Memorandum

Medtronic 3Q17 (F2Q18) – Sales down 2% operationally, flat as reported; 20,000+ now on 670G hybrid closed loop; sensor capacity still constrained – November 21, 2017

Executive Highlights

  • Medtronic’s worldwide diabetes sales of $462 million decreased 2% year-over-year (YOY) operationally and were flat as reported. US sales of $258 million declined 5% YOY on an easy comparison, and 6% sequential growth came on a very low base of sales in 2Q17. OUS sales of $204 million increased 7% YOY as reported –8% operational growth in developed markets (640G adoption) and 13% operational decline in emerging markets.
  • Medtronic has finished shipping pumps for the 670G Priority Access Program (sensors still constrained), and over 20,000 US patients are now on Hybrid Closed Loop – more than doubling the update we last heard at DTM 2017. ~13,000 patients are now uploading 670G data into CareLink, with real-world outcomes and performance “very similar” to the pivotal trial.
  • CGM sensor capacity remains constrained, but is expected to fully resolve in February-April 2018 (F4Q18) – the expansion is running a bit ahead of schedule, and the upcoming quarter (F3Q18) will see some improvement too.
  • The long-awaited Guardian Connect standalone mobile CGM and paired Sugar.IQ app are expected to launch in the US by April 2018 (2H FY18), in line with the 2Q17 update. This is a critical product to compete with Abbott and Dexcom.
  • Diabetes growth is expected to “significantly” improve in 2H FY18, with “mid-to-high single digit growth” expected for all of FY18 (May 2017-April 2018) – this up notably from the previous +1%-4% guidance and implies ~10% YOY growth in the coming two quarters. “Double digit” diabetes growth is expected in FY19 (May 2018-April 2019).

Medtronic reported 3Q17 (F2Q18) financial results this morning in a call led by CEO Omar Ishrak. Diabetes is page 12 in the presentation slides. Mr. Ishrak noted that diabetes is in a “difficult” phase due to the CGM sensor supply constraints. The pressure is certainly on to get this resolved quickly and scale the MiniMed 670G launch, along with the company’s US launch of Guardian Connect (standalone mobile CGM). Read our highlights on the financial and pipeline fronts below.

Financial Highlights

1. Global Sales Down 2% YOY Operationally, Flat as Reported; 5% Decline in US vs. 7% Growth Internationally

Worldwide Medtronic Diabetes sales of $462 million decreased 2% YOY operationally and were flat as reported. Sales grew 3% sequentially on an easy comparison to low sales in 2Q17. The YOY comparison was also fairly easy (3% growth in 3Q16). As the chart below indicates, the business has been relatively flat over the past few years – we saw almost identical sales of $460 million in 1Q14! For the second straight quarter, the international business provided 100% of Medtronic’s quarterly growth – a trend we’ve now seen in five out of the past seven quarters. Rewinding to a year ago, fresh off the 670G FDA approval in the US, we would not have believed Medtronic would see this level of US sluggishness. Management blamed the constrained sensor manufacturing for the slow sales, and we’ll have to see if things actually pick up in the coming two quarters.

  • US sales of $258 million declined a surprising 5% YOY on a fairly easy comparison (+3% YOY in 3Q16), with 6% sequential growth coming on a very low base of sales in 2Q17. This now marks YOY declines in the US in four of the past six quarters, including two consecutive quarters. Read more on the 670G launch below.
  • Outside the US, sales of $204 million increased 7% YOY as reported. Medtronic saw solid 8% operational growth in developed markets ($169 million) on 640G adoption alongside a 13% operational decline in emerging markets ($35 million). The slide noted strong pump performance in Canada and Latin America; 640G growth in Australia/New Zealand, Japan, and Europe; and ongoing post-reimbursement CGM strength in Germany and Australia.

  • The Animas exit and selection of Medtronic as the “partner-of-choice” was mentioned brieflythe majority of the ~90,000 existing Animas patients are currently under warranty. They will be able to transition to the less advanced MiniMed 630G and new Guardian Sensor 3 at no cost in “FY19” (May 2018-April 2019). For patients who are out of warranty or whose warranty expires by December 31, 2o17, Animas has actively encouraged contacting Medtronic to explore options. (Medtronic has direct access to the Animas customer database and has been emailing/calling Animas users fairly aggressively – Adam included.) Clearly this exit did not drive meaningful US revenue this quarter, and we’re not sure if it will drive significant incremental growth in FY19. Medtronic should theoretically benefit the most from Animas’ exit out of any company, though we’re not clear on the revenue implications when an in-warranty Animas user moves to the 630G. Can Medtronic execute and capture these up-for-grabs Animas patients? How will Animas users weigh the different options, especially given strong programs from Insulet and Tandem?
    • We remain disappointed that Animas and Medtronic have only arranged for in-warranty users to get the 630G – not the 670G. The cost differential between these pumps is presumably negligible, so there must have been other driving factors. Patients can choose to pay more to get on the 670G, though we wish Animas and Medtronic had been more patient-friendly in this move.
  • Notably, lower diabetes revenue and the ongoing infusion set recall were pointed out as negative drivers of overall company margins this quarter – it is rare that diabetes, Medtronic’s smallest business, is called out in this way.

