Medtronic plc (MDT) Earnings Call Transcript & Summary

Okay. Good morning. Welcome to Day 2 of the Wells Fargo 2025 Healthcare Conference. I'm Larry Biegelsen, the medical device analyst. And I am thrilled to host this fireside chat with the management team from Medtronic. With us, we have Geoff Martha, Chairman and CEO; Thierry Pieton, the Executive Vice President and CFO; Laura Mauri, Senior Vice President and Chief Scientific and Medical Officer; and Ryan Weispfenning, Vice President and Head of Investor Relations. The format is fireside chat. If anyone has a question, raise your hand. We'll call on you. So before we jump in, Geoff and Thierry, I just want to say thank you. You've been big supporters of our conference for many years, and I really appreciate it.

Thanks for having us.

So looking forward to the discussion. Obviously, a lot to talk about. So Geoff, before we jump into the business, I'm going to start with a couple of high-level questions, starting with the Elliott announcement. On the one hand, Elliott believes your growth is inflecting and there's an opportunity to create shareholder value. But on the other hand, they're activist and they believe there are things that you could be doing better. So my question is, where do they want to see improvement? And are you aligned?

Yes. There's -- first of all, they came -- they've got a real strong reputation for creating shareholder value, they came well researched on med tech and on Medtronic. It's not -- it was a research that went back a long time. And it was pretty quick in our discussions that there is a lot of alignment. And I asked them like why now? And like I said on the earnings call, they said, look, you guys are in a best spot we've seen in 20 years with the transformational innovation. And so the focus then -- and we think you're going to inflect. And the focus was on, I think, 2 words, this is their words, not mine: capitalize and accelerate. To capitalize on the moment that you're in. So execute on the growth drivers, which I'm sure we'll get into today, CAS, Ardian, Hugo, et cetera, along with the margin improvement work that we're -- that I'm sure Thierry is spearheading. Capitalize on that moment. And then accelerate the WAMGR improvement with portfolio and whether it be more tuck-in M&A or continuing to look at the portfolio. Diabetes, the moves we made before diabetes, getting out events, dialysis, LVADs. These things weren't big from outside, but from inside, with the exception of events, they did take up a lot of investment and then diabetes, and keep looking at that portfolio aggressively. And so there are a lot of alignment, step up the pace on the portfolio, including M&A, was the, I think, the area for improvement.

And we'll get into -- we can get into that like why we haven't done as much and why we think we can do more going forward, M&A.

I'd definitely love it. Can you guys hear me okay?

Is my mic working? Yes. Okay. So definitely want to ask about that. But first, I wanted to ask about kind of the breadth of the portfolio. You and I have discussed that many times in the past. Historically, we haven't seen the breadth of the portfolio translate into above-average growth. And people have speculated there could be a couple of reasons for that. One is just -- the breadth is just too -- it's just too broad a portfolio. It's difficult to manage, right? Your management could be spread thin, that kind of thing. The other is that the R&D investments are just not comparable to your pure-play competitors like the Dexcoms of the world, CGM, for example. What's your view on this? And is there any consideration of going further than the diabetes spin?

You mentioned a couple of things. First on R&D, I agree. We've been trying to get that R&D as a percentage of sales up. Last quarter, we grew at 8%. And I think we want to get that number up to 9%, 10% and not at the expense of EPS. Because we -- I'm sure we'll get into it. Between our incremental -- our new accelerating growth and margin expansion, we have room to invest more in R&D and still hit the EPS numbers that we've signaled in the past. So that's one. We agree there and do more tuck-in M&A, which is basically another form of R&D. So we agree on that one. And the -- in terms of the rest of the portfolio, I think the other thing is on growth, right? You're saying that the breadth translated into growth. We also need the innovation. And so we have a bunch of innovation coming. So I think that's going to help the growth a lot and make it durable. In terms of the portfolio, we do need to show more on how the breadth of the company, the scale of the company is driving differentiated top line and bottom line. And the areas we've talked about is technology platforms, go to market, so our distribution and our global operations and supply chain. Some help the top line, some help the bottom line. And so we've got to demonstrate that more. But we believe that they do drive differential top line and bottom line, but they need to be paired with the growth drivers.

Okay. So I'm hearing near term, that breaking up -- wholesale breakup of the company is not like something being considered that you're right now spoke...

