Medtronic 4Q17 (F3Q18) – Record sales of $584 million rise 17%, driven by 38% US sequential gain; sensor capacity to meet “all” demand in coming Q; 670G peds submitted to FDA; Guardian Connect under FDA review – February 20, 2018

Medtronic reported record-high 4Q17 (F3Q18) financial results this morning in a call led by CEO Omar Ishrak. It was a very big change following the previous two quarters of very challenging results (the business didn’t grow either quarter). Diabetes is page 12 in the presentation slides, and the call’s major highlights are summarized below.

Financial Highlights

1. Record-high global sales of $584 million rise 17% YOY, driven by 15% US year-over-year gain; US rises 38% sequentially to $355 million; OUS rises 20% to $229 million

Worldwide Medtronic Diabetes sales hit a record-high $584 million, increasing 17% YOY as reported and 13% operationally. Sales grew a record 26% sequentially, driven by remarkable 38% sequential growth in the US – we have never seen a Medtronic diabetes sales graph look like the below. The record-high sales easily beat the previous record of $512 million (1Q17), an impressive achievement though sales in early 2015 were also similar to this. The execution, particularly on the sensor manufacturing front, is on par with 3Q17 commentary. For the first time in two years, the US and OUS businesses provided near-equal shares of quarterly performance – the US sales represented 54% of Medtronic’s diabetes revenue vs. 46% for OUS. The YOY comparison was fairly typical for Medtronic (6% growth in 4Q16), implying that the coming three quarters – which have far easier YOY comparisons, given Medtronic’s relatively weaker performances in those quarters – will likely see stronger growth if demand continues.

• US sales of $355 million rose 15% YOY and an impressive 38% sequentially, hitting an all-time high and adding nearly $100 million (!) over 3Q17 (though we also point out that it is also $135 million over 4Q14, three years ago). Sales handily beat the previous record of $310 million (4Q16) and marked only the third time ever crossing $300 million in the US; although the business saw $293 million in the US three years ago in 1Q15, this is still very impressive growth, and things should bode well if capacity issues are fixed and with the eventual (now close we hope) US approval of the Guardian Connect. This was Medtronic’s strongest US growth in the past 14 quarters, indicating the 670G/Guardian Sensor 3 launch is starting to open up, now that manufacturing constraints are easing up. Medtronic is now able to meet the sensor demand of the existing customer base, and it remains on track to fully meet predicted demand from both existing and new users in the coming quarter (F4Q18). The J&J Animas exit is also helping to drive US sales, mostly via “strong” US consumables uptake (see quote below). US growth came on a typical YOY comparison for Medtronic (+6% in 4Q16) – the comparison had been very easy the previous quarter, however, when sales declined 12%, enabling an easy 3Q17 sequential comparison. Read more on the 670G launch below.
  
  • “As far as Animas goes, I'd say that's progressing very well. We're generating today consumable revenue from that transaction, and we're transitioning patients that are out of warranty from Animas to Medtronic as planned, and things are going very well with that, and we're getting some incremental growth out of that … even if you exclude Animas, we would have been double digits in Q3, but we’re very pleased with how that's going and we look forward to just continuing the transition.” – Hooman Hakami in Q&A
  • Medtronic is benefiting, of course, from the transition of Animas patients who are not only buying sensors and pump supplies, but who will now be upgrading to the 670G. Although many did not want to wear Medtronic’s “old” sensors, presumably they are happier with the 670G as they can transition to that as warranties allow.  
• Outside the US, record sales of $229 million increased a robust 20% YOY as reported. Medtronic saw 12% operational growth in developed markets ($185 million) on “strong” 640G adoption alongside 10% operational growth in emerging markets ($44 million). Beyond the 640G, the slide noted “strong utilization and retention” for OUS Guardian Connect users. Medtronic is “working to obtain CE Mark for 670G” – if the 640G is any indication, this product should do very well outside the US (there are lots of complaints in areas where it is not yet approved and it seems frustrating to us that so many of the same trials need to be done in different geographies for different regulatory bodies).

