Medtronic plc (NYSE:MDT) Goldman Sachs Global Healthcare Conference Call June 14, 2022 11:00 AM ET
Company Participants
Geoff Martha – Chairman & Chief Executive Officer
Conference Call Participants
Amit Hazan – Goldman Sachs
Amit Hazan
Okay. All right. Well, good morning, everyone and welcome to day two of the Goldman Sachs Healthcare Conference. I am Amit Hazan, the Medical Technology Analyst at Goldman. And it’s really nice to kick off day two with Geoff Martha of Medtronic and not a better way to kick it off really to have a conversation about everything going on with Medtronic. Always a lot going on. So Geoff, welcome and thank you so much. Very nice to do this with you in person.
I was reflecting back, I think when you got the CEO title, COVID hit. We were, I think, one of the first conferences you’ve attended virtually and had a good conversation with you just about what your thoughts were and you entered as difficult of a situation as one could imagine and have had to navigate through that for the last two years, it hasn’t stopped. And so the first question has to be just reflecting on those two years, where you think you are relative to what you expected coming in way back when. It feels like a long time ago but it was two years.
Geoff Martha
Yes. I was just going to say two years ago, it feels like 20 years ago. Well, certainly — first of all, thanks for having me and it’s nice to be here face-to-face in this nice setting. Sorry, I had to close the doors, actually. But yes, it’s been — the last two years have been a lot choppier than I would have expected and would have liked. No one predicted COVID. And for us, COVID took on to say it hit us like every other healthcare company but we also had a special role to play with ventilators and really proud of the way we responded to that.
And then, more — and then they have several waves of COVID and more recently, these supply chain issues. So it’s — and then on our own, we had a few of our growth drivers get pushed back, so pushed out in time. So it’s been a lot more choppier. And like I said, more recently here with the supply chain issues, it — not getting — not exactly getting the short-term results that we would like. And — but I do think on the short-term results, we understand these environmental factors which drove that in terms of supply chain or China and a little bit of FX in Q4. But when we look past that, we’ve got a really great — a lot of the changes that we made are starting to take hold. So getting back over the last two years, a lot of the changes we made are to the company, start to take home like our operating model and the culture that we’re driving in terms of being more competitive and the incentive changes we put in place to drive that type of behavior.
And then, of course, our pipeline despite certain things being pushed out, is very robust right now. And then, of course, we’re in certain areas, leverage — learning how to leverage our scale better and allocate capital and look at our portfolio, all of which we think is going to — positions us to really drive a higher level of growth and a dependable level of growth. So yes, it’s been an eventful two years. But along with dealing with many of these environmental issues, we’ve made a lot of changes to the company and I feel like we’re really well positioned.
Amit Hazan
Yes. Well, we’ll get into a lot of that. I agree, there’s a lot of good stuff to talk about and a lot of challenges, especially macro-related. So let’s hit that and maybe try to get it out of the way, although I want to hear a lot about what you’re thinking in terms of structural changes you might be making in this regard or whether this is all short-term stuff. But obviously, the supply chain challenges were front and center last quarter. They have been for a lot of companies. So for you guys, it was semi chips and resins inside your Energy business and the packaging explosion. I think it’s been, I don’t know, almost a month since you reported a few weeks. Maybe if you can give us an update on that situation and whether you’ve seen it improve as you had expected.
Geoff Martha
Yes. So we factored this into our guidance. I mean Q4 was obviously impacted. Starting in probably the middle of Q4, these things started to present themselves in a much more acute way. I mean going into Q4, a lot of our safety stock was depleted because of the ongoing chip issue and resins. But in Q4, like midway through, things got much more acute, especially for our Surgical Innovations business. Because of this packaging issue that we had in our supply chain, there was an explosion at one of the — our suppliers that shut them down for a couple of months and that really impacted our SI business. And then you had China shut down in the month of April and into May.
So we’re seeing the resin issue get better. We’re seeing the packaging issue get better. It’s going to still take some time and we factored that in. So it’s going to affect our Q1 as well and that wasn’t reflected in our guidance. And we’re seeing China starting to open up. Still tenuous there but it is starting to open up. So we’re seeing these really acute issues start to — we have line of sight to these things abating, especially by the second half of our fiscal year.
