Covidien plc (COV) 31st Annual JPMorgan Healthcare Conference January 7, 2013 11:30 AM ET
Jose E. Almeida - Chairman of the Board, Chief Executive Officer and President
Michael N. Weinstein - JP Morgan Chase & Co, Research Division
Michael N. Weinstein - JP Morgan Chase & Co, Research Division
Good morning, everybody. Thank you for joining us. Let me introduce our next speaker. We have from Covidien the company's Chairman, President and CEO, Joe Almeida. Following Joe's presentation, we will have a breakout session across the hall. Joe?
Jose E. Almeida
Thank you, Michael. Good morning. I like to spend about a few seconds on the Safe Harbor statements, and all of the statements we're making here today will be forward-looking.
I'd like to start with our pharma, our Mallinckrodt Pharmaceuticals spin. We're on track for spinning the business off by the end of June. In about a month, we'll be ready for the Form 10, and there's a significant amount of work being done today in terms of segregating the business outside the U.S., primarily by getting the assets split and also getting the business established in all the countries that today are Covidien businesses.
If you look at what we spoke about back in September in New York City, there are 3 major areas that will affect the financials. The tax rate will be a transitory one. As you know, Covidien had the same issue coming out of Tyco International back in 2007. But it's a transitory, affects all 3 non-GAAP, GAAP and the cash flow statements. Deal cost is going to be onetime, and we said that will affect GAAP EPS and cash flow. And most importantly is the shared services that will be created for both organizations, so they will have an impact also in the 3 financial statements.
Now I would like to spend the rest of the presentation, invest my time today, talking about Covidien. In about 18 months ago, we came out with a 4 very key points to drive the company forward and to achieve a top quartile total shareholder return. Let's start with the innovation.
We not only speak about product, the technology, innovation, but we also speak about go to market. You have to imagine that in a market like today, primarily in the U.S. and Europe, going to market like we used to do 5, 6 years ago is not going to cut anymore. So it's important for us to test and learn several different ways of getting the customer, the products, the technology, economical value with an eye on how much it costs to do it. So Covidien is very attentive and has several different models going on today across many divisions and how we go to market.
We also think about innovation not by delivering the product to the marketplace and the technology that saves lives, the economically sound and clinically is relevant to the patient, but also internally how we look at our productivity. So we have set very lofty goals about 2 different things. One is the productivity of our R&D group, which has to improve by 40% to 50% in the next 3 years. But also we set internal goals for our vitality index, which are very lofty. So we're very focused and continue to deliver the best innovation to our patients and our surgeons and providers and payers.
When you think about how Covidien today is structured and how we achieve above-market growth, a lot has to do with the choices that we make in our portfolio. If you think about the companies that we divest, the companies that we achieved, there are 2 major levers that drive total shareholder return in our view: top line growth, ROIC. So having the ability to trade businesses with higher gross margin and higher growth on the top line was key in decisions that we make every single day in companies that were out there to acquire or businesses that probably don't fit with Covidien anymore. So we've been -- we believe that we've been a good steward of our shareholders' money.
When you look at the strategy that Covidien takes for acquisitions are always opportunistic, despite the fact that we have a significant and very long list of companies that we continue to look into acquiring. We are very opportunistic. So it's very different to forecast. We also are very focused in tuck-in acquisitions, acquisitions that have value for Covidien in terms of research and development or technologies that suffice an unmet market need. We tend to become more focused on adjacencies, and I don't want to put off the table any large acquisition like we did for Covidien back in 2010, the acquisition of ev3.
When you think about the principles that govern our acquisition strategy are very simple. We use acquisitions [indiscernible] for R&D, and you can look at our track record back in 2012, MindFrame is one that comes to mind and several others that we made in our franchises, neurovascular, peripheral vascular and our surgical franchises. There are replacement for company internal R&D. But always keep in mind that we have an unbendable set of criteria that financially govern the way we buy companies, and we lost more companies that we ever bought. And we lost them primarily because they didn't meet our financial criteria. And we don't bend those rules. I want to make sure that investors have a very clear understanding that Covidien will be very disciplined in the way we deploy cash to our shareholders.
