Johnson & Johnson (JNJ) Earnings Call Transcript & Summary

I'm Travis Steed, medical device analyst, and also have Geoff Meacham from BofA. He's technically the lead coverage on J&J, and I co-cover the device business with him. And we also have Ashley McEvoy, Head of Medical Devices for J&J. So welcome to Vegas. Thank you.

Thanks. It's good to be here, Travis. Good to be here, Geoff. Welcome, everyone. Good to see people in person. Human beings, we're a social species. We like to see each other, talk to each other. It's good for health care after this conference. Health care will be booming.

Exactly. I guess I just wanted to start, Ashley, with kind of a bigger picture question. Looking at J&J on a historical basis, like there was a lot of markets that J&J missed out on that ended up being big growth markets and kind of before your time. When you think about like looking forward, I'd love to see like your strategic plan now. Is J&J willing to kind of take a little bit more risk on some of those markets, just on how you're thinking about the future of J&J devices?

Yes. He's getting right into it. There you go, a fast start for those who just had lunch. So I would say a couple of things, Travis. First, I would say, we have a really diversified business. And I'd love for everybody to start to think about us as a growth stock at scale, and I'll talk a little bit more about that. But we have like 11 $1 billion platforms. We're #1 or #2 in those. We're the world's leading orthopedics company. We're a world leader in surgery. We have this little feisty electrophysiology business that commands market leadership. It's been growing double digit for the past 10 years. #2 in eye health, but very compelling, posted 14% growth in quarter 1. So I think that we have a very diversified presence. We clearly have been very focused around performance and improving our competitive position, getting to above-market performance. I always often talk about 1.5%. That was pretty sobering, to 2.7%, to 3.9% growth, to 4.6% last year, 9% in quarter 1. It's hard slog, and we're going to dig our way out. When I think about the innovation agenda, I'll come to M&A, but I was talking this morning, 4 years ago, I've been in this role. Four years ago, we had 6 $100 million ENPV projects in our portfolio, 6. Now we have 27. We've doubled the value of our pipeline from $5 billion to $10 billion. And we absolutely want to compete in the areas of utmost medical, clinical need and high growth. We have some of those. We've divested some of those, but we absolutely want to have where the market is on our side.

Okay. No. That's great. I guess you just changed your name to MedTech, right? I don't know if there's anything to read into that or was this more of an update?

Yes. No. It was just MedTech.

Okay. Great. And then to kind of switch to elective recovery. I know it's also a pretty strong Q1, especially exiting March. Would love to look across your business and kind of see how that recovery has continued into like April, if things got, if April was better than March or kind of flat with March. We've heard different things from different companies. When you look across the hospital, what your hospitals are saying on capacity and some of the staffing issues?

Yes. I mean, look, it's like May, and we're still talking about COVID and just huge amount of empathy for our colleagues in China. I used to think that like ANZ had everybody beat of number of consecutive days in lockdown. But I think China is driving that with like 6 weeks. I'll come back to that. But I would tell you a couple of things. One, I think our worst days are behind us if we can head out on that. Two, we have a much wider armamentarium of solves to help change the curve of when surges happen. And three, it really depends where you are in the world. And four, labor presented itself as a challenge before on nurses. It just got accentuated. I don't see that solving itself anytime immediately. And that, combined with some macroeconomic, inflationary pressures, have all of us making sure that we're doubling down on being prepared to handle the patient recovery as it's coming. I always talk about in U.K., Lord Prior, we talk about 6 million folks on the waiting list in the U.K., 600,000 patients waiting for orthopedic procedures. So there's volume to be had and it's kind of clunky. Some folks have figured it out and some folks are still in the thick of it.

When you look at that backlog, how do you think that comes back into the system?

Yes. I mean, I think that Europe still has a lot of patient backlog to be solved. I think the United States still has a lot of backlog to be solved. Some are ahead of others. I always use, as an example, cardiac ablation because we are the world leader in that. But it still has less than 10% global penetration. So right now we are actually refilling the patient funnel as one example versus I would tell you like spine procedures, there's still such a backlog of folks that we're kind of plowing through the backlog. So it really is, we look at all the vertical beats of procedures. And I think over quarter 2, I remind everybody, let's look at the comp last year was a pretty phenomenal anomaly of a comp in Q2 2021. But I think year-over-year, we're going to start to see some more consistency relative to the WAMGR that we're used to in MedTech.

