Medtronic plc (MDT) Earnings Call Transcript & Summary

Thanks, everyone. We'll get started here. I'm Robbie Marcus, the med tech analyst at JPMorgan. I'm very happy to have Medtronic as our next company here. I'm going to call up Geoff Martha, Chairman and CEO, and then we'll do a little Q&A after. Geoff? All right. Thank you.

All right. Thanks, Robbie. Okay. Thanks for the introduction, Robbie, and thanks to all of you for joining the Medtronic presentation this morning and what looks like to be a packed house and despite the rain or at least the threat of rain, it wasn't nearly as bad as we were told. It's great to be back in person here in San Francisco. And before I get started, I do want to remind you of some disclosures, including that I'll be making some forward-looking statements today that and may reference some non-GAAP financial measures. And I encourage you to read these disclosures. These are also available on our Investor Relations website as part of this presentation. Okay. So let's get going here. So today, I want to update you on the steps that we're taking to set up Medtronic for durable growth. While it hasn't yet translated into our financial results, we have an aggressive transformation underway in the company. And I'll share with you today how the actions that we're taking get at the root causes of what's held Medtronic back and cover some of the proof points that these changes are working. I'll talk about how we're improving our operations, supply chain and quality and working to make our scale and synergies across the company actually count. We're also implementing changes to how we allocate capital and how we think about the portfolio, including divesting noncore assets. And all of this is geared toward getting to a faster and more durable growth. And as we look at the portfolio, I'll share with you how we're thinking about our mix of businesses and how this leads to a mid-single-digit organic revenue growth company and how we expect growth acceleration starting now in the back half of our fiscal year. And when I think about what is held Medtronic back over the years, I can sum it up in these areas: one, structure and culture; two market selection; and three, quality and operations. So starting with structure. We've taken decisive action, as I've talked about, to reduce the organizational complexity through our new operating model. We've eliminated group and region structures. We've empowered our businesses and more recently centralized our global operations. Regarding culture, we've brought in several new external leaders who bring much needed capabilities in certain areas, but also just as, if not more importantly, a fresh perspective. And we've put in place a much stronger performance-based incentive program. When it comes to market selection, we've implemented changes to how we allocate capital to ensure we're prioritizing investments in high-growth and high-return areas. And we've also sharpened our focus on portfolio management, implementing rigorous processes that look at both additions and subtractions. And finally, with quality and operations, we've been urgently enhancing our capabilities, including bringing in new leadership and implementing new systems. And as these actions continue to take hold, I fully expect to see improved financial performance and improve shareholder value creation over time. Now in order to change the culture of the company, it has been very important to bring in fresh thinking, fresh thinking from the outside, often from outside our industry. In operations and quality, I talked about how we hired Greg Smith over 1.5 years ago to lead our global operations and supply chain. And Greg has brought in underneath him, new leaders as we embark on centralizing this function to drive efficiencies and while at the same time, improving our resiliency and our quality. And in certain of our businesses, we need better operators. And to do this, we did elevate some leaders within the company but also brought in other leaders from outside the company. Finally, we're strengthening our functions, including strategy, digital innovation, IT and FP&A by hiring strong external talent. These new leaders, combined with our existing leadership team are driving the changes across the company. Another part of our transformation is turning our scale into an advantage. And we're focused on 3 specific areas: global ops and supply chain; leveraging technology like batteries, robotics and catheter delivery systems across multiple of our businesses; and sales, sales to larger health care systems, which keep getting bigger, where we are becoming a partner of choice through our contracting supply chain management as well as our data exchanges. Looking specifically at the progress we're making on global ops and supply chain. We centralized these functions to create efficiency and leverage our scale, moving from 13 supply chain and manufacturing organizations down to just 2. We're modernizing our operations planning systems, including our SIOP capabilities to get ahead of supply chain risk. And we're focused on consolidating our vendors to drive efficiencies, while at the same time ensuring redundancy. And we believe that all of this will lead to a competitive advantage for Medtronic, 1 where our scale is leveraged and from which all of our businesses will benefit. Now another part of our transformation agenda is improving our capital allocation across the company to disproportionately allocate capital to high-growth and high-return opportunities while ensuring that all of our businesses get the appropriate level of investment that they need to compete in their respective markets. We're doing this through increasing our level of R&D, and we target R&D growth at or above revenue growth. And as you can see in this chart, we've grown R&D at 5% over the past 5 years, 5% a year, including a 10% step-up in FY '22. And then we supplement our organic R&D with smart tuck-in acquisitions as well as utilizing minority investments, strategic partnerships and even incubators. And when it comes to capital allocation, we're prioritizing returning capital to our shareholders. We target a minimum return of 50% of our free cash flow, primarily through our dividend, which we've increased every year for 45 years. And we won't hoard cash on our balance sheet. So to the extent we can't find