Covidien, Ltd., F1Q09 (Qtr End 12/26/08) Earnings Call Transcript

Jan.26.09 | About: Medtronic plc (MDT)

Covidien, Ltd., (COV) F1Q09 Earnings Call January 26, 2009 8:30 AM ET

Executives

Richard J. Meelia - Chairman, Chief Executive Officer and President

Charles J. Dockendorff - Chief Financial Officer and Executive Vice President

Coleman Lannum - Vice President, Investor Relations

Analysts

Matthew Dodds - Citigroup

Tao Levy - Deutsche Bank

David Roman - Morgan Stanley

Taylor Harris - J.P. Morgan

Frederick Wise - Leerink Swann

Robert Hopkins - Bank of America

Kristen Stewart - Credit Suisse

Joanne Wuensch - BMO Capital Markets

Jayson Bedford - Raymond James

Glen Navarro - RBC Capital Markets

Operator

Welcome to the First Quarter 2009 Covidien Earnings Conference Call. (Operator Instructions). I would now like to turn the presentation over to your host for today’s call, Mr. Cole Lannum, Vice President of Investor Relations.

Coleman 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 first quarter results was issued earlier this morning and is available on our website and on the news wires.

During today’s call, we’ll make some forward-looking statements including an 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 of 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 website, covidien.com. In the first quarter, we reported GAAP diluted earnings per share from continuing operations of $0.74. After adjusting for certain one-time items, our non-GAAP results came in at $0.76 per share.

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

Richard J. Meelia

Overall, we had another good quarter with strong operational sales growth paced by a good performance in most areas of the business. We were off to a good start in fiscal 2009 and are operationally well positioned for the remainder of the year with a strong pipeline of new products.

The first quarter sales performance was broad-based as three of our four segments reported sales gains. Looking geographically, sales grew 12% in the United States, the highest quarterly growth rate in more than 3 years. Outside the United States, reported sales decreased 1% for the quarter, but grew 8% in constant dollars with operational gains reported in all geographies. These positive results reflect the recent investments we have made to augment our sales force and to expand geographically.

For the sixth consecutive quarter, we improved our year-over-year gross margin, largely due to favorable product mix and the benefit from Oxy ER. We also substantially increased R&D spending as expected and continued to make other growth-driving investments.

As planned, we started to leverage the recent expansion in our sales force and we expect 2009 will include only modest increases in sales and marketing headcount versus the significant increases we have made over the last few years.

We continue to be active on the new product front as we benefit from our increasing R&D investments. In Surgical, we have launched the Innovative Versaport Bladeless Trocars on a global basis and received FDA approval to market our unique SILS Port Multiple Instrument Access Port for laparoscopic surgeries through a single incision. SILS is a long-term growth area for our surgical business, and we are continuing to develop innovative products to further advance laparoscopic surgery.

In Energy, we launched the RapidVac Smoke Evacuator which helps reduce the hazards of surgical smoke in the operating room. We also received FDA clearance to market our Evident Microwave Ablation System for the ablation of non-resectable liver tumors.

We believe we have a good combination of breakthrough products and line extensions to drive our growth. Over time, we plan to continue to compliment this strong new product lineup with selected technology acquisitions designed to help us fill products gaps and expand into adjacencies.

We also announced a licensing agreement in our pharmaceutical business starting the quarter. We began collaboration with Depomed to utilize their drug delivery technology in the development of four new products over the next several years. This morning, we announced an agreement with Babcock & Wilcox to co-develop reactor technology for medical isotope production. This announcement is the first step towards establishment of US based manufacturing facility for molybdenum, a key component in molecular imaging in nuclear medicine procedures. Currently, the US imports all of its molybdenum, and the global supply chain has experienced significant reliability issues recently. While this is a multi-year project, it is a significant first step towards the development of a reliable domestic supply. We have noted the fragility of the supply chain in some of our previous calls, and this is an action we are taking to address the supply issues we are facing in the imaging business. We will provide you with updates as the project moves along.

While we delivered a good performance to start 2009, we still face several key challenges in our business. As we have noted previously, we continue to be disappointed with the recent results in both the Imaging segment and Respiratory, which have not met our expectations. As you know, we face strong competitive activity in Respiratory, particularly in oximetry monitoring and ventilators. We continue our efforts to accelerate growth, but expect the turnaround in this business will take some time, as we develop and launch new products to become more competitive in this market place.

