Medtronic F1Q15 – Sales grow 13% on easy comparison; MiniMed 640G to launch outside the US in upcoming quarter – August 19, 2014

Medtronic reported F1Q15 results this morning in a call led by CEO Omar Ishrak. Below, we discuss the call’s top business and pipeline highlights, followed by a pipeline summary and Q&A.

Financial and Business Highlights

1. Worldwide Diabetes revenue totaled $416 million, growing 13% as reported and 12% operationally year-over-year (YOY) – the YOY comparison was Medtronic Diabetes’ easiest ever, as F1Q14 sales one year ago grew just 1%.

2. US sales of $242 million grew 16% YOY and declined 10% sequentially. The year-over-year comparison was particularly easy in the US, as F1Q14 sales declined 3%, Medtronic Diabetes’ worst ever US performance.

3. Outside the US, growth was 9% as reported and 6% operationally on sales of $174 million – this marks eight straight quarters of international growth exceeding 7%.

4. Management mentioned lower overall gross margins related to “significant spending” to address quality issues in Neuromodulation and Diabetes.

R&D Pipeline Highlights

5. Medtronic expects to launch the MiniMed 640G predictive low glucose management system in international markets in the upcoming quarter (F2Q15), a significant acceleration from the F4Q14 timeline to launch by the end of FY 15 (April 2015). There is still no official US timeline on the MiniMed 640G, though an in-clinic phase 3 US study (n=84) is now expected to start in September and wrap up in December 2014 – so the company is moving in the US.

6. The MiniMed 620G Japanese language sensor-augmented pump is expected to launch in Japan in the upcoming quarter (F2Q15).

7. Medtronic started a limited launch in Europe of the MiniMed Duo combined CGM sensor/insulin infusion set. Management said early feedback has been “very positive” due to the enhanced comfort and single insertion site. We’re eager to get user feedback on this.

8. No specifics were shared on CGM sensors in development; management did say in a vague way that it was making good progress on its sensor pipeline as it advances towards a closed loop system.

9. The company’s new focus on type 2 diabetes was briefly mentioned, both through a new partnership with Sanofi and the recently published OpT2mise trial.

10. There was no mention of the MiniMed 670G (hybrid closed-loop system) or MiniMed Flex (a “hybrid” durable pump). These devices were first mentioned at the June 2014 Analyst Day.

Financial and Business Highlights

1. Worldwide Diabetes revenue totaled $416 million, growing 13% as reported and 12% operationally year-over-year (YOY) – the YOY comparison was Medtronic Diabetes’ easiest ever, as F1Q14 sales one year ago grew just 1.4% (the lowest Worldwide growth ever recorded for Medtronic Diabetes). Management said the “strong” US launch of the MiniMed 530G/Enlite drove “solid double-digit growth” in both insulin pumps and CGM. That said, sequentially, worldwide revenue declined 10% from record-high F4Q14 sales of $460 million.

• According to management, the F1Q15 growth translated into “global share gains in insulin pumps” and “US share gains in CGM.” We assume this is share growth vs. one year ago but not necessarily vs. the first calendar quarter of 2014. This was noticeably more vague than in the past two financial updates (F4Q14 and F3Q14), where management shared numerical estimates of the company’s US pump and CGM market share gains (ranging from four to six percentage-point gains). In these past calls, management did not provide more detail as to how the estimates were obtained/sourced and from what base; as we understood it, they reflected “internal estimates,” as we had of course suspected, since Dexcom doesn’t publish units so the calculation is actually not technically possible to make using public numbers. 
  
  • The US CGM share gain was somewhat surprising to hear –  management said the launch of the MiniMed 530G/Enlite is driving the share gains. Our model estimates Medtronic’s US CGM market share (by sales) declined from 49% in F4Q14 to 42% in F1Q15 (based on ~15% of Medtronic sales from CGM [per the 2014 Analyst Day] and Dexcom’s 1Q14 and 2Q14 calls).

Table 1: Medtronic Diabetes Worldwide Sales

2. US sales of $242 million grew 16% YOY and declined 10% sequentially. The year-over-year comparison was particularly easy in the US, as F1Q14 sales declined 3%, Medtronic Diabetes’ weakest ever US growth. One year ago, management attributed the lackluster performance to slow insulin pump system sales due to the delayed launch of the MiniMed 530G. We estimate the US provided 72% of F1Q15 growth, up from 57% in F4Q14, but down from 80% in F3Q14 – as  a reminder, F3Q14 was the first full quarter after the October 2013 launch of the MiniMed 530G/Enlite in the US. US sales growth should be quite strong in the upcoming F2Q15 quarter, given no US sales growth in F2Q14 one year ago; what will be particularly instructive is to see how growth looks in F3Q15, as the comparison will be quite challenging to 21% US growth in F3Q14 following the initial MiniMed 530G launch. US sales fell about $30 million in F1Q15 compared to each of the previous two quarters, similar to worldwide performance.