Amit Hazan
Okay. So the question becomes one of how you view these things internally and you as the head of the company. Are you looking at this as short-term issues that will subside and we return back to normal? Or are you starting to implement structural changes in reaction to what you’re seeing inside of the supply chain?
Geoff Martha
It’s the latter. I mean I think the acute issues, it’s just a tough environment out there and the level of acuity is — it’s really acute right now. But that part will get better, like I said, in the next couple of months. But I do think when you think about your supply chain, you have to balance efficiency and resiliency. And I think we were maybe not indexed enough on resiliency. We’ve brought in a new head of supply chain over a year ago. And there was — the primary goal there was I thought and we’re still confident about this, that given our — really Medtronic was operated from operation — a global operations and supply chain perspective, pretty fragmented approach.
We had a lot of acquisitions over the years and they came with plants. And so we decided to centralize our supply chain to really drive some more standards, leverage our scale. And the idea there is to get significantly more cost of goods sold productivity over time than we had over the last 20 years. And that was the primary reason. But now with this new environment and geopolitical situation, in addition to that, we’re going to be building in some more resiliency into our supply chain and architect that from the center of the company.
Amit Hazan
Okay. Okay. So it sounds like that’s an expectation that kind of this is a little bit of the new normal, what we’re seeing and you need to prepare for that.
Geoff Martha
Yes. I think over the last — in a year, we’ve seen some geopolitics that I think make it prudent to, like I said, build resilience in your supply chain. So an example of that would be — and even some of the climate issues like a couple of years ago, think about Hurricane Maria and what that did to Puerto Rico, a lot of med tech has manufacturing in Puerto Rico. You need to have as much as you can the ability to have some resiliency, so hedging your bet. So not all — a big product line, can you have it in a backup factory, if you will? Key commodities, key supply commodities, can you have that backup supplier? So that’s what I mean by resiliency.
Amit Hazan
Okay. Okay. And does it entail — I think about supply chain manufacturing past 10, 15 years. So much of it has also been about costs, tax savings, what have you. Are we seeing a little bit of a reverse of that? Does there have to be an incremental cost to what you’re describing? Or can this somehow be neutral?
Geoff Martha
So for us, I don’t know about everybody else, for us, the cost savings outweigh the incremental cost in this. The net — there’ll be net savings because we’re pretty — because we’re fragmented, there’s a lot of opportunity for cost savings. That — just from centralizing. That being said, we’re going to have to invest a little bit in the resiliency side. And I think the days — and this is kind of ended a while ago, the days of significant tax advantages by having your supply chain organized in a certain way. That’s much less than it used to be as globally, countries are aligning around taxes. And so tax is much less of a factor and that’s been that way for a while, at least for us. And so yes, there’s some incremental cost of resiliency but it’s way offset in our case by streamlining how we run our global supply chain.
Amit Hazan
Okay. Okay. Let’s quickly touch on inflation in a similar fashion. We kind of have to. Just talk to your expectations, your ability to pass through price. And I mean here, too, I mean, just with your own — whether it’s supply cost or labor cost, how do you think about it, not just here and now and what we’re all experiencing but does it change the way you think about the structure of Medtronic in some ways that you’re — are you effecting change that’s going to be more towards the medium term as well because of the inflation that you’re seeing?
Geoff Martha
Yes. I think a couple of things. One, we have — when we did our new operating model, we were able to take out three layers of management. And as we pushed the P&Ls down to the operating units and made it clear that they own the P&L on a global basis. For us, there’s still — we want [Technical Difficulty] large quantities from us at the end of the quarter for discounts and that became an operational problem for us as well as a margin problem. And we were able to end that during COVID. And that has also helped us on the pricing side when you don’t have these big buys or sales at the end of a quarter with discount. We don’t do that anymore. So that’s helping us.
Amit Hazan
Am I reading too much into what you’re saying if I assume that for this fiscal year that you just started, you have visibility that you’ll see better pricing?
Geoff Martha
Yes. Yes.