In Imaging, the shutdown of the Petten reactor, one of our external suppliers of molybdenum, is causing a short-term drag on our radio-pharmaceutical business and the negative pricing trends in the US contrast media continuing. We are moving forward with our long-term plans to improve operating margins in this segment.

As you know, there is significant concern about impact of the economic slowdown. In these times of economic downturns and market upheaval, I want to remind you that given our product portfolio, we believe Covidien should be well positioned to weather this difficult situation. Our broad product portfolio is used in a wide range of healthcare settings. We have relatively limited exposure to elective surgical procedures, bariatric procedures, which continue to be a growth area for us, do have a certain elective component to them. However, even these procedures encompass a wide range of potential patients, many of whom have significant comorbidities and are therefore candidates for the procedure with the support and reimbursement of their insurance providers.

As many of you know, our product line consistent primarily of consumables with less than 5% of our sales coming from products that are considered capital purchases. Those capital products that we do sell include ventilators, energy powered generators such as our ForceTriad, enteral feeding pumps, contrast 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. In the quarter, we did see some slowing of our energy hardware product sales, probably due to concerning capital spending by hospitals. We are monitoring this situation closely, 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 market place uncertainties. We continue to monitor these trends and are prepared to adjust our actions appropriately should we see them starting to move against us. We believe our product portfolio, strong balance sheet, and cash flow will ensure our ability to continue our strategy of making the necessary investments to drive future sales and profit growth.

I will now pass the call over to Chuck who will discuss the first quarter results in more detail and update our guidance for fiscal 2009.

Charles J. Dockendorff

Overall, we are pleased with our first quarter results. Sales, gross margin, and operating income were on plan as we delivered broad-based business growth despite the impact from unfavorable foreign exchange rates. As reported, net sales increased 6% to $2.5 billion led by the pharmaceutical products, medical devices, and medical supply segments, all of which registered higher sales in the quarter. Unfavorable foreign currency lowered the overall sales growth by 4 percentage points.

Looking at the results by segment, it was another good quarter for medical devices with sales up 3% to $1.6 billion or at 7% on an operational basis excluding foreign exchange. Performance this quarter was paced by gains in endomechanical, up 6%; soft tissue repair, up 8%; and energy, up 11%. On an operational basis, all three of these product lines grew at double-digit pace.

Endomechanical growth was led by higher sales of laparoscopic instruments while soft tissue repair increased primarily due to higher hernia and mesh sales. In energy, sales growth was below that of recent quarters as we did see some slowdown in capital related hardware products. As Rich mentioned products that as classified as capital items by hospitals represent less than 5% of our total sales, but we did see a slowdown in orders in the quarter.

On an operational basis, sales of oximetry and monitoring products were 1% above a year ago, while sales of airway and ventilation products were flat. These results were below our expectations, and we are developing plans to improve performance in Respiratory. Looking next at imaging solutions, sales declined 9% to $265 million with slightly less than half of the decline due to unfavorable exchange. In radiopharmaceuticals, first quarter performance was negatively impacted by the Petten reactor shutdown. The regulatory authority in the Netherlands which controls the timing of production for the Petten reactor, has indicated that it’ll be shut down at least until the middle part of February. We view the January 22nd press release from the NRG as positive, but given they did not provide a date we are still planning that the shutdown could extend into May. We are working through this situation, but now believe it could cause a drag on imaging results at least through the third quarter of fiscal 2009.

In contrast products, sales went down 7% as lower volumes and continued price pressures in the US offset positive results in Asia and Latin America. We expect the US pricing to continue to negatively impact us throughout 2009 causing further downward pressure on this segment. In pharmaceutical products, sales grew 50% in the quarter to $331 million. The strong sales gain was primarily due to the September launch of Oxy ER coupled with higher sales of branded pharmaceutical products. Sales of active pharmaceutical ingredients were about flat for the quarter. Given the significant impact that Oxy ER has on our pharmaceutical results, I want to provide a little more specificity for you. Sales were approximately $100 million in the quarter and while it is difficult to come up with an EPS impact from the sales of a single product, we estimate it to be favorable by about $0.11 per share this quarter.

