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Covidien Ltd. (NYSE:COV)

F4Q08 Earnings Call

November 17, 2008 8:30 am ET

Executives

Cole Lannum - Vice President of Investor Relations

Rich Meelia - Chairman, President and CEO

Chuck Dockendorff - Chief Financial Officer

Analysts

David Roman – Morgan Stanley

Taylor Harris – JP Morgan

Robert Hopkins – Bank of America Securities

Kristin Stewart – Credit Suisse

Rick Wise – Leerink Swann

Tao Levy – Deutsche Bank

Matthew Dodds – Citigroup

Operator

(Operator Instructions) Welcome to the Fourth Quarter 2008 Covidien Ltd. Earnings Conference Call. I would now like to turn the presentation over to your host for today’s call Mr. Cole Lannum, Vice President of Investor Relations.

Cole Lannum

With me today are Rich Meelia, Covidien’s Chairman, President and CEO, and Chuck Dockendorff, our Chief Financial Officer. The press release with details of our fourth quarter results was issued earlier this morning and is available on our web site and the news wires.

During today’s call, we'll make some forward-looking statements including and update to our financial guidance and it's possible that actual results could differ from our current expectations. Please refer to the cautionary statements contained in our SEC filings for a more detailed explanation of the inherent limitations in such forward-looking statements.

We'll also discuss some non-GAAP financial measures with respect to our performance. A reconciliation of non-GAAP to GAAP measures can be found in our press release and its related financial tables as well as on our web site, Covidien.com. For the fourth quarter we reported GAAP diluted earnings per share from continuing operations of $0.82. After adjusting for certain one-time items, our non-GAAP results came in at $0.73 per share.

Now, I would like to turn it over to Rich who will give a brief overview before Chuck gets into the numbers.

Rich Meelia

Overall we had another strong quarter which was somewhat above our expectations aided by favorable currency and a good performance in most areas of the business. We met our 2008 goals and believe we are operationally well positioned as we move into fiscal 2009. Fourth quarter sales performance was broad based as three of our four segments reported double-digit sales gains.

In the United States sales grew 10% the highest quarterly growth rate in more than three years. Outside the United States sales increased 15% for the quarter on a reported basis and 8% in constant dollars with double digit gains reported in all geographies. These positive results reflect the recent investments we’ve made to augment our sales force and to expand geographically.

We significantly improved our gross margin due to the benefit of exchange rates, favorable product mix and manufacturing cost reduction efforts. We also substantially increased R&D spending as planned and continue to make other growth driving investments. We generated strong cash flow and lowered our net debt by nearly $300 million in the quarter.

As we head into 2009 we believe that we’ve now right sized our sales force and we look to leverage the significant recent expansion in this area. Of course the 2008 additions will need to be annualized but overall the incremental investments in sales and marketing will be much more modest going forward.

We continue to be active on the new product front as we begin to reap the benefits from our increased R&D investments. In Energy we launched the Evident Microwave Ablation System which compliments our RF Ablation product line and provide surgeons with a more efficient way to ablate soft tissue. In Surgical we’ve launched the SprayShield Adhesion Barrier in Europe offering doctors a unique sprayable hydrogel to reduce post surgical adhesions.

We’ve relaunched Permacol Biologic mesh and introduced Parietex ProGrip a bio components synthetic mesh for hernia repair. Near the end of the quarter we launched a generic version of Oxycodone Extended-Release Tablets and TussiCaps in our pharmaceutical segment as well as generic sestamibi in Imaging.

We have a good combination of break through products and line extensions to drive our growth. Over time we will look to compliment this strong new product lineup with selected technology acquisitions that can help us fill product apps and expand into adjacencies.

While we delivered a good overall performance in 2008 we still face several challenges in our business. The recent results in both the Imaging segment and respiratory have not met our expectations. As you know, we face strong competitive activity in respiratory particularly in our symmetry monitoring and ventilators. We continue our efforts to accelerate growth but expect the turn around in this business will take some time as we ramp up R&D to accelerate the flow of new products and become more competitive in our markets.

In Imaging, while the shut down of the Petten reactor our external source of malibdinum will cause a short term drag on our radiopharmaceutical business. The pricing trends in US contrast media are more troubling. We are developing plans to improve operating margins in this overall segment. Overall we made significant progress during 2008 implementing a number of strategic initiatives across the business and are confident that we are in a good position to achieve our future growth objectives.

We have recently received a number of questions about our exposure to the recent economic downturn and market upheaval. Our broad product portfolio is used in a wide range of healthcare settings. We have relatively limited exposure to elective surgical procedures; geriatric procedures which continue to be growth area for us do have a certain elective component to them. However, even these procedures encompass a wide range of potential patients many whom have significant co-morbidities and are therefore candidates for the procedures with the support and reimbursement of their insurance providers.

Finally, many of your may be wondering about the impact of slowing capital spending by hospitals, given the current economic conditions. I’d like to remind you that our product line consists primarily of consumables as less than 5% of our sales are from products that are considered capital purchases. Those capital products that we do sell include ventilators, energy power generators such as our Force Triad and [Trotheden] pumps, contract media power injectors and oximetry monitors.