attractive tuck-in M&A, we will look to return capital to our shareholders by repurchasing our shares. Now portfolio management is an important part of our transformation agenda and critical to achieving the durable growth I'm talking about. And we've put in place a regular cadence of evaluating our portfolio. And you've seen the results as we've announced both additions and subtractions. On the divestiture side, we've announced 3 businesses over the past 8 months that we intend to divest that together account for 8% of our revenue. And on the tuck-in acquisition side, we most recently closed the acquisitions of Intersect ENT as well as Affera. I'm excited about both of these. And you can see how we are taking a very targeted approach on our tuck-in. So 1 example is in our Cardiac Ablation Solutions business, where we're using these acquisitions to create scale in this high-growth market. And most recently with the addition of Affera and their mapping and navigation technology and also Acutus' left heart access portfolio. So as we go forward, you can expect us to continue to make disciplined tuck-in acquisitions when it makes sense and also divest nonstrategic assets. So we have an aggressive transformation agenda like I've spoken about from our work in reducing organizational complexity to improving capital allocation and enhancing our capabilities. We're working to leverage our scale and implement new focused capital allocation and portfolio management processes. Now I realize that you're not seeing us come through in our overall financials yet. I get that. And -- but we're seeing signs of progress in certain businesses. And let me talk you through a few proof points. You're seeing these green shoots in certain businesses, in particular, those that are in our neuroscience portfolio. Because in these businesses, we implemented changes earlier prior to taking them to the entire company when I first became CEO. So let's talk about Neurovascular. This business was really a beta for the operating model that we now have in place across the company. When Neurovascular came in from Covidien it was stand-alone, and we kept it that way, allowing them to have the focus that they needed to compete and win in the marketplace. We also disproportionately funded their innovation due to the market opportunity which has proven to be a wise decision as they've really pioneered the ischemic stroke market and remain the leader here. And this experience of a focused operating unit within Medtronic led us to what we did with our Cranial and Spinal Technologies business. Here, we combined our spine and neurosurgery businesses to make 1 entity, given the close linkages between these businesses and the new business model where we use the enabling technology to pull through implants, we put these 2 businesses together, and we brought in a new leader to run the business. We also added to the CST portfolio at strategic tuck-in acquisitions, including Mazor Robotics, Titan Spine and most recently, Medicrea, which brought in an AI guide in preoperative planning software as well as customized hardware. And it's this ecosystem of spine hardware and enabling technology, which we now call [ Able ] has allowed us to extend our lead in the spine marketplace. And it's a -- this is an example of how we intend this model to work. And as you can see in both of these examples, we're realizing the benefits of the changes that we have made, and they're paying off from both in terms of revenue growth as well as market share wins. I can tell you similar stories about several other businesses like E&T and others. But the important point to take away is that, over time, we expect even more of our businesses to demonstrate the benefits of the transformation agenda, whether that's ensuring the current strong performance is durable like our cardiac rhythm business, or when we're talking about a turnaround like with diabetes. And you'll be able to track these very clearly as they accelerate our growth over time. These proof points are real, and they're exciting. But we recognize as a whole, we haven't been delivering the growth we should over the past few quarters as we've had a few headwinds that have held us back. The good news is that we have line of sight to these headwinds resolving and some sooner than others, but we have line of sight for all of them resolving. For example, ventilator sales. We've had a recent headwind impacting our first half growth by roughly 60 basis points given strong COVID-related sales in the prior year. However, these difficult comparisons, they abate as we go through the back half of our fiscal year. Another that I'll call out is China VBP. We get a lot of questions on that. We've gone through VBP now in coronary stents and in our spine business and have a few other businesses that are now going through provincial tenders. However, we expect that as we exit this fiscal year, over half of our China revenue will have been through VBP, and we expect to reach approximately 80% by the end of our FY '24, giving us a new, albeit lower revenue base to grow from going forward. Overall, our guidance assumes our headwinds become less in the second half of our fiscal year, leading to accelerated revenue growth. And aiding this accelerated revenue profile are several key drivers that are expected to accelerate our growth over the next 6 quarters. This page with 1 exception, are all drivers that are either here today or will have a meaningful impact in the second half of FY '23 and into our FY '24. The one thing that is a little further out is already in, but we are expecting regulatory and reimbursement catalysts over this time frame. And I'll point out the recent news that our pivotal data from the PULSED AF trial studying our PulseSelect PFA catheter has been accepted as a late-breaking clinical trial at ACC in March. And we expect to be 1 of the first, if not the first PFA catheter in the U.S. market. You should take away that we have many drivers, as you can see on this page, across all 4 segments. And several of these pipeline catalysts, like I said earlier, are here now, right, already on the market. These growth drivers are real and exciting for our top line growth even into next fiscal year. And we -- but as we move down the P&L for FY '24, we do want to remind you in our investors of some of the things we talked