Yes. No. That's great. Let's hope that's the case. And then on China, I guess more of a shorter-term question on China. If you look at Q2, the shutdowns and lockdowns, have you started to see that recover a little bit? And what you're seeing on the ground in China right now?

Yes. I mean, I think it's different now than in the beginning when COVID happened in China. I don't think, a couple of things, one, the percent vaccinated and the efficacy of the vaccines is different than a lot of the global interventions available. So we ideally would love to see that patient population have access to that. But two, I don't have a crystal ball to know what's going to happen in China by any means. But I think that there is going to be a more conservative approach going up to Xi's election in November. And we're not anticipating a major change in policy. Maybe some of you have different insight than we do. We're not betting on that. But I do think that, if anything, we've learned and what we've been spending our energy on is really making sure that physician education continues to happen on market creation, a lot of telementoring, a lot of sales force investment on acumen of like the next-generation technologies so that we're prepared to launch those. So when things do open up, we're ready to go. I mean, the whole country is not in shutdown. About 180 million folks are on lockdown. Tier 2 and Tier 3 cities are continuing to do cases. And we will see. We're not expecting a significant improvement in the immediate term.

Okay. And I guess more of a longer-term question on China. You had some China VBPs. Do you think that's going to continue? Like do you see China as the same opportunity longer term maybe as you did a couple of years ago?

Absolutely do. I mean, we've been in China for over 35 years. There's 1.4 billion patients that need to be served in China. It's the second-largest MedTech market. I think we're very fortunate that we have a diversified portfolio in China. We are the #1 leader in MedTech in China. We have very strong, locally groomed talent running our businesses in China. We've invested in local on-the-ground plants. We've invested in innovation centers. We've invested in local on-the-ground R&D. We have very strong partnerships, and we think that they really are kind of huge, at the forefront on a lot of data sciences and e-commerce and connected commerce and professional commerce. We're very sensitive and aware of the geopolitical environment that we live in. We like to say we serve all global patients. I think China will be bumpy this year. VBP has made China bumpy. We have to pivot to make sure we've got really differentiated innovation. Again, given the diversity of our portfolio, we've been able to weather some of those, some of the challenges that might come on pricing, how do you make it up on volume. We're benefiting from that right now, as an example, in joints. We're benefiting, as an example, right now in our intraocular lenses. We just took over #1 market leadership there in IOLs. But we are, by no means, naive to know where that market could go if that becomes the business model.

Ashley, while we're talking about sort of the macro issues, I mean, you have for a lot of companies in the device space as well as pharma, you have inflation. You have commodity. You have a lot of supply chain sort of disruption. So help us at a sort of macro level for your device business where you see a lot of these pressures start to play out with respect to inflation and even some scarcity of commodities?

Yes. I mean, well, I mean, many of us haven't seen these kinds of inflation rates in 40-plus years. It's kind of, I would say it's not business as usual right now at all. I think that's like the new normal coming out of the pandemic. My goodness, how many do we have ahead of us like this? But I would tell you, J&J, the benefit of scale is helping us on procurement, on category expertise in each of the different line items. I think they tend to fall into 2 different areas. One, we always call the spot buy is where there's 300% inflation on an item, on one good. Right now we're very much around business continuity, preparing for those cases, preparing to manage the procedures. We've been more successful than I think perhaps others that haven't had that benefit of that large scale. The second big segment is probably around just the investment in wage and labor and distribution and ports and fuel and energy. I think that's with us for a little while and we're going to have to really re-evaluate how we consistently pursue growth and prepare for patient backlogs. But make sure that while we continue to invest in R&D, we're challenging every other thing in our cost structure.

How are you looking at pricing offsets across your portfolio? Where is there opportunity to potentially get a little less negative price or some positive price on capital equipment and just through your various businesses, would love to see how those conversations are going if you're having those conversations with the hospitals at this point?

Yes. I mean, I think historically, we're probably known as a respected beat that given the long-term contracts and tenders and with government systems that prices typically set for a while. I would just say that this is not business-as-usual times. And I think everybody is reassessing what that looks like. You probably saw some hospitals take price from payers. And ultimately, that goes to employers and it comes full circle, if you will. We have parts of our business like our ACUVUE contact lens business, which is really a consumer iconic driven brand that has been able to earn price in today's marketplace. Historically, where MedTech has been more of a low single-digit dilution in price, we've been benefiting from the investment in R&D and innovation that we've actually been holding neutral to slightly favorable for the first time in years in price.