The vast majority of these products are priced in the range of a few thousand dollars to $25,000 or so. To date, we have seen no material impact on these products from constrained capital spending by hospitals. Sales growth for these businesses may come under pressure due to future capital spending restraints but we are fairly confident that these products will not suffer the same degree of pressure that you may have seen from other capital products costing six figures or more.

While no company is completely immune to the economic cycles and we are no exception our product diversity can be a benefit despite the recent marketplace uncertainties. We continue to monitor these trends and are prepared to adjust our actions appropriately should we see them starting to move against us.

I’ll now pass the call over to Chuck who will discuss the fourth quarter results in more detail and update our guidance for fiscal 2009. I will then provide some closing observations.

Chuck Dockendorff

Before getting into the results for the quarter I’d like to spend a few moments discussing the unprecedented market events we’ve seen in the last couple of months. In particular there are two areas I’d like to comment on; the tightening in the credit markets and the strengthening of the US dollar versus most foreign currencies.

Looking first at the tightening of the credit markets we believe we are in a good position as the result of the activities we have undertaken since separation. We successfully refinanced our bridge loan about a year ago with the first maturity of $250 million not coming due until 2010. We paid off almost all of our short-term debt thus lowering our net debt by more than $1.9 billion. We’ve improved all of relevant financial ratios. In addition to our strong cash flow we continue to have access to the Commercial Paper market and our $1.4 billion credit facility.

Looking specifically at our corporate cash and short-term investment portfolio we have no exposure to the sub-prime market and no material exposure to the financial service companies which have failed as a result of the credit crisis. At quarter end our cash balance was about $1.2 billion which is invested consistent with our policy of placing priority on safety and liquidity.

To date we have experienced no losses on these cash investments nor do we expect any material impact to our portfolio. We believe the recent financial market volatility supports our strategy of maintaining a strong balance sheet which along with our strong cash flow will ensure our ability to continue our strategy making the necessary investments to drive future sales and profit growth.

As we look at the recent changes to currency rates the significant strengthening of the US dollar against many foreign currencies will obviously impact our reported results negatively in fiscal 2009. The dramatic currency moves in such a short period of time are magnifying the effect on our full year projections.

Over the past few months we have seen a significant devaluation of all foreign currencies except the Yen against the US dollar. These devaluations have been in the range of 10% for the Euro and up to 20% to 30% in Latin America, Australia and other Asia/Pacific countries.

It is important to note while just over half our sales are in the United States more than half of our operating income comes from outside the US. In addition, approximately three quarters of our cost of production is in US dollar denominated countries which increases the cost in those countries which have had a devaluation against the dollar.

These devaluations will have a significant impact on our sales. For example, if we had reported our fourth quarter 2008 sales at recent exchange rates it would have decreased our reported sales growth by approximately six percentage points.

We do hedge some of our transactional exposure; the amounts hedged are in the range of 50% to 75% of the annual volume of expected purchases. There are some areas where hedging is not available or is cost prohibitive. We also have some natural hedges in the countries where we have a sales force or other infrastructure costs which move with the local currency. It is important to remember that we generally have higher operating margins outside the US.

Based on the recent currency movements we expect 30% to 35% of the top line impact from foreign exchange to drop through to our earnings line. This figure includes the effect of our transactional financial hedges. We received a similar proportional benefit from foreign currency in our earnings line in fiscal 2008.

On the positive side we now expect that raw material cost increases will be somewhat less than we originally anticipated. Obviously the price of oil is down substantially in recent weeks and this should benefit both raw material and transportation costs versus our earlier expectations.

Operationally we remain confident that we have had numerous growth opportunities and a strong product pipeline but the currency movements will negatively impact our reported sales growth, gross margin and operating income. I’ll talk further about this when we update 2009 guidance later in the call.

Turning now to the quarter, overall we were very pleased with our fourth quarter results. Sales, gross margin and operating income were all somewhat above our expectations as we delivered broad based business growth and continue to benefit from favorable foreign exchange rates. Net sales increased 12% to $2.6 billion led by Medical Devices, Pharmaceutical Products and Medical Supply segments all of which reported double-digit gains. Favorable foreign currency contributed three percentage points to our overall sales growth rate.

Looking at the results by segment overall it was another good quarter for Medical Devices with sales up 10% to $1.7 billion aided by favorable foreign exchange which contributed four percentage points to the sales advance. Fourth quarter performance was paced by strong double digit gains in Endomechanical up 13%, Energy up 25% and Soft Tissue Repair up 20%. In the Respiratory category sales of Oximetry and Monitoring products climbed 5% while sales of Airway and Ventilation products rose 3% from a year ago.

Looking next at Imaging Solutions, sales increased 3% to $300 million but were flat on an operational basis. We registered good growth in Radio Pharmaceuticals though performance was negatively impacted by the Petten reactor shut down in August. The regulatory authority in the Netherlands which controls the timing of production for the Petten reactor has indicated that it will be shut down at least until the middle of February. We are working through this situation but expect that it will continue to cause a drag on imaging results at least through the second quarter of fiscal 2009.