And finally, in medical supplies, sales at $235 million were 8% above those of a year ago. This stronger-than-expected increase was primarily due to higher sales of nursing care products. First quarter results included some opportunistic sales that we do not expect will be repeated. In addition, we are in the process of rationalizing some very low-margin business in this segment, which will lower sales growth rates for the second half of the year. This should bring sales growth in this segment back to historical levels, consistent with our 2009 guidance.

Now turning to items below the sales line, we continue to make good year-over-year progress on gross margin. The first quarter increase of 130 basis points to 54.8% was primarily due to improved product mix driven by Oxy ER coupled with sales of our higher margin products in other segments. These increases were partially offset by higher manufacturing expenses and supplies due to increased raw material costs, and in imaging, to the disruption in the molybdenum supply. Unfavorable foreign exchange had a small impact on gross margin in the quarter, though we expect the negative impact to increase over the next three quarters.

The improvement in gross profit was partially offset by higher SG&A and research and development expenses. As expected however, growth in SG&A is slowing and we are beginning to leverage our recent investments in sales force expansion and marketing. As a percentage of sales, SG&A expense declined 30 basis points in the quarter, the first quarterly decline since we became a public company. R&D expense climbed 18% in the quarter to 3.7% 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 $36 million for two legal settlements and a $3 million charge for restructuring. As you know, we announced a restructuring program last September. Implementation of this program has begun and we expect about $200 million in spending with savings estimated at $50 million to $75 million on an annualized basis. Most of the spending on this new program will occur later this year and in 2010 while the majority of the savings will be realized in fiscal 2010 and beyond.

As reported, operating income was $531 million excluding the items just mentioned, the legal settlements and restructuring, operating income would have been $570 million and the operating margin 23.2%.

Looking below operating income, net interest expense was $38 million and other income was $10 million primarily related to interest on amounts due under the tax sharing agreement.

Turning to income taxes, the first quarter effective tax rate was 26%. This rate deflected the impact of restructuring, the legal settlements, and several tax matters including the R&D tax credit. Excluding these items, the first quarter tax rate was 28%. Despite the upward pressure from Oxy ER, we were at the low end of our guidance range reflecting the positive impact of our tax planning activities.

Next, let me take you through some cash flow highlights. Our operating cash flow was approximately $290 million. Cash flow in the quarter was restrained by the timing of certain payments. We incurred about $90 million of capital spending in the quarter, resulting in free cash flow of approximately $200 million. I want to emphasize that we continue to expect that our business operations will generate strong cash flow, and we expect free cash flow in fiscal 2009, will be above $1.4 billion, roughly the same level as fiscal 2008.

Finally, I would like to reiterate our 2009 guidance. We are making no changes to our sales, operating margins, or tax rate guidance. As you know, there has been significant volatility in exchange rates recently, but as of today, rates are not significantly different than they were when we last provided guidance to you in November. At current exchange rates, we continue to expect total company sales for 2009 to be flat to 3% above 2008. Our operational growth excluding foreign exchange remains at 6 to 9% as we previously communicated.

By segment, at current rates, we expect sales of medical devices to be in the range of down 3% to flat and sales of imaging solutions are projected to be down 4% to down 1%. The imaging guidance takes into account our expectations that the Petten reaction will remain shut down through May. For pharmaceutical products, we expect to anticipate sales will be up in the 20% plus in 2009 and for medical supplies up 2% to 5% versus 2008. For 2009 operating margin, our expectations are also unchanged as we are maintaining a range of 21.5% to 22.5%, but continue to expect it will be in the lower end of that range. Our effective tax rate is still expected to be in the 28% to 31% range, and we remain committed to a 200 to 300 basis point reduction in our tax rates. We are very confident that we can deliver an improvement of this magnitude as our tax planning initiatives are well underway. Both operating margin and tax rate guidance exclude the impact admitting one-time items.

Looking specifically at Oxy ER, we are again increasing our expectations for the year to maximize the return to shareholders from this unique opportunity. Strong demand, improved pricing, and lack of generic competition have combined to deliver increased benefits for us in fiscal 2009. We now estimate that sales will be approximately $350 million all coming in the first six months of the fiscal year. The EPS impact will be about $0.40 per share this year.