Table 2: Medtronic Diabetes Sales – US

3. Outside the US, growth reached 9% as reported and 6% operationally on sales of $174 million – this marks eight straight quarters of international growth exceeding 7%. The comparison was fairly challenging compared to growth of 8% in F1Q14. We expect the strong international performance to continue with the upcoming launch of the MiniMed 640G in international markets in the upcoming quarter (F2Q15) and launch of the MiniMed 670G some time out. As US sales fell sequentially, so did international sales, which declined 8% sequentially from record-high F4Q14 sales of $190 million.

Table 3: Medtronic Diabetes Sales – International

4. Outside of the standard Diabetes Group discussion of results, management also mentioned lower gross margins related to “significant spending on additional resources, mostly diverted from R&D, to address quality issues in Neuromodulation and Diabetes.” This paralleled comments in the F4Q14 call, where management cited higher cost of good sold (COGS) related to quality system improvements in Diabetes and Neuromodulation; at the time, the Diabetes business was “getting close” to resolving the issues. It  was unclear, but we assume the issues have largely been corrected at this point and we do not know if higher spending on COGS is one-time or ongoing – we assume the latter (a negative since that means less going into R&D than had been planned to sustain operating and net margins per pump). As a reminder, Medtronic’s insulin pump quality system problems (first discussed on the F4Q13 call) delayed FDA approval of the MiniMed 530G.

R&D Pipeline Highlights

5. Management expects to launch the MiniMed 640G predictive low glucose management system in international markets in the upcoming quarter (F2Q15), a significant acceleration from the F4Q14 timeline to launch by the end of FY 15 (April 2015). We note that the new timeline is on par with what we heard in the in the F3Q14 call in February, when management called for an international launch “in the first half of FY15” (i.e., by October 2014). This was terrific news, as the launch timeline kept getting delayed and we continue to hear favorable things about the MiniMed 640G from patients who have tried it. The product already has a CE Mark. We’re not sure if it will launch in international markets with the Enlite 2 or Enlite 3 sensor; the former launched in Europe at ATTD 2014, though the latter is being evaluated in an in-clinic US study. We look forward to finding out more about this at EASD.

• There is still no official US timeline on the MiniMed 640G, though an in-clinic phase 3 US study (see below) is now expected to start in September and wrap up in December 2014. The 84-patient max study (60 patients is the target) previously had a start date in May 2014 and an estimated study completion date of November 2014, meaning the timing has been pushed back by a few months. It’s a single-arm study (a big improvement from the onerous ASPIRE in-clinic study, which was a challenging crossover design) that will increase patients’ basal rate to induce hypoglycemia (another improvement over ASPIRE, which used exercise to induce hypoglycemia). The MiniMed 640G’s low limit will be set at 65 mg/dl, and a subsequent observation period will evaluate its performance. Notably, the study will use the Enlite 3 sensor, on which we have never seen data. The primary outcomes are serious adverse events, unanticipated device effect, severe hypoglycemia, DKA, and rescue events during in-clinic procedures. Enrollment at seven centers (Stanford, AMCR Institute, Barbara Davis Center, Yale, Atlanta Diabetes Associates, University of Virginia, Rainier Clinical Research) will start with adults (22-75 years) and progress to pediatrics (14-21 years).
• There are four studies of the MiniMed 640G currently listed on ClinicalTrials.gov – the first study below was added in June and is new from the last Medtronic quarterly update.

6. The MiniMed 620G Japanese language sensor-augmented pump is expected to launch in Japan in the upcoming quarter (F2Q15) – this is the first ever detail we’ve heard on this model number (note: it will use the new next-gen pump platform, but it will not have threshold or predictive suspend). Management said the MiniMed 620G will be the “first integrated system in Japan,” implying Medtronic currently does not sell a CGM sensor-integrated pump in Japan.

7. In F1Q15, Medtronic started a limited launch in Europe of the MiniMed Duo combined CGM sensor/insulin infusion set. Management said early feedback has been “very positive” due to the enhanced comfort and single insertion site. As a reminder, the MiniMed Duo obtained a CE Mark on June 3 (read our detailed report) and was expected to launch in the UK first, followed by select European countries over the next few months (pending local approvals). The three-day wear combined insulin infusion-CGM sensor set (a “snake bite” configuration under a single patch, separated by 11 mm) has an MARD of 15.5% vs. SMBG. There is no pricing information at this time, though we assume the three-day-wear MiniMed Duo is at least somewhat more expensive for patients than buying the individual six-day-wear Enlite sensor and a separate infusion set (i.e., a patient would use twice as many sensors with MiniMed Duo) – though it could also be less expensive overall! We’ll be doing research on this at EASD. The downside would seem to be that patients are doing more frequent CGM insertions overall.

