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2 Winners and 2 Losers in the Med Tech Market This Quarter

Brian Feroldi, The Motley Fool

In this week's episode of Industry Focus: Healthcare, host Shannon Jones and Motley Fool analyst Brian Feroldi dive into earnings from four medical device makers -- two that crushed it and two that tanked. Abiomed's (NASDAQ: ABMD) FDA concerns proved too big for the company to deal with quietly, and that hurt this quarter. Intersect ENT's (NASDAQ: XENT) promising devices were overshadowed by some big and growing concerns about long-term viability.

Meanwhile, reports from Insulet (NASDAQ: PODD) and Novocure (NASDAQ: NVCR) were everything investors wanted and more. Tune in to learn how all these businesses work, where this quarter fits into their long-term stories, the most exciting prospects and biggest risks to track, and more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on May 8, 2019.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every single day. Today is Wednesday, May the 8th, and we're talking Healthcare. I'm your host Shannon Jones, and I am joined via Skype by med tech guru Brian Feroldi. Brian, so glad to have you on the show, because we're continuing with the theme of earnings, this time digging into med tech and the world that you know very near and dear to your heart. Brian, how's it going?

Brian Feroldi: It's going awesome! And you are right, we are in the throes of earnings season right now. Lots to talk about this week!

Jones: Lots to talk about! So for our listeners, we're going to kick off earnings bonanza med tech style this week. We're going to dive into the winners and the losers that have come out of earnings. We've got some notable ones for sure. Let's kick things off with our first loser. It's a company called Abiomed, ticker ABMD. Brian, I can just say for this company, 2019 has not been very kind to this heart pump maker. Stock has been down about 20% since the start of the new year off of some safety concerns from the FDA. But when we're talking about earnings, it sounds like we're starting to see some of those concerns start to hit their top line.

Feroldi: Yeah, and that's really shocking, because this is a company that has been an unbelievable performer for many years now. For those that need a refresher, Abiomed makes minimally invasive, temporary heart pumps that are put into a patient's body, either after they have a heart attack or before a high-risk surgery, and it lowers their risk profile, and it helps them to recover faster. And these guys are basically the only company that does what they've done. And they have just grown at a blistering pace for many years. But in the most recent quarter, they just produced 19% revenue growth and 100% earnings growth, which sounds pretty good in the grand scheme of things, but this actually fell short of their guidance.

Jones: They were guiding for about 25% top-line growth. A bit of a disappointment. As we briefly mentioned, there were some concerns back in February when the FDA sent out a warning letter, not a recall as some interpreted it to be, but a warning letter to physicians, basically stating that there were some concerns about the mortality rate associated with their bread-and-butter machine, the Impella. What can you tell us about that? How did you see that play out in earnings?

Feroldi: As you mentioned, the FDA did send out a letter to providers in February. Unfortunately, the media took note of this and they basically spread news that the Impella was under a recall over safety issues. That turned out to be not the case at all, that was a misinterpretation. But at that point, the company basically spent the last half of the first quarter on damage control. They basically said that they couldn't get their growth where they needed it to be in time. They're still actively working through that issue, and they have seen progress. But that was a major reason why this company failed to meet its guidance for the first time in as long as I've been covering the company.

Jones: Yeah, and it wasn't just the media. I can say that reading that safety letter from the FDA was a little confusing. They were quick to point out that there is a difference when you were looking at the studies that they use to get this approved versus some of those postmarketing studies that they did. I think there was a 56% difference between survival rates, pretty significant. But the FDA then came back at the end and said, "Despite that, we still think the Impella has a very favorable risk benefit profile." Basically telling physicians, "Don't stop prescribing it, but this is something you need to be mindful of, and something that we're watching." So I'm sure a lot of confusion just out there in the marketplace as prescribers are trying to figure out what to do with this type of information as they wait.

But as you mentioned, Brian, this is a company that hasn't just been taking it. They have been trying to do much more of an education and awareness campaign, and really about helping physicians determine who's the right patient for this type of device. So while they don't know exactly why that difference is there, it was a relatively small sample size in the postmarketing study, the company does believe there's some confounding factors, particularly that the patient base in this postmarketing study was just slightly sicker than what they had in the initial study. So that's all to say, still a lot of question marks for this company. I think it'll take some time to play out. But how are you feeling overall about this company, Brian? I know you've been tracking and following this company for a while.