Now I will turn the call over to Cole for Q&A.

Coleman Lannum

For Q&A, I’m going to ask that you please limit yourself as always to one question and a followup if needed then put yourself back in the queue.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Matthew Dodds from Citigroup.

Matthew Dodds - Citigroup

When you discussed the oxycodone numbers, you were saying that the vast majority of that number, it sounds like, is coming in the second quarter. So I just wanted to make sure that was right because that would have a significant impact on the EPS versus where the consensus is in terms of timing the quarters; and then for Rich, you didn’t discuss at all anything about inventory trends, either at hospitals or wholesalers; so I am assuming it didn’t have much of an impact on your business. Can you just say what percent of your business goes through wholesalers, and what are the inventory levels for your business versus some others we have heard out there?

Richard J. Meelia

We have not seen anything unusual from an inventory reduction standpoint. We occasionally see it from time to time, but we have noticed nothing currently in response to any pressure from hospitals. The majority of our US business goes through distribution; Owens, McKesson, Cardinal, those kind of folks. We have highly automated systems where we’re connected to the majority of our wholesalers so that when they ship a product to their hospital customer, we are aware of that and we begin immediate replenishment. So, we just have not seen anything from an inventory reduction standpoint. They have about 22 days, I believe, of inventory at the wholesaler level. I think the majority what they are selling to their hospital customers is almost just in time stock kind of basis; so, we just haven’t seen it.

Charles J. Dockendorff

The majority of the balance of the contract should be sold in the second quarter. There may be a slight amount that slips to the third, but right now we are projecting with the demand and the pricing that we are getting out there, that we will see most of that in the second quarter. I would just like to say around this, we set upon this settlement that we had on Oxy, to really go out and maximize this return as much as we could, and by selling it earlier when there is less generic competition out there, we are able to maximize the return on this settlement that we have had.

Operator

Your next question comes from the line of Tao Levy from Deutsche Bank.

Tao Levy - Deutsche Bank

Just two questions; first, with the benefit now that you are expecting in Oxy, obviously that went up by $100 million, how come you chose not to increase your outlook for the full fiscal year, you kept everything roughly intact?

Charles J. Dockendorff

A couple of things, Tao. There is certainly a better benefit and we are getting better results from the Oxy settlement, no question about it, but we are seeing that those issues in imaging and we have a reactor that’s down right now, that is projected to go up; so, we’re being a little cautious on that end. I think the other part of it as well, we still have strong results in medical devices, you saw supplies was good; so, we really feel good on those businesses, but you are also in a period here with extreme volatility in foreign exchange rates. They haven’t changed dramatically from where we’ve been in our last guidance announcement, but it has been very volatile with some falling further, others up, and I think we would just like to see how those pan out before we really revise guidance here going forward.

Tao Levy - Deutsche Bank

There is just a little bit of conservatism this early in the year?

Charles J. Dockendorff

Yes, I think it’s more realistic to think of where we are at with the economy. The other thing you are looking at is the impact of potential sales on the economic environment, where that's going to be as well. So, it's just taking everything in total and looking at it; we feel very comfortable with the guidance that we have right now.

Tao Levy - Deutsche Bank

And you had also mentioned on the gross margin side that you saw some negative impact from raw materials, and I thought those had come down; so, I was wondering, is there going to be just a delay in the benefit that you might see?

Charles J. Dockendorff

I think the two areas where we saw some pressure on gross margins was in supplies and that was around raw materials.

Richard J. Meelia

The supplies segment.

Charles J. Dockendorff

The supplies segment, yes; and that was an increase in raw materials year over year; however, if you go back to when we talked about on Investor Day, we talked about initially we saw a $75 million increase in these kind of costs, we are seeing that come down substantially and improving everyday, and we have some of that built into our forecast. On the other side of it, imaging also had some manufacturing cost increases, a lot of it around the molybdenum supply causing overhead in other areas in the cost of sales. So, those are really the two areas of cost increases that we had. We still continue to see positive mix and good price in medical device segment.

Operator

Your next question comes from the line of David Roman from Morgan Stanley.

