Medtronic plc (MDT) Earnings Call Transcript & Summary

Good afternoon. This is Josh Jennings, along with Brian Kennedy, Neil Chatterji, Eric Anderson from the Cowen Medical Devices Research Team, and we're moving down and starting the afternoon medical device track of the 41st Annual Cowen Health Care Conference. And we are excited to have Medtronic's Chief Financial Officer, Karen Parkhill, joining us. I think, Karen, this is your first -- I know this is your first Cowen Health Care Conference, and we're honored to have you here today. Thanks for spending time with us.

Thank you, Josh, thrilled to be here.

I apologize, my phone was ringing, that was a rookie error. I've had a couple of those this conference already, but it is not a rookie -- it is a rookie move because these virtual conferences is the first go around. But let's get to it.Regarding the pandemic, you guys had a recent earnings call. So it's a good time for some follow-up questions. But you've experienced continued procedure disruption through mid-February from COVID-19. Your outlook for fiscal fourth quarter, calls for monthly improvements over the course of the quarter. Aside from the benefit from the vaccine rollout, is there anything you're seeing now in hospital accounts that clearly signals an inflection in procedure volumes? Or is your fourth quarter outlook more based on trends you haven't yet directly experienced and you're still managing through some of these lingering challenges? I guess it's not unique for any of these companies, med-tech companies, if you will?

Josh, the good news on that is that we did start to see our average daily sales turn last week, which we think is really encouraging. And we think underlying was turning the prior week, but it was muddled by the tough weather issues that we had across the United States. But we saw a clear turn last week. And so things have really started to improve as we predicted. We do remain optimistic on the quarter. We've got an overwhelming decrease of COVID cases throughout the world. ICU and hospital capacity is improving, and the vaccine roll-up is picking up momentum. So we've also seen stronger sales of our capital equipment, especially toward the end of last summer that we noted on our quarterly call. And we think that's a leading indicator and a positive sign because customers believe procedure volumes are coming back. So despite the COVID uncertainty, we have lots of reasons to be confident in our fourth quarter.

Excellent. And you mentioned capital, there has been nice demand. I think other -- some of your peers, your med-tech competitors are reporting similar updates on the capital spending environment in the United States, especially. Can you help us sort through just where some of that demand is coming from? Is it -- there's 2 different channels, I guess, we kind of -- 2 different buckets we put capital placements in, the volume commitment channel or contractual channel and the upfront, capital purchase segment. Any changes in terms of the proportion of capital that's being placed in either of those 2 buckets over the last 4, 6, 8, 12 weeks?

Yes. I would say the good news is we did see hospitals invest in -- more and more in capital equipment this last quarter. And we actually saw record numbers of our Mazor robot being placed, a near record of our StealthStation navigation and O-arm imaging. So at this stage, our capital sales are, at least last quarter, back up to pre-COVID levels. And while we think 1 quarter is not necessarily a trend yet, we're encouraged by what we saw. And I would say on your question around arrangements that we have with hospitals, we have continued to partner with our hospital customers to provide flexible financing and alternatives for capital equipment. And we particularly stepped that up at the beginning of COVID. But I wouldn't say that demand currently is based on those flexible arrangements. In fact, we saw earlier take-up of those offerings in the summer time frame. And we've seen less take-up of those flexible options today. So I wouldn't say the demand is based on that.

That's great to hear. And it's encouraging for Medtronic's capital businesses and then in med-tech as well. Thanks for that update. Just wanted to talk about a couple of the business units and Diabetes has been one that's I don't want to call it controversial, but just the performance and the return to historic performance or revenue growth levels. I think there's a debate out there about the timing of that and the ultimate potential of Medtronic to get back to market growth. I mean, Diabetes is a double-digit growth segment within med-tech, one of the higher growth and thought to be a sustainably high-growth -- sustainable high-growth segments. It's almost 100 basis points of the -- or, sorry, 10% of the Medtronic revenue base, so double-digit growth implies that Diabetes, if you get back there, could deliver 100 basis points of organic growth, which is a nice chunk of that 5% plus LRP target that you guys have recently updated. Maybe you can just help us think about number of launches that are coming up? Just help in interesting about the timing of return to market growth rate and so they can get more conviction in the Diabetes turnaround story and then that march back up to 5% plus for Medtronic overall corporate-wide.

