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Medtronic, Inc. (NYSE:MDT)

Oppenheimer Healthcare Conference Call

December 10, 2013 09:45 ET

Executives

Steve Lichtman - Oppenheimer

Analysts

Gary Ellis - Chief Financial Officer

Steve Lichtman - Oppenheimer

Again, I am Steve Lichtman, senior medical device analyst at Oppenheimer. Very happy to have with us large cap medical device company, Medtronic, to be with us next. We are not going to have any formal Q&A, but formal presentation, we will go right into Q&A. Up here in the podium with me is Chief Financial Officer, Gary Ellis. We also have Ryan Weispfenning, Senior Director of Investor Relations. So again, we are going to have Q&A here for the 30 minutes. I will kick it off. Well, we have a microphone in the room, so please raise your hand and we will get it going.

So with that, I am going to sit down. We will kick off some questions with Gary. Gary, I guess maybe the first question to you, since Omar Ishrak has been on board, you talked a lot more about working more collaboratively with hospitals both in the U.S. and in Europe and beyond, can you explain a little bit more about what that means and what steps more specifically you guys have been taking on that front over the past year or two?

Gary Ellis - Chief Financial Officer

Well, as you indicated, I mean one of the big changes that I think really Omar brought to the organization and really just probably potentially even happy just because of what’s going on with healthcare trends around the world is we have realized that we knew to medical devices etcetera needs to be viewed as part of the solution, not the problem. And part of the issue I think we are running into was that healthcare in general was everyone is focused on the cost and the cost of devices and I am focused on the value that we bring. But the only way we can really focus on the value that these devices bring is that means we do need to be in partnership with the hospitals, the payers around the world to really get the true value and outcomes benefit from the products we are selling.

And so as a result of that, we have a different effort and it’s obviously the world is changing, where we are still very focused on our physician customers that are clearly the clinicians that are implanting the devices, but we are also recognizing that the hospital administration and payers and providers are going to be an important part of this process going forward. And really Omar’s view and our view of Medtronic is that if we are really going to solve this problem of healthcare cost around the world, we have got to work it together. We can’t work it in the silos that we have had before and we want to be a leader in that area and so our intention is to actually go forward with that and help drive transformation in the industry and focused on pay-for-value, focused on really focusing on the types of therapies that we believe will provide value to the entire healthcare system in general.

If you also think about it, it also plays right into Medtronic’s strategic advantage, because it’s for the first time, it really starts to focus on the fact that the size and scale of Medtronic becomes a strategic advantage, because now we are dealing with the hospital administrations, the providers, the payers, governments, where the advantage of what we bring to the equation is probably even more value than what might have been viewed strictly by the individual physician in general. So we are – clearly would have increased our focus on working with providers and payers that you would not have seen prior to Omar’s leadership, but we do believe that, that is going to the direction of the future. At the same time, we are staying very, very focused on our physician customers because they are still obviously the ones need to be implanting that products, in general. So you will continue to see this playing out, but we believe it is the way that we need to provide Medtronic as providing solutions not just devices.

Steve Lichtman - Oppenheimer

Bundling across multiple segments just going to clear positive in Medtronic’s cardiovascular in the CVG business, can this and will this be replicated in some of the other segments of spine and neuro and where are you on that front?

Gary Ellis - Chief Financial Officer

Yes. Obviously, we have seen a lot of success with them having a very, very broad and market leading CVG product portfolio on clearly the leverage of the product portfolio there has probably been more pronounced than you have seen in some of the other parts of the business within Medtronic, but we are seeing it coming in the other areas too. On the neurosciences side, with the spine surgeons and neurosurgeons, we are also starting to see that correlation where we are working together and seeing hospitals organizing themselves is similar to what they have done in cardiovascular side with cardiovascular organization. So the whole CVG strategy and this whole idea around these groupings really is tracking to what the hospitals themselves are already doing. So we are seeing that – we have seen that on CVG, we are seeing it a little bit on the neurosciences and ortho side of the equation. We are seeing it with even some of our general surgery type of products like the O-arm and some of those products where there are benefits not only to spine and neurosciences but also benefits to the cardiovascular side of the business. So pointing out mostly in CVG right now were the main benefits of that, but we see it pointing out through rest of our businesses, obviously diabetes will be the only that maybe is not the same, because obviously diabetes is not more of a health – it’s not really a hospital institution, it’s more of a patient business. But in general, we do see this is playing out across the organization and that there is value in that entire portfolio.