David Roman - Morgan Stanley

Just a housekeeping question for Chuck; the 28% tax rate, that excludes the R&D tax credit?

Richard J. Meelia

It excludes the catch-up on the R&D tax credit. There is a small amount in the quarter, very nominal, but you will see it broken out on the schedules; I think we have about $7 million there as a catch-up of the R&D tax credit through the quarter.

David Roman - Morgan Stanley

And then, on sleep and respiratory; can you give us a road map of some of the milestones we should be looking for over the course of the year, whether it is products introduction, and when you think we could start to see some type of turnaround there because at the investor meeting you laid out quite a number of product introductions. Could you just give us an update on that, what we should be looking for over the course of the year?

Richard J. Meelia

Sleep has clearly been a disappointment. Since that investor meeting, we have launched a couple of CPAP devices and the results have been disappointing. We’re finding it more and more of a challenge to impact that business not being one or two players, given all the channel control that is exhibited by those two players. So, as we look to what's going to drive the value of Covidien going forward, we’re not counting on sleep to be a big part of that.

David Roman - Morgan Stanley

At what point did you decide that the investment spending just isn't paying off on that business and you sort of almost run it for cash.

Richard J. Meelia

Well, I think at some point you just look at how much effort you have put in and how much resources you’ve committed and what kind of returns you get on those investments of time and treasure, so to speak, and then you make the call. So, we’re not going to review our investment strategies on a call like this, but you are asking the right question. We are looking very carefully at exactly what we do in sleep.

David Roman - Morgan Stanley

And then lastly, could you just give us any update with respect to capital deployment measures on buy-backs, dividends, and M&A?

Richard J. Meelia

We mentioned in our September meeting and again in November that it’s not our intention to build up cash in the balance sheet. We are discussing with our board ways in which we can return some of this cash to our shareholders, and I think had it not been for the pretty significant credit crisis that we encountered back in the September-October timeframe, we might have been further along, but we’re working through that issue pretty carefully.

Operator

Your next question comes from the line of Taylor Harris from J.P. Morgan.

Taylor Harris - J.P. Morgan

First question is just on the imaging business, and I was hoping you guys could help us out with your thought process on the rest of the year. You’ve talked about the Petten reactor, you’re assuming it’s going to be down through May, but yet your guidance for the imaging business on the top line is unchanged. So, can you walk us through your thinking there, and also on the profitability contribution from imaging, how impaired is that right now just given your alternate sourcing versus last year?

Charles J. Dockendorff

Yes. I guess two counts on that; first is on the sales side. Yes, we do have a wide range in there, minus 1% to minus 4% for imaging, clearly through May if it stays down that way, it puts us at the lower end of that range and that is what we are dealing with with imaging, but we feel that’s a reasonable expectation to build into our assumptions at this point as far as revenue. I think when you look at the overall margin of the imaging business, our goal as we’ve stated in the past is to go after that mid double-digit type margins of close to 14% to 15% to return it to that level. With the molybdenum where it is and the impact we are taking, we’re taking hits, basically on the cost of sales as we supply some of this outside at higher costs, and we are also experiencing some manufacturing issues which I talked about before around absorption as that plant is not processing all of this from the raw materials. So I think coupled with that, we’re still looking at margins in the high single digits in the imaging business, and we’ll be there until we can get the molybdenum supply back on track.

Taylor Harris - J.P. Morgan

Okay, and relative to when you gave guidance a quarter ago, is your outlook on the profitability contribution of imaging this year lower, significantly lower? How would you characterize it?

Charles J. Dockendorff

You’re talking about from when we gave guidance in September?

Taylor Harris - J.P. Morgan

That’s right.

Charles J. Dockendorff

It is a bit lower. Yes, it is. And they also initially got hit with foreign exchange as well, and we are experiencing some difficulties there, but it is slightly lower with a further decline in the delay of the Petten reactor coming online.

Taylor Harris - J.P. Morgan

Just the last question, Chuck, again for you; is there a way for you to quantify the impact that foreign exchange had through the P&L of this quarter, it seems like you characterized it as a small relative to some of the raw material cost pressures, and if that is the case, can you help us out with why that is so in this first quarter of this year and then how much we should expect that to change as we go through the year?