Yes. Thanks, Josh. Obviously, getting Diabetes back to market growth has been a key strategic focus and imperative for our company. And I would say the good news is that Diabetes is right now on a steady climb, back to market growth. And it's driven by some of the new products that we've introduced, particularly the 780G in Europe where we've seen really great strong reception for that product. Very strong new patient starts on that product. And we're excited to eventually get approval for that in the United States and see that happen across the United States as well. But in general, we believe that we'll be back to market growth in Diabetes in the next couple of years. But in the meantime, I think it's important to remember that we don't need all of our businesses to be at market growth or operating on all cylinders for us to achieve that 5% plus growth potential that we're focused on. 5% is the approximate WAMGR for total Medtronic. It's the average for total Medtronic. And I think it's reasonable to assume that at any given point in time, not all of our businesses are going to be taking share and growing faster than their markets. Some will; some won't. But at an average, it gets us to that 5% plus. So I think that's important to keep in mind.

Absolutely. No, understood. Maybe we could touch on the Cardiac and Vascular Group. It has had a great run, and organic growth slowed a little bit. There is some comp, product launches, headwinds, et cetera, and new leadership is in place. Sean Salmon is -- has his hands full leading 2 of Medtronics' 4 big silos, but if anyone can do it, he can, in our opinion. Could you help us piece some of -- together some of the drivers that will get CVG back closer to the 5% corporate-wide organic revenue growth trajectory? Or is that a target that's achievable? I know renal denervation is a big pipeline product. And I want to ask you a couple of question after this, but maybe outside of renal denervation, other needle -- not needle movers, but any combination drivers of an acceleration in CVG over the next 12, 18, 24 months?

Yes. We're really excited, honestly, by what's happening in our cardio space right now. We really do have a healthy mix of current products today and a super robust pipeline. You touched on Ardian just briefly. But I would say, I'd start with heading into the pandemic within CVG, we had a couple of big businesses that were declining. We had declines in CHRF (sic) [ CRHF. ] We had declines in drug-coated balloons. But now we're seeing growth in both of these, and it's really helped by new products. We've got the success of our Micra leadless pacemaker. We've got our Cobalt and Crome high-power devices that are really allowing us to outperform the competitors in that pacing space or in the cardiac rhythm space, and we expect that to continue. And then in drug-coated balloons, that was down in the low 30s, and we're now coming back. We're growing high-single digits, and that's on the strength of our IN.PACT AV product, and we expect that to continue. I would say also TAVR is a good growth market for us, and we expect TAVR to be a strong growth driver for the whole cardio space well into the future. And then just talking about our pipeline, Ardian is a huge multibillion-dollar opportunity in hypertension that we have been investing in heavily for a long time, and we're excited to show our trial results there, hopefully, in the fall and then work to achieve that big opportunity. We've also gotten our -- in our Cardiac Ablation business, we've got cryoballoon as the first-line therapy now and our pulsed field ablation system that's going to be taking share. And then in Structural Heart, we've got a whole pipeline, whether it's aortic or mitral or tricuspid, we've got a full pipeline there, too. So super excited about CVG back to mid-single-digit growth and super excited about sustaining that.

No. Thanks to [indiscernible], I mean the pipeline across the board for Medtronic and in CVG, particularly, is robust and maybe one of the most flush pipelines that Medtronics had and -- since we've been covering the company. But renal denervation, that's been in development for a little while now, and is on the cusp of bearing fruit. I think Ardian may have been one of the first acquisitions when Omar took the CEO seat, maybe back in 2011 time frame. But as you mentioned earlier, it's slated to be a big driver about your corporate-wide revenue growth potentially, but definitely for the Cardiac and Vascular Group. That base was about 1,100 -- excuse me, $11.5 billion, exiting fiscal '19, that's for CVG. So once approved, I mean, just thinking about the run rate for Ardian. I don't want to hold you to any kind of specific numbers, but in terms of how we're thinking about it, just for CVG, I mean, potentially adding 100 to 200 basis points of organic revenue growth for the unit, which would be about $100 million to $200 million of additional revenue each year once you get that first year of launch under your belt. I mean is that reasonable in terms of the margin to get to kind of $1 billion in revenue over 5 plus years? I know that's a little about your guidance question here, but any thoughts on that question?

Yes. I would say it's a big opportunity, Josh. And I'm hesitant right now to set time-based granularity for it just at this point. But we've said we expect that to reach $1 billion market by 2026. And honestly, I think it's multibillions after that. And because we've got the strong first-mover advantage, we'd expect to have the majority of that. So I'd think about it in that context.