Amit Hazan
I’m reading too much into it or yes…
Geoff Martha
No. No, I’m sorry. Yes, I think we’re expecting — we’re modeling on our own and taking an action that we’re going to get better pricing. Now you’re not going to hear — you’re not — if you go out and talk to hospitals, you’re not going to say, okay, Medtronic raised their price at 5%. It’s not going to — it’s going to be more strategic and very focused.
Amit Hazan
Okay. Okay. I want to spend a minute on revenue guidance. Just kind of me thinking through qualitative commentary you all have made. Going back to the third quarter call, you kind of said, all right, this five plus, we’re going to take the plus out at the moment because you’re starting to see some challenges in a number of areas. And then we get to the fourth quarter and you obviously have these supply chain issues and you have this first quarter guidance which is going to really see the most impact from that. But you’re still at 4% to 5% for the year. So we’re basically almost where we were on that 3Q call.
And so this is a question I get probably the most often from investors that I talk to, is this — can they make that number? And what’s the confidence how that they can make that number? It strikes me like it’s a challenge in the back half of the year, just given the qualitative comments I just described. Help us out why that’s going to develop.
Geoff Martha
For sure. First of all, like you said, we talked about like 5% and now on our Q3 call and our Q4 call, we ended up at 4% to 5%. And we had — our Q4 was not great, right? It was — so you — the 4% to 5% is off a lower base. So that’s one thing.
The second thing is — and as you get into the — starting our fiscal ’23 Q2, you start to have some much easier comps. In FY ’22, we were 2.6% in Q2, 1.6% in Q3, 1.4% in Q4. So the back half of FY ’23 has easier comps. We’re starting with a lower base. So there’s some math there. But then getting into some other insights, we are anniversarying about 200 basis points of headwinds that we had in FY ’22. There’s a 100 basis point headwind just from us — our ventilator sales. We had 100 basis point because as they come down from the COVID peak in FY ’22, it’s 100 basis points there. We have 50 basis points still on FY ’22 of a headwind from exiting our LVAD business and then another 50 basis points that are tied to a couple of different smaller things like the — our Navion product recall as well as our stent — China stent VBP, volume-based pricing. So that was 200 basis points of headwinds that we anniversary in FY ’23.
And then finally, we have a number of big product launches in FY ’23, like — starting with a new TAVR, Evolut FX. You have our EV ICD. You have — we’re anticipating launching our in pain stem [ph] ECAPs. And that doesn’t really include like Diabetes and Ardian and any of that. So we have a — that’s how we got there. Does that help?
Amit Hazan
That helps. And so kind of — let’s think about that for the medium term now and getting back to the 5-plus. And I want to ask a question in the context of R&D. So I think it was this time last year when we were talking and you guys were on your 4Q call just before that, talking about increasing R&D spend to about a 10% growth. You were talking about needing to do that to drive that visibility towards 5-plus. And I like that strategy. Personally, I think the investors understood it as well as just the price you pay for better growth in med tech and that maybe you had not been investing as much as you wanted to and now you are.
The end of the year and I think you grew R&D 6%. And I think you’re guiding to about five — roughly speaking, 5% growth in fiscal ’23. So that’s a little bit different. And so just help us understand the changes in R&D spend that we saw through the guidance changes and what that means for your medium-term growth visibility.
Geoff Martha
Yes. So look, we’re — we still want to continue to increase R&D at our sales growth or higher. I think for us, there’s definitely an opportunity to continue to invest more. And so a lot of the — because as we’ve gone to this new model and we have our now 20 business units and we have transparency, much greater transparency into the — in their end markets as well as their competition, as well as understanding the market opportunity, we look around, we see areas we want to invest more to ensure our competitiveness. When we invest, we tend to do well. There’s always opportunity to — with R&D productivity. But when we invest more, we do well. There’s a couple of areas. So in addition to allocating capital differently to the higher-growth opportunities, we are increasing R&D. And to do that, we continue to pull G&A down in our enabling supporting functions. And initially, FY ’23 is a bit of a transition year because of the inflation. The cost of goods sold productivity, we would give us some oxygen in our gross margin to allow us to invest more.