2. Challenges in Every Division: Intensive Insulin Declines in Low Single Digits; Services/Solutions Flat; Non-Intensive Declines in High 20%-range

  • The intensive insulin management (IIM) division declined in the low-single digits operationally for the second straight quarter. In the US, IIM saw 15% growth in new patients, but experienced delays in converting the existing installed base to new pumps due to CGM sensor supply constraints (see below). In international markets, IIM delivered high-single digit operational growth on continued strength of the MiniMed 640G. As big of a step as the 670G is, the 640G has really carried Medtronic’s business over the past several quarters.
  • Sales in the Diabetes Service and Solutions (DSS) division were flat operationally. This business has been slow of late, as the prior two quarters (1Q17, 2Q17) saw YOY declines. In the US, the press release noted installed base growth and improved patient utilization, offset by “price declines and increased payer requirements” – potentially concerning news for Medtronic, given the size of this recurring business and strong profitability. In international markets, the Diabeter business had encouraging mid-20% range patient growth, though consumables saw “temporary market pressures in China and France” – the latter may be due to Omnipod growth, which is quite strong.
  • Sales in the non-intensive diabetes therapies (NDT) division declined in the high-20% range operationally. This was the third consecutive YOY decline for this segment, a first in the two years since growth has been disclosed. The press release noted a temporarily limited supply of sensors for professional CGM, though the division had “60% new account growth in US primary care.” We assume Abbott’s FreeStyle Libre Pro is also a big competitive pressure – it’s a far better device on nearly every front (factory cal, price, fully disposable, startup, training), and Medtronic’s main way to compete right now is on analytics (Pattern Snapshot is quite strong) and sales rep footprint with Henry Schein. Of course, there is a huge PCP market to tackle here and we hope to see several CGM companies build nice type 2 businesses over time.

3. Guidance Raised to Mid-High Single Digit Growth for FY18; Double Digit Growth Expected in FY19

In a jump in optimism, Diabetes growth is expected to “significantly” improve in the coming two quarters, driving “mid-to-high single digit growth” for all of FY18 (May 2017-April 2018) – this is a notable rise from the +1%-4% guidance given in 2Q17, which was an unprecedented downtick from the earlier +10%-12% ambitions. The sensor manufacturing constraints have obviously capped previous expectations for the full year. For context, sales declined 1% operationally in F1Q18 and declined 2% operationally in F2Q18 (this quarter), so the second half of this fiscal year will need roughly ~10% YOY growth to get the full-year to mid-single-digit growth.

  • “Double digit” Diabetes growth is expected in FY19 (May 2018-April 2019), which seems reasonable given the easy YOY comparisons and improved sensor capacity coming online to start the year. We do note that the US pump market will get significantly more competitive for Medtronic next year, assuming Tandem launches PLGS and Insulet launches the new Dash PDM.

670G US Launch and Sensor Manufacturing Capacity Highlights

4. 20,000+ on Hybrid Closed Loop Now; Priority Access Program Pump Shipments Complete

Medtronic has finally finished shipping pumps for the 670G Priority Access Program (sensors still constrained), and over 20,000 US patients are now on Hybrid Closed Loop – more than doubling the “about 10,000” update we last heard at DTM 2017. The Priority Access Program included “close to 35,000” patients (per 2Q17), implying ~15,000 still don’t have Guardian 3 sensors/transmitters (i.e., they have a pump but are not on hybrid closed loop, since sensors have not full shipped).

  • ~13,000 patients are now uploading 670G hybrid closed loop data into CareLink, with real-world outcomes and performance “very similar” to the pivotal trial. This is a very positive sign for Medtronic, as the pivotal results (~72% time in range, average glucose ~150 mg/dl) were not guaranteed to translate to real-world use.
  • We’d love to know more about individuals’ subjective experiences on the system and how they vary from baseline – presumably some are absolutely elated with the performance, some wish it was more aggressive, some use it only overnight, etc. See Gary Scheiner’s early review here, which was also shared in person at the Diabetes Mine event last week. We expect to hear a range of experiences with this device and subsequent devices.