As Rich mentioned the performance for contrast products was below our expectations this quarter. Sales were flat as lower volume and continued price pressures in the US offset positive results in Europe and Latin America. We expect the US pricing pressure to continue in 2009 causing further drag on this segment.

In Pharmaceutical Products sales grew 37% in the quarter to $296 million. Sales of dosage pharmaceuticals registered strong increases more than offsetting a decline for active pharmaceutical ingredients. Dosage sales growth was aided by the launch of Oxycodone Extended Release Tablets late in the quarter and sales benefited from wholesale distributor pipeline orders.

Given the significant impact that Oxy ER has on our Pharmaceutical results I wanted to provide a little more specificity for you. Sales were in excess of $50 million in the quarter, as a reminder though these sales are all in the United States a relatively high tax jurisdiction. The increased US income causes some upward pressure on our overall effective tax rate. Given all the different factors it is difficult to come up with a specific EPS and tax on the sales of a single product but we estimate it contributed approximately $0.05 per share in the quarter.

In addition, Dosage fourth quarter results benefited from the launch of TussiCaps and we also received a continued benefit from a competitor supply constraint giving us opportunistic volume and some larger than expected orders in the quarter.

Finally, in Medical Supplies sales of $245 million were 10% above those of a year ago, this stronger than expected increase came largely in nursing care and OEM products. Fourth quarter results included some opportunistic sales that we do not expect will be repeated. Going forward we expect sales growth in this segment to moderate back to historical levels consistent with our 2009 guidance.

Now, turning to the items below the sales line, for the fifth consecutive quarter we made good year over year progress on gross margin. The fourth quarter increase of 280 basis points to 54.6% came as benefit from foreign exchange, favorable product mix and cost reductions more than countered somewhat higher raw material costs and increased freight expense. The launch of Oxycodone ER also aided our fourth quarter gross margin progress.

The improvement in gross profit was partially offset by our planned investments in SG&A and research and development. We continue to accelerate spending in these two areas to increase long-term revenue growth with sales force expansion, more competitive marketing and greater innovation. Foreign exchange impact also increased our SG&A costs in the quarter. R&D expense climbed to 41% in the quarter to 4% of sales and we remain committed to further increases over time.

As you saw in the release we also had a couple of special items that affected our reported results. These included a $4 million charge for restructuring and $7 million of expense for our portion of the Tyco International shareholder settlements net of the insurance recovery.

Thus far we have incurred restructuring program expense of $134 million and are on track to spend a total of $150 million with the majority of the remaining spending completed by the end of calendar year 2008. This program is already delivering significant savings and once completed we expect between $75 and $100 million in savings on an annualized basis.

As you know, we announced the second restructuring program in late September. This program will be implemented beginning in fiscal 2009 with about $200 million in spending and savings estimated at $50 to $75 million on an annualized basis. Most of the spending on this new program will occur in fiscal 2009 and 2010 while a majority of the savings will be realized in fiscal 2010 and beyond.

As reported, operating income was $541 million excluding the items just mentioned the shareholder settlement and restructuring, operating income would have been $552 million and the operating margin 21.5%.

Looking below operating income net interest expense was on target at $32 million and other income was $3 million. Turning to income taxes the fourth quarter effective tax rate was 18% this rate reflected the impact of restructuring, the shareholder settlement and several legacy tax matters. Excluding these items the fourth quarter tax rate was 27% and the full year rate was 29% consistent with our guidance.

Next let me take you through some cash flow highlights. We generated strong cash flow in fiscal 2008 on a reported basis our operating cash flow was approximately $600 million as earlier this year we reported the outflow of $1.26 billion related to the Tyco shareholder class action settlement announced in May 2007 prior to the separation.

Excluding the $1.26 billion outflow related to the class action settlement adjusted operating cash flow from continuing operations was more than $1.8 billion in 2008. The $1.8 billion adjusted operating cash flow from continuing operations less capital spending of about $400 million resulted in adjusted free cash flow of approximately $1.4 billion. For 2009 and beyond we expect that our business operations will continue to generate strong cash flow.

Finally, I’d like to update you on our 2009 guidance. Given the significant recent movement in exchange rates we are revising our sales guidance for the Medical Devices and Imaging Solutions segment. In addition, we are seeing some negative operational trends in imaging primarily due to the Petten reactor shut down and weakness in contrast media. We are revising guidance for these reasons as well.

As you know, sales in the Pharmaceutical products and Medical Supplies are largely US based so are much less affected by foreign exchange trends. At current rates we now expect total company sales for 2009 to be flat to 3% above 2008, five percentage points below our invested guidance primarily due to exchange rate movements. Our operational growth excluding foreign exchange remains at 6% to 9% as we communicated at investor day in September.

Including exchange at current rates we expect sales in the Medical Device segment to be in the range of down 3% to flat. The entire reduction in sales guidance is due to unfavorable exchange rate movements and operational growth in this segment is unchanged from our earlier expectations.

Sales of imaging solution sales are now projected to be down 4% to down 1%. The lower guidance for Imaging is about half due to exchange movement and half due to negative operational trends. Again, we are not revising guidance for Pharmaceutical Products which we anticipate will be up 20% in 2009 or for Medical Supplies which is expected to be up 2% to 5% versus 2008.