Okay. No. That's great. And then there's been a lot of discussion from investors on medical devices in a recession, if we do enter into a recession. So any thoughts on how your business would hold up around certain areas, maybe do better than others. But if you look back historically at other recessions, what would you expect to happen with medical devices in a recessionary environment?

Well, I mean, listen, couple with the backlog of COVID and look at the economics, I mean, health care historically has behaved to be a lot more resilient in times of recession. Our portfolio is a bit over-indexed on areas like stroke, trauma, electrophysio, where you can't, interventional oncology, you can't really avoid delaying of care for a certain period. And as we all know, folks have already delayed care. So I'm encouraged by history, and then everybody has different exposures. I would say we have a balanced exposure in the J&J MedTech portfolio and coming off of a significant once in a lifetime pandemic also has to be contemplated.

Right. And then I know you don't sell a ton of capital. But I know you talk to a lot of hospital CEOs and CFOs. I don't know if you have a view on like the capital environment right now, capital purchasing from hospitals.

Yes. I think that you're hearing sporadic as everybody is, we're weaning off of COVID government investment for a period of time. And COVID cases, there were, I would say, some temporary pauses of kind of the clearinghouse. If I think about the backlog of just volume that has to happen on patient care, I think capital is going to get more scrutiny in today's world. But I see as an enabling technology if it can really shift the curve on outcomes, I'm seeing not a change in behavior from predicate times.

And I guess the inevitable M&A questions. And would love to kind of get a sense for like if you look across your portfolio, where do you want to invest inorganically, adjacencies, which markets that you're probably the most interested in, in doing M&A.

Yes. I mean, I would tell you, listen, it's no small chump change. We've invested $10 billion over the past 5 years. And so you can say where is that? And do I want to continue to invest because have we been getting a good return? Yes. Our deals have delivered above the cost of capital as a minimum. Where we deploy that capital, number one is we get the best success of where there's an adjacency. There could be some synergistic value. They can kind of feed off of each other and help each other. An example of that is we have a world-leading ACUVUE contact lens business, over $3.5 billion, very profitable business, very innovative business, very modern, sophisticated, end-to-end supply chain, kind of world-class in optics and material science. If you take that when we bought AMO, a leader in intraocular lenses. You put those teams together and there's some really differentiated innovation coming in optics for premium IOLs and monofocal IOLs, let alone a sophisticated cost structure of end-to-end supply chain. I think of our neurovascular business, which is adjacent to our electrophysiology business. That business has doubled in size over the past couple of years, is growing double digit. And it's one where we're not #1 or #2. So I would like to be #1 or #2 when I think of the future, but that's really benefited from some of the sophistication of our miniaturized catheters on mapping and zapping the heart and how do you take that know-how and apply it to the brain for neurovascular. And that's really been, I would see an accelerator, Travis. And then I'd say, obviously, we've invested significantly in robotics and digital surgery. So our VELYS, which is our knee business, I'd like to always say the robot is an enabling technology, not a replacement. What's equally, if not maybe more important at times is the permanent implant left in your body. We have the most modern knee on the marketplace with a significant amount of compelling scientific evidence. You combine that with a very capital-efficient technology called VELYS. We've done over 2,000 cases. We get good feedback of its precision. You don't need a CT scan. The workflow has improved, much more capital efficient than what's available in the market today. Very early innings, again, less than 10% to 15% penetration in ortho. Just this week, I was with our Monarch team, which also came through an acquisition, really building how we go solve lung cancer. First, we have approval for diagnostic. We're in active clinical trials right now for ablating lesions on the lung. And we're in clinical trials of dispersing localized drug delivery on the lung lesion, again, not a systemic effect, but a localized drug effect that really changes the, quite frankly, patient outcomes of Stage 4 cancer patients to really intercept the disease early on. We just got approval the past 60 days of endourology. Like one out of every 2 folks, unfortunately, if you get a kidney stone, you have to have a reoccurring procedure. We're starting to look at some good rates, around 90% stone-free. So I'm encouraged about Monarch, and then our soft tissue also came through an acquisition. So M&A, we use unbelievably strategically where we want to be #1 or 2. Can it feed those 11 verticals and we want to start to compete in the highest growth end state markets. So it really is an and.