Steve Lichtman - Oppenheimer

One of the other changes that it seems that you guys have brought on board last couple of years is on M&A, it seems like the hurdles are a little bit higher for each of the segments, can you talk a little bit about when you go to your business units, what is going to take for them to get a deal approved by you guys in the board?

Gary Ellis - Chief Financial Officer

I think overall the biggest changes are probably we have made in the acquisition front. First of all I think we have learned some things from – over the history of Medtronic of what we do well and what we don’t do well on the acquisition front and where there is higher risk and we have learned some lessons on acquisitions. I think we have figured out over the past strategically it makes more sense for us buy in an acquisition earlier on the technology side whether it’s easier to integrate it in. It’s easier for us to get full value of our bringing that product to marketplace. And so earlier stage acquisitions, smaller acquisitions we have been much better at integrating in the company versus larger things.

Some of the financial parameters have been the same basically since I have been at the company. But where I think there has been a fundamental change is even on accretion-dilution aspect where the expectation is if we make an acquisition it’s going to be viewed as the alternative is something internally. So if we decided to acquire something then you have to offset that dilution because what you are saying is rather do that and do internal R&D or internal investments. And so the expectation is when businesses come forward is they need to be able to cover accretion and dilution. They need to have the appropriate return in general and obviously strategically it’s got to fit.

And we know from what our history tells us what we are good at doing as far as these smaller types of integrations and so if there is something that’s outside of that norm they are going have to explain why it makes sense in general. So those are the parameters right now that I think we have laid out. We have been pretty clear and I don’t think there is any real change over the last few years. And I think we have shown a better success rate on some of the more recent acquisitions over the last three to four years as a result of those changes.

Steve Lichtman - Oppenheimer

Is the mix of your cash balances with U.S., o U.S. is that a headwind for you or a large hurdle in terms of doing anything sizable from a deal perspective in the U.S.?

Gary Ellis - Chief Financial Officer

I don’t think the cash U.S., o U.S. cash issue is necessarily a hurdle. I mean obviously it takes a lot to manage the issue as far as and you know a lot of our cash balance is offshore right now, outside the United States and so that literally with $12 billion outside the United States it makes it if you do an o U.S. deal versus a U.S. deal obviously it makes it easier from a financing perspective. So overall I think the cash balance is something we can manage and we have been managing as we go forward. I wish I had more flexibility. I wish we didn’t – weren’t the situation that we can get access to the cash as easily as we can. On the other hand it’s manageable. We have continuing to manage it. So I don’t think the cash balance itself is in the imitation on what kind of deal we will do in general. We try to look at these deals whether it’s U.S. or o U.S. under same parameters, same guidelines and then we will figure out after that how we finance it.

Steve Lichtman - Oppenheimer

Despite raising interest rates do you anticipate following sort of the same pattern that you guys have been following in the last few years in terms of borrowing against here in the U.S. put into more in the stock buybacks and maintain that commitment of 50% return to shareholders?

Gary Ellis - Chief Financial Officer

We are still maintaining the commitment to 50%. We believe we can continue to do that with our basically our debt capacity and our cash flow generation that we are focused on. We are working to improve the U.S. o U.S. split. And so I mean we have not – we like to see that improving it closer to 50-50 that we have on the cash back to shareholders commitment. And so we have several efforts underway to try to continue to improve on that. But even without improving on that, we feel comfortable that we can continue at the 50% commitment the way we have right now and manage that effectively. Obviously, increasing interest rates when that – if and when that happens we’ll come into play in the decision-making process, but it also means that maybe my debt cost go up a little bit, but it also means the $12 billion in o U.S. cash that we have right now, we start probably getting a better return on that. So the reality is actually it’s probably net positive for us if interest rates actually increased from the standpoint of the impact in the P&L.

Steve Lichtman - Oppenheimer

Any questions in the room? Again, we have a microphone in the back that we can get to you. As people think on that, just maybe shifting the emerging markets here, Gary, why do you think we have seen a slowdown in your emerging market business and what is your outlook for emerging markets growth the next couple of years?

Gary Ellis - Chief Financial Officer

Well, we have said that clearly our expectation is that the emerging markets has the potential to grow 20% combined going forward in the – for the next four to five years. And we truly believe that the potential is there. And we have seen that in many of our emerging markets over the last several quarters, last several years. We have been more in the high-teens ourselves and where we are trying to get to that 20%, we haven’t been a consistently they are like we would like to be, but we have been more in the mid to high-teens, which is still very strong growth and very – and we feel very good about what we are doing in the emerging markets. And it’s part of our critical basin, it’s 12%, 13% of the revenues now and we expect it will grow to be almost 20% of our revenues over the next five years. So, it’s a big part of our growth story.