For 2009 operating margin we expect it will be in the range of 21.5% to 22.5% same as we communicated on September 10 but now think it will probably be at the lower end of that range. This guidance reflects the negative impact of foreign exchange partially offset by lower raw material and oil related costs. We now expect to mitigate some of this exposure through our continued efforts in cost reduction in production efficiencies.

In addition, we now expect that sales of Oxycodone Extended Release Tablets could exceed $250 million. While many of the potential issues surrounding the launch that we mentioned at Investor Day including availability of quota, pricing, timing and potential competition remain unknown we are somewhat more optimistic than we were at that time. However, the entire positive impact of lower raw materials and higher Oxy ER sales will be more than offset by the recent foreign exchange trends we mentioned earlier.

Because of the timing of projected Oxy ER sales and timing related to foreign exchange cost increases we expect that our overall results will be more negatively impacted in the second half of the year than in the first half.

With a stronger dollar and higher Oxy ER sales we now expect that the effective tax rate will be in the 28% to 31% range. Despite this upward revision for 2009 we still anticipate a 200 to 300 basis point reduction in our tax rate over the next couple of years. Both operating margin and tax rate guidance exclude the impact of any one-time items. For free cash flow we are expecting that it will be about the same level as fiscal 2008.

Now I’ll turn the call over to Rich for some concluding comments before we go to Q&A.

Rich Meelia

As you’ve just heard our business in the fourth quarter and throughout fiscal 2008 was operationally strong with good sales growth and improved profitability. Our operational growth was in fact ahead of our expectation giving us good momentum entering the new fiscal year. Despite this we, like other companies, are concerned about how the recent turmoil in the financial markets will impact our business going forward. We’ve seen some tightening in capital spending by our customers though as I noted earlier we have limited exposure to the aforementioned.

We are constantly monitoring procedure volume at our customers through the end of September there has been no noticeable slow down and while we do expect some slowing of elective surgical procedures at hospitals the majority of our products will not be significantly impacted. Of course, the recent move in foreign exchange rates is major negative headwind which we cannot control.

There are however a number of critical success factors that we can control including our internal growth, focus on innovation, cost reduction programs, manufacturing efficiency, business development, just to name a few. These are the areas that have driven our past success and are expected to drive our continued success.

My biggest concern is that we let external forces outside Covidien’s control distract our employees from the focus needed to maintain our momentum. Let me assure you that the entire management team will do everything in its power to make sure this does not happen.

Now we’d be happy to take any questions you might have. I’ll turn the call back to Cole who will explain the procedure for signaling if you have a question.

Cole Lannum

For Q&A I’m going to ask that you please limit yourself to one question and a follow up if needed then put yourself back in queue.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Roman – Morgan Stanley

David Roman – Morgan Stanley

On the R&D and SG&A spending side at the analyst meeting you talked about our starting to see a leveling off of spending and certainly starting to generate leverage on the SG&A line toward the back half of ’09. Can you update us on that especially given the very heavy increase in R&D this quarter?

Chuck Dockendorff

The R&D increase this quarter was a bit higher than we’ve experienced in the prior quarters of the year. It has to do with the timing of some clinical spending and things like that and we do not expect it to be at that rate going forward. I think we finished the year at 3.4%, while we expect it to increase and our goal is to get to 4% to 5% of sales.

As far as the SG&A leveraging piece of it we have mentioned that in 2009 we’ll begin to leverage SG&A. The majority of that will be on the administration portion of the line which we’re trying to keep our costs flat in that area. We do leverage the selling and marketing but to a lesser extent as we still have added people in 2008 and we’re getting a full year impact of that in 2009. We would begin to see that gain in leverage going forward. Most of that sales leverage in the back half.

David Roman – Morgan Stanley

On the share count every company in this group, mostly buys back enough stock to offset the impact of options being exercised. Your stock hit an all time low this quarter, you don’t have an authorization in place, can you square that with the comments from the analyst meeting on the priority to return cash to shareholders.

Rich Meelia

As we mentioned at the investor day we were looking at potential options relative to returning cash to shareholders. At the time no one had foreseen what was about to happen in the credit markets. Quite honestly when things began to unravel externally we just believe that preservation of capital was the best strategy for us going forward. We’ve essentially adopted that as our position until we feel a little more stability in the world around us we do believe that it is the best thing for us.

David Roman – Morgan Stanley

Does that also explain the dividend being maintained and not increased?

Rich Meelia

It does.

Operator

Your next question comes from Taylor Harris – JP Morgan

Taylor Harris – JP Morgan

A few questions on the foreign exchange impact, number one is as I’m calculating it the impact as a percentage of your earnings basis close to 10% which is a fair amount higher than we’ve seen with other companies other competitors in some cases. Why do you think that is, what is it about your business or distribution of income that would cause that? Are you planning on doing anything different on the hedging front or operationally as we move forward in response to what’s happened so far and what may happen in the future as well?

Chuck Dockendorff

Let me just make some comments on the FX we figured this would be a question going into it because of the impact. Just to reiterate we’ve seen really dramatic change in these currencies over the last couple of months with the Euro down 10% and other currencies fluctuating 20% to 30% down against the dollar. It was in a very short period of time. We have seen the Yen appreciate but that’s the only currency we have.