That makes sense. Wanted to touch on Structural Heart as well within CVG. That's one of the more attractive growth segments in the broader cardiology segment. And I did ask -- I apologize I'm not repeating the question I asked on the earnings call recently, but just about Medtronic's pursuit of -- or interest in participating in LA -- left atrial appendage occlusion or edge-to-edge mitral repair markets. So I wanted to ask a different question. I understand that Medtronic's driving for market leadership or potentially seeing a path to be market leaders, and there are other players that are more advanced in both of those 2 device categories. But maybe you could touch on just that strategy and why it wouldn't make sense to be a -- Medtronic to be a third player in the ring, if you will, and just at least participate in that, in the growth trajectory of a segment like LAAO or edge-to-edge mitral?

Yes. No, thanks for that question. And I'll start with edge-to-edge because with that, we believe that we've got a better solution than the edge-to-edge technology. There are limitations with that technology. It doesn't fully eliminate mitral regurgitation. And in our opinion, with edge-to-edge, you're just trading 1 disease for another. You're getting rid of a leaky valve. You're -- but you're ending up with a stenotic valve that still partially leaks, and it doesn't allow for you to do future procedures. So we believe we've solved for these issues with our project with Half Moon Medical. We think that what we could coming out -- could have coming out of this partnership is something that's highly disruptive to the existing edge-to-edge technology. And we're not focused on investing in me-too technology, especially when we believe that we can bring a superior solution to market. So that's why we're focused on what we've got with Half Moon. And on left atrial appendage, I would say it's a great market. And if we play in there, we'd want to go in with something that's differentiated, again not just a me-too product. We're not currently doing any internal development on left atrial appendage, but we are actively looking externally and identifying technologies that could have advantages over WATCHMAN. And if we found one of those, we'd have a large appetite to invest.

That makes sense. I mean, so let me just recap your answer to make sure I'm clear. And it sounds like these -- at least these 2 segments, maybe segments like these are attractive. You're not ignoring them by any means, but you're pursuing solutions that, as you said, would be disruptive and capture the patient opportunity, but with a different approach or that could drive more better safety or an efficacy evidence.

You got it, Josh. Yes, you got it.

That makes sense. Makes me -- definitely answers my repeat question there. One big topic that's come about and gaining more steam just environmental, social and corporate governance. It's a major focus for Cowen's clients. We're fortunate to have you. You have a leadership role in Medtronic's ESG initiatives. Maybe you could just spend a little bit talking about some of the ESG priorities at Medtronic and any time lines associated with some of your top goals?

Yes. Thank you for that question because we do have a robust ESG program at Medtronic. And it is well embraced within our company, and really because the whole concept of ES&G ties directly to our mission. So it's truly embedded in our culture. And so unlike other companies that have had to think more hard about ESG; to us, it's just a natural extension of what we're focused on every day because we are so grounded in our mission. But I would say, today, we have 3 key focus areas around ESG, and we've recently outlined these with a lot more detail in our annual integrated report that you can see. But those 3 are innovation and access, where we focus on driving strong innovation and on helping open markets to enable access to that innovation around the world. The second is product safety and quality, which is something we -- that is just fundamental to everything that we do, where we're focused on ensuring that we design and manufacture safe products -- safe quality products and that we have the right global compliance in place around those products and that when -- in the small instances where we need to do corrective action that we are all over it right away, that's a key focus. And then thirdly, I would say, is inclusion and diversity. We have a focus and built into our mission to respect and value the worth of every single employee, no matter who you are, no matter what your background is. And we want to make sure that we're driving that focus on inclusion, diversity and even equity within our 4 walls and beyond our 4 walls. And so we're taking big stands on inclusion and diversity and equity, not just in Medtronic, but more publicly too. And then I wouldn't want to leave out environmental because that's a big focus, too. And we've recently announced our goal to be carbon neutral by the end of the decade to help, obviously, with sustainability in the environment.

Excellent. No, thanks for detailing that. And I think you talked about kind of just inclusion, diversity outside of Medtronic as well in your response. And AdvaMed recently released MedTech industry principles, I think, in October of last year to address racial health disparities. And there have been a number of publications. I think Circulation had a publication in December for the cardiology community, just talking about 1 topic. I mean, just the inherent racial inequality in the health care delivery system in the United States. And one of those tenets is just the access to clinically efficacious, innovative device-based intervention is one of distinct racial inequalities in the health care delivery system. So what can and is Medtronic doing along with AdvaMed to address that issue?

