Medtronic PLC (MDT) Presents at Barclays Global Healthcare Broker Conference Call - (Transcript)

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About: Medtronic plc (MDT)
by: SA Transcripts
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Earning Call Audio

Medtronic PLC (NYSE:MDT) Barclays Global Healthcare Conference March 12, 2019 9:00 AM ET

Company Participants

Karen Parkhill - EVP, CFO & Principal Accounting Officer

Conference Call Participants

Kristen Stewart - Barclays Bank

Kristen Stewart

All right. Good morning, everybody. Thanks for joining me for this session of Barclays Global Healthcare Conference. I'm Kristen Stewart, the Medical Supplies and Devices Analyst. With me today, it's my pleasure to have Medtronic, the CFO of the company, Karen Parkhill, with us today. So Karen, I want to just kind of kick off this session just asking a question. That's what do you think is the most underappreciated aspect of Medtronic from an investor perspective? What do you think kind of people are really missing there?

Question-and-Answer Session

A - Karen Parkhill

Well, thanks, Kristen. Is my mic on? There we go.

Kristen Stewart

Yes.

Karen Parkhill

Hopefully, all of you who have heard us talk about our really exciting pipeline. And we are so excited about this pipeline. We firmly believe it's the strongest pipeline we've ever had in our company's history. And when we look at the strength of our pipeline, it's across all of our groups. And it's not just -- we talked about the pipeline starting to kick in, in the back half of FY '20, but it's beyond that into our long-range plan. If we think about some of the great things in our CVG business, for example, we've got the Micra AV coming toward the end of next year. And the Micra AV is our -- the smallest pacemaker out there on the market. And currently, the Micra addresses about 15% of the pacing market today. When we are able to launch the Micra AV, it will address more than 50% of the pacing market. And this pacemaker is one-of-a-kind. It's a tiny pacemaker that's inserted through a catheter and it reduces the rate of infection because of how it's inserted, and we get 3x the reimbursement from CMS. [I know my mic keeps going in and out. We need to switch mic].

Kristen Stewart

Apologies from the webcast for the technical difficulties.

Karen Parkhill

Thank you. Okay. Oh, this will do. Okay, better mic. Okay, so the Micra AV, truly one of its kind smallest pacemaker out there, will address over 50% of the market when we're able to launch it. We get 3x the reimbursement from CMS on this before when we're able to address more than 50% as opposed to just 15% that we have today. That will be very large for us, and we're really excited about it. Longer term in our CVG business, we're really excited about the Ardian trial and work that we got going on to use renal renovation to address the hypertension market. If we look at our MITG business, we're really excited about launching our surgical robot this coming fiscal year. We believe that this will be a very competitive robot. And we'll use the strength of our surgical training centers around the world.

The fact that we train more surgeons than anyone around the world today to train on that platform and to ultimately launch it. And we're learning a lot right now about the launch of our Mazor spinal robot and how we can take what we've learned with the Mazor spinal robot that's paired with the Core Spine implant to do the same with our surgical robot, our general surgical robot, that will be paired with our end effectors, which are the consumable piece of that business. So very excited about that launch within RTG. We're really excited about what's going on across many of our businesses. But I'd note our Neurovascular business and the fact that we're going to be focused on the DBS primary cell with Bluetooth capabilities soon. And then as we look longer term, closed-loop DBS and the cranial-mounted DBS system. And then in our Diabetes business, we obviously are taking our 670G, the first closed-loop system in the market outside the United States right now. And we'll be doing that through next fiscal year.

And we're investing heavily around an advanced hybrid closed-loop system, which will have Bluetooth capability and advanced algorithms to keep blood glucose in range 80% of the time. And then we're focused beyond the advanced hybrid closed loop on investing heavily in the personalized closed-loop system, which is a system that will be the true artificial pancreas where patients won't have to focus on carb counting and knowing how exercise and insulin affects their body, that it will have personalized algorithms to be able to understand all that for each patient. So really excited about our pipeline, Kristen. Really excited about our improvement on free cash flow. Hopefully, investors have noticed the significant improvement we've made this fiscal year on free cash flow. We're going to continue that. And then we're also focused on our ROIC, too. We have been under the target that we have been focused on our ROIC since our merger with Covidien, and we're getting closer to the target every year and we're very focused on getting it to that target and above.