When you look at our situation I can’t comment on what other companies have as far as their earnings and manufacturing but for us more than half of our operating income is outside the US. We’ve mentioned that 45% of our sales are outside but over half the operating income is and 75% of our production is in US denominated countries. We have a significant portion of our manufacturing going to these various entities.

As you look at the impact of the FX it really is two components that we have to deal with. One is the transactional piece, this is the product that we manufacture in the US going to these other countries and this really represents as their currencies have devalued it increased to their cost of sales. It’s costing them more to buy those products from the US countries.

Second is the translational, in the case of that it really is just the profits that we make in each of the various jurisdiction translated at a lower rate as those currencies devalue. We talked about the impact to our earnings on sales of 30% to 35%. When you break out the components between transactional and translational about three quarters of that is related to translational impact. The majority of it is translating the products back.

I could just talk about that and the transactional side the impact is less, it certainly has an impact on our gross margin and operating income percentage but as we’ve mentioned in the past we hedge the transactional component of our exposure. Our policy is to hedge approximately 100% of the first six months and 50% of the following six months. In fact, as we enter 2009 we had approximately 70% of our exposure in this area hedged. Some of the smaller transactions and some of the smaller currencies that we may not hedge but overall we had 70%.

On the translational this has been even more significant impact. To give you an example in Australia where the currency has devalued 30% over a couple months where we would have made say for example $100 million in Australia after that devaluation we are making $70 million as we translate it back at the devalued currency. As you can see that’s a significant impact going forward.

We’ve had during ’08 had an increase in the foreign exchange rates. We did have a positive impact to our results in fiscal year ’08 and you’ve seen that through the increase in our sales revenue guidance and also our operating margin finished on the high end of where we had given guidance as some of that flow through.

The biggest difference between what happened in ’08 and ’09 is that in fiscal year ’08 these currencies appreciated but at a much steadier rate over the course of a year. What we’ve seen here is a dramatic drop in a very short time in all of the currencies outside of the US and it impacts us for the full year. So we see a large and quick drop that we need to put into our forecast going forward. We don’t try to forecast where rates are going, we can only forecast the impact to our business as the rates sit at the end of any one period.

The other thing in all of this is that the FX rates still remain volatile. We see intraday changes within the Euro of $0.03 which is quite dramatic. We expect this to be this way for a while until the financial situation kind of stabilizes itself. What we’ve done is that’s the impact on us from FX, that’s how it hits our business and as Rich mentioned what we need to do here is continue to focus on the operational growth through this uncertain period.

We’ve look at our hedging strategy, we carefully considered this at the beginning of the year as we separated into a public company. We reviewed our hedging strategy with our Board and we’d like to mention that, we feel comfortable with what we’re doing and we’re not going to change that, there is a cost to these hedges and there’s the balance off of the cost of hedging it versus the stability of income. We weigh this into that calculation. That’s kind of our policy and the way its impacting our business it is dramatic and we wanted to make sure that everybody understands that as best they can.

Rich Meelia

What are we doing differently? One thing that we’re staying with is our commitment to drive the top line and drive innovation. We don’t want to back off on the momentum we’ve created and especially in Medical Devices and Pharmaceutical. What we are doing differently and the opportunity that we see today versus say at the Investor Day is the opportunity from a manufacturing and a raw materials standpoint it’s much more clear than it was then.

We are seeing definite opportunities in raw material and we are literally all over that very aggressively and doing everything we can to take additional cost reduction out of 2009 more so than what we initially planned. Whatever we can do to maximize profitability especially in light of all these significant FX headwinds we really are doing but we don’t want to negatively affect some of the momentum that we built with the strategy we’ve been executing.

Taylor Harris – JP Morgan

I know that you don’t have perfect visibility into what other companies do but it is still a big impact relative to what we’ve seen elsewhere. I’m curious if a big portion of this impact is coming from countries where you cannot hedge or you disproportionately profitable in Latin America or Asia ex. Japan for example. That would be question number one. As you’ve looked at hedging strategies versus your peers is there a big difference either in the translational hedging strategy or in the extent to which you hedge your transactional exposure.

Chuck Dockendorff

As you look at the mix of our business as we mentioned we have a big portion of our operating outside and we have sales people direct in almost all of those countries. A lot of our growth is being generated outside of the US as well; some of our faster growing areas and it’s our more profitable areas when you look at operating margin as a percentage of sales. That’s the mix of our business that we deal with. A comment on the transactional piece that’s a lesser extent of this impact in the translational piece, we see a bigger piece coming from that.

From what I’ve seen most companies in our area do hedge on the transaction piece and some of them have natural hedging on the transaction piece because they have production outside the US in local jurisdictions so they get the costs go up and down with the currency as well. Very few I think hedge earnings, it becomes more speculative on just purchasing forward contract on currencies. There are very few healthcare companies that I see that hedge on the earnings piece of it.

Those are the two I think biggest things. We probably have a little bit more production in the US than the other companies and I think we may be more profitable outside of the US than the other companies. I can’t compare that to the companies.