I didn't say that. What I said we believe we can manage this portfolio and get the growth. So that's going to happen, right? In parallel, we're looking at the portfolio in total. And so I'm not taking anything off the table.

Okay. That's helpful. Sorry, didn't mean to put words in your mouth. Thank you for clarifying that. So -- and one other -- one follow-up on kind of the portfolio. We've heard this argument that it would be difficult to split some of the businesses outside of diabetes because they're so well integrated. The battery technology is used in the cardio group, and it's also used in the neuroscience group. Is that a reason why it would be difficult to split other businesses?

I'd say no. It does create an additional hurdle. But because we said diabetes is easier. The diabetes spend, there's a number of reasons for it. Like I said before, we think we'll grow faster without it than with it, we can focus more. It's a different business. It's consumer. It had less synergy. So it definitely -- there's less barriers like that in executing the Diabetes spin. But we've got a -- we've developed a good muscle over the last couple of years on a standing divestiture team operationally on how to do that. And if we believe there's more shareholder value on trimming down the portfolio and more focus, et cetera, we won't let those things get in the way that you mentioned, the synergies that are there, right? So it is an additional challenge, and if we were to carve off those businesses, how do you not have negative shareholder value because there are real synergies there. You listed some, but there's more. But we won't let that get in the way.

That's helpful. So Geoff, you obviously mentioned tuck-in M&A a couple of times already. Why haven't we see -- the impression is you've done less than your peers, certainly than Boston Scientific...

For sure, Boston...

Why have you done less? And it sounds like you expect to do more going forward. So remind us just size, area of interest?

See why we've done less is, I mean, coming -- starting in the middle of COVID -- on the tail end of COVID there between our supply chain issues that we had to deal with, some product quality issues. We really wanted to get the -- and then the operational foundation of the company is strong. And we had -- in the past, we've had IT things. We've had this host of what I'd call operational issues that we don't like shareholders like, we wanted to get that nailed down and fixed. We still did deals like Affera, we did Intersect deals like that we felt were really strategic. We didn't want to pass on. But we did raise the bar because we wanted to focus on getting this operational foundation, right, which I think we've -- those issues are behind us, and we're moving forward. And so now we think we're in a better position to do more M&A. And the areas that we're focused on are the high-growth areas, right? The high-growth areas where we believe we have a right to win. So areas like in cardiac -- like in AFib, right? We did the Affera deal, we did a needle crossing deal. There's more you could do there of surrounding that procedure in that ecosystem. We believe we have a technical lead and a clinical lead in ablation right now. I'm sure you're going to ask me about that. We want to keep that. Some of that will be backed by organic investment, maybe some more inorganic investment there. Structural Heart, all the different segments there, there's opportunities. Even though it's new, but we're thinking not just short term, but medium term and long term on hypertension. So those type of areas are where we're focused, not exclusively, but that's where we're really prioritizing. Doesn't mean we wouldn't do a deal that can help one of our other businesses that aren't in those high-growth areas, but that's where the focus is.

So Geoff, two potential reasons we hear about you guys doing less M&A. One is the dividend payout ratio is about 50%. You'll have the free cash flow. And then second, the dilution because obviously, the earnings growth has been hard to come by in recent years. And so a lot of these deals Affera was -- look, it's going to turn out to be a good deal for you, but it was...

It has turned out.

But it was a little bit dilutive at first?

Yes. Yes. It's -- the dividend isn't the issue. And I'll let Thierry answer this one. The dividend isn't the issue, it was more the focus, like I just walked you through. The other thing that you mentioned, the dividend is not an issue, I'll let Thierry walk through that, but the dilution and things like that -- with our -- we're in a better position to take on those things. But, I don't know if Thierry, if you want to answer it.

No. I think you said it, Geoff. I think -- I'm not sure if the mic is working, but...

Yes. We can hear you.

I think, the dividend is not getting in the way of anything at this stage. We've got significant firepower to do tuck-in M&A of material size. So that's not getting in the way. In addition to that, I'm sure we'll talk about it, but margin is going to improve, which will help with cash generation. We're coming out of a phase where we still had some old items relative to the Covidien acquisition costing some cash on the tax line, which is now behind us. So we're going to see the cash conversion improve starting in '27. So with all of that, we've got significant firepower to do the M&A without having to reconsider the dividend policy.