Kristen Stewart

Okay. And I'd like to bring up one of the audience response questions. So you guys can see the little devices in front of you here. The first question that we'll have is around the organic sales growth rate of the company.

If you could just respond to what you view to be the sustainable organic sales growth rate for the next three years for Medtronic, ranging from 2% and under to 8% and above? Please start the clock. [Voting]

Kristen Stewart

Okay. And so Karen, it seems like everybody is pretty well aligned, I guess, in terms of the LRP. Maybe just walk us through your impression of these results. And I'm interested in those who also put greater than 8%, that's interesting. But how do you just feel about these and just kind of thinking about the broader medtech markets that are probably going around that 4% to 5%? And you talked a lot about these new products that you have across multiple divisions. So should we think about 4% of your LRP as the baseline and obviously, the aspirations are to do much better than that? How should we put the LRP into context?

Karen Parkhill

Thanks for the question, Kristen. I think you put it well, and I think it shows on these results. When we gave our long-range outlook last Investor Day, we were focused on giving an outlook that we were highly confident that we could meet and exceed. And that's why we had 4% plus on our long-range revenue growth outlook. And so we're very confident in our ability to deliver that 4% plus. And yes, you can think about the 4% as a floor on an annual basis. And our pipeline, depending on when we launched certain key products, we have a great ability to reach well above that 4% at different points in time. But long-range sustainable is where we would focus on the 4% plus.

Kristen Stewart

Okay. And just to talk about one of the areas in particular within diabetes that should be a division that grows in excess of the overall LRP plan. I guess, how confident are you in the sustainability of that growth? And do you expect to see maybe lower volatility to the extent you seeing greater sales within the CGM franchise and whatnot? How should we just think about diabetes longer term?

Karen Parkhill

Yes, yes. So diabetes is one that we expect to grow greater than the corporate average over the long-range plan on an annual basis, and we're confident in that. In terms of diabetes, now that we've launched our closed-loop system, the 670G that's paired with the sensor technology, it's not just the reservoirs and the tubings that are the consumables on our installed base, but now we have the sensors as a consumable on our installed base. And as we grow that installed base, that annuity revenue will accrue. And so the business model there has been changing to be more annuity revenue than just one-off pump sales. And so I think in terms of diabetes, you should think about that similar to our other groups. When we have significant product launches, you'll see some spikes in revenue growth, but that annuity base is a very strong base.

Kristen Stewart

Okay. And then I want to talk a little bit about the operating margin profile of the company. I'll bring up the next audience response question as well. You guys have a goal of improving operating margins 40% to 50% or 40 basis points each year. I want to get the audience's view in terms of what they believe the achievability of this forecast is, whether it's too aggressive or reasonable or very conservative. We'll start the response time now. [Voting]

Kristen Stewart

I'm getting it. It's 40 to 50 basis points of operating margin expansion each year. And very well show that you can, for the most part, do it, 52% reasonable. Some in the room say it's a little aggressive. So maybe just talk through how you view this to be. I know that the operational excellence program is something you initiated last year and you're driving a lot of these efforts on the margin front. So how do you feel confident about this 40 to 50 basis point number?

Karen Parkhill

We feel confident about it. And if you think about moving from 4% plus revenue growth to 40 to 50 basis points operating margin, you need at least that operating margin, plus financial leverage, to get to the 8% over the long-range plan. And there are some years that we'll have stronger revenue growth. But we are focused on driving this operating margin expansion through our Enterprise Excellence Program. We're still in the earlier stages. We've seen great results and traction so far. And that Enterprise Excellence Program is specifically designed to drive margin improvement and to drive greater margin improvement to enable more reinvestments in our company. So in R&D, in large product launches, and marketing, that reinvestment is really important as we think about the strength of our pipeline and bringing those products to market. So the enterprise excellence goal is designed to do just that. We have been focused on operations consolidation through consolidating plants and distribution centers and becoming more efficient on the operations side. We've been focused on functional optimization and excellence, where we're driving greater use of shared services and Centers of Excellence across our global function to become more efficient. And we've been focused on commercial optimization where we're focused on looking at parts of our back office and our go-to-market strategy and where can we drive greater efficiency on the commercial side as well. And so we're seeing strong traction and you're seeing the results.

