Medtronic plc (MDT) Earnings Call Transcript & Summary

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Good morning. I'm Larry Biegelsen, the medical device analyst at Wells Fargo. And it's my pleasure to host this session with the CFO, Karen Parkhill, of Medtronic. In terms of the format, it is going to be a fireside chat for 30 minutes. And we're going to try to do a couple of polling questions, which have worked well so far. So Karen, thank you so much for joining us.

Thank you, Larry. Thrilled to be here.

Great. So why don't we start, Karen, with the recent news about the new operating model at Medtronic. Can you please talk about the rationale behind it and what changes you're making in the organization?

Sure. I'm really happy to talk about that. We've talked about our vision of being the leading health care technology company. And as we focus on that vision, we realized that we needed to change our matrix organizational structure to really realize that vision. So our new operating model, which we are beginning to make happen is really a transformation that simplifies our structure, where we're focused on becoming more nimble, more competitive, focus on accelerating our innovation which, in turn, accelerates our growth and our market share. We're also focused on enhancing our customer experience and our employee experience within Medtronic. And really, the primary change that we're doing is reorganizing our 4 groups and their respective business units into more highly focused, accountable and empowered operating units that will be organized around specific therapy areas. And this is really designed to accelerate our decision-making, drive our growth, make us closer to the customer, drive better execution. We're also centralizing our operations, and we're focused on driving even greater efficiencies within our enabling functions at the enterprise level. And that's really designed to provide greater service to our operating units and really leverage our scale. So we're really excited, and you're going to hear more about these changes directly from Geoff at our Investor Day.

That's helpful, Karen. So CVG, MITG, Diabetes and what did I forget there? I forgot RTG. Are those going away? Or will you still have those 4 divisions?

From a segment reporting perspective, we'll figure out if there are any changes to segment reporting. I don't anticipate any at this stage. What's really changing is the group structure around those groups where we're driving more of that structure into these accountable operating units.

I got it. I got it. And is there one tangible difference, for example, where the sales force reports into from the old -- the current structure and the new structure that you could highlight?

Yes. There are some changes there. Currently, the reporting of our sales force varied, honestly, by group and by operating unit. In some cases, that sales force reported directly into the operating unit. In other cases, it was shared or reported indirectly. But this model does clarify the sales force reporting and streamline that they directly report in developed markets, in particular, into the operating unit. So that just helps with clarification and again, decision-making.

That's helpful. Are there people -- with any change, there might be people who are happy about it, there might be people who resist it. Are there -- for example, how are the country managers going to feel now that the sales reps report into someone in Minneapolis?

Larry, now that we've communicated these key changes across our organization globally, we are really getting really good feedback from our employees. And in fact, our employees are really excited by this change and, honestly, the clarity that it provides. As I mentioned, we're focused on making it easier for employees to get work done. We're focused on clarifying the decision [ right ], and our employees are really excited about that. So honestly, we're getting really good feedback on it.

Good to hear. And then one financial question. In the 8-K, you put out $450 million to $475 million in annual cost savings from this change. How should we think about the cost savings in the context of your comment on the Q1 -- fiscal Q1 call about not expecting much margin improvement at Medtronic above the pre-COVID level of about 30%?

Yes. So we will be driving cost savings with this model improvement, and we said it's between $450 million to $475 million. And those savings are really -- we're focused on having them enable greater reinvestment for us into areas as we're focused on driving and accelerating our top line growth. And those savings will also help us ensure that we deliver a strong bottom line results, in line with our long-range plan that we've talked about before of about 8% EPS growth, absent the pandemic that's going on right now. We're not pulling back on investing in the business. We're very focused on continuing to invest in R&D to ensure our pipeline remains full. And that as we accelerate that revenue growth, we make it consistent going forward. And so the clear focus is on driving greater reinvestment.

All right. Perfect. Karen, I wanted to transition to fiscal 2021. But before we do that, anything else you wanted to communicate on the new operating model?

I would say just that we're really excited. We're getting great feedback. And I do think that this is going to drive an important culture change within the company. That we'll be focused on driving greater top line growth, taking market share, being more competitive, driving that competitive edge into the company that Geoff has been talking about. So honestly, we are really excited about it.

All right. Good to hear. So fiscal 2021, you reported fiscal Q1 results in August -- late August, which came in better than expected. Overall sales declined about 12% year-over-year on a constant currency basis when we adjust for some onetime factors. You also talked about improving trends month-over-month and into August, which was encouraging. So I guess, given some of the moving parts, like lower bulk purchase and all -- purchases and all, how do you know that average daily sales are improving? And are there any data points you can share with us?

Yes. So when we looked at just our raw revenue on a month-to-month basis, Larry, we had to adjust to really see the underlying trends. So we first, adjusted for the number of selling days in each month, which were different in May and June and July, to get to the average daily sales. And then we also adjusted for the extra week that we had and the impact that we had on taking down our bulk purchases. But after we made all of these adjustments, our company-wide average daily sales did see a significant step-up in May, then again in June, and that continued into July and August. And so we're really excited about this trend, and we see things improving more quickly than we had originally anticipated.

That's helpful. And you also talked about the cadence of growth through fiscal 2021, with Q2 down 9% year-over-year and getting to normalized growth on a [ statutory ] basis in Q4 -- fiscal Q4. So first question is the negative 9% in Q2 seems conservative given that you declined 12% in Q1 and trends improved through the quarter. Is that fair?

