CEO INTERVIEW - William Hawkins: Cardiac Kid

The Medtronic boss is looking overseas for growth, but first he has to overcome safety problems with a key defibrillator part that have hit the company’s stock price.

WILLIAM HAWKINS HAD been CEO of medical-device giant Medtronic for seven weeks when, on October 15, he had to make the tough call to suspend sales of certain wires used in its im- plantable defibrillators. The wires, known as leads and sold under the Sprint Fidelis brand, were fracturing at an uncomfortably high rate, creating the risk that some of the hundreds of thousands of patients worldwide who wear the company’s defibrillators would be shocked unnecessarily or that their devices wouldn’t function when needed.

Hawkins, the company’s 53-year-old former chief operating officer, was lauded by some in the medical community for being far more cooperative with regulators and doctors about sharing information related to the lead fractures than had rivals who experienced safety issues in the past. But that didn’t prevent plaintiffs’ lawyers from slapping Medtronic with lawsuits on behalf of patients or allay the concerns of investors, who sent the Minneapolis company’s shares down 11 percent on the day of the announcement. The leads in question have generated $1 billion in revenue since their 2004 introduction; Medtronic’s total annual sales are $12 billion. By late October the stock had fallen a further 4 percent, to about $47.

Even before the safety crisis, Hawkins had quite a challenge ahead of him. His predecessor, Arthur Collins Jr., oversaw six years of expansion on a grand scale, integrating a series of big acquisitions that grew earnings by 167 percent over the period, to $2.8 billion for the fiscal year ended April 27, 2007. But Medtronic’s share price increased just 22 percent during the same time, compared with a more than 70 percent jump for the Standard & Poor’s 500 index, of which it is a component. The problem: investor worries that Medtronic’s size and intensifying competition in its industry would make such rapid growth harder to come by in future years.

One weapon Hawkins plans to employ to get the stock back on track is managing the company like the giant, mature enterprise it is, by consolidating technology and rationalizing manufacturing to exploit economies of scale. The new CEO also expects that the U.S. launch of Medtronic’s Endeavor coronary artery stent, hoped for by the end of the year, and the company’s planned $3.9 billion acquisition of rival Kyphon will keep earnings expanding.

But the company’s biggest growth opportunity is overseas, particularly in -- where else? -- China, where Medtronic confronts a vastly different health care system. Hawkins recently chatted with Institutional Investor Assistant Managing Editor Justin Schack.

Institutional Investor: Some critics suggest Medtronic waited too long to disclose problems with the defibrillator leads. Why did you decide to suspend sales when you did?

Hawkins: Earlier this year we received reports from some physicians indicating they had experienced higher-than-expected fracture rates with Sprint Fidelis leads. We communicated this information and the results of our initial review in a letter to physicians on March 21, and committed to sharing information as we learned more. Since then we have examined six months of additional returned-products analysis and data from our own study of the product’s longevity, which encompasses issues with leads that were not returned. The analysis of that data shows that the Fidelis leads are failing at a slightly higher rate than our Sprint Quattro leads are after 30 months. The difference isn’t statistically significant now but will become statistically significant over time if the current rates remain constant. Only when we had this information were we ready to make a responsible decision regarding the Sprint Fidelis leads, and we did so, with patient safety and well-being as our primary concern. We worked with the Food and Drug Administration, the Heart Rhythm Society and physicians to ensure that patients were provided with this information responsibly.

Medtronic and other device makers have had safety issues in the past with implantable cardiac defibrillators and stents, particularly.How big an issue is safety for the industry right now?

ICDs are implanted to treat patients at risk of sudden cardiac arrest, which kills more than 1,000 people a day in the U.S. Without protection, patients who experience SCA have a 95 percent chance of dying within minutes of the event. ICDs are more than 98 percent reliable in preventing those deaths. The benefit clearly outweighs the risk for most patients. As much as you would like people to think that products never fail, these are man-made devices, and they have random failure rates. It’s our job to make sure we’re doing the best we can in designing quality products, making sure that they are safe and communicating very transparently about their performance. We’re very proud of what we are doing in those areas.

One investor I spoke with joked that your stock needs a defibrillator as badly as your customers do. What’s wrong, and how do you fix it?

We’ve had some work to do. The diabetes business we acquired didn’t perform like we expected it to, and there was some uncertainty about our vascular business because some people didn’t believe we’d be able to make it to market with our drug-coated stent. But I believe that we have tremendous opportunities ahead of us. The stock will respond as long as we’re able to get people excited about the future and then deliver on that promise, and that’s what we’re going to do.

What will you do differently from Art Collins?

One area where my agenda will be a little different is in changing the way we manage Medtronic. For the past five years, we have managed business by business. I want us to not just manage up and down each unit but also to look across the enterprise, so that we can translate revenue growth into improved profitability.

What, specifically, will that involve?

Technology is a good example. Because of all the acquisitions we’ve done, we’re operating 16 different IT systems. Over the past three years, we’ve been investing in replacing those with one common architecture, and that should take our IT expense from about 4 percent of sales to less than 3 percent. That’s about $130 million to the bottom line. We’re also shifting manufacturing to a model in which plants aren’t run by business units but are aggregated around common technologies. The technologies for pacemakers and neurostimulators are very similar, so instead of making them separately, we now make both in the same facility. We’re trying to move to common suppliers and common components to exploit economies of scale.

What are you doing to ease shareholder concerns?

I’m telling them about our growth opportunities, in existing businesses as well as overseas and in other business lines. The big opportunity for us is outside the U.S., and we’ve been investing in our infrastructure to take advantage of that. We also believe we can invest in new markets. We think we can leverage some technology we have in drug-device combinations that can treat hepatitis C, for example. I’ve also been telling people that by looking across the businesses and not just up and down each unit, we can grow our bottom line faster than our top line, and that message is resonating.

How will your non-U.S. business change over time?

Japan is our second-largest market today. I think that within ten years it will be China, just considering the demographics and the strengthening of the economy there.

How do you have to alter your approach to the business in China?

We don’t manufacture or do much R&D there. It’s really sales and marketing. And there’s no nationalized health care system and no established infrastructure for reimbursement. It’s a cash-and-carry business. Patients pretty much have to pay out of their pockets. But today there are more people with disposable incomes over $200,000 in China than there are in the U.S. That’s a lot of people who can afford to pay for an insulin pump, a pacemaker or a coronary stent. The good news is, we aren’t subject to the reimbursement concerns that you have in countries that decide to change their policies overnight. But the bad news is that you’ve got to really market it patient to patient.

So it’s almost as if you’re a consumer product business there?

We don’t really advertise. But physicians, knowing that the patient’s going to pay, have to be convinced that our devices really are the right thing for their patients.

How is being CEO different than being No. 2?

My previous role was about making sure that I had the right people in the right jobs, setting targets for our businesses, allocating resources and reviewing the businesses to make sure we were delivering on what we set out to do. Being CEO is more about making sure we have a clear vision and strategy. I still focus on leadership development and talent management, except now I get to make the final decisions. There’s more work on governance and policy. And there’s a big emphasis on communication -- making sure you’re telling the story to stakeholders in a way that gets people excited about Medtronic. And I enjoy that.