That being said, as you indicated over that last quarter or two has been a little softer and some of the emerging markets and it’s a different issue in each one of the markets, we ran in just a couple of issues in India, for example, whether there were some price decisions based on what the government had done and that we had to work through. There were some distributor terminations and change-outs that occurred. Latin America, the same time we have bought out a few distributors and as the transition occurred, had buybacks and inventory, those types of things. We have had some product registration issues in the emerging markets. Fundamentally, we see the emerging markets overall are still kind of growing in that mid to high-teens for our marketplace and we believe that we should be able to continue to do that in the near term and as we go forward. So even though, we have been more down in the low to mid-teens over the last couple of quarters, we would expected to get back up to mid high-teens as we go forward as some of these initiatives we have on place to really start to kick in and we execute more effectively in some of these markets. And as we see some of these initiatives like Healthy Heart for All and a few other things in India start to play out, we would actually expect the growth rates to get above that 20% level in the future. That might take us a few more quarters to get there, but the reality is we do expect to get to a high teens, 20% growth rate in the emerging markets.

The last thing I would say about emerging markets is we did see especially this last quarter in China, it was a little, the market itself was a little soft and we can’t tell whether there is some speculation from our sales organization that they were hearing a lot of noise in the marketplace about the whole GSK pharma issue. And so as that having somewhat of a negative impact in the marketplace, it’s hard to say right now, but we were hearing some of that as we mentioned on the earnings call. We will have to watch that to see whether that truly is having a slightly negative impact in the China market, but in general, our team there still feels very confident that even if there is an impact it’s over the next quarter or two and then ultimately the market growth potential will still get back up into the high-teens 20% going forward. So we still have a lot of excitement around the emerging markets, a lot of programs there and we believe a large part of our growth will come from the emerging markets in the future. We have been a little disappointed over the last quarter or two, but we think we have steps in place to correct.

Steve Lichtman - Oppenheimer

You mentioned obviously in China, lot of the focus has been on the pharma side, is there anything you guys have had to do proactively to change anything from a distribution prospective or how you are feeling overall with that issue?

Gary Ellis - Chief Financial Officer

No, I mean, I think obviously with everything that’s happened with the GSK issue. I think every multinational company obviously whether it’s in China or anywhere around the world is probably taking the step back and said alright, do we have any concerns or any issues? And so we have strengthened and we have put in some additional compliance steps in many places, including China to make sure that we don’t have any consequences or any concerns there. I think the fact is that in many of these markets, things will continue to evolve. You will continue to have to strengthen your compliance programs to make sure that you understand what is being done in the marketplace in general. But there has been no real change overall. I mean, there is increased focus, I would say within the company in the area. I think as we go forward we are clearly making sure that we established not only in China, but around the world our whole dealer channel management, how we handle dealers and distributors and what they do versus what we do. We are trying to make that clear and make sure there is no room for any surprises in that category. So more channel management, I would say, is something that we clearly have strengthened internally. And I think over the time in some markets you will see us probably going potentially that we are taking on more of the responsibility versus our dealers and distributors. And I think that is natural as you develop in some of these markets.

Steve Lichtman - Oppenheimer

Any questions? Yes, bring the microphone at the front here.

Question-and-Answer Session

Unidentified Analyst

Is it too early to get into individual products?

Gary Ellis

Yes, please.

Unidentified Analyst

Okay. Can you update us on the regulatory status for CoreValve in the U.S.? And then on CoreValve given that there seems to be a higher pacemaker implant required with that, how does that work in terms of pricing the product? Do you anticipate discounting the product, because it has to fit into the DRG and you have to put something in for a pacemaker on a weighted average basis or how do you think about that and how is it – you probably aren’t allowed to have discussions with the hospitals on it yet?

Gary Ellis

Yes, right.

Unidentified Analyst

So anything – any color you can give us on that would be great?