about on our last earnings call. Macro factors, combined with the imperative to ensure we invest for the long term, will create significant EPS headwinds for our next year. Now we're working to partially mitigate these headwinds through significant expense reductions, but inflation, interest, FX and the increased R&D investments that we want to make are reducing our earnings power in the near term. Now over the long term, our transformation agenda is sending us up for durable growth. So let me walk through how we think about our businesses and our overall growth formula going forward. On the bottom of the page, you have our durable growth businesses, which are established leaders in their markets and make up 50% of our revenue. These are big businesses with nice synergies that drive disproportionate amount of our profits and our cash flow, and we need to ensure that we continue to invest appropriately in each of these. And to get the company to the overall growth profile that we want. On top of this, we need to invest in our highest and largest growth opportunities, and these are in secular growth markets. To do this, we use cash flow from the 4 businesses highlighted below to help fund these high-growth opportunities because they require a disproportionate amount of investment. And I'm going to talk through in more detail about both of these groups of businesses over the next couple of slides. So let's start with our highest growth areas. I'll start with structural heart. Here, we have a strong position in the TAVR market, where we just launched our latest generation TAVR valve Evolut FX in the U.S., and we're investing in future growth drivers in the mitral and tricuspid spaces. We also have a leadership position in neurovascular market that I talked about earlier, where we continue to gain share in a double-digit growth market. In diabetes, while we remain under a warning letter in the United States, we are driving consistent mid-teens growth in international markets, and we recently completed 100% of our warning letter commitments and are prepared for FDA reinspection. In cardiac ablation solutions, I mentioned earlier, this 1 as well, how we're assembling a full suite of products for this space, including bringing multiple PULSED ablation catheters to the market. And in surgical robotics. We've made very meaningful progress over the past few quarters as we expand to new geographies and specialty indications. And just last month, we announced our first enrollment in our U.S. IDE trial and expect to be a strong player in this multibillion-dollar market. At the same time, we have established leadership positions in our largest businesses that make up about half the company, as I said. So in cardiac rhythm management, we continue to win share with our micro family of leadless pacemakers and we're gearing up for the CE Mark approval of our Aurora EV-ICD here in the second half of our fiscal year. In CST and our E&T business, I mentioned earlier the impact of our [ Able ] technology ecosystem is having in the spine market, but the E&T business also drafts off this enabling technology in areas like navigation and powered instruments to drive its market leadership. And in Surgical Innovations, we have resolved the acute supply chain challenges that have held this business back over the past 3 quarters, and we expect to recapture share going forward. Now pulling this all together, this slide shows you how we're thinking about the portfolio and how we can deliver mid-single-digit revenue growth over the long term. Starting with our established market-leading businesses. This makes up about half the company, and we've been consistently growing 3% to 4% prior to the pandemic, and we expect them to grow at this rate going forward given the durability of these businesses. And as I mentioned, these are big businesses, and they drive a lot of the economics both in terms of profits and cash flow to feed other investments. On the other hand, you have our highest growth businesses, which are also our largest growth opportunities. These are growing collectively 10-plus percent pre-COVID. And we expect them to grow in the high single digits, if not higher going forward as we capitalize on each of these growth opportunities. We're well positioned in these markets, but they do require a lot of investment. And in the middle, you have what we're calling our synergistic businesses. They don't fit any 1 growth profile nor do any 1 of these have the economic impact of our established market-leading businesses. But collectively, they deliver mid-single-digit growth and have strong ties to other businesses in the company. So for example, our neuromodulation businesses, Here, we leverage the strength of our broad implantables franchise, and we're building on our implantables base and investing to drive innovation in areas like closed-loop spinal cord stimulation and closed-loop DBS. Another example is in cardiac diagnostics where we're evaluating opportunities to potentially expand this business, which leverages technologies from our CRM business, and we're looking to expand it into new diagnostic areas. And you'll also notice the businesses that we've announced for divestiture, which make up 8% of the revenue, and that rounds us out. So this is our portfolio today. We continue to evaluate it, but we like how this portfolio is shaping up. And this is what gives us the confidence in our ability to deliver durable growth over the long term. So to conclude, we are urgently forging a path towards durable growth. Our aggressive transformation agenda is getting at what has held us back at the heart of what's held us back, and we expect this to result in the creation of a durable growth company. We expect our revenue growth to accelerate in the near term as we overcome headwinds and realize the impact of our growth drivers that are here today on that page I showed you across all 4 segments. And we're also working to turn our scale into an advantage. And we expect all of this to drive improved execution, financial results and shareholder value over the long term as we deliver on our operating initiatives and our growth drivers. So with that, I'll have the -- several others of my management team join me on stage and Karen, Sean, Bob, Brett, Hugh and I are happy to take your questions that I think will be moderated by Robbie.