How about dilution? You want to grow earnings, I think you said high single digits in '27. How do you think about dilution?

Well, look, I mean, I think there's got to be a clear picture for the deal to be accretive, right? So sometimes you have to accept a short-term dilution. But we've got a significant opportunity to continue to drive margin improvement. So look, we'll look at the opportunities. And if we get comfortable that we've got a right to win that it fits, then we're going to generate synergies. I think in some cases, short-term dilution might be acceptable if it's going to be a significant impact to our growth drivers.

So Thierry, you talked about margin expansion a couple of times. I think there's a new Board committee looking at -- there's two, one on growth, one on operations. Anybody could look at a Medtronic P&L and see the issue has been the gross margin compression. And so my question is really how -- and I know Medtronic has tried to address this, Geoff, you've talked a lot about this. What can you do differently new, especially in light of the fact one of your major new products, Hugo is coming, and I don't think that's going to be gross margin accretive initially. So what can you do differently to improve the gross margin?

So first, to address some of the headwinds that you mentioned. So short term, we have tariffs and that's going to stabilize.

Short term...

We have the impact of the tariffs, right? And so that's going to stabilize. Hopefully, no one knows what's really going to happen, but hopefully, after '27, that becomes a normalized situation. And then we've got some mix pressure coming from the growth of cardiac ablation and diabetes in particular that are putting some pressure on the margin rate. Diabetes is going to take care of itself, I should say, based on the transaction that we're going to do there. So hopefully, second half of next year, the dilution that comes from diabetes will be behind us. CAS is a great business from a profitability perspective, but it does put some pressure on the GM rate. Some of it is due to mix between the CapEx sales early on in the deployment of the product versus the catheters. So that's going to turn around and get better. You're right, Hugo is going to be a bit below our average. But Ardian, on the other hand, is going to come with very healthy margins. So we see that mix pressure getting better over time. So we still have a handful of quarters in front of us where that's going to be an offset to a lot of the margin improvement. But over time, this is going to get better. If you put those things aside, the operational -- the underlying operational margin improvement is there. So we've made durable changes and improvements in pricing. So we're now getting positive pricing in a consistent fashion. You saw it in the first quarter results, you saw it in last year's results as well, and that's been a factor of three things, really, better management of foreign exchange. So in countries where we have foreign exchange pressure, we know how to price it better now. The second one has been better controls about discounting and contractualization. And the third one has been innovation, right? So when we deploy products like Affera, we get significantly better pricing. We've had that in neuromodulation as well. And if you look forward, what we call our vitality index, which is the proportion of our sales that consists in products that we've launched in the last 2 years, that proportion is going up. So we used to be in the teens 5, 6 years ago, we're kind of in the low to mid-20s now. And that's going to continue to grow with some of the growth drivers that Geoff mentioned. So that's an opportunity for further pricing. So pricing is going to be a consistent positive. And then on the cost-out side, with the rigor that has been put in place by Greg Smith and the team. We now have consistent performance from the plants, from purchasing. So the net cost out after inflation is now a positive driver as well. And if -- again, if you take the example of the first quarter, that was 30 to 40 basis points consistent, right? So look, we're today on a sort of a run rate between pricing and cost out to do 70, 80 basis points of margin improvement. So as some of the headwinds go away, we should be able to deliver consistent gross margin improvement. And then look below gross margin, as Geoff said, we'll reinvest a portion of that improvement in R&D. So you saw us do that in the first quarter, and we'll keep doing it until we get closer to 10% of revenue. But we still have significant opportunity to drive leverage at SG&A level. And it's mostly G&A. So we protect the selling side to be able to capitalize on the innovation. But look at first quarter, we had 170 basis points of leverage between top line and SG&A and we'll keep doing that. So combination of this GM improvements and driving more leverage with the growth and acceleration should put us in a position to deliver high single-digit EPS improvement starting in '27.

That's helpful. So Geoff, one more big picture question before we transition to the business. And that's -- I wanted to ask about Hugo specifically because high-profile pipeline product. The impression is it's an expensive investment and it's obviously super competitive. So I guess the question is, how are you thinking about the return from Hugo? And basically, you talked about the margins, but just the commitment to Hugo, and how do you manage that balance between the -- cost of investment?

