Boston Scientific Corporation (BSX) Earnings Call Transcript & Summary

Good morning, everybody. It's a pleasure to see you all. Thank you for joining us here in the room and online. It is my great pleasure, and it's sincere pleasure to welcome 2 outstanding members of the Boston Scientific team. Dan Brennan, to my left, Chief Financial Officer and Executive Vice President; and Lauren Tengler, Head of Investor Relations, to open up this year's health care conference. Thank you both for being here. And Dan, I don't know whether to offer congratulations or condolences. This is -- we're celebrating our 10th year together here, you know?

Excited. Excited to be here. Thanks again for the invitation. It's always a pleasure to be here with you.

And we're grateful and always happy to see you and to talk about Boston Scientific. As I was preparing for this year's event, just reviewing the conference call, the numbers for the third quarter, looking at the note we wrote and looking at the business, up 9% year-to-date, an incredibly strong quarter. It just feels, in some touchy feely way and yes, analytical way, that Boston is in excellent shape.

My question is now you all sort of begin third quarter or any earnings season. Now, here we are near the end. Your performance seems particularly outstanding as I reflect on it. Help me understand, help us understand how Boston's coping? Why is Boston coping at the upper end, the best performers right now? And what does it mean now and as we look ahead?

I'd say a couple of things. I think on the revenue side, I think we have good momentum as a company. We just completed Q3. We were 11.5% organic revenue growth, as you mentioned. 6 of the 8 businesses grew double digits, which was great to see. So the underlying environment for our revenue growth, I think, is supportive from the -- in the health care ecosystem. Our full year guidance of approximately 9% organic revenue growth, I think that compares favorably to our peer set, which is great. And then the other piece is the rest of the P&L. So we've been very public about saying we have $375 million of headwinds from the global supply chain and inflationary macroeconomic challenges. And we're kind of seeking to offset those and get back to 26% -- approximately 26% adjusted operating margin for this year, which is important because it would do a variety of things. One, it would be back to where we were in 2019, which I think is important. Two, it would be 70 basis points ahead of where we were last year at the 25.3. And third, it would effectively offset those $375 million of headwinds. So really trying to dive in with some winning spirit and perseverance and do that. And I think if we do 9% on the top line and that 26% on the bottom line, I think that would be a green check plus for Boston Scientific for '22.

And when we think about the macro headwinds, a phrase I've come to loathe, currency, supply chain, cost inflation, hospital staffing, et cetera. From your perspective, when you look ahead, which do you feel like are getting better or stabilizing? Which are you just as concerned about or may be more concerned about it?

We can take them one at a time. So if you look at staffing, it is a challenge in pockets across our network. But obviously, as I said, I think the overall backdrop is constructive and allowed us to grow 11.5% in the quarter and the approximate 9% organic guidance for the year. So we feel like the environment for -- in the health care ecosystem is supportive of growth. So we like that. On the global supply chain and inflationary headwinds, what we've said is we're not banking on an improvement in that in '23, right? So we're going to look to continue to offset that. If we get some help in that, that's great. But I think it's prudent to just assume that those continue relative to where they are and do the margin expansion on the backs of what we do, making trade-offs within the rest of the P&L. On FX and hedging, obviously, significant movements in '22. We have a thorough, but it's a pretty conservative hedging program. We go out multiple years. So we don't just go 12 months in terms of contracts we buy, which is helpful because now we're largely hedged for '23 already. And so that's been very helpful over many years for us in helping just limit the volatility. And so this year, on what is around a 500 basis point impact on the top line, we'll only see about a $0.06 impact on the bottom line EPS. And part of that is actually unhedged currencies as well because it doesn't make sense to hedge all the currencies. So the hedging program impacts a little less, and then we have some impacts from the unhedged currencies. But I feel good that the hedging program we have in place is operating effectively.

And on the call, I think CEO, Mike Mahoney said, I think Mike mentioned that you've locked in some longer-term contracts for critical components or at-risk components. How big a program is that? Are you feeling -- does that derisk the outlook for '23? We'll get to that, but just maybe a little more color on that initiative.