Feroldi: Yeah, I mean, personally I view this as more of a hiccup than anything else here. I think that this management team knows exactly what they need to do to get the growth story back on track. You mentioned the stock price movements over the last year to date. It hasn't been a pretty 2019. But this company has long traded at a very, very high multiple of earnings and sales. They were priced for continued growth and guidance increases. So the fact that they came out with an earnings report that was less than what the market was hoping for, I was actually surprised to see their stock didn't decline more based on this information. So that tells me that Wall Street still believes that this company has a substantial amount of growth left ahead of it. That's what I expect the company to still do moving forward.

Jones: Exactly. And they have a number of products that are in the pipeline. They've got the Impella 5.5, the Impella ECP, and a BTR system as well as just additional enhancements. They're still trying to expand internationally as well. I do think that this is a blip in their long-term growth story, but we'll be sure to keep eyes on this one, for sure.

But let's turn our attention to the second company that really took a beating on earnings. This is a lesser-known company, one called Intersect ENT, ticker XENT. Stock is down about 30% as of this morning, and it's not just about the bad earnings here, Brian. There's a lot going on with this stock. Before we get into earnings, though, I think it's important for our listeners to know exactly what it is this company does. Can you tell us what they actually do and how they make money?

Feroldi: Yeah, sure. So this is a company that is focused on ear, nose, and throat market, that's the ENT in their name. And they basically make a family of products that treat chronic sinusitis, which is inflamed nasal passages. They make these devices that are inserted directly into the nasal passage and they keep it open, almost like a stent in an artery. While it's in there, it actually slowly delivers a steroid to the inflamed area, and the combination of having it opened up plus a steroid leads to long-lasting results. And some of their products are actually absorbed by the body over time, so it's just a minimally invasive procedure to get it in there and then it provides long-lasting relief.

This is a company that had been growing very rapidly over the last couple of years. They have a multibillion-market-dollar opportunity ahead of them. So this is a company that I was following very closely and was very interested in. However, the results from this quarter, I think, really raised some question marks about the long-term potential of this business.

Jones: Yeah. The results and also a change in leadership that, honestly, Brian, has me scratching my head. Just looking at some of the headline figures, revenue grew 8%. Beat guidance. You also had some gross margin expansion as well. But operating expenses grew. I suspect this will also be a huge part of their story. Looking from the outside in, Brian, I see a company like this that has a device, and really devices, that really have an interesting mechanism of action and are pretty innovative. So it's a little surprising to me to not see growth figures in the way that I would expect for this quarter, and more importantly, knowing that they're going to have to beef up their commercial team, I do worry about expenses really overrunning and overtaking top line. What are your thoughts about that?

Feroldi: Yeah, I agree. I mean, this is a company that has long touted its market advantage, its innovative products, its huge opportunity. So to see revenue growth in the single digits is, to me, very disappointing. I mean, this is a company that should be posting at a minimum in the double digits. Their excuse on this call was that a new product launch called Sinuva, which they're just in the process of getting out there, has been off to a much slower start than what they originally focused on; and they invested heavily ahead of the launch here in an effort to drive growth. So as a result of their really poor first-quarter results, not only did their net loss expand, but they cut their guidance for the year. They were previously calling for $123 million to $127 million. That was reduced down by $10 million to $113 million to $117 million.

But as we teased a little bit earlier, the big news to me here is that the longtime CEO, Lisa Earnhardt, announced that she was leaving the company after 11 years to take a leadership position at Abbott Laboratories. That really had me scratching my head. It's not often that you see the CEO of a supposedly high-growth, very innovative company choosing to enter middle management of an established medical device maker.

Jones: Exactly. It does not leave you with any sort of confidence in the management team at this point, particularly about the direction of this company. In listening to the conference call for earnings, they talked a lot about reimbursement issues, and really the inefficiency of trying to get their products reimbursed. A lot of the physicians' offices -- this is an outpatient procedure that's done -- are using this buy-and-bill system. There's some hurdle to get a lot of these doctors' offices to do the buy and bill. So the company now is really focused on beefing up its reimbursement specialists, as opposed to sales. They really want the salesforce to be focused on selling the benefits of this device and less on a lot of the back office, trying to get these patients started. So basically, they're calling it a reshuffle of their commercial team.