Thank you. Great. So thanks, everyone. Maybe we could start it off. I was thinking Medtronic is probably the largest med tech company around the world with that touches more markets. So I thought it'd be good. I realize you're intra-quarter and you're clearly not preannouncing fiscal third quarter, but what's your latest sense of what trends are looking like around the world? China is a big one, whether there is a lot going on. And just have you seen a return to normalization in most markets in med tech?

Well, like we said in our last earnings call, most of the markets have returned. We called out a couple that hadn't. And we don't -- and since our earnings call today, we haven't seen a lot of change. So like the ones that we called out that hadn't fully returned or TAVR, coronary, PCI, SCS our SI certain procedures within our surgery business that are more elective and GI. And most of those are unchanged so far, except coronary has gotten slightly better in the last couple of weeks. We don't really -- this is 1 that's -- we're kind of scratching our head as to what happened, why it's slower, but it is coming back. And as you mentioned, the China dynamic with the COVID there is new since our call. I can tell you this, it's a couple of things. One, it's moving, as you guys read the headlines like I do, and it's moving fast. And I can tell you, talking to our leadership there. We have like 400, 500 employees. I mean, it's ripped through our company quickly, like unbelievably quickly. But from a supplier side, they have a different approach. Our supply chain is -- hasn't -- we haven't seen issues yet there. People are going to work with symptoms. So it's a whole different world and -- but it will impact cases on the end market side, and we're watching this closely as it evolves. But our hope is that it's going to be short-lived. But it's something that's evolving and we're kind of watching closely. But the others haven't changed too much. I don't know, Karen, if I missed anything you want to add anything?

You said, well, I would -- the only thing I would add is just on China, even though we're watching it closely, we're continuing to track with our expectations for the quarter.

Great. Good eye. As we look back over the past year, I think there are a couple product issues that we're all well first. And as we look over the next 12 months, you had a slide up there with a lot. What's the new product launches that you're the most excited for? And I think what we all care about most is what could be the most impactful of Medtronic?

Well, I think in terms of impact, it's the totality of them. I mean, if you look across, there's a lot. And since I became CEO, these things were further out. And now with the exception of Ardian, we're not really counting on much in our FY '24 from Ardian. The others were all -- they're very -- they're either on the market or close. And from a long-term perspective, I'm excited to -- our diabetes products in the U.S. I'm seeing what we see in Europe in another -- and around the world the patient clinical results as well as the patient experience. And we just see the market turning back to this AI automated in some delivery, whether it's a pump a patch or a pen and we have a very strong position there. So getting that as products back in the market. Obviously, we have to get through this, the inspection. That's very exciting. Hugo is exciting too. I know there's a lot of skepticism out there because it took us so long to get this product out there and other competitors have struggled to get our competitive system out there in the against da Vinci, but we're getting really good feedback. And I think we have something to build from here. So I'm excited to see that ramp. But the impact is going to come from the totality of everything, including some of the -- just the -- it's not 1 product like in our CST business or E&T business where they've got this ecosystem of technology that creates a moat around them, just seeing those business models really extend their lead versus their competition is something I'm excited about.

