Medtronic plc (MDT) Earnings Call Transcript & Summary

Hi, everybody. I'm Lee Hambright, U.S. Medical Devices Analyst at Bernstein. We are thrilled to host Medtronic's CEO, Geoff Martha today. Geoff is going to take us through some opening remarks, and then we'll jump into Q&A. Just a reminder that investors can submit questions at any time through the live Q&A tab on the right side of your screen. So Geoff, thanks so much for joining us. Please take it away.

All right. Hey, thanks, Lee, and hello, everyone. It's really great to be with you today. Before I jump right in -- before we jump into the Q&A, I thought I'd take a few minutes just to provide a brief overview of Medtronic for those that are less familiar with the company because I understand some of the investors on this call are more generalists. So Medtronic, we're the global leader in medical technology, founded in Minneapolis in a garage over 70 years ago, very strong mission-driven company with the mission to alleviate pain, restore health and extend life. This -- and this mission has guided us for decades. And really, as a new CEO, kind of walking into the pandemic, the mission really helped guide all of my decisions over the first year, and there's a real kind of clarifying force for me personally. We serve physicians, hospitals and patients in more than 150 countries. Strong growth tailwinds as emerging markets develop, more advanced health care systems with aging demographics. So we've had a huge -- over the last decade, a huge push in emerging markets, now it's 17% of our revenue, pre pandemic, that is, and growing in solid double digits for the last 10 years prior to the pandemic. We touch a lot of people's lives. We improve the lives of more than 2 patients, 2 people every second. And our therapies are focused in areas of -- like cardiovascular, medical, surgical, neuroscience and diabetes. Touching on our key priorities. Our key priority is to sustainably accelerate our revenue growth at/or above our end markets, and we're doing this by first investing in innovation. We have the most robust product pipeline in our company's history. And just started our fiscal year, this new fiscal year, we intend to increase our R&D spending by more than 10%. This is the largest increase in the company's history. So really bullish about our innovation capabilities in the MRI markets. The technology we're bringing to market today is enabling us to go on the offensive and win share. And while we're doing that, we're making big outsized investments to create and disrupt big markets like surgical robotics, renal denervation for hypertension, which are both multibillion-dollar opportunities for us. We're -- look, we'd like to say we're putting the tech into med tech, taking advances from the tech world like big data, artificial intelligence and applying these to medical technology to address unmet clinical needs, improve patient outcomes and lower cost and improve access. I mean data is a real inflection point for us as we bring big data into health care to not just improve outcomes, which we've been doing over the years, but to bring down costs and to drive access. So I really think data is a missing link to doing all 3 at once. And finally, we're empowering -- we've made some organizational changes here, and we're empowering our operating units to become more nimble and competitive as we've decentralized the company over the last year. Last kind of topic here before we jump in -- or one of the last ones here, is we've made an announcement this morning about our HVAD product, our left ventricular assist device. And before I get into the accomplishments of the past year, I do want to note that earlier this morning, we did announce that we're stopping distribution and sales of our HVAD left ventricular assist device. Earlier this week, this is pretty quick breaking news. The Annals of Thoracic Surgery published a real-world registry that compare our HVAD device to Abbott's HeartMate 3, the other HVAD device in the market. The study indicated that HeartMate 3, Abbott's device, in fact, had lower mortality than our device. And it's not that our system is performing worse than expected, as defined by our U.S. pivotal trial results, it's that new data is emerging that shows Abbot's device has fewer neurological events and lower mortality rates. This is an unusual situation for us. And in addition, our system has had a number of quality issues since we acquired it that we haven't been able to completely resolve. So in light of these 2 things, the Abbot data showing lower mortality and lower neurological events, plus the kind of some of the performance issues, the quality issues we have not been able to solve, in light of this and the availability of what appears to be a better device for patients, we've decided to pull our product from the market. The Abbot devices is better for patients. It's a challenging decision to make given the blood, sweat and tears we've invested in this therapy over the last 6 years, but this is clearly the right decision for patients. And we remain committed to serving the needs of patients that are currently implanted with our system. In terms of financial impact, because we're going to have to follow these patients for years and support them -- in terms of financial impact, we noted that on a non-GAAP basis, It is expected to be neutral to slightly actually accretive to our FY '22 non-GAAP EPS. And the potential of this decision, we had contemplated it in the guidance that we gave last week in our Q4 earnings call. We actually guided up 100 basis points above consensus from a growth perspective. We would have been another 50 basis points higher if it weren't for this issue. So our underlying business is very strong. It's never easy to make a decision like this to exit a business, but nothing is more important -- I talked about us being a mission-driven company, nothing is more important than the safety and well-being of our patients. All of us in Medtronic, we need to sleep at night, and so we think this is the right decision. Now shifting gears. Let's look back over the past fiscal year, which was my first as CEO. We executed through the pandemic with a number of transformative changes to the company at the same time, which puts us in a much stronger position. We continue to invest in our employees and our pipeline all throughout the pandemic. We helped our customers and patients as well through the pandemic. And for example, we manufacture high-acuity ventilators, and we significantly increased our production and even open sourced our IP to allow others to produce ventilators around the world when ventilators were in short supply. We increased our production by 5x, 5-X, and we did this in a