Medtronic plc (MDT) Earnings Call Transcript & Summary

Well, good morning and good afternoon for those of you on the East Coast. My name is David Lewis, medical device analyst here at Morgan Stanley, and thanks for joining us here for the continuing coverage of day 1 of the Morgan Stanley Health Care Conference 2020. It's my pleasure to have with us here as we progress through the day Medtronic and their Chief Executive Officer, Geoff Martha. This is the first time Geoff's been at our conference as CEO of Medtronic, and we've already seen a significant number of action changes under Geoff's tenure of the business. We're going to start off this morning. Geoff's going to give us a bit of preamble and talk about some of his early thoughts on the business, and then we're going to jump into Q&A. With that, Geoff, the floor is yours.

All right. Thanks, David. So first of all, thanks for having me. It's great to be here. And you're right, there's been quite a bit of activity at Medtronic in my short tenure as CEO. So let me start by saying, look, I'm really excited about where things are and where we're going. We reported our quarter a few weeks ago, and we talked about the faster-than-expected recovery that we've had over the past several months. And we're continuing to see this improvement. We -- that was in August, and we're continue to see this into September. Procedure volumes continue to improve. And on top of that, we're continuing to take share in a number of our businesses and overall, so performed much better relative to our competition than we have been in the past few years. And this is all really driven by a healthy TAM-expanding pipeline. It really is the best it's been and we're energized across the business with this pipeline. That's like a sea of products that are coming in and kicking in right now. And a number of these products, like we said, are launching right now and we're using these products and this wave of innovation that's hitting the market to really go on the offensive and take share. And there -- look, there's more waves of innovation coming here. We are really focused on making this, the route of product launches stick, but also keeping that pipeline full. And by -- we're going to do anything in our power here, everything in our power to increase the level of investment in R&D and bring -- to bring more of this disruptive technology to the market. We're -- we think we're doing the right things here to prioritize our investments and make sure that we're focused on the highest-growth opportunities. And over the last couple months, I really -- I believe, powered by this -- powered by some of the actions we took in -- during the pandemic as well as these new product launches, we're finding a new gear. You're seeing more innovation coming from us, increased growth. It's hard to do the math here during COVID, but increased growth and market share. Our customers are giving us good feedback here. Employee morale's as high as it's been. We do these employee surveys. It's high as it's been at least in a decade I've been here by a long shot. And so on top of that, we've recently announced, as you indicated, these new operating model changes. And this, I think, is going to really help ensure ongoing innovation as we've decentralized decision-making and put power in the hands of the operating units to really give them more empowerment but also more accountability. The focus is on innovation, like I said. But with this new operating model comes new incentives and some culture changes to drive, I'd say, a more competitive mindset. This isn't just a structural change at Medtronic. It really is truly an operating -- a comprehensive operating model change that will improve the speed of decision-making. So I know, David, you've asked us, "Can these guys really pull this off?" I assure you that we're up to the challenge here. And the Executive Committee has been spending quite a bit of time on this over the last couple months, and our Board is very supportive. The Executive Committee is excited to implement these changes. And you've already seen quite a bit of, like you said, change over the last couple of months in terms of creative R&D partnerships, acquisitions. I hope you'd feel like a little bit more of a competitive mindset coming out of Medtronic. And at the end of the day, this is going to drive up our revenue growth. We're confident of that. And I'm -- we're sticking with the 8%, confident 8% EPS growth with a healthy dividend on top of that. That gets you to double-digit shareholder returns but also a higher revenue growth rate. And we'll have some optionality what to do with the incremental margin, but our bias is to reinvest that back into growth. So we'll go into a lot more details on our Investor Day coming up in the next -- about a month from now, October 14. And so with that, David, that's all I got to kick it off. I'm ready for the Q&A. Thanks for giving me a chance.

Well, I appreciate it. Look, I mean, you're reflecting kind of our last quarter no. We said, why is this going to be different? And maybe I'm just getting old and cranky. You're my fourth Medtronic CEO so I ask the question, "Why is this time going to be different?" I guess you answered some of those questions, I think, in your preamble, Geoff. But can you change Medtronic's culture without changing the personnel? And more specifically, what would you say to investors who say, "You know what? I've heard new strategies at Medtronic before, but it hasn't driven that durable, consistent performance." So why are you so confident this is -- you're the right CEO with the right strategy at the right time to really change Medtronic and get them that sort of premium multiple versus the S&P they may deserve.