There's still some skepticism though, because these aren't necessarily new issues. Over the past nine months or so, they've been dealing with this reimbursement overhang. I think, in looking at where they're going and how they're trying to tackle the problem, and now with the CEO leaving, I'm not as confident that they've got a clear strategy outlined for the way forward.

Feroldi: Yep, I agree with you there. And it is possible that a new management team could come in and rejuvenate the business, make changes to the sales team, get the growth story back on track. But for me now, I have more questions than answers about this business. I used to be very excited about it, but the recent results out of this company really have me questioning the bull thesis for this stock.

Jones: Yeah. It's not just about getting past the approval line. It's also about commercial viability, something that we talk a lot about on this show.

As with every earnings season, there are winners and there are losers, but there's always some standouts, and that's what we're diving into next. We've got two companies posting some pretty impressive stats. Let's start with the first, and that's insulin pump maker Insulet Corporation, ticker PODD. Stock is up nearly 20% off of earnings, Brian. This is a space I know that you know better than anybody out there. You worked in the med device space for, what was it, about a decade or so?

Feroldi: I worked for Insulet Corporation.

Jones: There you go! Now I'm really curious to hear, what did you think about their earnings this particular quarter?

Feroldi: I mean, they just knocked the cover off the ball basically all around. We saw sales growth of 29%. That was ahead of their guidance and ahead of the Street estimates. We saw their gross margin ticked up. We saw earnings per share on the bottom line, that was a multimillion-dollar beat. And on top of all that, they increased their guidance for the full year by a few million dollars. The report was pretty much spotless across the board. Beyond that, they reaffirmed their long-term guidance for 2021. This is a company that's targeting $1 billion in revenue, 70% gross margin, which would be continued expansion, and a mid-teens operating margin. So they reaffirmed that on the quarter call. Basically, it was a great report all around. No surprise to see the stock was up huge in response.

Jones: No, no surprise there. Impressive stats when you just consider how competitive this space is, especially going up against the likes of Medtronic, and also Tandem, who we covered in earnings last week as well. They also posted some pretty impressive numbers, also showing they're encroaching on Medtronic's space. But Insulet doesn't have its own automated system just yet. Is that right, Brian? That's something potentially on the way that could make that $1 billion in revenue all the more attainable, right?

Feroldi: That is completely true. Yeah, these guys do go up directly with Tandem. Tandem just posted spectacular results too. You guys covered them on the show last week. It is so nice to see that yet another company in this space is also doing well. It just tells me that the category itself is growing very quickly.

But to your point, yes. Insulet does not have an automated insulin delivery system as of yet. That product should be available within about a year or so. They are a little bit behind on that. But clearly, that is not holding them back, because this is a company that makes an insulin pump that is worn on the body that does not have any tubing, and just the appeal of a system that is completely wireless, which makes them stand out from the competition, is clearly leading to strong growth without that key feature.

Jones: Yeah. I continue to say it, I know I've said it a number of times on this show before, but the diabetes space, just in terms of innovation, with wearable tech that's actually driving health outcomes, is pretty remarkable. I don't think it gets nearly the amount of love and appreciation that it should. These companies are really on the forefront of that. We'll come to a point where literally on your Apple Watch, you'll be able to not only track your glucose readings, but an algorithm will be able to then drive exactly how much insulin you're getting, and this will all be completely automated, really taking away a lot of the pain and inconvenience that a lot of these systems, and just overall paradigms, have right now.

Feroldi: Yeah, I totally agree. The next couple of years should be very exciting in this space. People with diabetes have a lot to look forward to. But yeah, I agree, the med tech companies that compete in the diabetes space don't get enough attention from investors. But a lot of them have been tremendous winners.

Jones: Yeah. Huge winners, especially for 2018.