We have been very focused in emerging markets. We, back 3 years ago, made significant investments and continue to make investments in emerging markets. If you think about how that is going to play in the future of Covidien, we're planning to have greater than $2 billion in sales for emerging markets, which is a significant growth by 2016. Emerging markets for Covidien is about 130 countries, but we tend to focus primarily on the BRIC countries, and also South Africa has been a strong market for us.
How did we do that? We have deployed to date about 1,000 sales reps across these regions. We had offered products that are being designed now in our R&D centers in Shanghai and Hyderabad to our customers. We launched 1 product in the last 3 months. So we have a plan to launch 4 to 6 products a year coming out of those R&D centers into China, Brazil, Russia and other parts of Asia and Latin America.
The growth of Covidien's BRIC countries are greater than 25%, and we're putting significant amount of infrastructure behind these countries to be able to do it right. We have learned significantly from experience. We've been in these markets for a while, and we made a lot of mistakes and we learn from them. And we think that we got it right now and is going quite well.
So all these investments in technology, investments in emerging markets, and if you think about the acquisitions of companies such as BÂRRX and superD, which require a significant amount of investment in market development capabilities, there's no 2 ways about it and Covidien has to become even better at looking at cost structure and making sure that we can self-finance most of this.
So our focus has been and for the most part, manufacturing. We had significant track record in closing plants and creating efficiencies, and we have a very strong culture of operational excellence within Covidien. But that's not enough, so we're very focused right now in our SG&A in terms of leveraging our call centers, leverage our back office. And if you think about what we have done in terms of manufacturing, there is here a significant reduction in footprint for about 20%, 25% with about 10%, 12% reduction in personnel and manufacturing alone. Not only by moving the plants you have a significant cost reduction because the places we're moving the plants to are lower cost manufacturing countries. But also, there's efficiency that we have generated to be able to support the significant increase in marketing expenses and R&D expenses that we have provided the company in the last 5 years.
So if you think about what we're doing in terms of SG&A, I spoke about the innovation chapter about having different ways of going to market and more cost-effective ways of going to market. What we have here is better ways of processing the company's payables, receivables, customer service. So now we have 2 centers, 1 located in Dublin -- in Europe, we have 2 centers: Dublin and Czech Republic, Prague. In the U.S., we have 1 center we consolidated our back-office operations, and we're relentless looking in off-shoring that. And if you think about medical technology companies, we probably are behind the curve when you compare us to the oil and gas industry and automotive. So we have significant opportunities to consolidate those operations.
So why is Covidien unique and why are we positioned to grow in the future? If you think about the businesses that we currently operate, we are in great markets still: general surgery, neurovascular, peripheral vascular, profusion, respiratory monitoring. Those are great markets that Covidien still has the demographics in our favor. The portfolio of products that we have are diverse, and they allow Covidien to balance risk. One of the things that we've been doing very disciplined in the company is to take funds from businesses a and deploy them to businesses b. It's one of the most difficult things to do when you're running a company is to really take R&D money from one business, get SG&A money from one business and deploy to another one. We have overly vested and rightfully so because the business is doing so well in our Vascular business, also our Energy business. So the ability to continue to have a diverse portfolio that allows us to continue to look into adjacencies to augment them will drive Covidien's success in the future.
If you think about where we go from here, we have 4 to 5 white space studies going on at all times within Covidien, and we are relentless in finding what is the next platform for the company, what are the next businesses that will be acquired to create more shareholder value. We do that through our venture capital group. We also do that through our strategy group and businesses.
But when you peel the onion one more layer and you think about what are the opportunities still sitting on the table on your current businesses, I have 2 highlights for you. One is the penetration of minimally invasive surgery. If you think about [indiscernible] lap cholecystectomy, which is the removal of the gallbladder, which is a pretty simple and cost-effective surgery done through MIS today, all the other procedures are still under-penetrated, not only in the U.S. but across the globe. If you think about Brazil today, that's not reimbursed on the public sector, minimally invasive surgery, neither does China and many other countries in the world. So there's a significant amount of work that we are doing today in creating that value, in creating the training and the opportunity for these governments to understand the cost that is around doing MIS versus open surgery, plus the clinical benefits are enormous.