Right. And looking at some of those end markets, I think in the past you've mentioned peripheral neuro. If you can think about what markets those are that maybe would fit best in the J&J portfolio?

Yes. I mean, when we're looking at growth, again, I start with areas that we're in now that can be bolt-ons. And I think of like, you know us as the world's leading trauma company, but there was a fast-growing elective foot and ankle company. So that elective foot and ankle is growing 2x the category average of trauma. So we just did an acquisition in bunionectomies and hammertoes with the CrossRoads acquisition. In our Ethicon business in surgery, making sure that we're going into the highest growth areas like in interventional oncology. We've been adding on there. I talked about neurovascular. We're going to continue to look at those higher-growth subsegments that are 2 to 3x the general WAMGR. And then I look at the world of interventional, where right now electrophysiology is one of the largest and fastest-growing areas in cardiovascular, but there are other subsegments of cardiovascular. We're looking at other areas in interventional oncology. When I look at the future of surgery, we're a leader in open and we're a leader in lap. We're in endoluminal. We're going to be in soft tissue. There are technologies out there that we've got equity investments that are incisionless surgery. So those are a couple on the horizon.

Ashley, when you look at the deals that you guys have done, both pharma and in MedTech, there's a certain sort of technical component to it. You digitize a patient experience. You have a lot of software that could also help onboard folks, identification like that. How much of that plays a role in your decisions on M&A beyond just the product itself, the totality of the patient experience?

Geoff, I mean, I think that is kind of the new normal. I mean, I'm very encouraged with how kind of the more traditional med device market has that beautiful intersection. That's why we changed our name because we're very much 100% all-in in digital, not just from a product development and not just how we really revolutionize our supply chain, but really how we change episodes of care. And I'll give you a couple of examples. Some are small, some are big. I mean, simple things like we're all human beings. Surgeons are human beings. They love to know how they compare relative to the best in the world. They love to know how their case is racking and stacking versus the best surgeons in Japan, in Korea, in Italy. So we, through an acquisition, we bought a technology that we're integrating into our surgical portfolio called C-SATS and gives them real live time feedback of how their case is tracking relative to the best-in-class. We have investments and technology that in a procedure, it's kind of do no harm, stay away from that tissue, stay away from that structure. It gives you interoperative real live time information and data so you can scale up and improve your outcome on that. I shared some examples about in orthopedics even with our, we're a leader in hip replacements. And while we have very competitive technology of implants, understanding all of the variability that still happens around when you take out the ball in your hip, how do you make sure that you get the absolute, precise, highly personalized size of what that cup needs to be. We just bought a technology called CUPTIMIZE that gives you near 99.9% precision on that. Let alone another application that will assess your pelvic tilt, which leads to hip refractures and reinjury. So I'm encouraged by a lot of these new utilizations that will help narrow the variability in how procedures are done and give more predictable outcomes.

When you think about size of acquisitions that you're interested on, how you're thinking about tuck-ins versus larger acquisitions and how you'd put any parameters around how to think about the potential for various sizes of M&A?

Yes. I mean, historically, we've gotten the most value. 90% of our deployment of M&A has been in less than $1 billion. We always start with also keeping the ecosystem healthy. We were the first development core, Johnson & Johnson development core to really reach out to the ecosystem to work with the start-ups to enable access to regulatory sciences. We spent over $1 billion in equity investments that we can then nurture and then scale globally. So that continues to be, I'd say, a feeder. If you look at a lot of the areas that turned into acquisitions, they came from early equity investments. So we continue to pay a lot of attention to that. But listen, we are not afraid of, history would suggest less than $1 billion. You've got robotics at a couple of billion dollars; AMO, a couple of billion dollars. But really, we just have to have a good value creation thesis. And certain MedTech markets, as we know, we're looking at valuations. And some are tougher than others. And you need to hold us accountable for making sure that we've got good conversion to value.

How are valuations today? Like, obviously, like are you seeing expectations from sellers resetting yet or not yet? There's been a lot of fluctuation in the public markets at least.