Yes. So what we said, Larry, on our Q1 decline was that it really was 17% on an organic basis, and that's adjusted for the extra week. And when we look at the trends of decline of 25% in our fiscal Q4 and then 17% in our fiscal Q1 and that delta improvement of about 8%, we said that we expect, hopefully, some similar improvement of about 8% from that negative 17% into our Q2, which by math just gets you to that negative 9% we talked about. Could we do a little better than that this quarter? Yes, we definitely could, but it still depends on how the pandemic plays out this fall. We are seeing good trends, and that's continuing.

That's good to hear. Karen, you gave a very specific color on Q2, very specific color on Q4 but not much on Q3. Can you be flattish in Q3 on a year-over-year basis?

We -- like many companies, we're not giving specific guidance in our back half in our [indiscernible], in particular, yet. But could we be flat? Yes, we could. It just depends on how the pandemic plays out at this stage.

Okay. Makes sense. And just on EPS. The Street seems to be netting out, and I looked a couple of days ago, at $0.83 for Q2. I thought you gave pretty specific color that got us to about $0.78 in Q2. Am I missing something?

No. When we talked about the color we gave on the improvement in revenue growth and color that we gave on margins, which was really that we expect sequential improvement in growth in operating margins this quarter, your numbers are about right.

Okay. And based on your comments for Q2, in the second half, it seems like you're comfortable. I know you don't have formal guidance, Karen, but somewhere in the, call it, $4.03, $4.04 range for EPS for fiscal 2021. Any reaction?

Yes. As I said, we're not giving specific guidance on the back half or the full year at this time. But we do expect revenue growth to continue to improve sequentially. And we expect some deleveraging to continue in the next couple of quarters, but we expect to be back to more normal revenue growth and more normal margins in our fiscal fourth quarter.

Okay. And Karen, I know it's ways off, but I'm intrigued by fiscal 2022 given some of the color you've given. Because if you get back to kind of mid-single-digit growth on a stacked year basis, like fiscal Q4 of fiscal 2021 and kind of apply an underlying growth of, call it, 4%, 5% next year, you kind of get to about $33 billion in sales. And you've given very specific color on the operating margin getting back to pre-COVID levels, by the end, I think, of -- by the end of this fiscal year. So I guess my point is that it's easy to see -- or the math kind of gets you to almost $6 in EPS in fiscal 2022, which is well above consensus. I know it's a ways out and I know we're in a very uncertain environment, I certainly appreciate that. But I'd be curious to get your reaction to that.

Yes. So I'm glad you're thinking ahead, Larry. And I would say, for us, it's premature to be commenting about FY '22 because our FY '22 is still 8.5 months away. It doesn't start until May. So we need to go through our annual planning process, which we have yet to start. It typically starts in the winter time frame for us. And the pandemic is still largely an unknown. But I would say, as we think forward, even beyond this fiscal year, we feel really good about our pipeline of products and our ability to take share in an increasing number of businesses going forward. So hope you hear that excitement from us.

I hear it loud and clear, So Karen, and maybe we can touch upon some of the pipeline products later, but I wanted to ask about the investor meeting coming up in October. I know we can expect that to be virtual, I believe. Maybe you could confirm that. I'm assuming that. But what can we expect at the investor meeting?

First of all, absolutely, it will be virtual. And we're focused on trying to make it a really exciting virtual experience for all of us. So you should expect at that meeting to hear about how we intend to accelerate our revenue growth and increase our WAMGR. We've talked about the robust pipeline of products that we've got, many which are coming to market now and will come to market soon. And we'll be highlighting those, obviously. We'll also lay out where Geoff is taking the organization with this new operating model, including the changes around our culture, particularly around our seed and our competitiveness. You'll also hear from many members of our leadership team around our pipeline and the strength of that portfolio. And then, of course, I will lay out our long-range outlook as well.

Okay. Sounds good. And it seems like you suggested on the Q1 call that Medtronic is going to strive. Again, you mentioned this just a minute ago, to increase its top line growth above the previous goal of 4% but maintain the EPS goal of 8%. But you also said operating margins could improve a little, but you're more focused on driving an acceleration in top line growth, while maintaining again the 8% EPS growth. Was that the message you were sending? And if sales increased by, say, 5%, where do you get the other 3% of earnings growth?

Yes. So first of all, that was definitely the message we're sending. We are really focused on accelerating our top line, driving that to consistency and still ensuring we deliver a strong bottom line, committed to the 8% EPS growth. And when you combine that with our dividend, getting to a double-digit shareholder return. In terms of how we generate the leverage to move from top line growth to a greater bottom line growth, we will generate leverage. And much of that may come from operating leverage. Some of it may come from financial leverage. And we still have plenty of efficiency that we can drive in the company because we're always focused on growing our expenses less than our revenue. And that drives the leverage.

Okay. So let's go with the polling question. So we're going to get -- try to do both of them upfront here, if it's -- one after the other. So [ Josh ], could you please show the first one? So I think everyone -- so what do you expect Medtronic to provide for its long-term organic revenue growth target in its upcoming October investor meeting. And I'll let everybody read the choices here, and it's pretty easy to just -- to answer this from what I can tell or to -- just click on the little -- the dial button. Karen, you can vote. [Voting]