couple of months, which is pretty hard to do. And by open sourcing this and allowing others to manufacture it, that even increased the world's supply of ventilators. And that's just the kind of company we are. And at the end, that made us a better business. We reduced our customer quarter end bulk purchases, resulting in a more balanced order flow across each of one of our quarters and improved our predictability, our pricing and reduced stress on our operations, and it just made our business easier to manage and more predictable. We advanced our pipeline with more than 230 regulatory approvals around the world in the U.S., Europe, Japan, China, et cetera. That's a huge amount of product approvals. We accelerated tuck-in acquisitions, executing 6 acquisitions for a combined $1.2 billion in present value total consideration. So we also returned $3.3 billion to our shareholders, primarily through growing our dividend and just recently increased the dividend by 9%, which is our 44th consecutive year of increases as we remain an S&P Dividend Aristocrat. As I mentioned before, we increased our R&D funding through innovative -- we increased it, overall, our income statement. We also increased it through innovative partnerships like through Blackstone and our Diabetes business. We reached -- and this is a new vehicle for us that we can continue to do in other areas. We reached important milestones for key products under development, highlighted by -- we submitted our Hugo, our soft tissue robot for CE Mark approval, and we filed for our U.S. IDE from the FDA, and we're recently granted IDE approval. We also submitted our 780G, our latest insulin pump and our Zeus sensor to the FDA, which is now under active review. We implemented our new operating model, like I mentioned, decentralizing the organization from these 3 big groups of businesses into 20 operating units. And our intention is to be a small company and move with speed and entrepreneurship, but at the same time, in certain areas, leverage the scale of Medtronic, like in our manufacturing and our core technology development. We've also aligned our incentives around this new model. We enhanced our corporate culture, emphasizing being bold. We introduced what we call the Medtronic mindset. Alongside our mission-driven nature, which is really into our DNA, we launched this Medtronic mindset, which talks about being bold, more competitive, moving with greater speed and decisiveness. These are things that, I think, augment our work, alongside our mission and close some cultural gaps that we have here at the company. And we could talk more about that. And this is already paying off as we're winning market share and more businesses across the company. That came quicker than I even thought. And so overall, FY '21 was a very strong year of execution for us and really a transformational year for the company, and we're excited to continue the momentum in FY '22. I mean we really are leading into FY '22. So next, real quick on ESG. We've been focused on this for a long time before the term ESG was even used. Many of these concepts are built into our mission, which is written in 1960, and now the world has changed. The underlying themes of ESG, like I said, are deeply rooted in our mission. Our mission gives us a strong corporate sense -- gives us a strong sense of purpose. It directs us to maintain good citizenship as a company. Being a good corporate citizen in our communities is one of our -- is our tenet 6th, #6 tenet mission, and that wasn't even a word in 1960, but yet our founder responded and put it into our mission. On that point, tenet 5 gets into the personal worth of all our employees. And on that point, we're proud that we were recognized last month as #11 on the DiversityInc's Top 50 U.S. companies for diversity. On the environmental side, we announced last fall our intent to be carbon-neutral in our operations by the end of the decade, so by 2030. And regarding governance, our Board is very engaged in all topics of the business, including ESG. In particular, our nominating and governance committee oversees Medtronic's ESG practices and engages on specific ESG agenda topics. So before we jump into Q&A, I'd just like to say, why invest in Medtronic? So to summarize, as you think about your investment in Medtronic, we're the world's largest medical -- medical technology company with strong scientific underpinnings and strong clinical underpinnings, and a broad and deep portfolio of innovative therapies. We have a robust pipeline of innovative and disruptive technologies launching over the next few years. I'm sure we'll get into this in the Q&A with Lee here, that address unmet patient needs and are in attractive growth markets. We have an advantaged footprint in key markets around the world, with unparalleled infrastructure and capabilities in emerging markets, like I talked about earlier, providing significant runway for growth. We've made transformative structural and cultural changes to unlock value across the organization that I know will generate greater speed and agility at the operating unit level, which is where the innovation happens and increased competitiveness out in our field, and enhanced execution in our operations across the company. We're developing new vectors for growth by rapidly advancing digital technologies, digital capabilities to improve therapies and patient outcomes as well as enhance patient and physician experiences. Like I talked about earlier, I think data and AI is a real inflection point for med tech, and Medtronic intends to lead this. We're strategically developing capital through investments and we're strategically deploying capital through investments in R&D and disciplined M&A and leveraging the strength of our balance sheet, all of -- which is to drive more innovation, drive growth. And finally, we're committed to delivering double-digit shareholder return. It starts with our 5% plus organic revenue growth combined with leverage and margin expansion to get to an 8% plus EPS growth. We're committed to converting greater than 80% of our earnings to free cash flow. And we're balancing the deployment that capital -- deploying that capital to investments in the business and delivering strong returns to our shareholders, including our strong and growing dividend. So as we look ahead, look, our future is brighter and markets are good. The company is well positioned, strong clinical and technology underpinnings and a foundation based on a purpose-driven company in a time when purpose really matters. And we look forward to creating a lot of value for our shareholders. With that, Lee, I'm sure you want to get into a lot of these topics in more detail. So I'll turn it over to you for the Q&A.