Karen Parkhill

And one of the things, I guess, that has been of recent focus is obviously the fiscal '20 outlook. You've commented earlier this year that you're going to see a little bit of a higher tax rate and that, that is going to prompt maybe EPS growth to be a little bit below that 8% target that you had. You recently just completed a very large debt transaction. Can you maybe just speak to how the investment community should view that in terms of offsetting some of the headwind of the tax? Does it make you more comfortable in just achieving the consensus numbers that are out there? Just maybe put that into context for people.

Karen Parkhill

Yes. No, thanks for the question, Kristen. And as always, we'll give our fiscal year '20 guidance on our fourth quarter earnings call in May. But we have signaled that we are facing a higher tax rate next year from tax reform. So this fiscal year, we're likely to end the year with a tax rate of around 14%. And next year, we're looking at a tax rate between 16% and 17%. So a decent one-time step up in our tax rate. We will be focused on tax planning everywhere we can. We have been planning, and our tax rate will be higher than 16% to 17% if we haven't done some planning already. So it is something that we are focused on. We will do. But at this stage, we're looking at the 16% to 17%. And we're pleased that we had a very successful year at that offering and tender over the last week. And that was specifically designed to help offset the tax rate increase that we're facing next year. And so we were pleased with that outcome. At this point, The Street was already anticipating a decent amount of interest savings next year and so we're comfortable with street consensus right now where you are for FY '20.

Kristen Stewart

Okay. So in other words, this doesn't completely offset the tax saving -- the higher rate, I guess, but it helps to mitigate what otherwise could be a greater flow through the bottom line a little bit more?

Karen Parkhill

Yes, well said, well said. And if you think about it, you need this margin expansion plus financial leverage to typically get to our 8%. What we've done is we've offset the negative financial leverage for next year, but we just may not have positive financial leverage.

Kristen Stewart

Right, okay. And I want to talk a little bit about just the free cash flow generation that occurs at Medtronic. That's been an area where you've done a lot of improvements over the last couple of years. And with that, I want to do the last audience response question here on capital deployment. If you could bring up the question, please? Where do you see the greatest opportunity to create shareholder value? The audience has choices from increased R&D, emerging markets, tuck-in acquisitions, larger M&A, repayment of debt share purchase and breaking up the company as well. Please start the countdown there. [Voting]

Kristen Stewart

Okay. Well, the time run out there. And Karen, maybe while it's counting down, can you just talk about the improvements that you've had in cash flow over the last couple of years?

Karen Parkhill

Yes. So we've had really strong improvements. It's been a concerted focus for the entire company. It now is 1/3 of our incentive comps for the entire company, and you've seen it in our results. This year, we're tracking to be well ahead of last year in terms of free cash flow. And we recently increased the guidance for the year of our free cash flow from $4.7 billion to $5.1 billion, to $5 billion to $5.2 billion. So we've seen great focus on cash flow. In terms of our use of capital, we're focused on continuing to generate strong free cash flow and deliver greater than 50% of that to our shareholders in the form of dividends and share repurchase. We have a strong dividend. It's in line with our peers. We intend to continue to grow that as we grow with the company. And then share repurchases and tuck-in M&A are things that we will do. We don't intend to hoard cash on our balance sheet. So we will be disciplined about tuck-in M&A, as we've done over the last several years. We'll continue to find great opportunities to help supplement our own R&D portfolio that are designed to ultimately be accretive to our growth and our margins. And then when we don't have the opportunities for the right M&A and tuck-in and bolt-ons, we'll be return to more to our shareholders in the form of share repurchase.