Well, yes, it's a good question. I do believe this is the right strategy for the right time. Hopefully, it'll prove out that I'm right CEO as well. And your initial question about changing the strategy, about changing the people, look, we've got -- we're driving a lot of change here. Like I said, this is a big change at Medtronic, putting these decision rights down in the -- reconstructing the P&L, putting it down into the business units, taking away this group layer that we've had. There's a lot of structure there and a lot of operating decisions made there. And like I said, consolidating decision-making from the regions and in the P&L and the decision-making from regions and functions all into the business unit, so it's quite a big change. But one thing we have kept -- is a lot of leadership. We've made some changes, like we've made some changes in Diabetes and that leadership team and a few other spots where we felt like we really needed to make those change. But to mitigate some of the disruption caused by this, we left a lot of the leaders in place. I think they're the right leaders, and particularly at the operating unit level, they've been responsible for making the choices that resulted in this new product cadence. And I want to make sure they're held accountable for it. But that -- I do think we're going to be able to change the culture without -- and changing the results without changing -- a wholesale change of the people. I really do believe that we've got the right people here. And look, I know it's early, but in the short tenure I've been here, we've been -- we've seen some decisive moves in terms of increased cadence of M&A, this whole new operating model and I think just clarifying who we are, what our goals are. I mean we're not trying to dramatically drive up revenue at the same time, expand our margins and change our cash flow profile. We want to hold our cash flow conversion, hold this 8%, hold our margins, not necessarily increasing, but really focus on revenue increases.

Okay. That's fair. It's very fair. So really, very focused on growth is the message.

Yes.

This decentralized model, we fully support it. We do believe decentralized medical device companies do better than a centralized one. That's been proven time and time again. Some people would say what you announced a few weeks ago was just a cost restructuring. Help us understand this. It obviously does create $400 million to $500 million of cost that you can redeploy. But how specifically is it not a cost restructuring? Very much, is a move to a more decentralized, nimble Medtronic?

Yes. Cost was the secondary component of this, right? I mean when you're -- and the cost is coming from, the cost reductions are coming from, we're delayering the company in certain places. Like I said before, we started with the simple premise of let's go from -- and I talked about this back in January to analysts and investors. Let's go from a $30 billion company to 30 $1 billion companies. And that was the basic premise that we started with. And in order to do that, to make these 30 $1 billion companies, you've -- we've got to empower them and give them the P&L and the decision rights. So then you look at, okay, where does that come from? Well, just in the business unit structure, we had smaller businesses that reported to bigger businesses that reported to groups. So we took that group layer away because they were making a lot of these decisions that we consolidated out. So you see layers like that going away. That's where some of the cost is coming. And then in giving the operating unit these decision rights, including sales because they didn't own sales, we had redundant -- like take Europe. We had a redundant sales management infrastructure because technically, the region had sales management responsibilities, but the operating units did it as well. And so you have redundancies there. And then Medtronic alignment became like a dirty word. You had to align with a bunch of people. That meant a ton of approvals getting done. So now we don't need those duplicative sales management because the sales management is in the operating unit. So now the regions can eliminate that sales management. So the cost was secondary. That all started with the premise of the 30 "$1 billion" businesses. And then once we were able to work our way through that, then we said, okay, we do have scale, breadth and scale. And where can that be leveraged? And then we said, look, people use this whole idea of, hey, look, leverage your breadth and scale. That could become a problem where you have too many people -- that can become a euphemism for people outside of the operating units making decisions for the operating units. And so I don't want -- we don't want that. And so what we said is, look, we're going to limit the benefits of scale to like 4 or 5 distinct areas. It's certain technology platforms that we're investing in from more an enterprise mindset that the businesses can pull from. It's certain, like, strategic account relationships in the region. So even though our operating units are all going to the specialist physicians, certain hospitals -- and at that level, we want those specialist physicians to think that we do nothing else but whatever they do, interventional cardiology, electrophysiology, spine, whatever. But then sometimes at the purchasing level at the C-suite, they -- customers will want to deal with one Medtronic. We now made that possible. That's an area. So we've done that in the regions. Manufacturing scale, where we can get lower cost but with higher quality. So we're -- the manufacturing footprint for the company globally is managed more from an enterprise perspective. So it's things like that. And then finally, the fourth area would be our enabling functions. They've been split in 2. Part of the enabling functions that are the business partners are in the operating units, a sole line of reporting to the operating units. But then certain things that are more transactional in nature, like accounts payable, accounts receivable, that we're going to do at a regional level or a global level. In this case, it's a region level to bring down transaction costs. So those are 4 areas that we're doing, leveraging our scale. But kind of keeping it to that, and everything else is in the businesses.

Okay. And Geoff, there's been a lot of change in just your early tenure here, right? We had the balance sheet, but obviously we have Blackstone. We've seen more M&A out of the company. We've seen more growth-oriented M&A most recently. We obviously had the bulk order dynamic that you've been very focused on in the last 6 months and the decentralization. So that's a lot of stuff in the first 4 or 5 months. What's next? I mean we don't often see those type of changes this quickly at a CEO's tenure. So I'm kind of curious, what is that -- what's the next major thing that you're very focused on for the business?