8. Management offered no specifics on CGM sensors in development other than saying, “we're making good progress on our sensor pipeline as we continue our advancement towards a closed loop system.” As noted in the pipeline summary below, upcoming Medtronic pipeline sensors that we are aware of include Enlite 3 (“intelligent diagnostics” and “improved accuracy & comfort”), a redundant glucose oxidase sensor system (multiple glucose sensing elements and a Bluetooth LE transmitter), and orthogonally redundant CGM (glucose oxidase and optical sensing). We expect the MiniMed 640G will launch in the US with the Enlite 3 sensor. As a reminder, Enlite 2 has launched in Europe and the original Enlite has been available in the US since October 2013. There are no official timelines on any of the upcoming CGM pipeline products.

9. Management briefly mentioned the company’s new focus on type 2 diabetes through a new partnership with Sanofi and the just-published OpT2mise trial. Indeed, a major theme of the June 2014 Analyst Day was the type 2 diabetes opportunity – Medtronic has established a type 2 diabetes business unit and has future plans to launch a type 2 technology platform and establish a “type 2 ecosystem.”

• At ADA 2014, Medtronic announced a new strategic alliance with Sanofi focused on developing novel type 2 drug device combinations and care management devices. We believe there are many directions Medtronic could dive into type 2 diabetes – simpler insulin delivery devices, pre-filled devices, wearable patch-like devices, pump delivery of concentrated insulin and non-insulin hormones like GLP-1 agonists, intermittent CGM to aid HCPs in optimizing care, and more. While many orals and GLP-1 agonists are delaying the move to mealtime insulin for type 2 patients, as these patients live longer, we assume more patients will ultimately lose beta cell function and will need mealtime/snack insulin. We expect to see a big focus on cost-effectiveness and new business models as well, given management’s comments from the Analyst Day and new Medtronic Diabetes President Hooman Hakami’s previous experience at GE.
• Full results from Medtronic’s OpT2mise trial were published in The Lancet on July 3 (Reznik et al., 2014). The randomized, six-month study compared insulin pump therapy (n=168) to MDI (n=163) in type 2 patients in poor control (mean A1c: 9.0%). After 27 weeks, A1c declined by 1.1% in those on an insulin pump compared to 0.4% in the MDI group (p<0.001); notably, 55% of the pump group achieved an A1c <8% vs. 28% of the MDI group. Masked CGM data (iPro2; baseline vs. six months) revealed no significant increase in hypoglycemia and significantly greater reductions in time spent >180 mg/dl in the pump group (-226 minutes per day vs. -57 minutes per day; p<0.001). In addition, the group on pumps used 20% less insulin vs. those on MDI at the end of six months (122 vs. 97 units; p<0.001), a major positive given less insulin should be associated with less weight gain. Overall, it was valuable to see these results from a randomized, controlled, multi-center study of pumps in type 2 diabetes – this is the largest comparative study ever done examining pumps vs. MDI in type 2 diabetes, and it overcame some of the limitations of previous data (e.g., non-randomized, non-poorly controlled patients, small n’s). One could argue that a 1.1% reduction in A1c is fairly small given the high baseline, but we emphasize that this is a highly challenging patient group – late stage type 2s failing MDI. It was quite significant that nearly double the number of patients got to an A1c <8% using a pump, while simultaneously using 20% less insulin and not experiencing any additional hypoglycemia or weight gain. We expect the real-world results in a poorly controlled population would be even better, since control group patients of course received a lot of attention, dose titration, and education.

10. There was no mention of the MiniMed 670G (hybrid closed-loop system) or MiniMed Flex (a “hybrid” durable pump) – these devices were first introduced at 2014 Analyst Day, though few details and no timelines were shared. At the time, new Diabetes President Mr. Hooman Hakami assured listeners that he “intends to continue that march to an artificial pancreas. It is a noble goal, it’s the right goal, and it’s one we’re going to continue.” 

• At the 2014 Analyst Day, the MiniMed Flex was positioned as a “hybrid pump.” Mr. Hakami said it’s going to have smaller footprint than a traditional pump, which will allow a patient to choose whether to wear it on OR off the body. However, it will still be a durable pump with tubing. From our view, this is a clear strategic move to achieve some of the advantages of a patch pump (discretion, wearing it on the body instead of a pocket, no tubing hanging out), while maintaining Medtronic’s established durable pump business model. No further details were shared, but we assume this pump would have a handheld to enable a patch-pump-like experience. As a reminder, the Analyst Day revealed that Medtronic has discontinued development of its traditional patch pump.

Pipeline Summary

Questions and Answers

Q: If we look at the expense side on gross margin and SG&A, you came in a little lower than we thought on gross margin and a little higher on SG&A. The full year guidance is really unchanged. You've got a big improvement it looks like in the back half of the year. For the gross margin are a lot of these issues going to linger? Or are some temporary other than FX?

A: As far as the gross margin goes, we do expect it will improve as we go through the year. As we indicated, it was a little lower here in the first quarter due to some things that we've known about, which are the quality costs in Neuro and Diabetes.... We also expect that with the issue we addressed on the quality side within Neuro and Diabetes, as we go through the year [expenses] will also start to come down, 

-- by Adam Brown and Kelly Close