2. Intensive insulin – “high-teens” growth; Service/Solutions – mid-single digit growth; non-intensive – declines in mid-single digits

• The intensive insulin management (IIM) division grew in the “high-teens” operationally, improving on low-single-digit declines in the previous two quarters. As expected, sales were driven by the MiniMed 670G/Guardian Sensor 3 US launch. Outside the US, IIM delivered “low-twenties” operational growth on the continued strength of the MiniMed 640G system – the multi-year sustained 640G adoption represents a very positive sign for 670G, once it receives a CE Mark and launches in various new international geographies.
• Sales in the Diabetes Service and Solutions (DSS) division grew in the “mid-single digits” operationally, with growth in consumables benefitting from customer base growth and improved patient utilization. The slide noted US growth in consumables driven by new patients, likely many from the Animas exit; there was no mention of the infusion set pricing pressures alluded to in previous quarters. Guardian Connect, the standalone mobile CGM, also falls in this division – the system is seeing strong utilization and shipments will expand in the coming quarter OUS (F4Q18) and once this is finally approved in the US. Finally, the Netherlands Diabeter clinic has expanded coverage to type 1 adults, and the clinic has a “growing” funnel for expansion in other countries; we assume this is not generating significant revenue at this point, and expansion plans have moved slower than we would have guessed following the acquisition nearly three years ago although we hear absolutely stellar things about the service where it is available.
• Sales in the non-intensive diabetes therapies (NDT) division declined in the “mid-single digits” operationally, marking four straight quarters with a sales decline. The press release noted a commercial focus on the MiniMed 670G launch and “competitive pressures” – presumably the latter refers to Abbott’s FreeStyle Libre Pro CGM, which is a stronger product than iPro2. There were some bright spots, however: iPro2 has seen ~30% growth in US primary care penetration; three contracts with ACOs have been secured for iPro2; and Medtronic has developed “an early framework” for value-based healthcare in type 2. Now that the sensor manufacturing constraints are easing, we’ll be interested to see if the professional CGM business returns to growth. 

3. Double-digit diabetes growth expected in F4Q18 and FY19, consistent with JPM 2018 remarks

Following a big focus on Diabetes growth at JPM 2018, management maintained expectations for “double digit” growth in the upcoming quarter (F4Q18) and for all of FY19. Given the strength this quarter, plus easier upcoming YOY comparisons over the next three quarters, this seems absolutely doable. Notably, Diabetes is Medtronic’s only business segment expected to drive double-digit growth in the upcoming quarter and fiscal year; the rest of Medtronic’s businesses (all much larger) have mid-single-digit growth expectations (~3%-6%). In our view, while achieving upside on the guidance will rely on a few key factors, Medtronic will also be benefiting from a weaker year overall (calendar year 2017) and easier comparisons. Here is what we’ll be looking to assess:

• Continued strength of the US 670G launch: How much runway is there, outside of priority access users (i.e., early adopters) now on the system? Will Tandem’s Basal-IQ (PLGS – Summer 2018 launch) and Insulet’s Omnipod Dash (limited market release in 2H18) offer more competition for 670G?
• Guardian Connect securing FDA approval: When will this come through (presumably soon given the remarks on the call though it has taken meaningfully longer than expected)? How will it compete with Abbott and Dexcom? Will Sugar.IQ be a compelling differentiator for the product?
• 670G launching outside the US: Is the successful MiniMed 640G uptake a good indicator of 670G adoption?  
• Medtronic successfully turning itself into a CGM-first company, rather than a pump company that happens to sell CGM as an add-on. Omar Ishrak noted in Q&A, “we continue to shift our customer base from standalone pumps to sensor augmented pumps, [and] we expect sensors to be a key component of our growth.” We’d add that the future of the business – and the bold goal to serve 20 million patients by 2020 – rests heavily on Medtronic’s ability to drive real-time CGM into broader populations and professional CGM into type 2 diabetes and primary care.   

670G: US Launch, Pediatric Submission, and OUS Timing

1. 20,000+ on 670G in the US; sensor production doubled sequentially, will meet “all” demand in the upcoming quarter

“Over 20,000 patients” are using the MiniMed 670G in the US, the same update that we heard in 3Q17 – we’re surprised the number has not been updated, given the January update that Medtronic has now fulfilled 99% of Priority Access Program orders (~35,000 people). CMO Dr. Fran Kaufman did say last week that “over 25,000” are now using the system – perhaps this wasn’t updated in time for today’s remarks/slides. Sensor capacity improvement efforts are on track to meet “all” sensor demand in the upcoming quarter (F4Q18), on par with previous comments.

