabilities, our -- a lot of our infrastructure, our DT -- direct-to-patient marketing. So we've really significantly enhanced our capabilities in that way, which hopefully will drive some productivity in SG&A and our marketing spend. Every company has seen significant travel savings, and the hope is that it doesn't go back to what it used to be in '19. And then we have some discipline there. It's not going to be as cost savings that we saw in '20 or maybe the first half of '21, but somewhere in the middle. And so I think you'll see a lot of the internal initiatives that used to be done in person, leveraging more digital tools. And many of the external-facing, customer-oriented programs likely will go back to be in-person, but not all of them. So we think it will be more productive than it used to be, but we don't want to get back to 2019 travel and expense living and spending levels.

Got it. Great. Maybe just a question on organization. I went back and listened to an interview you did back in the summer of 2012, right before you take the CEO role.

Wow. That was a slow day for you.

That's right. Yes. You talked about the power of decentralization and empowering business leaders to drive speed and accountability and not -- kind of not getting too bloated in the middle of the organization. I think some of your competitors are now kind of pivoting in a similar direction. And maybe without giving away your secret sauce, I'm just curious, what is it that you believe works so well about your unique model at Boston Scientific?

Well, I don't know if it's all that unique. There's only so many models you can implement. It's always about the people and the team that you have. That's always the most important. So we have excellent leaders. We're highly motivated. And the #1 thing we try to do is drive employee engagement. And you're not going to have that all the time in every division, in every region, in every function. But we really do our best to ensure that we stay modern with our training, our education, our development of our employees, to bring employees to understand how they make an impact on our business, how they help impact patients. So we do a lot to try to drive employee engagement. We're very supportive, have massive support of lots of diversity and inclusion efforts to further engage our employees to make Boston Scientific a place where people really want to work and stay. So I think that's the most important ingredient. As you know, in any company, if you're more engaged, you're going to work a little bit harder and drive more results, and care more, and come up with new ideas. So that's always #1. And then we do run a bit more decentralized than most companies do. And that's what leaders want. Leaders don't like a bunch of matrices or a bunch of dotted lines and so forth. So you're always going to get that as you have a larger company, but we try to minimize that, which promotes faster decision-making. It allows leaders to make difficult decisions; to allocate resources; and holds them accountable, which leaders like, to delivering on their goals and targets. And so I think most leaders really embrace that, and some leaders don't really want that. So we try to vet that out when we look at future leaders within the company. But we do certainly drive leverage with centralization in many areas of the company. Many of our back-office functions, all of our supply chain, quality, IT, compliance, legal, all that's centralized. And so we try to do as best we can to hold flat many of the spending areas year-over-year in those central functions to drive efficiency there so we can invest more in R&D and innovation and commercial capabilities. So I'm not so sure the model is that unique. It's really how it runs and the chemistry of the company. That's the secret sauce.

Got it. Excellent.

It's pretty easy to put that on an org chart and say we're going to modify and do it this way. But not so easy to do.

Yes. It takes some time. Great. Okay. Let's bounce around the businesses. Maybe starting with the Interventional Cardiology. In LAAC, of course, WATCHMAN has been an increasingly important growth driver for you. You're the first mover there in a very large addressable market, and market penetration is still really low. Competition, of course, is launching in the U.S. this year. Can WATCHMAN continue to be a double-digit grower for you as competition ramps up?

We believe so. Yes, this is a fantastic business for us. It's exceeded our expectations. The FLX launch has exceeded our expectations in terms of the effectiveness and safety profile of that device and the confidence that doctors have in it. And that was done organically within the company. So big kudos to our R&D team who really developed a second-generation device that's significantly better. And so that platform is performing extremely well. We have a significant infrastructure in place. We're launching it now globally in Japan. It's doing well in China. And as you know, we have a bunch of clinical trials that are actively enrolling to expand the addressable market. So we think, in our current indication, we're well under probably 7%, 8% of the indicated patients who are actually receiving WATCHMAN. So there's a significant amount of growth to drive in the current indication beyond geographic expansion. And then we have a number of trials in place to expand the TAM over time. So we think LAAC will be one of the fastest-growing markets in medtech for many, many years. With competition coming, they will certainly take some share. Difficult to predict what that will be. But given the strength of the portfolio that we have, the infrastructure that we have, the growth rate of the market and the indication expansion we anticipate, it's going to be a big grower for the company for many years.

Yes. Great. Yes. What do you think -- like you said, it's hard to predict share. But what does success look like in LAAC over the next 5 years? I mean, would 60% share by 2026 be a win or -- ?