Cole Lannum

The other thing I think is important to keep in mind too is the phenomenon of timing. It just so happens as Chuck talked about the dramatic move we saw in the dollar corresponded almost exactly with the beginning of our fiscal year. It is entirely possible that other companies because of other operations and other things that they have gone makes a different degree of timing on this as we go forward. As noted earlier given the volatility in currency rates we could be sitting here three months or three quarters from now seeing a very different kind of scenario depending on what happens at this point going forward.

Chuck Dockendorff

I think that’s part of the thing when you saw in Q4 2008 our results you saw our consistent improvement in foreign exchange it really didn’t impact us at all in the fourth quarter and yet as I mentioned when we re-run those numbers based upon the end of October rates we saw a six percentage point decline in our revenue growth in Q4 if we had run then at that rate. It’s that quick and that dramatic that happened.

Rich Meelia

The last point I’d like to make is just to provide a little perspective. From day one as we came out and talked about committing we identified our global footprint as being a huge differentiating factor for us as we compete with other companies in this marketplace. We continue to see that as a huge advantage. Right now the significance of the FX downturn it’s a temporary negative but we continue to see this as huge advantage for us and we’ll continue to exploit it over time these currencies will begin I think to moderate.

We will continue to see sales growing at a very fast rate outside the US and with the strengthening the dollar this will create a problem for us.

Operator

Your next question comes from Robert Hopkins – Bank of America Securities

Robert Hopkins – Bank of America Securities

A couple clarifying questions on the guidance, I’ll start with the biggest picture thing you guys have talked about because I remember on the last quarter call I believe it was or maybe it was when you gave guidance previously you talked about a goal to compound earnings over the next two years ’09 and 2010 at a double digit rate. I was wondering if in light of the higher Oxy sales if you could update that goal for us.

Chuck Dockendorff

That was our goal over time to drive double-digit growth and we mentioned that at Investor Day. Certainly with this significant change in FX it’s kind of reset the base. I would tell you that at this point we’re still going through this; we’re continuing to look at the raw material impacts and things like that. I would comfortable saying that from an operational standpoint we would continue to grow on a double-digit earnings growth over the long term but I think until we see what happens excluding the Oxy ER one time impact but I think we need to see what happens with these foreign exchange rates and things like that going forward.

Robert Hopkins – Bank of America Securities

I’ll focus on ’09 then, the $250 million in Oxy contribution given what we saw this particular quarter with the $50 million and $0.05. Is it roughly $0.25 of contribution then that you expect to your bottom line in fiscal ’09 from Oxy?

Chuck Dockendorff

Sure, that’s approximately.

Robert Hopkins – Bank of America Securities

When you gave this guidance the first time what was that number previously?

Chuck Dockendorff

I think we said roughly $100 million plus in sales and $0.15 plus in earnings.

Cole Lannum

A little bit more fine-tuning at this point. The numbers are obviously consistent with that but as we’ve gotten a little bit further into the launching process that $100 million plus looks like its going to be closer to $250 million that $0.15 plus it will be ballpark in the 25 range give or take a little.

Robert Hopkins – Bank of America Securities

So then the organic growth excluding Oxy you give 6% to 9% we can do the math on it but its going to be somewhere in the neighborhood of a little bit above 5% and a little bit above 8% maybe?

Cole Lannum

You need to do the math there we haven’t specifically broken that out and I don’t want to throw that number out there at this point but I think we’ve given you the components that you can do that math.

Robert Hopkins – Bank of America Securities

You talked about the potential for lower raw material costs to have a positive impact this year. Was that something that was actually factored into your guidance for fiscal ’09 or is that something that you have yet to formally factor in to the ’09 thought with the rapid decline in raw material costs of late?

Chuck Dockendorff

This is another area that’s happened very rapidly here the decline in oil and some of our products. We have factored some of that in as we looked at the operating margin guidance. We still feel comfortable within that range and I think the amount we get in there and how quickly it can flow through our system will determined really where we land within that range.

Robert Hopkins – Bank of America Securities

On the organic guidance I’d love to ask you a qualitative comment on that 69% because you mentioned an uncertain economic outlook at this point you feel like you don’t have a tremendous amount of exposure to that. I’m wondering though why you didn’t lower that a little bit in light of the uncertainty is that perhaps a statement from you guys of your level of confidence in your business outlook at you look forward or just some more qualitative comments there.

Rich Meelia

I think it’s a function of how much of our business really is exposed to two things that have manifested themselves as certainties that one is elective surgery a reduction and some tightening of capital budgets at hospitals. We don’t see much at all from elective surgery standpoint we talked about bariatric by definition being elective but it’s very different I think than many of the other cosmetic surgeries. There are some real significant benefits that are accrued to the patient by having this procedure and we think all the constituencies would continue to support that kind of procedure.

From a capital standpoint we don’t have that much exposed for sure some of the people that sell this equipment will have some pressure on their forecast but we think its going to be more a matter of because of the size of our particular product purchases we’re not six figures its much lower than that as I mentioned in our comments. We think we may have to be a little creative in how we work with our hospital customers and how to maybe finance some of these purchases but we do not see anything material at this point in time affecting our business. That’s why we’re staying with our projections.