And then finally, we’ve done things where we have a gap. And again, we want to protect our operating margins. We’ve done things like third-party financing like with Blackstone. And so you start to add all this up and tuck-in in M&A which for us, tuck-in M&A is like R&D effectively. And you’re buying an early-stage company and — so all this added up is kind of how we’re looking. And of course, there’s — we’ll get to this later with portfolio opportunities as well. But all that added up really is helping us increase our R&D.
And I thought the 6% might have been a little higher last year but I don’t have the number on the top of my head but it definitely — it’s got to be above sales growth. And that’s our thinking here because there’s a lot of opportunity in med tech right now.
Amit Hazan
Okay. So let’s just kind of conclude on operating margin real quick and then we get to some of the products and bigger-picture thinking on capital allocation. But — so you guys were pre-COVID 28% or so operating margin, even 29%, I think, in fiscal ’19. We’re back to about 28% now. But obviously, we talked about a lot of things that are a little bit out of — some of out of your control, like inflation, supply chain and thinking about our R&D, too, some things in your control. So what’s the message that you want to send on operating margin? Is there improvement to be had here beyond fiscal ’23?
Geoff Martha
Well, I’d just say we’re committed to the 5-plus top line and the 8%-plus EPS growth. And that’s where we’re — we want to get FY ’23, we have to work through the inflation and some of the supply chain but we want to get back to that as soon as possible. And that’s where we’re headed. And on top of the 8%-plus bottom line growth, EPS growth, you have a healthy and growing dividend which we just had another 8% increase in that last quarter. So that gives our shareholders a double-digit return and that’s really where we’re focused.
And in that equation, though, we have to figure out a way to invest more. Another thing that’s going to help us and I’m confident this will come as our growth gets higher, our top line growth. And you get some leverage and it’s easier to put more in R&D. So key for us is some of these bigger growth drivers that we haven’t addressed yet, whether it be R&D in robot, Diabetes, 780G in the U.S., those kick in as well on top of our base business. But there’s a lot of singles, doubles, maybe some triples in there in terms of top line growth. We’ve got to get that growth up as well.
Amit Hazan
Okay. Let’s spend a minute on a few of the key products people care about and you all talk about a lot. Let’s start with the surgical robot. We’re getting to a point — I think you guys talked about ’23 being a meaningful step-up from the double-digit millions you’ll get in ’22. Just give a sense of how you’re feeling about that and the progress you’re seeing both outside the U.S. and then in the U.S. with the clinical trial. Like is this a year where we could see a meaningful step up in…
Geoff Martha
Yes. We’re counting on that. I mean what we’re seeing outside the U.S. and now we’re not in the U.S. yet, what we’re seeing — I’ll get to the U.S. in a second. What we’re seeing outside the U.S. is not — although we have the CE Mark and we’re in Europe and we continue Australia. We’re continuing to get into some of these developed markets with experienced robotic surgeons, high-volume surgeons. And we’re getting — and they’re now using the robot and stretching it a bit. And we’re also getting — they’re using it in different cases, urogyn and general surgery. And so we’re getting great feedback on — first of all, a lot of support like — they like the design features and some feedback: if you change this or that, I think it would really help. And so some of these changes we’re trying to incorporate into the robot before we hit the U.S. IDE.
The other — on the U.S. front, we just — I’ve actually personally attended a number of demos with — they had the colorectal surgery meeting in Tampa, Florida recently, the industry did. And I went down just to talk to surgeons as they see. We had the robot in a demo, a training suite at Tampa General Hospital and we cycled through a lot of surgeons. We got some great feedback. They love the modularity of it. They love the display. There’s a lot of things to like. And they think we have something really competitive.
And so we’re bullish on it but I want to make sure two things: one, if we can incorporate some of these tweaks that we heard from the European surgeons; and two, these aren’t major design changes but some tweaks. And two, I want to make sure from a supply chain perspective, it’s ready to go because it does have a lot of — it has chips. It has a lot of things in it that are in short supply right now. So we don’t want to launch it and have to pull it back. So we’re making sure that’s all set. So we’re getting close to a U.S. IDE but it’s — and once we do that, we expect a pretty big ramp here.