Yes, I think what it does is it just brings more consistency of supply. So if you imagine yourself running a manufacturing plant, one of the things you don't want to have is inconsistency of supply. You have a product and it has 30 inputs in terms of materials, and you can source 29 of them reliably, but you can't get the 30th, you can't make a product. So if you can get that 30th and lock it in from a consistent supply perspective, you bring efficiencies back into the manufacturing setting. Our team has done a real nice job, I think. Kudos to them of continuing to supply physicians and customers needs. And for us, as you look at consistency of supply is a big piece of that. So yes, we've been able to, for some of our larger suppliers, lock in some more consistency and durability of supply, which will help us run more efficient manufacturing plants, which is helpful for that, but it's also helpful because then you're not putting negative manufacturing variances on the P&L. And as we know, those come off over a 6-month period. So the more efficiently you run the plant, the better your P&L looks.

Actually, [ Kim ], it's something I didn't appreciate as much the impact of plant inefficiency. It's how critical that is actually to the process -- to the margin process. And again, looking ahead, it's hard for me not to reflect on the potential for positive margin leverage. And certainly, as you pursue better growth and better operating margins looking ahead. But I don't know if this is the right way to think about it. It's a simple matter, but like so many of my thoughts. But when I sort of add back the headwinds from this year in the $375 million you talked about I mean, your $1.73 goes to $2, I'm sure there's other moving pieces there. The operating margin increases by 300 basis points more like 29%. Is my simple minded thought directionally way off? What am I missing? And the question I'm trying to get at in my long-winded setup here is it just seems like maybe we're underappreciating Boston's potential for margin expansion as things return to normal, whenever that might be.

If we're only that simple, just to raise the $3.75 million.

I'd love to, yes.

No, I think the -- I'll answer it in a long-term fashion. So we talk about -- so just take 26% as the 2022, adjusted operating margin number. And we talked about a long-term goal of 30% for a variety of reasons. One, other companies are there that proves that it can be done. Two, we have the plans for durable, consistent revenue growth because that really is the lifeblood of margin expansion. So we have those plans in our long-range plan. And then the ability to manage the different lines of the P&L as we've proven over the last many years. That -- gross margin used to be 72.4% in 2019. This year, it's probably in the 70.7% range. And so there's 170 basis points of gap there to get back there. SG&A, we continue to look to eliminate the lower value-add spending. We look to continue to do the shared service centers that we do, and so that can contribute. And then R&D, we've historically been kind of 10% or north of 10%. And I think over time to get to that 30%, you could see us in the 9% range, which would still be able to significantly fund and fuel the portfolio and the pipeline for the company. So I think over time, getting to that 30% is our goal and consistent margin expansion along the way is how we get there.

Yes. Well, you've been consistent over the years in talking about that potential. You've never been willing to go above 30%. But years ago, in a more challenging time, I said, if -- and I'm not going to say this exactly, but if CR Bard could have a 33%, 34% operating margin, I didn't see why Boston Scientific, given the mix, the volume, the efficiency of the superb Chief Financial Officer. I think that's the way Lauren wanted me to say it. Is it unrealistic to dream about the 30% plus area for Boston over the next 3 to 5 years? I don't know, picking a arbitrary time frame?

Yes. I wouldn't commit to a time frame, but that's why the plus is on that slide that we show at Investor Day. So it isn't a 100-meter dash to race to 30% and stop. We think there's an opportunity to go beyond that over time. And so we'll take it one bite of the apple at a time. We're at 26%. We need to continue to -- as guidance for this year. So we'll continue to do the things that we, I think, do well as a team and close in on those goals.

Okay. Pursuing that type of just one other small way. We didn't know a few months ago saying that a lot of the M&A that you had done over the last year or so would add maybe 30, 50 bps to your organic top line, obviously, with, I'm assuming, better-than-average margins, et cetera. Is that the right way to think about it? And when I reflect on the kind of growth we're seeing right now, it shouldn't -- couldn't I assume that these are going to be pushing more towards the upper end of the high-end 6% to 8% kind of growth outlook?

I don't think we comment specifically on what the acquisitions contribute over time. But if you just go back in the very near history, I'm super proud of the class of 2021. So we did five deals in 2021 at the time, bought $600 million of highly accretive growth in terms of the markets as well as our performance in those markets. So I like the size we are as a company, kind of at that, call it, in the round of $13 billion because adding five companies like that makes a difference.

It's impactful.