Another area of under-penetration for Covidien is Energy. If you think about other than bariatric surgery, which is mostly done in the Western countries, there's a significant amount of under-penetration, and Covidien is the leader in the energy -- surgical energy products with our LigaSure and now with our Sonicision product. So these are the 2 examples that I have, and I could sit here and list a series of, like, hypertension with our OneShot being delivered in Europe. I could talk to you about stroke, which has done extremely well for Covidien with the launch of Solitaire. So we can go on and on, on a lot of opportunities in terms of penetration for Covidien that we're still now scratching the surface.
So what are our financial goals for the long term? Mid to single -- mid-single-digit sales growth, and we have a pledge within the company to continue to grow above market at least with an 80% to 85% of our products. So if you think about how we had performed in the last 5 years, most of our growth came from volume and mix, which is pure portfolio execution and sales and marketing execution. This is market share gains above and beyond market growth. Our EPS has grown about 13% CAGR in the last 4 years, and we continue to accelerate and our objective is to deliver double-digit growth in our earnings.
Return invested capital. Despite the fact that we've made all these investments in acquisitions, Covidien is still improving, since 2008, its return on invested capital and it's a very important measure for our managers to understand the deployment of cash. You can't grow solely by acquisition. You've got to be able to blend a strong organic growth, above-market growth, execution by our sales and marketing teams with good choices that we have made. And this 14.5% for 2012 has $1.2 billion in acquisitions, and most of these companies have -- are early-stage companies. So you can see the accretion is very different for companies at that stage. But we're still improving, and we're going to continue to improve our ROIC.
And the most important thing that we have changed in the last 4 to 5 years is how progressively we've been returning money to the shareholders. So if you go back to 2008, a year after we went public, and what last year brought to us about $1.3 billion in money back to our shareholders. And how did we do that? We had an increased dividend we just announced of 16%. But most importantly, we had made a commitment to grow the dividend above our earnings growth. We repurchased about half of our $2 billion authorization of share buyback, with about 70 million shares being repurchased. We also did that while we're spending $1.2 billion in acquisitions.
We are very confident in our cash flow. The reason we are confident is because the health of our operations. Therefore, we made a commitment to our investors that we will return, at minimum, 50% of our free cash flow in form of dividends and share buyback from the original 25% to 40% that we had before.
So if you look at Covidien today, we are company that is delivering better organic growth. In most of our segments, you think about neurovascular, peripheral vascular, Energy, Endomechanical, those segments are growing extremely well. Our respiratory monitoring has recovered and continues to make progress. We launched significant amount of new products in that unit today, about 8 new products in 2012.
So our execution, we talked about a strategy and for me strategy is about 20% of the conversation. 80% of the conversation is to deliver to our shareholders the numbers that we're delivering today. We will continue to incrementally invest in our businesses. We are relentless about that, and we will focus on the most attractive opportunities to make sure that we augment not only our internal R&D with significant amount of technologies out there today. I have to tell you that we have a very, very strong business development group, and that business development group has the ability to really spot nowadays opportunities slightly ahead of time and had made a significant difference for us.
We have delivered 20 to 30 new products a year. That's not changing. We are on track for 2013. Our pipeline looks quite full for 2014. And we understand the market, the current market challenges that Covidien faces. We understand the Accountable Care Act, its implications to the company. That's one of the reasons we're testing new ways of going to market and getting ahead of that curve. We understand the current low growth of Europe and where to invest money. That's the reason we have shared services focused in Europe to be able to reduce our operating cost, but also we understand all the opportunities that emerging markets have for our company.
So we'll be relentless and continue to invest the money in the technology that will make a difference and emerging markets because we can see the results and their return on investment, for any investment made in emerging markets is wonderful. It's very, very quick, and it comes in a way that is quite sustainable.
Above all, we have a very, very strong management team. Covidien has -- as I said, 80% of the conversation is execution. We are blessed with a strong management team in several levels of the organization across the globe and this is one, if not the only reason Covidien today has a performance in terms of growth, our top line above our peers and above market. Thank you.
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