Well, one you forgot, which was a big one was the ventilator crisis. That was like for 6 to 8 weeks there, that took a lot of time. And -- but all that, it's been busy. But -- so we've got our foot on the accelerator, and it's motivating because we're moving at a faster clip, but we have so much investment opportunity. So right now, now that we've got this right, we've announced this, we've got to execute it, right? Like you said, you've asked me, "Can these guys pull it off?" So I feel like we've crossed a big chasm here to get this announced. First of all, get everybody on the leadership team aligned. I mean get them aligned and behind this and focused because if it's just me, it's not going to work. And then get this announced. Now we've got to execute it. But as we move forward, some of the more intellectually stimulating focus areas for us as a company beyond -- there's a lot there in that first bucket in terms of all the innovation, new products and all that, putting more money in innovation but specifically some big areas. One is, I think this whole convergence of digital technology that's coming into med tech, some of the things like data and AI, 5G, edge computing, I think this convergence, we need to not just embrace it, but like speed it up. That's one. That'll -- everything we sell needs to be connected into the cloud, and we've got to have faster processing power on our devices. Because the way we do R&D in med tech, we're dealing with like 2-, 3-generation-old chip computational power because of the way that the approval process goes with the regulators. So we've got to fix that. Another one for us is more consumer. You see a med tech becoming more consumer. And if you look at some of our portfolio, David, as the mix changes, it's as to get back more competitive in Diabetes, which is happening, and it's going to happen faster than you thought. As we launch things like Ardian, these things will drive more -- we'll need more consumer B2C type of -- not just product thinking, but marketing. So that's another shift that I can see happening over time. And our plans in both these areas aren't as far along. And I continue to be focused on the dynamics of China and figuring out a strategy there that's both robust in terms of -- if you got continuity, if the walls go up between China and the rest of the world or China and the U.S., that we're protected outside of China, so we're not reliant on product or supplies coming out of China. But also that our business can continue to thrive within China, so it's almost self-sustaining. So that is the third area. So those are the 3 areas outside of that first broad bucket of operating the company differently and just better leveraging the scientific underpinnings of the company. Medtronic's always been a great technology company. We just haven't leveraged some of these technology capabilities to their fullest. And this new operating model and this commitment to innovation and this creativity to not be outspent in any sector, any end market if we feel like we're being outspent, we'll figure out a way to be competitive there or exit the market if we just can't prioritize it.

What you said though, Geoff, I guess is fascinating me because there is this algorithm I'm always worried about Medtronic. Could Medtronic grow 4% to 5% top line, 8% at the bottom? Maybe. But if Medtronic then wants to go faster than 5%, can they still grow 8%? You talked about taking share. I mean how does Medtronic take share in all these different markets and not get beaten to the punch without, frankly, finding ways of spending more money? And what I think is interesting in the last few weeks between the restructuring opportunity, between the off-balance sheet deal with Blackstone and some of the balance sheet M&A that you're doing, I feel like is another way of saying it, you've just sort of freed up capital to reinvest back in this business, which dramatically improves your confidence that the top line is going to accelerate? I mean did you just break the algorithm or improve the algorithm by doing these last 3 actions?

I don't know about breaking the algorithm, but we've definitely improved it. I mean -- and the thing that -- like I go to these reviews with these scientists and technical people and product development people, and they show me what they're working on. And I walk out of there just so excited and then ashamed that we're not funding it enough. And so then I don't go to sleep. I don't sleep well until we figure out a way to fund this stuff because it is so motivating for not just me. The whole company is motivated by innovation, and we have these ideas, and we have good end markets, and we have good capabilities. And so look, I'm unfortunately not going to be one of our Bakken Fellows. That's the highest technical honor, but I will work my hardest to make sure we have the right environment to support that kind of innovation, including the right amount of funding however we need to get there. We'll be creative. We'll cut costs and reinvest, cut like G&A cost if we have to, to reinvest. We'll use our balance sheet creatively. And I've got -- we've got some more ideas. We're not done. I don't want to walk away from innovation or a market because of margin concerns. I want to hold our margins, but there's ways to do that. And look, we'll see how far it goes. I'm confident we've got a lot of room to increase the top line while holding that 8% plus the 2% dividend, and we'll see how far we can go with it.

Okay. And then you've already sort of said in Analyst Day, you're not walking away from that 8% minimum. When I think about that $450 million of cost restructuring, another way of saying that is, that's about 1 point, 1.5 points of incremental R&D investment. Is that how people should be thinking about what we could hear in a month that there's going to be an incremental step-up in R&D as a percent of revenue with that cost-cutting being redeployed there?

Some -- I wouldn't go -- you're using a 1:1 there, but I think your math is pretty accurate there. But there's other -- outside of R&D, we've also got other growth-related investments, right? So like I mentioned, we've got to build up a robotic sales force for the soft tissue robot. Like if we do some of this consumer advertising for Ardian, that's going to cost some money. So it will be, I'll call it, growth investments. Now again -- and our bias, I mean, there could be some dynamic that changes our thinking on how much we want to let drop down and do we want to get that 8% higher. But as we sit here today, the strong, strong bias is to reinvest and keep the higher -- get the higher growth rate and make sure that it's consistent. I'm convinced, and I know that our executive team and the Board is convinced, that the discount that we've been trading at for the last decade is driven by the fact that we've been growing below the market. And even sometimes we spike up, but it's inconsistent. We'll not be able to hold the market growth. And so that is our bias, to put that 1%, 1.5% into growth investments. R&D is a big one, but also could be sales and marketing as well.