Yes. Obviously, both inclusion and diversity and access are 2 of our 3 key priorities that I just outlined. So it's so important to Medtronic and we're thrilled that the industry has taken access and racial disparity on too. We're clearly very focused on helping to lead the industry here. And it includes things like driving a very strong supplier diversity program to help with economic impact, which has been embedded in Medtronic for a long time, and we're continually getting even better on supplier diversity. We're also focused on increasing the representation of women and minorities within the stem areas through our important investments through our foundation and through the work that we -- the volunteer work that we do through our employees, focused on increasing that. And then, I would say, we're also focused on driving greater access and not just for our own products, but opening up markets around the world. And we're doing that a lot ourselves. And then we also have, as part of our foundational efforts, we have Medtronic LABS, which is a not-for-profit entity that is driving greater access for things like hypertension diagnosis and treatment in the developed countries, particularly in Africa. So we are very focused on it and thrilled that the industry is really putting arms around it.

Thanks for that as well. Maybe moving back to just take advantage of having the CFO with us today, talking about the financials -- Medtronic's financials. And you talked about fourth quarter operating margins on the last call, returning to normal exiting fiscal '21, and you targeted kind of 150, 200 basis point sequential improvement, which is a little bit lower than the 29% that you had outlined prior to the earnings call. It's very close, whether is there anything that you call that's affecting operating margin in the fiscal fourth quarter? Is that -- is it just continued pandemic headwinds? Or anything specific? Or is it just that's basically the same level you consider being -- just repeating what you had said earlier in the -- prior to the fiscal 3Q earnings call?

Yes. And I would start, Josh, back at the beginning of our fiscal year when we first talked about our outlook trends for the full year. We did say that we expected to be back to more normal growth and more normal operating margins by our fourth quarter. And that hasn't changed throughout the year despite the fact that we said that in the height of the cloud of COVID. And then folks would ask, "Well, what does normal growth mean on revenue and what does normal margins mean?" And so we went through the math on a 2-year stack basis for revenue. And for margins, we talked about being back to pre-COVID margins, which were roughly 29%. And I would say we're roughly there in the fourth quarter. I would keep in mind that our margins back in FY '19 that were 29%, had a good FX tailwind in them. We disclosed that we had a 70 basis points of FX back in FY '19. And those headwinds and tailwinds change over time. But I would say we are dealing with the resurgence of COVID that impacted us in January and impacted us in February, but we're starting to see that turn, which we're glad about. So that impact has an impact on our margins. We also have greater COVID costs right now that have remained, and that I think will remain for at least the near-term foreseeable future, things like increased cleaning that's required in all of our facilities, particularly our manufacturing facilities; things like increased freight costs because there are less commercial flights out there right now to move our product around. And so we've got increased costs in freight. Those are likely to continue a little bit. And so all of those impacts our margin. But the good news is we've seen sequential improvement throughout the entire year. And we said that we expect to continue to see that sequential improvement. And you said it was 150 basis points to 200 basis points improvement in the fourth quarter.

Excellent. I mean just thinking about -- you gave some high-level commentary on the outlook for fiscal '22, although we're not there yet and yet you didn't issue guidance for fiscal '22 clearly. But you do have product launches with that robust pipeline we talked about earlier and some incremental expenses like fiscal '22 and fiscal '23, unlocking or reaching some major pipeline milestones, soft tissue robot, renal denervation. How do you approach kind of accounting for the spend needed to launch these programs in guidance from a revenue standpoint as well as an expense standpoint given all the unknowns here once we get into the guidance for fiscal '22?

Yes. So obviously, it's too early for me to give you guidance on '22 because we're still finishing our plans, and we'll do that on our fourth quarter call. But I think the way I'd frame it to you on thinking about '22 and '23 and the strength of some of our pipeline is that we're focused on accelerating our revenue growth and our market share. And I already said, and you know it, Josh, if we grow just in line with our underlying markets for the total company average, we're already at 5%. And then when you add new markets like Ardian and the soft tissue robot, I think that drives us to the plus side of that 5%. And of course, we're going to need to invest to drive this, not just in R&D, but also in commercial execution of this. These are big opportunities and we will need to invest. So we're evaluating all those investments that we want to make in these new programs as we speak. And -- but we'll make those investments within the framework of delivering our 8% EPS CAGR over our long-range plan. So hopefully, that helps.