Kristen Stewart

And then what would you say, for the webcast purposes, the response to the various things? We had 27% of people who are good for tuck-in or bolt-on acquisitions and an equal amount who thinks that the company is too big and would argue that there's value in breaking it up. How would you address kind of just of the size of Medtronic, either the acquisition of Covidien significantly increased the size of the company, the breadth of the portfolio, and that's definitely been, I guess, has that been additive, I guess, in your view in hindsight now. Just how do you think about that from a management perspective?

Karen Parkhill

Yes. So I would say the Covidien transaction has absolutely been additive to the company. If you just look at the value that we've driven to shareholders through that acquisition, it's clear. We also have seamlessly integrated that acquisition and there have been clear synergies through cross-sell across the company, through taking best practices in one area of the company and moving it to another through leveraging the size and scale and strength of Medtronic and things like clinical trials and things like R&D, and in things like manufacturing excellence. So there is clearly a benefit to having all of these businesses together. Should there ever not be that benefit, we would clearly focus on doing the right thing for our shareholders as evidenced by a very large divestiture that we did a couple of years ago when we sold a large portion of our patient monitoring business to Cardinal Health. So we do portfolio management. We do focus on doing the right thing for our shareholders. And at this stage, we see great benefit from our businesses benefiting from each other.

Kristen Stewart

Okay. And then just to kind of circle back kind of on FY '20. You guys have talked a little bit about kind of tail of this year, fourth quarter being kind of the low watermark. It sounds like in 2020, growth should start really accelerating and then the pipeline should start kicking in more meaningful. How should we just think about kind of cadence for the year? And then -- and maybe some of the timing for things like Micra and some of the other programs that you have out there that you're pretty excited about.

Karen Parkhill

Yes, yes. Agreed, Kristen, that we're -- we've talked about this fourth quarter as being our low point. And in FY '20, we're focused on delivering that 4% plus for the year. Our pipeline is back-half loaded and back-end loaded in FY '20. So as we look ahead, we should see accelerating growth throughout the year.

Kristen Stewart

And to the extent that you are able to outperform on that, that 4% rate. And it sounds like you have a high level of confidence in the 40 to 50, what do you think that you'd be able to see that drop through to see better than 8% growth as we're looking out to 2021 and 2022? Because it seems like you've got the levers to drive significant, perhaps, upside to that 4% if everything kind of goes right.

Karen Parkhill

Yes. So when we think about the bottom line growth, we talked about 8% over the long range plan at our Investor Day, and we said that there could be some years where we might be a little bit underneath the 8% because of one-time events. We talked about foreign exchange as a potential event there at the Investor Day. And as we look right now, we're facing a tax rate increase, which is nonoperational one-time. And so there could be years under 8%, but that -- but if we're getting to 8% over the long range, there's got to be years above the 8%. And if you look at this year alone, we're tracking to be well ahead of the 8% this current fiscal year.

Kristen Stewart

Okay. And then, I guess, just in the last couple of minutes left, what would be the one thing that you want people to kind of walk away from this presentation feeling? Is it the conviction in the pipeline? Is it the conviction in management doing the right things from a cash flow deployment? Sure, maybe it's kind of everything. But what would be the one thing that you want to kind of really convey to the audience?

Karen Parkhill

Yes. I would say, obviously, our pipeline is, I mentioned at the onset, the strongest that we've ever had in our history, and we are really excited about this pipeline. But I would say beyond the pipeline, we are focused on driving to be a world-class company. And we're focused on driving to consistent executions. We're focused on driving to continued operating margin expansion, getting our free cash flow to a conversion above 80% and driving long-term value for this company, and that's what world-class companies do. That's what we are focused on.

Kristen Stewart

All right. With that, I think that we will wrap this up. We are going to have a breakout session just down the hall. So I hope everyone can join us for that. Thanks, everyone, for your time. Appreciate it. Thank you, Karen.

Karen Parkhill

Thank you.