Charles J. Dockendorff

I think a couple of things on FX; when you look at the total quarter results, not the EPS, it was relatively neutral, and we did have negative translational impact. That was offset with some of our mark to market on our hedges, which we have on a year-over-year comparison; so, those two almost offset each other. So when you look at the net difference of us a year ago on a quarter, it was just basically a breakeven on the FX impact. As far as gross margin, our product cost, if you remember these currencies took a pretty dramatic drop in September; so up until that point, we are buying these products and capitalizing them at the old exchange rate and that is the kind of flowing out into our cost of sales as we capitalize some of those unfavorable variances and normally we capitalize them for 60 days. So, our quarter impact on gross margin this year was relatively nominal, it was down, but it was not significant in any way. However, looking forward over the next three quarters, this will become more of an impact on our gross margin as the year-over-year compares get more difficult, and we’re now going to roll out the product at the new exchange rates with the timing on the capitalization of our inventory.

Taylor Harris - J.P. Morgan

I got it, and will that be offset to some degree by lower raw material cost, etc., but I assume not fully, is that fair?

Charles J. Dockendorff

Not fully, but we are aggressively going after the raw material cost, and we are seeing that improve every time we sit down with the purchasing people.

Operator

Your next question comes from the line of Frederick Wise from Leerink Swann.

Frederick Wise - Leerink Swann

First, can you talk a little bit about the cash and the free cash flow; your relative thinking on how you might best use that cash, it seems like, broadly we’re seeing acquisitions picked up, you talk about, in your comments, about selective technology acquisitions; should we assume that one or more opportunities are near, and again may be your latest thoughts on the profitability of a share buy-back, dividends, etc.

Richard J. Meelia

As I mentioned previously, it’s not our intention to build up cash. We are looking different options in order to share this cash with our shareholders and certainly the notion of a share buy-back, especially to cover dilution, is something that is being considered, and I think had we not encountered, like I said before, this pretty significant credit crisis, we might have been there already. So, there is I think support certainly at this level and at the board level to do something like that. In terms of acquisitions, I would like to emphasize that the decision about something like a share buy-back, it’s not an either/or relative to acquisitions. Our capital plan would not allow for us to do both. We do see this as a pretty attractive environment. We don’t intend to stray from our previously utilized approach and strategy where we were looking at the technologies and expanding into adjacencies, and the environment is fairly rich; you can't predict timing of the deal flow, but we have said in the past that our capital plan would suggest anywhere from $500 million to a billion dollars per year on acquisitions and we are adhering to that kind of a game plan.

Frederick Wise - Leerink Swann

Chuck, I would follow with you on gross margin commentary; I am not certain, did you give us specific gross margin guidance, but maybe more specifically relative to the first quarter level and what seems like another gross margin good quarter on tap, maybe help us think about how the flow goes through the year?

Charles J. Dockendorff

We haven’t given any gross margin guidance, but again in the first quarter, when you look at it, certainly Oxy ER was a positive; we continue to see a positive in the mix of our sales, specially around medical devices both as it becomes a bigger part of our overall sales in Covidien, but even within medical devices itself, with the higher-margin products growing at a faster clip, so we continued to see that. And secondly we saw increases in cost related to raw materials year over year on the supplies segment, and as I mentioned before, on imaging related to some of the manufacturing issues. FX again, was very little in the quarter. So, as we go forward FX pressure will increase, so that will be a drain on our gross margins going forward. We expect to continue the favorable product mix going forward, and I think those are the two big drivers; we will continue on cost reductions and things like that, but there will be pressure in the O quarters, especially when we look at the first quarter with no Oxy ER as well. Second quarter, we are going to have a bigger piece of Oxy ER, which will help drive up those gross margins in that period, but I think that is what you look at as you go O, continued FX pressure, continued positive product mix, and part of that is where the rates are going to go throughout the year.

Frederick Wise - Leerink Swann

Probably, the second half gross margins will be less than the first half for all those factors?

Charles J. Dockendorff

Yes that is true.

Frederick Wise - Leerink Swann

The S&P 500 issue, the move to Ireland from Bermuda; any insight into how S&P is going to view this transitional change relative to Covidien and when we can we assume this is resolved or settled?