• “The sensor ramp-up is actually progressing well…our Guardian Sensor 3 production in the third quarter was twice as high as what we experienced in the second quarter. So that should give you an indication of how things are progressing and as the commentary alluded to, we're on track to fulfill all the needs – the sensor needs of our installed base this quarter, and by the end of this quarter, we'll be able to meet unconstrained demand as we have been saying all along…” – Medtronic Diabetes CEO Hooman Hakami
• We saw real-world data from ~14,000 US 670G users at ATTD last week, which showed outcomes and performance consistent with the pivotal trial. Across all ages, 670G auto mode time in 70-180 mg/dl was ~71%, time <70 mg/dl was ~2%, time <54 mg/dl was 0.49%, and time >180 mg/dl was ~27%. The largest divergence from the pivotal study was the ~96 minutes fewer per day spent in auto mode in the real world (from 87% in the three-month pivotal to 80% in real-world use). Unsurprisingly, the pediatric and especially the adolescent groups had lower time in range than the other age groups, but still fared significantly better on hybrid closed loop – 7-13 year olds and 14-21 year olds saw time in range increase from 52% to 65% (+3.1 hours/day) and from 53% to 63% (+2.4 hours/day), respectively. In this cohort, people ≥60 years old stayed in auto mode for the longest, at ~20.4 hours per day, and also spent the most time in range, at ~75% (up from baseline of 68%). These data suggest that 670G consistently improves glycemia across all age ranges, and supplements the pivotal data in 7-13 year olds presented by Dr. Bruce Buckingham on the same day (see below). 

2. Working to obtain CE Mark for 670G; upon approval, launching in select OUS geographies

Per the slide deck, Medtronic is currently “working to obtain CE mark for 670G.” Upon approval, the hybrid closed loop will launch in “select OUS geographies” – we’d guess this will focus on Europe and perhaps strong 640G markets. This was not acknowledged in prepared remarks. The 3Q17 update last fall more firmly called for a 670G OUS launch by this April, but JPM timing last month suggested a broader window between now and April 2019 (“FY18/FY19”) – the latter pushback could reflect a longer-than-expected OUS regulatory process, which has stretched more than six months beyond the initial plan for a “summer 2017” approval. Launching by this April is doable if the CE Mark is secured in the next two months – increasingly tight timing, depending on how far along the CE Mark process is. No matter when it launches in Europe, this means the OUS 670G is ~1.5 years behind the US approval, a testament to the forward-thinking FDA device division.

3. 670G pediatric (7-13 years) indication submitted to FDA; 2-6 year-old study wrapping up soon

Though not mentioned on today’s call, we learned last week that Medtronic has submitted 670G pediatric data (7-13 years old) to the FDA. We saw pivotal results three days ago at ATTD: compared to a two-week open-loop run-in period, 670G drove a 0.4% reduction in A1c in the pediatric population (baseline: 7.9%); time-in-range (71-180 mg/dl) improved from 56% to 65% (a strong +2 hours/day); time <70 mg/dl declined from 4.7% to 3.0% (-24 mins/day); and time >180 mg/dl improved from 39% to 32% (-1.7 hours/day). We’d guess a pediatric launch this year is possible, depending on how long the FDA review goes. Dr. Fran Kaufman said last week that a seven-site, n=50, three-month study in 2-6 year old is also in the process of wrapping up. Overall, this likely means Medtronic will be out with a pediatric indication before other companies are out with a commercial hybrid closed loop – a big advantage and one we think parents may be quick to jump on. Interestingly, the real-world 670G data mentioned above (~14,000 patients) included nearly 500 7-13 year old users that are already using the system as part of the US commercial launch – this age group’s real-world Auto Mode time-in-range (~65%) was identical to the pivotal. (We assume these users received off-label prescriptions, perhaps for those close to the age cutoff and on more than eight units of insulin/day.)