It does help. It does help. And you've -- yourself and Geoff have been more vocal just on the accelerating the tuck-in M&A strategy. It has not -- it's been in existence clearly over the past couple of years, but maybe a step up there. And I wanted to ask, you also pursue this development partnership track as well. And maybe you can help us just understand how your business development team evaluates the option of foreign partnerships, such as the Diabetes partnership with Blackstone or The Foundry partnership for Half Moon versus funding those initiatives yourself? And how should we look at the potential for additional development partnerships in the next 12, 24 months? And any inkling where you see the biggest need?

Yes. Yes. So we're -- as you know, we are very focused on driving our revenue growth higher and sustaining it. And to do that, we've got a myriad of things that we can invest in. And we recognize that we're not going to be able to do all of that on our own P&L. So we are supplementing our own internal R&D investment with the use of partners, with the help of tuck-in acquisitions, with minority investments that we make that can turn into future tuck-ins. And how we evaluate those is, how do they fit within the long -- within the overall long-term strategic priorities of Medtronic and can a partner help us in certain areas? So with the Foundry and Half Moon Medical, that is a partner that is helping us drive, hopefully, a disruptive technology to edge-to-edge, as we talked about. And that is a partnership where we're -- we've invested our IP and some dollars into a separate venture that we could acquire. We have the rights to acquire as we come out of this. Then we've got the Blackstone partnership where they are helping us accelerate and advance our Diabetes R&D investments. And at the end, when we commercialize these, we will pay them a royalty for a certain period of time up to a certain cap. So we'll continue to do more of these kinds of things and how we evaluate them is what does it -- how does it work within the overall Medtronic framework? And how does it work for that business? For example, the Diabetes partnership needs to be a technology that is not way out there, not a decade away because a partner won't fund that, but something that is more near term and something that can afford to pay a royalty on the back end for a certain period of time. So hopefully, that gives you some insight in how we're looking at it.

It does. It does. And I wanted just to follow-up there, not on partnership, but just in terms of -- I think we got an inkling on the last earnings call that the strategy going forward may include some more active portfolio management. And there is some pruning of some lower growth assets or lower margin assets. And maybe you can touch on just how much more active your team will be and in active portfolio management?

Being a good steward and manager of our portfolio is something that we have to do to be able to drive our own growth and financial profile and it's the right thing to do for our investors. So we will be focused on pruning from time to time. You saw us do that in a larger way when we sold portion of our PMR business to Cardinal health. We'll continue to evaluate and review our portfolio. And if there comes a time when we believe that a business would have better value and better growth opportunities outside of Medtronic because another owner is better than we are or if it falls to the bottom of the pile, every time we look at how we do our capital allocation and investment, then it does belong outside of our portfolio. And we'll do that over time as we need to.

And just in terms of getting that 5% plus LRP, does that bake in the divestiture or pruning of lower growth assets?

Depending on the size of the asset, it may be large enough where we take it out of the base and take it out of the go-forward. But regardless, whatever we do, the key goal will be to help us drive that growth acceleration and sustain it.

Excellent. We're right up to end of the half hour here, Karen. Maybe just one more on the M&A front. What's Medtronic's current thinking on the bigger transactions, if the fit is right and you've talked about tuck-in M&A? But just a frame of thought Medtronic could have expertise in critical areas like integration, regulatory compliance, and could arguably be an ideal buyer for larger assets. I think there's been some commentary from some med-tech -- other med-tech companies about -- thinking more about pursuing larger M&A, but is that something that is an absolute no for Medtronic? Is that if it's the right fit? Or how would you answer that question about could Medtronic pursue large M&A and outside of this tuck-in strategy?

So I would say our focus is on strengthening our existing portfolio through tuck-ins and really growing what we buy. That's what you've seen us doing. We've said that since the beginning of last calendar year, we've done 8 tuck-ins that amount to $1.7 billion. And sometimes those tuck-ins can amount to the low billions of dollars. But our key focus is to use those tuck-ins to help drive our revenue growth even higher. But we're in a great spot right now with our pipeline, just look at the huge opportunities coming on the horizon. We're not in the mindset to buy growth at this stage. We're in a mindset to deliver higher growth and sustain it and use tuck-ins to help us do that.

Understood. That was very clear. Thank you for spending time with us, Karen, today and participating in the Cowen Health Care Conference. Love to have you back again in the coming years. Thank you.

Thank you, Josh. I appreciate it.

Have a great rest of the day. Okay.

Okay, you, too.

Take care.