It's great. Thank you, Geoff. I think we'll touch on a lot of those points. Maybe we'll get started. It's been a little over a year since you took over as CEO, a pretty remarkable year to get started. You acted really quickly to delayer and decentralize the organization, which you talked about in your preamble, and you've worked to create a culture of accountability. Changing culture is hard. I can imagine some people who thrived in the old kind of consensus building-oriented culture might not fit in the new org. I just wonder how have you managed through turnover? And how would you assess your progress toward creating the high-performing culture that you'd like to see at Medtronic?

Well, that's a great question. So just to recap, as you know, we began the implementation of our new operating model, really, at the start of our Q3, and it was fully effective on February 1. So we've made all the announcements, all the changes. The dust is still settling, but people are in their seats. They understand their jobs, and we are now looking forward. So the hardest part is behind us in terms of the disruptive part. The culture change will take some time. And as you're right, it's not easy. But we do feel good about the leadership we have in place and for the -- and our employees are energized. And we have the highest employee feedback scores, employee health scores that we've had ever. And they're all world-class levels. We pulse our employees twice a year. During COVID, it was even more frequently than that. So we have lots of comparisons and we benchmarked that. And our employee engagement is world-class and proud -- pride of being part of Medtronic's at all-time highs, optimism is at all-time high, so we're feeling good. Our portfolios and our regions are adapting well to this new way of working. We've decentralized it, like I said, and try to consolidate decision-making and clarify decision-making and consolidate a lot of those decisions into our operating units. And so that's been a big change. And I think -- it's also brought us closer to our customers. So we're feeling good about it. But look, the culture change, and we launched this new Medtronic mindset, it's going to take some time. But we're off to a good start. People are very optimistic about it. We're trying to quantify, though, these cultural mindsets and describe, what does it mean to be bold? What does it mean? Here's an example of being bold for a Vice President, here's an example being bold for like a manager or a frontline worker. And here's examples of not being bold. And you go down to each one of these traits now competing with speed and being decisive, getting results the right way. These are different. And this -- the organization has really grabbed on to this and we're working to, I'd say, operationalize this culture. And to your point, I liked your comment, the old consensus building model doesn't fit certain people. Because in striving for consensus in every decision, in many cases, you're just not making a decision. And that's what was slowing us down. And just talking about that out loud is therapeutic for many of us that didn't like that old way of doing things. But there are some, and we have had some turnover, and I do think it's healthy because we've also brought in a fresh perspective. And you get new people, even on our executive community, we've added 2 new people from outside the company. One is our Head of Communications, the other is Greg Smith from Walmart that I talked about. And it's interesting just to see their take on certain things. And we're very optimistic here. And how we're going to measure it? First and foremost, I want to see us -- I mean it was all based on innovating, more innovation-driven growth. I want to see us growing faster, taking share. But it's harder to quantify, but you can quantify the strength of your pipeline. How good is our pipeline? Are we moving fast enough? Are we investing a lot of money or enough money? And those measures right now are much improved.