All right, let's round things out with our last med tech earnings winner. That's a company called Novocure, ticker NVCR. This is a company that's been paving the way really in the fight against cancer. Making its mark by treating one of the more aggressive forms of cancer, brain cancer, glioblastoma, with a technology that's really centered around, of all things, electrical fields. Brian, catch all of our listeners up to speed. What is their tech, and how in the world are they doing this?

Feroldi: This is a company that I've followed with great interest for a number of years and I've actually talked about several times on the show before. This is a very odd duck med tech company. They make a medical device that uses electric fields to inhibit cell division and fight cancerous tumors. Their device is used alongside standard of care chemotherapy/radiation therapy to improve health outcomes. It looks like a swimming cap that you put on your head. It has some wires on it. And while you wear it, it inhibits cell division in tumors and fights, as of right now, a deadly form of brain cancer called glioblastoma multiforme.

This company has just thrown up unbelievable growth over the last couple of years as more and more providers have been willing to use this oddball therapy to treat cancer. We saw a continuation of that in the first quarter. Revenue growth was up 40%. Strong growth in the U.S. and international markets, specifically Japan and Germany. We saw gross margin expansion. Their net loss dropped by almost half to $12 million. That's notable because this is a company that is significantly ramping up its spending on R&D.

Jones: With this company being centered around a solid tumor indication, you mentioned the glioblastoma indication, they've got a pipeline lined up going after pancreatic cancer, ovarian cancer, lung cancer. Solid tumors are really the Holy Grail of many of these biopharma companies that are trying to come out with innovative therapies. These solid tumors are really complex, and oftentimes it's not a one-and-done treatment or a one-size-fits-all treatment. So they haven't had a whole lot of luck in the solid tumor indication. So to see a company like this with an electrical field technology, basically leveraging physics to, in many cases, shrink the size of tumors, is giving hope to a lot of patients, especially in glioblastoma. This is oftentimes where patients are literally counting the days or the weeks in terms of survival. This is a technology, the Optune System, that is giving them more months to live.

Really impressive tech. I'll be really curious to see just logistically how their tech works with some of these other indications. It's one thing when you put on a skull cap, if you will, that has electrodes; it's a whole 'nother thing when you're trying to treat pancreatic and ovarian cancer with this technology. But, to have something separate from the standard chemo, radiation, and surgery -- in some cases it's a supplement to those things, but to have something new, with potentially fewer side effects, less complications, is truly innovative in a space where cancer continues to be the No. 1 killer in the world.

Feroldi: Yeah, totally. You mentioned before, another big thing that happened this quarter was, they moved their ovarian cancer study into Phase III trials. So now that is their fourth clinical study that's studying Optune in Phase III. They now are in Phase III studies with brain metastases, lung cancer, pancreatic cancer, and ovarian cancer. All of those markets dwarf the brain cancer market. I mean, they are just enormous. If the company can have success in any of those indications, the addressable market for this company just explodes.

In the meantime, the other exciting thing to note about this company is, they are currently pending FDA approval for mesothelioma. That's a cancer that, if they can win it, is a very small market. The revenue upside potential from that potential approval isn't that game-changing. The big thing for investors would be, it would be their first indication that they could potentially win outside of brain cancer and really prove out that the therapy can be used in other areas of the body beyond the brain. All in all, tons to like here.

Jones: All right, Brian, of these two, who's your top winner from earnings so far?

Feroldi: Well, if I had to pick between these two, I think I would have to say Insulet because they've already crossed over into the net income positive category, and they're posting that incredible growth without an artificial pancreas basal adjustment feature. I could easily see that number accelerating once they become competitive, as we've seen with Tandem's numbers just exploding. So if I had to pick, I would say that they're the bigger winner between the two. But there's no doubt that both of these companies have very bright futures ahead.

Jones: Yeah, totally agree. No bias there, right, with Insulet?

Feroldi: No, no bias. None.

Jones: [laughs] Fair enough. Well, that will do it for this week's Industry Focus: Healthcare show! Thank you so much for tuning in! As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Brian Feroldi, I'm Shannon Jones. Thanks for listening, and Fool on!

Brian Feroldi owns shares of Abiomed and NovoCure. Shannon Jones owns shares of Apple. The Motley Fool owns shares of and recommends Abiomed and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Insulet. The Motley Fool has a disclosure policy.