It's impactful still. So -- and M&A is an important part of our strategy. So I'm not going to tick through all of them, but if you just look at Lumenis and Baylis and Farapulse and Preventice and Devoro, I guess I just ticked through all of them, that's a real good class that I think is going to be helpful. It's already helpful. You've seen the impact of Farapulse for us in Europe and on the overall global EP business and hopefully, those continue to increase their impact over time.

Yes. Another aspect of the third quarter that really stood out, particularly so -- more so now looking back over the rest of Medtech was your international performance. It was really stellar this quarter. And even most particularly in the geography that I expected at least, China, up 36% in the third quarter. Just can you offer some high-level perspectives on what's driving your international performance, the sustainability and maybe spend some time talking about your special sauce in China and how sustainable is that really impressive growth is?

Sure. Let me start overall international. Yes, you're right. The international contribution has been significant. It isn't just China. It isn't just Asia Pac. It's Europe. It's our growth emerging markets in Europe. It's the emerging markets outside of EMEA. And it's really been a nice growth driver overall and very consistent as well. If you look back over time, the growth in Asia Pac and the growth in EMEA. And even LatAm and Canada is becoming less of a rounding error now they're growing 20%, north. And so that starts to matter even more. Specific to China, it's a good team for us. It's a diversified business that we have there. I will say that being a part of the value-based tenders that we are there is a good thing because that's been able to allow us increased market access, and it also allows us to pull through a lot of our other coronary technology. So that's -- we're happy to be in there. Yes, you get lower prices on stents and such, but you -- the pull-through and the market access been helpful for the top line there. And then WATCHMAN, I think is going to be a great opportunity there. With Flex, still need to finalize the whole reimbursement schemes across the whole country. But the number of strokes are 5x the U.S. in China. So we think WATCHMAN FLX can be a helpful product for China and for BSE.

Yes. And remind us your latest thinking on timing for Flex.

Flex is in China now.

Yes, exactly.

Yes. And do you need to build out a special team? Or...

No. So we'll secure reimbursement by province, and we'll build up the team as necessary in that way.

I see. One thing I wanted to come back to you, I was really distracting you with the next question on China because Lauren particularly was urging me to talk to you about 2023. I know that's your favorite topic. Actually, I can -- I was thrilled that you gave us a little color -- helpful color on the third quarter about currency share count and your -- obviously, your margin goals. You didn't mention revenue growth, and it was hard to me to avoid noticing that we're at 8% kind of growth. The Street seems to be 8% growth. So we're on the upper end of your -- the kind of general guide, 6% to 8% guidance. I'm not, of course, asking for guidance or any detailed commentary. But how do you feel about it? Does the M&A that we were just talking about push you potentially should we feel encouraged that it can push you above that kind of range?

It's good that you're not asking guidance because you won't get it.

I'm sort of shocked.

As you would expect. Yes, too early to talk about '23. We do feel good about the momentum we have as a company from a revenue perspective. And I mentioned it's a good -- it's a supportive environment. So we'll talk about '23 as we get closer to giving guidance. We did, however, as you mentioned, give some helpful modeling elements that maybe you want to run through them and just tick through and make sure everybody has them all.

Sure. So for FX, we had about a $0.06 headwind expected this year. And because we're largely not completely hedged in 2023 and the outsized growth on some of our emerging market countries where we may not hedge, we're expecting FX to be potentially slightly unfavorable next year just based on the current rates. For the mandatory converts, that's going to convert on June 1. There's a preferred dividend in each quarter of $13 million. That will go away. It will convert to shares. And we've got some good guidance in our financial and operating highlights that talks about how many shares will be converted based on the stock price. But in any instance, it should be EPS neutral. And then I think the last one I want to mention is tax. So just based on current legislation, we would anticipate our operational tax rate to be roughly the same next year as it is this year, which is at 14%.

Sounds good.

And just on tax, we are still hopeful relative to the -- our provision for R&D amortization tax. We've talked about that probably that that's an impact this year. It's bipartisan support in Washington that hopefully, at some point, whether it's this year or next year, that gets reversed.

Got you. Obviously, I think you'd be a great person to talk about the balance sheet and cash flow, I hope. It's hard for me to forget the days where free cash generation gush, when you came, were you generating $200 million? Were you generating free cash? And you've walked us up a ladder. This year, I think we're talking about $2.2 billion, if I remember correctly, in free cash generation. Before we get to the uses of cash, maybe talk us through from -- it's like as you look ahead to the next year, the next 3 to 5 years? What are your priorities now as CFO? What are going to be the biggest drivers, the biggest leverage you've got pull and push to double or triple that?