Getting the diabetes warning letter lifted is obviously a very important factor for helping Medtronic growth going forward. You said in the slides that you've completed everything and you've invited the FDA to come inspect. Is there any way to think about how long it may take or from now to approval? What's a good benchmark maybe for the industry? I realize it's impossible for you to say exactly.

Maybe I'll introduce Que. This is our first JPMorgan. She's really excited to meet you in person, Robbie. But I'll Introduce Que, and maybe have her answer that one.

Robert, thanks for the question. I mean, look, we don't have a crystal ball. I think we feel very confident about being ready for the FDA. And it's really in the hands of the agency on their resource levels. COVID it is also an impact in the wintertime. And so it's really a resourcing. They've indicated to us that this is a priority for them. And so our anticipation is that it will be, I think what Geoff has said previously is it's months not quarters. So we're waiting when they can come back in.

Okay. Maybe I'll touch on fiscal '24. You had a slide up there and whether Geoff or Karen. First question is, do you think Medtronic can return to 5% plus organic sales growth next year? You had a long list of headwinds to consider down the P&L. Do you think Medtronic can grow on the bottom line next year?

Let me take the beginning, I'll have Karen answer it. I mean, look, I think what I'm excited about right now as we sit here today is the improvements that we've made on our supply chain issues and quality issues, the product launches and the revenue acceleration that we're seeing. I wish it were faster. But each quarter, it's getting higher and we're excited about the back half of the year and exiting the year in that mid-single-digit range. So we're not -- it's too early to provide guidance for next year. I don't want to get into that right now. But on the top line, just excited about removing some of the headwinds, fixing some of our kind of execution issues on the operations side, at the same time, these products are hitting, exiting the year mid-single-digit and we're not at the guidance for next year, but it will be a tougher year from an EPS perspective. And I'll let Karen maybe tackle that one.

Yes, absolutely. And again, I'll reiterate, it's too early to give guidance for next fiscal year. We're still in our planning cycle. We still have 2 quarters to go this fiscal year. But as we look ahead, it does start with the top line, as Geoff mentioned, and we should exit the year as we expected in mid-single-digit territory, which helps because the earnings power starts with the top line and helps with the top line. That said, we are facing continuing headwinds into next year include inflation, currency, interest, taxes, and all of those headwinds will play a role. We are focused on driving significant expense reduction next year, and we're working on those plans right now to take both fixed cost and variable cost out of our base. Our new operating structure, I think, helps us get at those costs a little bit better. Where it shakes out, too early to give you specifics at this stage, but we'll keep you posted as we move through the rest of this fiscal year. And as Geoff said, next year will be a tougher earnings year just given all of those headwinds.

Geoff, you guys have been fairly active in smaller-sized M&A and you recently announced divestiture or spin of the patient monitoring business. How far along are you in your portfolio review? Should we expect potentially more actions from Medtronic, both or either additions or subtractions in calendar 2023?

Well, I think in the near term, I mean, look, first of all, divestitures take a lot of -- a lot more work to execute, not the analysis, but the execution. And so I think given we've got 3: our dialysis business; our patient monitoring business; and our respiratory interventions business, which has our ventilators among other products, that's a lot. It totals 8% of our revenue, and there's some operational entanglements we've got to undo. So I think over the near term, from a divestiture standpoint, I wouldn't count on others. However, that being said, the portfolio review, as I mentioned in my commentary, it's ongoing. It's not -- there's not like a date that says, okay, as of this date, we're done. It's part of our ongoing process here. On the tuck-in acquisition side, those are a little bit less in our control. And if there are certain things we've been tracking, we try to get ahead of processes and things like that. So you could see more on the tuck-in M&A side, but on the divestiture side, I'm not saying no, but I think it's unlikely in that time frame.

Okay. You do have a fairly robust balance sheet right now. So where does M&A relative to share repurchase investment or dividend fall?