Yes. Look, the Hugo is a big investment, like you said, all the things it's hypercompetitive. We believe in the system, we believe in the future of it and we believe in the impact on the surgery business. And you mentioned robots are lower margin. But we have an example, compared it in our spine business, right? Our robot there was a lower margin, but we've surrounded that robot also with other enabling technologies, imaging navigation, surgical planning, digital, and it's helped us pull through more profitable implants. And despite the "dilution" from the robot in spine, the growth of the business has gone up materially. The market share has gone up and the profitability has gone up materially in that business from that business model. So it's very strong profit and cash flow. We believe the same will happen in our Surgical business. It's a $6 billion business. Yes, the robot itself, when you look at it, bare naked, it is a lower-margin product, but it will be surrounded by a digital platform, other enabling technologies, visualization, et cetera. And the overall business model will help the profitability of that business, inclusive of the robot. So that is the model we have confidence in that. We have confidence in the system. But to your point, it is highly competitive. We don't have our head in the sand. We're not dogmatic. We're looking at this thing every quarter, making sure that we're hitting the milestones because it's taken longer than we thought. I don't think we're alone on that, but we feel good where we are and what will we have. But we look at it every quarter, are we hitting the milestones? Is this still the right strategy for Medtronic? And we look at it as a management team and, we talk about it with the Board every quarter as well.

That's helpful. So Geoff, let's transition to the business. Your Q1 results came in line with your guidance on the top line despite 4 areas that came in below at least Street expectations, U.S. Diabetes, U.S. TAVR, Pelvic Health and Neurovascular. If those all improve going forward, I think your organic growth was 4.8%. If those all improve going forward and CAS, which was strong, almost 50%, continues to accelerate, which is what you've guided to, it looks like you're going to exceed your 5% guidance for the year. So what's wrong with that line of thinking?

I mean nothing is wrong with that line of thinking. We do see a back half. We constructed the plan that the first half of the year, there are some puts and takes, and then you have a back half ramp, and we don't intend to look back after that, right? There's the growth drivers that everyone's talking about in the big areas, but also some of our slower growing businesses over the last year, a couple of quarters, all have growth drivers themselves, not to the extent of Affera or Ardian, but pelvic, our peripheral vascular business has a thrombectomy device coming, Liberant. It also has carotid stenting coming. Neurovascular has also carotid stenting and some hemorrhagic products coming. And then Pelvic Health has a pretty big product coming that we expect approval on here soon with its tibial stimulator, which we think is a big deal. So you think about the head of the business and the tail, like the slower growth businesses, coming up, not double digits, but maybe Pelvic Health, but the others incrementally up and then you got the big growth drivers. And the back half of the year could be pretty exciting. Now we gave you the guidance in Q4. After Q1, I'd say we have more confidence in that guidance, but it's still early in the year. So we're not -- we haven't changed our guidance. So we want to make sure we're set up for success. And -- but the back half of the year could very well be pretty exciting.

And U.S. Diabetes also should improve.

Diabetes. I mean, diabetes is, yes, because we have not 1 but 2 sensors coming, right? And recently, we just got the Abbott sensor approved, and we call that Instinct. Remember, we're not just -- it's fully integrated into our system, branded Medtronic. But everyone knows that's the Abbott sensor. And then we have Simplera, our own sensor. So that in the U.S., in particular, patients are waiting for those 2 sensors and they're both approved. And as you know, on Diabetes, there's a little bit of a gap between approval and launch, but a couple of weeks, but those will launch, and we're excited about it.

And type 2.

And type 2 indication. Thank you for reminding me. So the Diabetes business has the best -- you got the type 2, you got the 2 sensors. You've got -- now we take those 2 sensors and pair it with our Pen. Our Pen, we've been waiting. We didn't want to launch it aggressively without a more competitive sensor. We'll be submitting our new durable pump pretty soon. That's derisked and ready to go. And then we have the patch a little bit further out. And all this will be laid out as we start to market the IPO in more detail. Diabetes business is exciting.

Good. Good. Can you hear me okay? I don't know for some reason it feels like mic is not working. So one, on fiscal '27 before we turn to CAS. So for Thierry, I think, the recent earnings slides talk about accelerating revenue growth and high single-digit EPS growth in fiscal '27. Starting with organic growth, could we see 6% plus in fiscal '27? And second, what are the drivers of the high single-digit EPS growth? And how much of a tailwind is FX as of today because it does talk about FX as a component of that?