5. CGM Capacity Constraints to Be Resolved by February-April 2018

CGM sensor capacity remains constrained, but is still expected to resolve in February-April 2018 (F4Q18) – in Q&A, Diabetes President Hooman Hakami said the expansion plans are running a bit ahead of schedule, encouraging considering the unexpected Puerto Rico storm challenges. In line with 2Q17, the press release noted “strong global demand” for sensors outpacing supply. The press release implied things are improving on the sensor manufacturing front (“as evidenced by the improved sequential revenue growth”), though this is hard to unpack – US revenue was very low in 2Q17, which made the sequential comparison quite easy anyways.

  • Per an October HCP letter, for those with new 630G or 670G orders, sensor and transmitter orders were expected to ship by the end of 2017 (for orders made before September 5) or in early 2018 (for orders placed after September 5).

Pipeline Highlights

6. US Launch of Guardian Connect Mobile CGM + Sugar.IQ by April 2018

The long-awaited Guardian Connect standalone mobile CGM and paired Sugar.IQ app with IBM Watson are still expected to launch in the US by April 2018 (2H FY18), in line with the 2Q17 update, but delayed from the prior May-October launch plan (JPM 2017). We assume Guardian Connect is still under FDA review, but this was not specifically addressed today. The slide deck noted Guardian Connect’s “strong utilization by established patients in Europe” – as a reminder, the version outside the US uses the prior-gen Enlite Enhanced sensor.

  • At DTM 2017, we saw new Sugar.IQ outcomes data from the continued ongoing “limited learning launch” phase – 256 users showed encouraging engagement metrics. In an n=136 subset of users (with 2+ weeks of data), Sugar.IQ’s glycemic insights helped increase time in range by a modest 33 minutes per day. Users spent an additional 2% of the day in range (baseline not given, not statistically significant), as well as 14% fewer lows longer than 120 minutes per year (p<0.001) and 3.9% fewer highs longer than 120 minutes per year (p<0.001) – the latter were very strange metrics, and we’d speculate it the more traditional time <70 mg/dl and >180 mg/dl were not significantly changed (given the small bump in overall time-in-range). Of course, reductions in prolonged events more than two hours are very positive and presumably of strong interest to payers. Within a week after a low glucose “insight,” 55% of users had fewer lows, with an overall 2.4% less time spent below target; within a week after a high glucose insight, 54% of users had fewer highs, with an overall 1.7% less time spent above target – we assume the latter were absolute reductions, meaning ~30-minute daily improvements in time spent low/high after insights. These are fairly modest, but presumably the group on the app is doing quite well at baseline. On average, participants in the study used the app 2.1 times per day – indicating it is engaging and could drive good ROI from the pattern recognition. Users “liked” 86% of the nearly 4,700 insights generated in the period, and 68% were logging food (2.8 items/day, on average). This analysis was part of the limited learning launch, from which we saw preliminary data at ADA (smaller n of 81).
  • We think Sugar.IQ will pull more helpful insight out of CGM data, but how much differentiated value will it add to Guardian Connect? Will a non-early adopter population use the app? Wil engagement remain strong over time or wane after early use? Can Guardian Connect sufficiently differentiate from Abbott’s FreeStyle Libre and Dexcom’s G5/G6 in the US? Guardian Connect lags behind competitors with 3-4 recommended calibrations per day (vs. 0 for Abbott; 2 for Dexcom), a seven-day wear time (vs. 10 days for Abbott), availability only on iOS (vs. Android, iOS, and watches for Dexcom), a reusable design (vs. fully disposable for Abbott), and on-body form factor.

7. 670G International Launch Expected by April 2018

In the first update since January, Medtronic is “preparing” for the international launch of the MiniMed later in FY18 – i.e., by April 2018. This is delayed from the plans to launch by May-October, per the company’s JPM 2017 slides in January. Management did not comment today on which countries will launch first. As of the September 2016 FDA approval, we only knew that international regulatory “approval” was expected in “summer 2017” – it’s not clear if any countries have received approval at this time. The constrained sensor manufacturing has presumably gated an OUS launch. On the plus side, we assume learning from the US rollout will heavily inform OUS plans – perhaps things will ramp more quickly outside the US, assuming reimbursement is there.  

8. Medtronic’s iPro 3 Professional CGM Launch in FY19 (May 2018-April 2019)

Medtronic’s next-gen iPro3 professional CGM is expected to launch in FY19 (May 2018-April 2019). This is the same timing as was shared in 2Q17, which itself was an ~1 year delay from prior plans. Today’s update did not specify whether this would be a US, international or global launch – the 2Q17 update only positioned this as an international launch. However, with strong US competition from Abbott’s FreeStyle Libre Pro, the pressure is on to launch stateside as soon as possible. Per the 2016 Analyst Day, this sensor will be “single-use,” blinded, and have an expected MARD of ~11% - key updates given the current high-hassle, reusable form factor in iPro2.