CGM, Infusion Set, and Other Pipeline Highlights

1. Guardian Connect standalone mobile CGM remains under FDA review, with approval confidently expected “shortly”

Medtronic is “working closely with FDA on US approval” of the standalone, Bluetooth-enabled, Guardian Connect mobile CGM. A launch is expected “shortly,” and in Q&A, Group President Hooman Hakami shared lots of optimism: “We are very confident that we're going to be able to get this out shortly. It's hard to predict exactly when the FDA is going to approve it but we're working very closely with them and all indications are that we'll have an approval here in short order.” This review has now stretched on for nearly two years (!) following the March 2016 submission – much longer than we expected, and we’re not clear on what is taking so long. The 3Q17 update last fall called for a US launch by this April, but JPM timing last month broadened the launch window between now and April 2019 (“FY18/FY19”). The remarks were not specific on timing, but “shortly” implies it could indeed happen in the next two months. This will launch in tandem with the long-awaited Sugar.IQ app with IBM Watson.

• “When we say by the end of this quarter we'll be able to meet unconstrained demand, that's not only talking about pump users…It's also about our ability to go after new markets like standalone sensors, which I had talked about with Guardian Sensor 3 and the pending approval in the United States. We really feel confident that by the end of this fiscal year [by April 2018] we'll be in a position to really go after our existing markets as well as start to really penetrate aggressively new markets that we currently don't play in.” – Hooman Hakami

2. Mio Advance hidden-needle, auto-inserter launches in UK, Italy, Netherlands; more countries in upcoming quarter, including Canada

At ATTD last week, Unomedical’s Mio Advance debuted in Medtronic’s booth and workshop, reflecting a limited launch in the UK, Italy and the Netherlands in F3Q18. Canada, Hong Kong and certain Europe/Middle East/Africa launches are expected in F4Q18, with availability in other countries expected later in 2018. There is no US timing to report, though we’d guess a stateside launch might fall in the countries slated for later this year. The all-in-one, hidden-needle, fully disposable inserter is a big upgrade in our view – see a video demo here. The Unomedical rep told us it’s been the “best feedback ever” about an infusion set, a major win and certainly strong competition to BD’s FlowSmart set. The initial Mio Advance launch with Medtronic does not appear to be an exclusive partnership (like BD), though Unomedical has not developed a version for Tandem’s t:lock at this point. However, the set’s website does indicate a luer lock version is available, meaning Roche pumpers could theoretically use it.

• The MiniMed Mio Advance is ready-to-use upon unwrapping, inserts with the single push of a button, and can even be inserted one-handed for difficult-to-reach areas. It looks particularly great for pediatric patients and elderly patients who may struggle to insert their infusion sets independently. According to workshop leader Dr. Carine de Beaufort, the MiniMed Mio Advance works with any insulin pump with a luer-lock connector, though it is only compatible with 6mm teflon tubing to date (other variations are on the horizon).
• Developed by Unomedical, we saw the set for the first time at ATTD 2017, and Medtronic’s ATTD symposium this year implied it has launched in the UK. Notably, the patient feedback has been quite positive: In a small UK-based pilot launch test (n=24), 92% of participants claimed that the product is better than their current infusion set, 87% were “extremely” or “very” satisfied with the product, and it exceeded customers’ expectations for eight out of ten users.

3. iPro2 CGM + custom Nutrino app in Type 2 Diabetes: successful pilot of photo-based logging

In a blog post yesterday, Medtronic’s Laura Stoltenberg shared high-level details on a new type 2 diabetes effort – tying professional CGM data (iPro2) with photo-based meal logging in a custom version of the Nutrino app – we love it! Like the current Nutrino app (which can pull personal CGM data from Apple Health and Dexcom’s public API), this intervention creates a “FoodPrint” that pairs glycemic response (in-range vs. out-of-range) with meal photos. In this iteration, a custom version of the Nutrino app collects the images from the phone’s camera roll (the app does not need to be open), analyzes the data using its proprietary tools, generates a FoodPrint report, and scores meals from “A” to “F.” There are some basic tips shared for different meals, like swapping out white bread with whole grain bread, swapping white rice for brown rice, etc. We see big potential here in linking meal photos with CGM, and it reminds us of what Onduo is doing with photo-based meal logging in its diabetes pilots with connected CGM/BGM. It’s great to see this work spreading (Meal Memory was the pioneer!), and we see this as a key area of development for adding more context to CGM data and driving behavior change. We love that Nutrino does not require the app to be open – it can pull the photos from the camera roll automatically, as it can recognize photos of food. Our only quibble with Nutrino is that it can be buggy, especially in draining battery life in our tests with Dexcom’s API. That said, we know it will improve and it does a lot of things right.