Yes. Great. It strikes me, those 20 operating unit leader roles are real kind of critical linchpin to this whole thing. And you've got a great talent pool to draw from at Medtronic. But those roles are essentially sort of kind of CEO roles of $1 billion or $2 billion businesses.

They are.

So it'd be great if you got them all right out of the gate 20 for 20, but maybe you didn't get all of them, right? How do you think about coaching those people and maybe making decisions about changes where they need to be made?

So first of all, we spent -- at the ExCom, we spent a lot of time debating this, what -- because these roles, I would argue are 20 of the best roles in med tech. Like you said, these are running our structural heart business or running our spine business as we're transforming our pulse enabling technology, launching the robot, soft tissue robot, nerve. These are great businesses, global. So first of all, we spent a lot of time debating on do we have the right -- I'm sure that, over time, there will be some -- there's already been a little bit of movement already. We've had a few changes, even though we just announced them a couple of months ago. And there'll be more, over time. These jobs are hard. They're rewarding, but they're hard. But we're creating a culture where it's -- these roles aren't easy, they're rewarding and it's an exclusive club, and people want to get in and get to work hard to stay in it. But it means something to be in these jobs, it means something. And there's a source of pride. And this group is in constant contact with me and ExCom and with each other, and we're making a group that learns together. There's some healthy internal competition, but the real competition is outside the company. And the reward is innovating for patients. And so it's not easy to stay in. We're probably setting in pretty aggressive goals and we're making them public. Lee, no one wants to be at the bottom of the list. No one wants to be that share donor. And worst yet, share donor of some companies that we just don't really like. And so putting this out there and speaking truth to power, I mean, it's creating a fun culture. But more than anything, the one thing that's not changing is our mission-driven nature. I mean we're a company of purpose. And like as evidenced today by the decision on our LVAD business, we're always going to do what's right for patients, and that won't go away. But I do think moving faster, being a little bit more competitive are areas for improvement for Medtronic, being more entrepreneurial, being more -- more sense of entrepreneurship in the company. And then we've matched -- we've started to match our compensation plans this way, too, and shifting to more equity. And so their success, their personal financial success is also tied to the success of our stock. So all of this added together, some people are opting out because it's maybe not for them. Others are thriving and others are struggling a bit, and we'll see how that plays out over time. We're providing them a lot of coaching and support, but it's tough. I mean it's just like we were talking -- we were making fun of before we got on, we're talking sports, as I saw that the other day in football, it's like a professional sports team. It's hard to stay at a role -- in those jobs, right? There's always somebody competing for it. It's a lot of work. You got to bring it every day. And that's the attitude we have to have here.

Great. Let's just touch on COVID recovery. Some med tech leaders are suggesting that as we kind of come out of COVID and people are feeling some newfound freedom, they may not rush right back into the hospital to get procedures done right away, only to be laid up again for a few months of rehab. Maybe people want to enjoy a little bit of time with the family, et cetera, and then come in for procedures later this year or even next year in some of the more elective categories. Wondered if you have a view on recovery cadence through the year across your various businesses.