Pipeline Summary

Pump, Automated Insulin Delivery, and Infusion Sets

Pump/Infusion Set Pipeline Product

 

Latest Timeline

MiniMed 670G with Guardian Sensor 3

Hybrid closed loop

>20,000 US users on hybrid closed loop. Priority Access Program pump shipments complete, with sensors/transmitters to ship to new users in late 2017/early 2018.

International launch by April 2018.

Pediatric pivotal clinical trial (2-13 years) currently recruiting, expected completion April 2018.

1,000-patient RCT currently recruiting.

MiniMed Pro-set Infusion Set with BD’s FlowSmart technology

According to BD’s 3Q17 call, patient training clinical trial has been “conducted.” No new launch timing shared.

Future Bluetooth-enabled pumps incorporating Roche Accu-Chek Guide Link BGM

No official timing shared by Medtronic. A Roche webinar suggested that this could launch in mid-2018, but Medtronic has never confirmed this.

Advanced Hybrid Closed Loop (Formerly called the MiniMed 690G)

Incorporating DreaMed MD-Logic algorithm to add automatic correction boluses

Feasibility study shared at ATTD 2017. NIH funded IDC/Schneider Children’s Hospital study to start later in 2017 and compare to 670G. No FDA submission or launch timing shared.

Other infusion set innovations:
- An extended wear set
- Two different CGM-insulin delivery combo sets
- Two unknown innovations (“SC2,” “Solo”)

 Over next three years
(per the June 2016 Analyst Day)

 

CGM Sensor Pipeline (Personal and Professional)

CGM Pipeline Product

Latest Timeline

Guardian Connect standalone mobile CGM

Bluetooth-enabled transmitter, Enlite 2 (OUS) or Guardian Sensor 3 (US).

Launched outside the US (EMEA, APAC).

US launch expected in 2H FY18 (by April 2018), in tandem with Sugar.IQ apps.

iPro 3 Professional CGM
“Single-use,” blinded, MARD of ~11%.

Launch in FY19 (May 2018-April 2019)

 

Data Analytics and Connectivity Pipeline

Data/Connectivity Pipeline Product

Latest Timeline

IBM Watson app, Sugar.IQ Gen 1 (“Personal Diabetes Assistant”)

Analyzes retrospective data: “How have I been doing?”

US launch by April 2018 with Guardian Connect CGM. Positive feedback from patient preview; first data from “limited learning launch” (n=81) presented at ADA and subsequently at DTM.

 

Fitbit partnership for professional CGM

myLog mobile app launched in December 2016 to capture exercise, food, fingerstick data while wearing iPro2.

Turning Point Program with IBM Watson

Bluetooth-enabled BGM, a patient mobile app, a one-on-one health coach, clinical decision support for PCPs, and optional iPro2 to help patients with uncontrolled diabetes.

Went live in F3Q17. Initial pilot data reported at ATTD demonstrated 2.0% A1c reduction from a 10.1% baseline in n=35 completers (view the poster here).

mySugr-CareLink integration for pump/CGM data management

Partnership announced in a mySugr industry update in November, but no launch timing shared.

 

Questions and Answers

Q: How are you feeling about the reacceleration in diabetes? How confident are you? What gives that confidence that next year you will grow in the double digits?

Hooman Hakami: Let's start with the back half of this year and then we can talk about FY19. I'd say the acceleration that we expect in the back half of the year is really driven by three things. The first one is our that sensor capacity plans are actually not only going according to plan, but are slightly ahead of schedule. We anticipate that we're going to be in a position by the end of this fiscal year where our sensor capacity will allow us to meet all of the demand. As we get that backup we expect to see acceleration, not only of sensor revenue but also of pump revenue.

The second one is the 670G and the real-world performance of 670G as more of those systems get into the market. This is a system that now has 13,000 patients that are uploading their data into CareLink. What's really encouraging is that what we’re seeing even at these volumes that outcomes and performance are very similar to what we saw in the pivotal trial for the FDA. And so as those things really start to continue to take hold, I think both from a physician perspective and a patient perspective we'll start to see traction.

And then the third dynamic for the back half of the year, which will also go into FY19 is Animas and the transition of those patients to Medtronic. And then as we look forward into FY19, there's a series of new product launches in addition to all of these dynamics. Guardian Connect and our entry into the standalone sensor market is number one. iPro 3, which will be a new professional CGM for our type 2 business is number two. You combine all of these things and we feel good about the acceleration into the second half and also double digits for FY19.

Q: So you'll have full sensor supply as of the fiscal fourth quarter?

Mr. Hakami: That's right. So we're going to ramp up and Q3 should be better than Q2. So our capacity expansion plans will allow us to produce more sensors this quarter than we did last quarter, and then by Q4 we'll be in a position where we can meet all of the demand.

 

-- by Adam Brown and Kelly Close