Value-Based Healthcare Highlights

1. Linking 670G Reimbursement to Hypoglycemia Prevention, per WSJ; UHC and Aetna diabetes deals progressing; more discussions underway

The diabetes slide and a WSJ article today indicated a few updates on the value-based healthcare front. First, the well-written WSJ article/interview by highly-respected writer Peter Loftus posted today (“Medtronic Moves to a New Health-Care Model: Pay Only if It Works”) mentions diabetes a couple times, including news that Medtronic is “exploring contracts with insurers” that would link 670G reimbursement to hypoglycemia prevention. This was not mentioned on the call, but could obviously give Medtronic a leg-up on the competition, especially Tandem and Insulet in the US. The diabetes slide also noted: (i) the United Healthcare value-based agreement is “progressing well” (no details on what diabetes outcomes are tracked in the preferred pump provider arrangement); (ii) Medtronic has completed phase I of the VBHC program with Aetna (focused on MDIs transitioning to pumps – if they don’t achieve an A1c benefit, Aetna gets a rebate – we would have loved to have seen “time in range” assessed by the MDI patients probably do not have that data); (iii) Medtronic has secured three contracts with accountable care organizations (ACOS) for the iPro2 professional CGM; and (iv) Medtronic has an early framework for VBHC in type 2. A bullet point also noted diabetes discussions around value-based relationships are also in progress with “multiple payers.” There were a number of broader mentions of VBHC in other Medtronic divisions on the call, learning that could translate over to diabetes too – see the quote below.

• “We’re pleased with our continued progress in creating new value based business models that directly link our therapies to improving outcomes. We now have over 1,000 hospitals under contract and over 25% of our US CRHF implantables revenue is covered under a TYRX-related value based healthcare arrangement that links total payment to patient infection outcomes. Beyond TYRX, we've also commercialized five other value based healthcare programs covering various therapies including ICDs, CRTs, AF ablation, drug coated balloons and aortic stent grafts where a portion of our payment is tied to specific patient outcomes. Collectively, these five programs, in addition to TYRX, cover over $650 million in mostly US-based device revenue.”

Pipeline Summary

Pump, Automated Insulin Delivery, and Infusion Sets

CGM Sensor Pipeline (Personal and Professional)

Data Analytics and Connectivity Pipeline

Selected Q&A

Q: Can you give an update on the continued glucose monitor program?

Hooman Hakami: The sensor ramp-up is actually progressing well. It was a key contributor to our growth rate in Q3. Just to maybe put some additional color on it, our Guardian Sensor 3 production in the third quarter was twice as high as what we experienced in the second quarter. So that should give you an indication of how things are progressing and as the commentary alluded to, we're on track to fulfill all the needs – the sensor needs of our installed base this quarter, and by the end of this quarter, we'll be able to meet unconstrained demand as we have been saying all along.

Now the other thing I’ll just point out is the performance of the sensor itself, not just the capacity. As Omar talked about in the commentary, the MARDs that we are seeing on over 20,000 patients in the installed base is fantastic, and continues to really essentially mirror what we saw in the pivotal trial. We're very pleased, not just in terms of the output, but also the quality of the sensor.

Q: What about timing in the US [for the Guardian Connect standalone CGM]?

Hooman Hakami: That one is with the FDA. We are very confident that we're going to be able to get this out shortly. It's hard to predict exactly when the FDA is going to approve it but we're working very closely with them and all indications are that we'll have an approval here in short order.