Gary Ellis

Yes. Well, first of all, as far as the timeline for approval and what we are expecting is I think everyone is aware, we just released and was published the data from our trials for the extreme risk arm. It just came out and very – exceeding the strong results and so we feel very good about that. The FDA also was obviously pleased with the results and there is results, that we are not going to have put a panel, I mean, the results were strong enough that they in fact we are not going to have put a panel. So our expectation now is that the early in calendar year ‘14 that we will get FDA approval. It’s all based on their timing obviously, but that’s our expectation sometime in early calendar ‘14. For the extreme risk arm that extreme risk patients we would get indication approval and be able to launch the product at that point. The high risk, which is the other module that one will have to play out and that could be another six months to nine months after that depending on whether there is panel and what the results are on that part of it. But the high risk, excuse me, extreme risk, we would expect to launch sometime early calendar ‘14 depending on the FDA approval timeframe.

Pricing wise, I am not – from a strategy perspective, I am not going to get into the details on how we are going to actually expect to price it. Although what I would tell you is all we are not expecting this certainly do anything different than what we have done in Europe where we have not discounted the product at all. The higher requirement for a pacemaker are the higher indications, it’s always thinking it back to how sick the patients are. It also can get to a situation of the benefits, because the reality is there is a lot of benefits in the CoreValve product that I think most people are valuing those benefits as being more important than the negative aspects of the pacemaker. And so from a market perspective, the market has accepted that, has accepted the fact that there might be a higher pacemaker requirement with CoreValve, but the benefits more than outweigh that. And from a pricing perspective we have had to do nothing different in the European market when we have launched that product as a result of that.

And our expectation is that we won’t have to do any different necessarily in the U.S. market either. We will have to wait and see how that plays out, but I won’t get into any more details from that at this point in time, the business is figuring out how they would price the product and what they will go forward with, but our expectation is the benefits from the product more than offset the fact that potentially you have a pacemaker that’s also required for that patient. And these are very sick patients having a pacemaker most of the physician community has not reacted negatively to that at all. And again financially, they will have to figure it out and we will have to make sure that it makes sense from a reimbursement perspective, but we have not seen that being an issue in Europe and we don’t expect it will be on the U.S. either.

Unidentified Analyst

In terms of the rollout, you talk about little bit how we should be thinking about the cadence in the first sort of 12 months beyond clinical trial site, any goals in terms of number of sites in the first 12 months or anything along those lines?

Gary Ellis

Yes, the business unit does. I don’t have any – we haven’t published any certain goals yet. As you know, we will have – this is a product that obviously requires a lot of proctoring and training, you can’t – not anyway can just actually start implanting a CoreValve product. So obviously, we’ll start with a rollout clearly with those locations that have been under the clinical trial and the continuing access and they immediately start implanting products when the product is approved. In addition, we will start very aggressively obviously as quickly as we can, getting more and more centers up in trainings and proctor, but that takes time. So this is – this will be – and we are going to do this very systematically. We don’t want to – the worst thing we can do is put too much product in the marketplace and have this people who don’t understand that aren’t used to using that have a negative reaction. So proctoring and training will be very important. That the business has a plan laid out as far as how, excuse me, they are going to go and ask the accounts. I haven’t seen that yet. I don’t think it’s actually formalized as far as what our commitment is, but we are going to do this in a controlled systematic fashion, but we also know that there is a lot of demand for the product and we will train and educate people and proctor them as fast as we can.

Unidentified Analyst

I want to turn to the state of the spine business, you’ve seen some better results the last 12 to 18 months on the medal side with some stabilization in the market and un-stabilization on share and you still have a couple of problem trials in INFUSE and balloon kyphoplasty on those two segments, those last two, what can be done to stem the tie there in your view to at least stabilize?

Gary Ellis

Yes. We had thought that INFUSE would somewhat stabilize after the Yale results came out, because the Yale results we thought supported what did support, what we have always felt, which is the product works and is efficacious and that the safety issues are well-documented and weren’t that concerned. And so we thought at that point in time that would stabilize the market having those results. So we were little surprised to saw that we saw the decline here in Q2 again. Our team would tell us they still expect that the market is stabilized and that the people who are using the product feel comfortable with it and feel like it’s – after everything that’s happened over the last two to three years that there are clearly those people who believe that it works and it’s effective for their practice. And that at some point, we are stabilizing and we are – sequentially, we are starting to – we are hoping that, that’s going to occur over the next couple of quarters.

Other than that, I mean, we are obviously going to be out there. We are talking about the Yale results. There is more clinical trials we are going to get started on now to start to expand the indication, but to some extent, we are still limited by the fact that we cannot promote this product line, because lot of it is used off-label and we cannot promote that. So the reality is this is a product that doctors are using based on their own wish and we can’t change that much other than for indications what was kind of promotion. And so the information is out there. We think the doctors who are utilizing will continue to utilize it. Those who want more data we are going to start clinical trials to expand the indications. And with those clinical trials starting, will that give people more and more confidence in the product and start to accelerate it, possibly, but I think in the near-term I think we are going to have to watch it. In the near-term, we are expecting the things have stabilized and to flatten out.