Amit Hazan
Okay. And you got this question last night at the dinner. I think people are asking the question as we see this progress maybe a little bit more slowly than had been anticipated. But as you think about your spending levels on the surgical robot and you think about the opportunity ahead of you, is the return on investment still there in your view? Is it — as I think about your story, it’s not just exclusively the surgical robot, it’s also the fact that you’ll probably be cannibalizing some of your lab business as well. It will move from lab to the robot. Ultimately, when that rolls up into a P&L for Medtronic, is that accretive to you? Is that accretive or a reasonable amount of time that it’s where the current investment that you’re making?
Geoff Martha
Yes. No, it is — I think it’s going to be worth the investment. I mean it’s — the surgery market dynamics are — I like them. It’s a big market. You have two big players and you had Intuitive coming in. But it’s — there’s a lot of growth there in terms — even just minimally invasive, right? But going from open to minimally invasive, there’s still a lot of runway, especially outside the U.S. and then going to robotic. And as you go down or up that continuum from open to minimally invasive surgery to robotic surgery, the margins keep getting higher. And I think that, that — being a player in robotic surgery, soft tissue robotic surgery, is important for the overall health of your surgery business. Surgeons will — they want to work with somebody that has the complete portfolio. And so it is worth it. It’s our biggest business. When you look at the — right now, our robot is very small in terms of revenue. But when you look over — when you forecast over years, you look at that plus our surgery business, that’s a big piece of Medtronic. And our surgery business is our single-biggest business right now.
Amit Hazan
Diabetes, just a quick — I don’t know if you have an update but if you can give us one. Just thoughts on the warning letter and your ability to get 780G on the U.S. market. And progress outside the U.S., anything there?
Geoff Martha
Well, the dialogue with the FDA continues. I mean it’s really hard to predict. I mean there’s lots of dynamics in the FDA and, I feel, how that will go. And we make strong progress against the warning letter. And we can either get the warning letter lifted or get some variance from the FDA. We’re working on both tracks but I can’t forecast timing because it’s — anybody that’s dealt with the FDA, they don’t — they keep their cards pretty close and there’s a lot of dynamics that they have to think about. But we continue to have constructive dialogue.
And then, the thing that is very encouraging is that — what we’re seeing. I think we have the 780G with the Guardian 4 sensor on over 5,000 patients around the world. And we were just getting phenomenal results. And I talked to some of the investors during the dinner last night that are doing their own market checks on this, talking to physicians. They’re hearing great things about the level of automation in our new system just for patients that don’t — or for people that don’t want to count carbs or bolus at meals, it just takes care of it for you. So it really puts diabetes in the background which is what people want.
And so our position as an integrated insulin delivery player with the pump, the sensors that work with the pump and the algorithms that drive the therapy, we feel, is a very strong value proposition going forward. It enables — but like I said, diabetes in the background. And then you start to think about our business, that same closed-loop system, when — with a durable medical durable pump, a pen which we have and we have a very — a pen that works really well. But we just haven’t put it on a sensor on it because our next-generation sensor, we think, will be how we pair that and create a revenue stream there. And then finally, we talked about having some patch technology in our pipeline. That would be a third. So these three different systems appealing to a lot broader range of diabetics.
Amit Hazan
Yes. Is it possible that Diabetes becomes accretive to Medtronic growth in the next two years?
Geoff Martha
Yes. Yes. No, it should. I mean it’s rough right now because it’s shrinking. But you start to get these products on the market — and in Europe, it’s double-digit growth right now. And we’re — like we talked about in Europe, we’re competing — it’s a level playing field. We’re competing against everybody there and we’re still growing double digits.
Amit Hazan
Okay. Okay. Obviously, RDN is another one that we’re going to be watching very closely. Just to remind people what the key elements of what you’ll be looking for in the data are and how that will shape the market.