Relative to the cash flow specifically?

Yes.

Yes. So the lifeblood of that is revenue because the lifeblood of that is operating income. And when you look at the statement of cash flows, the biggest number on there is operating. So for us, it's all about driving that durable consistent top line growth, continuing to move margins north to drive more operating income. And then for the most part, within the working capital line, really, trying to leverage working capital. This year has been a little different in inventory because we're looking to build inventory in the face of the supply chain challenges. So could that be a use rather than a source? Likely. And actually, I'm probably okay with that because at this point, I'd probably rather have a little bit more inventory than less. And then receivables and payables and other elements, increase our conversion cycle. But it's become a hallmark of the company, the strength of the cash flow. And it one-for-one goes and provides the opportunity for us to continue the M&A pipeline. So it's important, and it's one of the most critical things we do.

Right. Before we talk about M&A, what are your capital priorities? I'm going to suspect M&A is tough, but let's save that separately. But what are your thoughts currently, given your relatively modest leverage, 2.5x, am I remembering that correctly?

At the end of Q3, balance sheet leverage, 2.5x.

And the significant cash flow. Beyond M&A, what are your cash priorities? Or is that just a...

I mean it really -- it's been consistent. I think it's worked well for us over the past many years that our capital allocation strategy is -- our #1 priority is for available cash is high-quality tuck-in innovative M&A. We've done a lot of that over the last 10 years. That's really the #1 priority. And we fill in on the back with share repurchase when we have excess cash, really only done that a couple of times in recent memory, most recently at the end of 2020 when we had the proceeds from the sale of a noncore asset and we used the cash there to retire shares and also to pay down a small amount of debt that was coming due the next year. So it hasn't been a big part of the capital allocation strategy because the M&A pipeline has been robust, and we've been able to do what I believe are very high-quality deals over the time.

All right. I agree. To talk about -- to start talking about the M&A strategy. I'd like to start in an unusual place, which is J&J's announcement that they're acquiring Abiomed. Honestly, Dan, I'd be very curious to not about your thoughts about Abiomed and whether that's a good or a bad deal, obviously. But does that change the game or your thoughts about acquisition or the portfolio in any way in the sense that you've been pursuing this sort of smaller tuck-in VC kind of strategy? Do you feel like you have to dial it up or ratchet it up? Or just high-level thoughts on how that changes, if anything.

Yes, it doesn't change at all. So for us, one of the keys over the last 10 years has been to continually increase the weighted average market growth rate of the company. And so we've effectively done that from the low single digits to kind of the 5 to 6. We hope with entering new markets over the next few years to get to 6 to 7 and kind of float the harbor of growth for Boston Scientific. That's done through the VC portfolio, seeding M&A. It's done through regular opportunistic M&A, and it's done through our R&D -- internal R&D pipeline that we spend, call it, $1.3 billion a year on. So really no change to that strategy. The seven verticals in physician specialties and disease states that we support provide more than enough growth for us to be able to continue to grow the company, and we hold ourselves accountable to growing faster than our market. So it's really no change for us. Steady as she goes.

Got you.

It's proven to be successful and don't see the need to change it right now.

And again, just as we contemplate the year ahead, to what extent are you interested or willing to use debt to fund the M&A strategy at this point? And what's an acceptable upper ceiling, if you will? Where do you want your -- I mean...

We have done that before with a couple of deals where we surged a little bit north and then had incredible deleveraging plans that we executed either at or ahead of schedule. So obviously, it's a rising rate environment, so not unique to us. If you're going to use debt to finance an acquisition with a higher cost of capital, it puts a higher emphasis on returns. You got to make sure that the asset that you're acquiring has the level of returns to cover the increased cost of capital. That's not new to us. We do that all the time in terms of making sure that our M&A has a strong strategic fit and compelling financial returns. But with a higher cost of debt, it just puts a little bit more emphasis on that if you were to try to use that.

Totally. And I'd really ask you if you ever think about share purchase. And obviously, given how well Boston shares have held up, maybe this is not uniquely, how to say, bargain basement think on us opportunity to do that. Is that part of your thinking at all over the coming years?