Do you guys have the answer to that? Some folks are different. I mean, I would tell you, the good news is this. The market is still very attractive for MedTech, and we start there. And I believe that the market will continue to be attractive. And why do I believe that way? Because there's a lot of unmet medical need. I think the state of technology on the S-curve is moving up that S-curve. We're still lower relative to other industrial beats. And then we're coming off of the world's largest backlog in patient care in over 100 years. And I think that the patient mindset of managing health and investing in health as an investment, not just an expense, is why governments are investing significant dollars in there. It's why we have to innovate the experience because the experience, as we all know, as consumers of health care, is not where we need it to be relative to other industries. So that gives me optimism, Travis, I would say. Listen, we also know there's cost pressures. So we also know there's inefficiencies in the system. And we have to do our part. We're doing a lot on emerging sites of care, where you almost have like a clean canvas, and you can reimagine what that whole care experience looks like, whether that be in like Tier 2 or Tier 3 cities in China or whether that be in the ASCs in the United States. That's really been fun for our teams to kind of reinvent benefiting from all the learning of 100 years at surgery.

Great. And I guess shifting away from M&A and you look at more of your organic investments in R&D, just any color on like where you're putting most of those dollars in? Any of the pipeline products that you think can move the needle the most in the next year or 2?

Yes. I mean, I really get most excited about, I always say, solving the 5 leading causes of mortality and really having a meaningful impact on care and outcomes. And I use cardiac ablation as an example because it's still very much at its early innings, less than 10% penetration around the world. Managing atrial fibrillation is a precursor to stroke. So it is, in fact, a disease interception. If you can manage that, you can prevent a stroke. We understand that cardiovascular is the leading cause of death in the world, big significant investment of cost and profit item for hospital systems. So I look at how we can double and triple the penetration of managing people earlier on in the onset of disease so that they can have a much better quality of life. And I think of things like your sight and myopia and really having a meaningful intervention on the disease interception of slowing down the disease of high myopia. And if high myopia is not managed, it leads to retina detachment and you go blind. So that's a great example of disease interception to get a better outcome. I think about lung cancer as I talk about not waiting until you're at Stage 4 to get diagnosed, but how do you in a very minimally invasive do-no-harm way get a proper diagnostic and a same-day treat in a minimal way. So I'm encouraged with the best that MedTech has, the best biopharmaceuticals. You put software in there. And I think that for the next couple of decades, we're going to see our best days ahead.

And I guess last question for me really is more of the consumer spin. Like how does that change the view internally of medical devices? Now there's only 2 divisions or will be 2 divisions. As you get more investment dollars, any particular focus that changes within corporate J&J?

Yes. Well, first, I'm happy. I have to give a shout out. Thibaut Mongon was announced today. He's a close colleague of mine. We've worked together. I'm a big believer in Thibaut's leadership. He's a visionary. He's smart as a whip. And he's got a really keen eye of where that model is going on consumer health. And so I'm encouraged with that. I mean, the reason why we made this and elected to make this change, a pretty profound change over our 135-year history, is we felt like, listen, consumers and their behaviors have evolved. And so they want to, it is all about e-commerce and m-commerce and small localized brands at social media. Anybody can be their own brand. And we needed to kind of unleash them to be at their best self and unencumbered from a highly regulated, high science industry. And so why the 2 together? You've heard us say, we still believe that there's a lot of unmet need in health care. And we believe that to solve some of the biggest issues in health care of chronic conditions, it's going to take the best of access to tough-to-reach anatomy, the best of software to navigate, the best of gene editing and gene therapies, the best of localized biopharmaceuticals to solve those big sweaty health care issues. And equally, it's an and, not an or that we have to be super competitive in the individual verticals. So you need to hold us accountable to getting the MedTech business to above market and very competitive than composite and similarly, our pharmaceuticals. So we start with that and then the rest is kind of gravy on top.

After the consumer separation is completed, when you think about R&D dollars for both a MedTech and a pharma company together, what are the decisions that go into like how you allocate capital between the 2?

Yes. It's really not, we often get asked this, Geoff. Really, there is no math formulaic that X percent have to go to pharma. It really is, what is best at that time. And we hold MedTech accountable to its composite MedTech and not versus pharma. So every deal has to live on its own. And I will give, as an example, in MedTech, our R&D dollars as we are right now are very competitive relative to the composite. And I mentioned we did $10 billion of M&A, and they've all been above the cost of capital. So that gives us more confidence to say, I mentioned that the innovation that the teams have been sharing with the world have enabled us to hold or improve price. So positive reinforcement going forward that I think there's a commitment to make us super competitive and innovation is the whole oxygen of the industry.

Great. Thanks. I think we're out of time. So thanks a lot, Ashley.

Thank you. Pleasure. Stay safe, everybody. Take care.