Well, that dynamic, and I heard some of the comments on that from yesterday or the day before. That dynamic, we're not seeing that in terms of patients waiting on the sidelines now. Like let's just stick to the U.S. where vaccinations have hit an inflection point. We're seeing, in most of our therapeutic areas, we're seeing patients coming back into the health system and reengaging with the health system pretty fast. And the dialogue that we're having with our physician partners and with the hospitals is "Medtronic, are you ready to support not this rebound, but a snapback? And are you ready?" And that's been more of the dialogue. If there are patients waiting on more elective type of scenarios, it's on the fringes for Medtronic. We do have a few therapies that are more elective like obesity surgery or something like that. But even our orthopedics business, our spine business, which I talked about earlier, that has come back really quickly. And it didn't go down as far as we thought it would during the height -- the depth of the pandemic, the worst part, the trough, and it's coming back faster than we thought. So we're not really seeing that dynamic. We're not counting on some big backlog to come later. We don't need that to hit our guidance. But if it does come already, just like during the pandemic, we have kept our inventory levels, our faith in manufacturing. We've committed to our suppliers throughout the pandemic. Like you have other industries dealing with this kind of chip shortage, the semiconductor shortage. We faced that, too. But because we kept talking to our suppliers and making financial commitments during the pandemic, unlike the automotive industry they just stopped, we kept going. We held up our commitments, we doubled down, and so that's helped us be ready for this. So we're ready. We have too many -- our pipeline's in good shape. We're ready for a surge if it comes. But -- and we're seeing right now just a quick return, but we don't see this big backlog hanging out there. For us, it's on the fringes.

Any backlog across your businesses then you would think of as kind of upside to guidance. Is that the right way to think about it?

It will be.

Okay. Got it. So your long-range plan calls for 5% plus organic revenue growth and 8% plus adjusted EPS growth, as you said. It seems like the top line trajectory could go to 6% or higher if some of your high upside investments really hit, things like Ardian or Surgical Robotics or CGM, pulse field ablation, PillCam Genius, mitral, the list goes on. Is that the right way to think about it, that some of those larger programs could take you kind of well above that 5% plus?

Now just listening to you listing all those off, I get pretty excited. But yes, 5% is just a starting point, right? The plus is there for a reason. Look, growing at our market has been the issue for Medtronic. It's been -- we've been growing below our weighted average market growth rate, and it's been a little choppy. So coming in with the CEO transition, it's not just about me, but the whole executive committee, we've made this a priority to prioritize growth, not at the expense of margins, we'll talk about margins, but -- and making these investments. And so the 5% is just -- the 5% plus, in my mind, is a starting point. We don't need all those things that you named to hit in a big way to get the guidance. We feel we've got the appropriate cushion in there. And I look at us as, first, let's just get back through execution to growing at our market. And then with some of these other disruptive plays we have, and maybe potentially M&A, but some of the other disruptive plays like renal denervation and the soft tissue robot, those are -- that changes our weighted average market growth rate, and capital deployment and portfolio management and acquisitions could help with that, too. But we can't count on that. What we can count on is what we control right now. So yes, I do think the 5% plus is a starting point. We don't need all those things to hit.

Got it. I think some investors have thought about some of those more disruptive innovation programs kind of as free options. You don't really need them to get to the 5%, like you said. But last week, you made it clear that you're really starting to ratchet up investment with the largest annual increase in R&D in Medtronic's history. Surgical Robotics and Ardian, together, will be a $400 million loss for you in fiscal '22. So in one sense, those free options kind of aren't free anymore. You're really starting to invest behind them. Why is now the right time to kind of hit the gas on those investments? And how do you think about measuring returns?