Same thing with kyphoplasty, balloon kyphoplasty, we are seeing procedures starting to stabilize and starting to grow again and especially in the U.S. And so we are expecting that market to stabilize from a kyphoplasty position and we are coming out with some new products that we think will actually help start to regenerate growth in that business in general, but INFUSE is kind of again there is depending on what the doctors how they utilize and where they want we think it’s going to stabilize here in the next quarter or two. We thought that it occurred back in Q1 and Q4 and then we saw a little bit of drop again in Q2, so we are going to have to watch it very carefully.

Unidentified Analyst

Maybe another, you had interesting press release yesterday about a pill-sized...

Gary Ellis

Pacemaker?

Unidentified Analyst

Pacemaker goes right into the heart valve. My assumption it seemed like over the last few years that growth had really come out of the rhythm management business, ICDs were penetrated as they were going to get and pacing has been flowing for a while, you have the MRI safe products now, you have this what you are looking out over the next three to five years, what does cardiac rhythm management business look like in terms of is there more innovation possible, is there further – are there further clinical inroads that you can make and kind of become a growth business again?

Gary Ellis

Yes. I mean, first of all, the cardiac rhythm management business, I mean, there are certain aspects of the business that are continuing to grow. So, for example, AF in the marketplace, I think people still forget, I mean, it’s still a large, but growing part of the business and you think there is still potential lot of growth opportunities on the AF side. Specifically, when you refer to a high power and pacing in general, I think especially with high power, our expectation gets developed markets versus developing markets. In the developed markets, pacemakers and defibrillators are probably in a situation that they are more mature over the next three to five years and the growth rates are going to be low single – flat to low single-digit growth in those markets. They are not going to be big growth markets, in general.

Emerging markets, there are still plenty of opportunities and this is one of the aspects of this new pacemaker we talked about, which is called we referred to as Micra, but it’s basically the tip of a pin that we are looking at would basically not have a lead. It would be a single chamber pacemaker that goes right into the heart valve. We actually see it could be a bigger opportunity in the emerging markets and it might be even in developed markets, because it’s just single chamber pacing initially as we go forward. And so that might be where we are launching this. So there is still growth in those markets in the emerging markets as we go forward. So in general, the markets, pacemakers and ICDs, we think to be if you stay flat in developed market and then growing in emerged markets, you are probably seeing low single-digit growth in those markets in general over the next four to five years, excluding AF.

Now you get to AF, you get to some other things where some other monitoring aspects of heart failure patients, not just the implants themselves, but the business of monitoring the heart failure patient or a patient who is having cardiovascular disease. There are still big market opportunities there. And so we think there will be additional technologies that are starting to play out and that could actually expand the market in general, but it might not be specifically around the pacemaker per se, but how do you manage that patient and their disease going forward. And so that’s where you have seen some of the things like Cardiocom, some of our investments in AF, where there are still potential growth drivers in CRDM in general. So we expect that the CRDM business, we do not believe that this is a business that’s not going to grow in the future. CRDM, we expect will be a growth business for us going forward, not necessarily pacemakers and ICDs, but in any other aspects that I just mentioned.

Unidentified Analyst

How much into the rollout are we on the new ICD and CRT-D in the U.S., I mean there was some transition on contracts and how much should we have in runway there?

Gary Ellis

For the most part, I mean, as we indicated that was had been little bit of an issue for us in Q1, because it occurred right at the end of Q1. We saw most of everyone was on correct by the end of Q2 and so that will continue to play out as we go forward over the rest of the year that launch of those product lines, but we are seeing very good uptake is now on contract with almost all of our hospitals in the U.S. And so we are seeing the mix shift back to those some of those new product lines continuing to increase and we think it will help us not only from a pricing perspective, we think pricing will as we saw here in the last couple of quarters has been better, had been flat, for example, the last couple of quarters, because of the new products, not only ourselves, but the competition is launching. We think that could continue here over the next several quarters of a little bit less pricing pressure with some of the new products that have been launched.

Steve Lichtman - Oppenheimer

Thanks. Okay, we actually ran out of time, Thank you Gary and thanks Ryan. Thanks everyone for joining us.

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