It's just as I said, I mean, the capital allocation strategy is, number one is the high-quality innovative tuck-in M&A. And then we would fill in on the back with share repurchase to the extent that we're not doing M&A. And so far, over the past many, many years, we've been able to successfully do M&A. We've done two deals this year. I would look for that trend to continue.

In the VC portfolio. Last year, I was looking through your comments at the Stifel Healthcare Conference, and you were strongly emphasizing the VC portfolio and the pipeline. I'm -- am I mistaken, there haven't been many from the -- your VC portfolio year-to-date, has something changed? Or are your hands full? Are you just letting the others mature? How are you thinking about that pipeline?

No, consistent again, that the VC portfolio has been, I think, unique in being able to provide and seed opportunities for us. If you look at last year, 3 out of the 5 deals we did was Devoro, Preventice and Farapulse, were all from the VC portfolio. And it really -- it's about $1 billion invested to date. We started about 10 years ago. At any point in time, there's about 35 companies in there. And it just really provides you a lower stress situation to be a thoughtful, well informed, potential, not always, acquirer of these companies when they exit. And we're going to keep that going. We continue to invest in small innovative companies and ride the wave and see if those turn into acquisitions for the company. But I'm super proud of what the team has done on the VC portfolio over that time frame.

That's been impressive. One thing I meant to ask you earlier, dripping out of this topic, price. Obviously, inflation as I've come through the quarter, I've better appreciated how many medtech companies are talking about raising prices very actively, very aggressively. Can you update us on what's happening and how you're thinking about it and maybe the impact of the raising prices could have as we look ahead to '23?

Yes. It's one of the ways we're offsetting the [indiscernible] we're no different than a lot of industries trying to offset their inflationary headwinds. And so it's one thing that we've -- one lever that we've looked to pull this year on -- in a thoughtful way on our more innovative technologies to try and offset our headwinds. Historically, we've been in the low single digits of decline in price. We've gotten better over time and better this year. And I think not unrealistic to set of goal that we'd like to be flat over time. Flat price could be will be a nice place to start every year, flat instead of having to kind of make up for prices being down.

And are you getting a lot of pushback? How are those discussions going? Are hospital customers, physician practices, are they understanding and working with you? Or...

Absolutely. I think if you're doing it again on your most innovative technologies that are providing benefit to the physicians, the patients, the ecosystem, hopefully, the hospital's bottom line, then I think you can engage in those conversations in a productive two-way discussion.

All right. One unusual question that we like to talk about, so many companies are spinning off assets or divesting assets during a period like this. Is that part of your thinking at all? Is this -- are you basically content with the portfolio?

I think -- we review, obviously, every year, our continual look at our overall portfolio, and I think we're comfortable with where we are right now. Everything kind of fits in that box of the seven verticals that we have.

Turning to two products in the brief amount of time we have left, I thought touch on WATCHMAN a little bit. I'm particularly impressed that WATCHMAN shares, over 90%, I think, still you're adding a new delivery system in '22, a next-gen, the WATCHMAN FLX PRO in '23 or so. Should we imagine that when we think about WATCHMAN growth and maybe, Lauren, you want to tackle this, does this -- do these expand the market? Is that a topic? I don't know how you're going to increase share. So help us understand that WATCHMAN growth sustainability with these new -- this pipeline initiatives?

Sure. So year-to-date, our WATCHMAN franchise has grown about 25%. We've pegged the market around 30%. So we feel really good with the trajectory this year. And we've actually stated that we expect that market to keep growing 30% just with penetration into the existing indication through 2024, and that represents about a $2 billion market. . Things like our Versa cross connect, which is an easier solution to accessing the left side of the heart in conjunction with our Baylis access system as well as new products like our steerable sheath in 2023 and WATCHMAN FLX PRO in 2023 plus, those will just contribute to that nice a 30% growth rate.

Yes. And again, not to push on this part, but I mean, will better technology expand the number of patients or the indications? Is that going to be part of the story? Or no?

We are just still early days in penetration, right? So if you think about the very large market that WATCHMAN can address, we're still maybe high single-digit penetrated. So there's really a lot of opportunity to continue to improve patient awareness and bring more value through these innovative products.

Great. I think we're just about out of time here. So I'll say on that exciting note, thank you so much. Congratulations on the great quarter and the great shape that Boston is. I appreciate it.

Thanks.

Pleasure to be here.

Yes.

Thank you.

Thank you.