Operator

Your next question comes from Kristin Stewart – Credit Suisse

Kristin Stewart – Credit Suisse

I was wondering if you could go through and maybe give us a little bit more detail on the gross margin year over year just in terms of the breakdown on a basis points you talked about product mix and FX maybe if there’s a little bit more color you can give there.

Chuck Dockendorff

You want to go through the full year or is it the quarter you are interested in?

Kristin Stewart – Credit Suisse

The quarter.

Chuck Dockendorff

In the quarter we continued to see, I’m talking about gross margin percentage at this point. We continued to see favorability from the volume and the mix of sales of our product. We also had certainly with Oxy ER and the $50 million that was added in there added close to 100 basis points to our gross margin bridge. We did see also from foreign exchange another 100 that came from that both in translation and transaction so that was favorable in the fourth quarter.

We saw some negatives related to some of the raw material impacts that were rising during the course of the year both in freight and warehousing and some of the variances. The fourth quarter was consistent with what we have been talking about all year where we saw an increase in raw material costs and oil related costs. We had favorability from FX and we certainly had favorability from mix and we had favorability from the Oxy ER.

Kristin Stewart – Credit Suisse

Given some of the commentary you had mentioned earlier just about preservation of capital can you update us on what you’re thinking in terms of your appetite for M&A in this environment.

Rich Meelia

We have not changed our strategy relative to M&A it’s been a very successful program for us. The businesses and the technologies that we’ve acquired such as Confluent Surgical and [Florian] and Aerox, TSL it’s just been a lot of good deals that have helped provide top line growth. We’re very disciplined about how we approach our deals and so we just think it would be a mistake for us to not do what we can to utilize M&A to enhance the value of this business for our shareholders.

We’ve been pretty out front with our commitment to spend somewhere between $500 million and $1 billion. We didn’t spend that much in 2008 we wish we had more opportunities but again it’s an opportunistic environment so you just take advantage when it presents itself. We’re still on that mission looking not from platform creating but for franchise enhancing kinds of opportunities.

Operator

Your next question comes from Rick Wise – Leerink Swann

Rick Wise – Leerink Swann

Can you touch on, especially chemical sales and update there is this still in discontinued operations, any news on timing?

Rich Meelia

We’re continuing to attempt to divest that property. As you can imagine in this environment it’s not been conducive to that. We’re still in a process and we’ve just made a decision we’re not going to just unload it at any price, it’s a good business, it’s operating pretty well and so we’re just going to make sure we maximize the value when we finally do a transaction.

Rick Wise – Leerink Swann

Is it still possible to see it this fiscal year?

Rich Meelia

I think that’s a possibility but again especially if some of these external forces begin to become a little more conducive to this type of activity then definitely this year.

Rick Wise – Leerink Swann

That’s not in your forecast for cash flow?

Cole Lannum

No, it still remains in discontinued operations because the process continues. We wouldn’t include any of that in the numbers that we guided you today.

Rick Wise – Leerink Swann

If you could give a little more color on the specific steps you’re taking to resolve some of the operational challenges. Respiratory you said will take some time and again it sounds like internal R&D acquisitions maybe you could give us your perspective on what is reasonable to expect and when? You talked about US contrast pricing being a more troubling issue again what actions are you taking and how do we think about that business going forward?

Rich Meelia

Let me talk about respiratory first we had a chance to talk a little bit more about it in detail in September and essentially we have a two-fold objective here. One is to create an algorithm that will allow us to compete effectively in the marketplace without having to pay royalty to a competitor at this point. Secondly would be to work with internal/external capabilities to identify new parameters such as when we announce the acquisition of Cardio Digital which we hope will give us additional parameters.

That’s more of a probably 18-month type of timeframe. Some of the positive things that we’ve seeing in Respiratory, because they’re working diligently to find ways in which to improve the business. The whole issue about ventilator associating pneumonia has become front and center and it’s given us an opportunity to provide additional clinical data on some of our endotrach tube like the Hi-Lo Evac.

Within the past month it was a pretty compelling article in Chest magazine which talks about the statistical reduction in that associated with our product. We’re seeing a nice up tick in that particular segment.

Ventilators, Aerox is helping us at the present moment. We’re looking for internal development relative to a higher level, higher functioning and more featured high-end ventilator as well as a mid range that would be developed internally.

On the contrast side the contrast media has been experiencing price pressure for years and years. This is not a new phenomenon. It tends to go at different levels based on different market forces, big group contracts, etc. We’re seeing pressure on the contrast media. There’s not much we can do relative to that to be perfectly candid, there’s a lot of companies selling a very similar product which tends to create price pressure.

What we’re trying to do is just on the radio Pharmaceutical side with the generated pricing and generic sestamibi both initiatives have gone well but unfortunately they both affected by our inability to get our full supply of Malli from the Netherlands plant. We’re hearing mid February is when we get Malli we think you’ll start to see more activity on the generic sestamibi and sell more generators but that’s really been a hiccup in our ability to get imaging profitability improved. We still are committed to improvement this year it will be at a lower pace.