Well, overall -- okay, so first of all, overall, we're seeing more opportunities in med tech than we've seen to -- in memory. Some of it's driven by advancement in technology, miniaturization of electronics, longer batteries, data and AI, the increased use of software. All these things enable us to drive up improved outcomes and lower cost and improve access all at the same time. And so, overall, that's one reason we're -- and then our capabilities, like we mentioned, are strong in these areas. So that's why we're confident in increasing the investment. And on the ones, like you mentioned, Ardian and robot, we're ramping up investment because they're closer. The robot, we just launched in countries that have lower regulatory barriers like India and Latin America, filed for the CE Mark, filed for U.S. IDE, the FDA just approved that. So it's closer. So we've got to be building up. We're confident in this. And we're confident in the surgeon feedback we got through our validation and verification testing was phenomenal. The demand from customers on the robot is not the issue. We have a lot of demand. And so we're ramping up for that launch. Ardian, there's a little bit more risk in that one, right, because we don't have the pivotal trial results back. We do clinical trials for a reason. So we're optimistic about the data, based on the data we've accumulated over the last 10 years. We think that, that will be reflective in this last pivotal work that we're doing. And we're -- because of that, we're ramping up there. So we are -- so there's 2 things I'd say: one, we're just seeing a lot of opportunities across med tech. And in many ways, we're -- it's not all places. I don't want to -- but in many -- in several areas, we're moving ahead of the line of pharma. And it's because we've gotten less invasive, more efficacious in med tech. Things like in AF for Afib, cryoablation for Afib, we published some data in the New England Journal of Medicine and that it's a better first-line therapy than the existing drug therapy for paroxysmal AF. And we think we're going to get a first-line indication from the FDA. And so then it puts you ahead of pharma. So we've got to invest for that, building the referral pathways, driving the awareness with patients. So we're seeing a lot of opportunities. Now how we measure this, I don't want people to get the wrong impression on this increase in R&D that, hey, look, we're putting [ eternal ] margins to the wind here, and we're just going to -- it's -- the reason we're doing this now is: One, we're seeing these opportunities, just in general; two, we got some very big disruptive plays that we've been investing in over the last decade, the robot, Ardian. For those that know med tech know the history of Ardian and we paid a lot of money, put a lot into this over a decade. It's taken us longer than we thought. Covidien had invested in this robot for a long time. We've put a lot of money in these things, and these are big opportunities and now is not the time to go cheap. The timing is important. Plus we're seeing these broader opportunities. I gave you the Afib one, but I could go therapy by therapy. And so the timing was important to keep that investment going and actually ramp it up a bit. And we are confident we'll get back to pre pandemic margins despite this. We're not pinning down a specific quarter or even a year yet, but it won't be -- it's not years out. It's in the near term. We'll get back. We have opportunities. Even if we keep increasing our R&D, we have opportunities on the gross margin and on the operating margin too, for margin expansion. Gross margin, there's a lot of work we can do on cost of goods sold. That's why we brought in Greg Smith from Walmart. And he's -- we're investing around him to improve the capabilities that we have in med tech on this. So that gives us some room on operating margin as we lower the cost of goods -- I'm sorry, on gross margin as we lower the cost of goods sold. And then on operating margin, we've made a lot of changes in our new operating model here that'll allow us to grow our revenue much faster than growing our enabling expense -- support expense like G&A, like finance, HR, IT, et cetera. So we believe we're set up for that kind of margin expansion that will support even a more increasing amount in our R&D if we choose to do so.

Got it. So like you said, I think people think of Medtronic as having best-in-class operating margins, 29%, 30%. You're guiding to more like 27%, 27.5% this year. You said you will get back there. What is the right way to say, I mean, is sort of 50 basis points a year kind of the ballpark of how to think about improvement from here? Or...

You're starting to walk me into some kind of quantifying the timing and all that, and so I'd like -- Karen and the other -- we're not comfortable saying that yet. I don't want to get in trouble with my CFO. So I'm going to kind of duck that question other than to say that, look, we're committed to that. We need it. I mean we're -- I'm rock solid on this EPS commitment of 8% to 9% growth, and then you add the dividend to that, the double-digit return. I'd even like to increase that over time. And so if you're going to do that, you've got to get your -- you've got to get for us, you've got to get those gross margins improved because I want to keep improving that R&D line as well. So if you want to hit those EPS goals, keep the dividend. You want to increase the R&D line, which drives our employee engagement, as we're investing in more therapies, that's what makes this company so great, and our shareholders will benefit from that. If you're going to do all that, you've got to make improvements to your gross margin line. The math has to come in somewhere, even a Notre Dame guy can get that, right? And so the gross margin, that's where we're going to go after, over time, here. We understand the pricing declines that we'll face, so we can offset that with significant cost out, and we're going to step up our game. Our margins have been high despite our sloppiness in supply chain and operations over the years. And I don't mean that to denigrate our employees there. It's just not a focus area for health care. We haven't invested appropriately, and there's an opportunity here to bring in expertise from outside of the industry.