Geoff Martha
Well, what we’re looking for in this — first of all, we’ve already completed our pivotal data but the FDA asked for this other ON MED trial and — for their approval. So we’re just looking to hit the end points. And I wouldn’t — it’s very complicated. It’s statistical randomized control trial with a lot of statistics in it but all we have to do is get the end points. The — we have enough data now with the registry that we’ve had of patients over the last 10 years with the three year data we just put out a couple of months ago at ACC or — trying to remember which one but recently that shows the three year data, that shows Ardian because it’s always on. And the delta between Ardian and the control arm got really wide as you got, well, from six months to three years. And then we just put out some more data that showed like over the course of a three year period, are your patients on a tight blood pressure zone, a control zone more than almost 2x of the control arm. So it works, it’s safe. We feel really good about it. We just have to hit the end point. We’re not looking for a bigger — a certain wider delta between the control arm. We just got to hit the end point and we feel good about it.
Amit Hazan
Okay. So that probably comes to the market next year?
Geoff Martha
Yes. Well, after that, once we get approval, we can accelerate our — but yes, it’ll — remember, in Europe — so I think in Europe, it’s technically approved and you’re starting to see bread crumbs from some of the changes of guidance from their physician societies. And you’ll see Europe change. I think you’ll see some guideline changes once we get the data in. And so that will — our Europe business will go faster. And then in the U.S., we have to go to the different Medicare stakeholders and private payers to get them on insurance, so get to reimbursement.
Amit Hazan
And you’ve got this as a $500 million product by ’26. You still feel good about that?
Geoff Martha
Yes, we do. I think — look, I think it’s going to be a big — I was just out in our Santa Rosa, California, where — that’s our headquarters for that business, looking at past the first generation of Ardian and how we’re going to stay — I’m less concerned about how big the market is going to be. It’s how do we stay ahead. I think like — I think you’re going to see some competition here and we want to make sure we’re a couple of generations ahead.
Amit Hazan
Okay. Let’s touch on a couple of bigger-picture topics to end here in the last 1.5 minutes. China really quickly. Obviously, a lot of changes, pricing perspective. The last couple of years is just I think med tech companies are generally starting to look at China a little bit differently than you used to. How do you think about China both near term and the interim?
Geoff Martha
So in the short term, one, we got — with these lockdowns, we got to get out of that, the COVID lockdowns. So we see that like I talked about earlier, starting to abate here, things to open up but it’s tenuous. So if they have another wave of COVID, they’ll continue to shut things down. But we — it’s important for us because China is an end market, plus we have some of our supply chain there. We’re not overly indexed on supplier — our supply chain there but there is some. In this environment, you — we have supply chain issues all over the place. You don’t really want an incremental one. But in the short term, you got to navigate that. The — and you’ve got to navigate these volume-based purchases — purchasing arrangements. So we’ve had one in stents. We talked about one coming in spine here shortly. And as we looked at our portfolio, we think part of our Surgical Innovations business might get hit with one of these VBPs here in the coming years. So you got to navigate those.
In the longer term, I do think there’s more risk in China than there was. I still think it’s going to be — continue to grow double digits and be a really big market. Even with these pricing issues, the market is still going to grow double digits and it’s going to grow double digits for a long time. And from our perspective — but there is more risk coming from some of the pricing and coming from just overall geopolitics. Where is the relationship between China and the U.S., China and the West? Where is that going? But our feeling is you got to factor in those risks into your strategies but I still am bullish on investing in China. But you do have to consider the risks and that does impact how we make those investments.
Amit Hazan
Okay. I’ll take 20 seconds since we’re out of time here on just — you get to talk about possibility of divestitures and you’re doing a deep dive there. Just a very quick reaction to where you are in that process and what you’ve…
Geoff Martha
It’s ongoing. And this is going to be a process — like I talked about, we’ve really ramped up like our capital allocation process and making sure we’re allocating capital to higher-growth areas and allocating appropriately but it’s — portfolio is part of that and making sure that we’re funding everything in our portfolio appropriately and that we’re the best owner. And so we wanted to — we hadn’t done like a real authentic deep dive in a couple of years and we’ve been doing that. You’ve seen the dialysis announcement that we made with DaVita. That joint venture, that’s part of that. And it’s ongoing. And I think there’ll probably be some more changes. But is it around the edges or something bigger? We’re still working through that.
Amit Hazan
Okay. Let’s end it there, Geoff. Thank you so much for the conversation.
Geoff Martha
Yes. Thank you. All right. Thanks, everybody.
Amit Hazan
Thanks, everyone.
Question-and-Answer Session
End of Q&A
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