Rick Wise – Leerink Swann

On EPS I know you don’t give EPS guidance but playing with some back of the envelope and trying to gauge the impact of currency and the higher tax rate and everything. It looks like we’re talking if the consensus was somewhere in the neighborhood of $3.05 before it looks like we’re talking something back of the envelope $0.15 to $0.20 below that just due to FX. Am I in the right ballpark thinking about that so implying maybe $2.80 to $2.90 might be more comfortable range for EPS for fiscal ’09?

Cole Lannum

You’re absolutely right we don’t give specific earnings ranges. As we noted earlier I think you touched on this there are some positives and some negatives but I would urge you if you just take a look on the foreign exchange side of things alone if you take a look at what we said about where we think rates are going to impact our top line somewhere in the 500 to 600 basis point range for 2009 versus where we were September 10 and you further take the fact that we said 30% to 35% of that downward movement falls directly to our net income line then you’re talking in excess of $0.30 a share just from FX.

Clearly there will be some offsets from better Oxy and some better flow through from raw input prices but I think that’s what you have to think about and there will be some downward move because beyond that we don’t want to comment.

Operator

Your next question comes from Tao Levy – Deutsche Bank

Tao Levy – Deutsche Bank

I just want to make sure operationally you didn’t lower growth so basically the way to look at that is the upside that you’re getting from Oxycodone is slightly offset by what’s going on in Imaging and the rest of the stuff stays neutral?

Chuck Dockendorff

We didn’t lower what?

Tao Levy – Deutsche Bank

Operational revenue growth.

Chuck Dockendorff

That’s one way to look at it.

Cole Lannum

There might have been a little bit of movement within that range but not enough for us to change the range.

Tao Levy – Deutsche Bank

You talked about preservation of capital how does that impact your thinking on paying down debt and what’s your current debt position as of the end of the quarter?

Chuck Dockendorff

Our debt position is right around $3 billion and we feel that’s the right level to be at at this point. We’re pretty much done with that piece of the capital structure. I don’t think we’ll be paying down debt any further than this.

Cole Lannum

The vast majority of the debt that we still have outstanding is long-term debt that we just termed out just about a year ago. We did that intentionally to get an appropriate debt structure around the business. We’ve used some of that cash flow to pay down most of the floating debt that we had outstanding prior to this.

Tao Levy – Deutsche Bank

When you talk about elective procedures you talked about bariatric but as you look beyond the end of the quarter more recent data points internally any changes that you’re seeing on procedure volumes, hospital census numbers, some of the stuff we hear that things are certainly slowing down to flattening there and that obviously would have an impact to your business aside from just elective procedures.

Rich Meelia

We’re hearing that all the time. We’re looking at it obviously more closely than we ever did. We have not seen it yet. We’re definitely seeing not in our numbers but in our research elective procedure reduction and we know first hand about some of the restrictions from pressures on capital. Based upon what we’ve been seeing within our business and our research we’re not seeing general surgical procedures slow down. That’s not to say that can’t change but just based upon what we’re seeing today and what is existing within our database.

Tao Levy – Deutsche Bank

On TussiCaps, at the Analyst meeting I think you guys had relatively low expectations for that product, 5% for that opportunity. Now that you have some experience with it is that still the right way to think or is it doing a little bit better than you thought and maybe we should be thinking differently about it.

Rich Meelia

We’ve been out about a month. At this point I would say it’s on schedule. I think the TCaps a very positive but at this point I think we’re staying with our general projection without a fortified percent penetration.

Operator

Your last question comes from Matthew Dodds – Citigroup

Matthew Dodds – Citigroup

On the Oxycodone ER numbers the $250 million seems a lot tighter now. Are you using that on a share run rate what you’re seeing so far or are we hitting numbers where the quotas or the production won’t let you get much past that. Just a little more color on how you came to that.

Rich Meelia

It’s a combination of the quotas and the settlement terms. As we said in our opening comments we’re making assumptions on quota and pricing and competitors etc. As we get more visibility and more experience we’re getting, I think, a little more comfortable in fine-tuning these numbers. We’re feeling pretty good about these numbers.

Cole Lannum

If you go back to the original disclosure that both Perdue and we gave when we announced this deal we noted that there were specific limitations both on the quantity of product that we were licensed to produce under this agreement as well as limitations on the period of time that we had this license. It’s important that people understand that.

Matthew Dodds – Citigroup

One follow up on the surgical side, in soft tissue did Permacol have really any impact on the quarter or was that mostly just share?

Chuck Dockendorff

No, hardly any. The sales for Permacol were under $20 million when we acquired them.

Cole Lannum

From a marketing standpoint we relaunched that product in ACS in the middle of October which actually hit after the end of our fourth quarter. It was not a material amount.

Starting at Eastern Time today a replay of the call will be available. Additionally the replay will be available on our corporate website Covidien.com a few hours from now. For members of the media listening to the call and have additional questions please contact Eric Kraus our head of Corporate Communications.

For analysts having more detailed questions involving non-material information Wayde now will be available to take your calls. Thanks everyone and have a great day.

Operator

That concludes the presentation thank you for your participation you may now disconnect. Have an excellent day.

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