Q: It's encouraging to see the Diabetes turnaround and you talked about getting to a point where you're now meeting demand. Could you help us sequentially understand, from here, how much improvement you could see in terms of your ability to grow beyond that and actually go after more new customers? And maybe just touch on in a little bit more detail the Animas change and how that could help your pump business as a preferred provider?

Hooman Hakami: When we say by the end of this quarter we'll be able to meet unconstrained demand, that's not only talking about pump users and our ability to satisfy the sensor needs of the patients who are on pumps. It's also about our ability to go after new markets like standalone sensors, which I had talked about with Guardian Sensor 3 and the pending approval in the United States. We really feel confident that by the end of this fiscal year [by April 2018] we'll be in a position to really go after our existing markets as well as start to really penetrate aggressively new markets that we currently don't play in. That's number one.

As far as Animas goes, I'd say that's progressing very well. We're generating today consumable revenue from that transaction, and we're transitioning patients that are out of warranty from Animas to Medtronic as planned, and things are going very well with that, and we're getting some incremental growth out of that. The way I would characterize it is even if you exclude Animas, we would have been double digits in Q3, but we’re very pleased with how that's going and we look forward to just continuing the transition.

Q: On revenue growth, obviously this was some of the most best and most balanced revenue growth we've seen out of Medtronic for some time, so congratulations on that. From a macro perspective, can you talk a little bit about maybe about the drivers of the growth? How much of this was just particularly strong execution and new products versus strong markets?

Omar Ishrak: Like I've always mentioned, our revenue performance is highly dependent on new product launches, and when we've got new products, the revenue growth goes up quite significantly, especially with respect to the market. Overall, the market is no real major changes since before. We expect what we said in November is about still holds the same in terms of surgical procedures and in terms of other procedures. Some elective procedures in diabetes in particular, have a ramp up in December, which then tails down in January – so these are all normal patterns. I think the only thing that I'll point out is of course that we're pleased with the Diabetes business as promised and expected with the sensor shortage issue being addressed, bounced to double-digit growth which clearly just on its own helps.

Q: I just want to come back to revenue momentum. Obviously very strong quarter here in the third. If I think at the top end of your guidance, it sort of implies 5.5% for the fourth quarter, but also your commentary implies some deceleration in franchises like CVG and RTG. Were there any one-time dynamics in the third quarter or pull forward because of the hurricane dynamics? Or perhaps the fourth quarter reflects some type of conservatism?

Omar Ishrak: Well, I think the hurricane dynamics were relatively minor. I mean, there was some of that, but really that was relatively minor on the overall base of our revenue. I think, in Q4, it's mainly tougher comparisons year over year that are driving this. In some areas like Diabetes, we expect continued strength, and I think CVG has had a strong, high, almost high-single-digit growth rate over past several quarters and we're running into a tougher comparison in Q4 […]

Q: Historically, you've talked about 40 to 60 basis points of organic growth contribution coming from the Services and Solutions business. I was wondering if you could update your thoughts there. Should we still be considering the annuity revenue growth from hospital solutions and some of your peers’ services business like CardioComm as well as the value-based programs driving 40 to 60 basis points of organic growth, or should we be thinking more about the implant benefit with some of those programs driving growth more on the implant side going forward?

Omar Ishrak: I think both. We haven't been able to hit the 40 to 60 basis points, but I know we talked about it as a target. We're closer to the 20 to 40 I'd say, and our growth in hospital solutions continues and we had actually a particularly strong quarter with the VA in our Care Management Services business. So I mean that annuity revenue actually continues to grow. We are increasing the number of hospitals. We're pretty excited about the spread of contracts that we're getting in hospitals around the world now in Latin America and in the Middle East as well as in Western Europe through our hospital solutions and that's increased from our cath lab managed services to our operating managed services as well, so there's a strong focus in the company around that and that'll deliver increased annuity revenue.

I think though what we've found is that the bigger benefit, and that's a value, but the bigger benefit actually is the linkage with our new therapies which is then driving incremental share in our new therapies and incremental pricing in some situations where the innovation and value are directly linked. That's why we started to look at this in a much more integrated fashion and the contribution of economic value actually to our innovation program is greater than the annuity revenue, although I'm not by any means saying we're going away from that in any way.

--by Adam Brown and Kelly Close