Coleman Lannum

It’s a fairly good question because we got a lot of questions around that. Let me throw a couple of things your way. First of all, it is important to understand that we, as a company, have absolutely no influence whatsoever on what kind of index that we are in and out of, that’s completely an independent decision made by the S&P people. They don’t let us know what they’re going to do, and you might expect, they keep those things fairly close to the vest. A couple of things to think about though; first of all from talking to all of you, the people in the investment community, I think, you overwhelmingly do think of us as being a US company, our shareholders think of us that way, and I think regardless of what happens from the S&P 500 or Russell or anything in the other index, I think just given our large exposure to the US market, the fact that we compete so much with what you have in US companies, and the fact that we’re such a big mid-tech player, it means that most managers will probably continue to benchmark us as a US-based company whether we are based in Bermuda or whether we are based in Ireland. Still though, I think the real key is, people are of course worried about the technical event as to what could happen in trading of the shares should they come up for sale, should S&P decide to delete us. Again, that’s a decision, they’re not going to tell us about it, we’ll just have to wait and see what they decide. I would note again two things to keep in mind, one is we think that the facts around our situation are truly unique and unprecedented in the way that we’re putting this situation together and that our new headquarters in Ireland will be something that S&P will have to look at independently that they haven’t seen quite before, and then the second point is that ultimately because of the way we’re putting this together, it is going to take a little bit of time. From a time-line standpoint, you should expect a proxy to come out some time in the next month or so with more details surrounding the move to Ireland, and as we expect the shareholders vote to take place some time in the April or May timeframe. In the past, S&P has waited until after shareholder vote before making a final decision, again we have no reason to think it will be any different this time. Hopefully that’s helpful.

Operator

Next question comes from the line of Robert Hopkins from Bank of America.

Robert Hopkins - Bank of America

Two questions, one followup up on FX and secondly on patent. First on FX, Chuck, can you give us the exact revenue hit in dollars in the quarter?

Charles J. Dockendorff

Yes, it’s roughly the 4%, which was the difference between our recorded growth and operational growth.

Richard J. Meelia

In dollars, around $90 million.

Robert Hopkins - Bank of America

And then if we were trying to calculate what the constant currency earnings growth was in the quarter with just Oxy, would we subtract that $0.11 and do we add back nothing on currency, was it really a neutral or was it may be it hit you guys by a penny or two?

Charles J. Dockendorff

When you take all of the components of FX, I would say it was neutral, and the reason I’d say that is and I mentioned is, the translational fees, when you just take our earnings year-over-year and look at translational, it was down slightly, a little under $0.05 for the quarter. However, as we have these hedges and we look at the year-over-year impact of the hedges and we have mark-to-markets, that kind of offset that. So, we had a favorable from that. So, I would say in looking at the quarter, when you back out RC that really is the cost of currency growth.

Robert Hopkins - Bank of America

Do you guys disclose what the hedging gain was in SG&A for the quarter?

Charles J. Dockendorff

No, we don’t know.

Richard J. Meelia

The one thing I would say Bob is if you take a look at the absolute dollar amount, we’ve obviously dealt pretty precipitously on a sequential basis. So you can assume that a sizable chunk of that was from our currency hedges.

Robert Hopkins - Bank of America

Okay, and then on patent, when you think longer term, what do you think of a normalized growth rate for that imaging business?

Richard J. Meelia

We’ve always felt comfortable that that’s kind of a mid single digit grower combination with radiopharmaceutical in contrast with may be a little bit faster growth in the radiopharmaceutical versus the contrast. So, it’s a good business that just is flat with supply chain risk and what we announced today is hopefully a big step, albeit it’s a long step to bring a little more certainty and reliability to that whole supply chain. But it’s a good business and our pricing plans and launching of our generic sestamibi all were part of the overall plan to improve margins, and while we think this shortage has clearly delayed our ability to execute on our strategy to the level that we’d like, we do believe that the strategy is waiting to happen and we can execute on that once we get this back up and we’re pleased with the announcement by the regulatory folks over there, and we’re waiting a decision hopefully in the next couple of weeks about what the timetable would be. So, I would say our May projection gives us enough cushion so we shouldn’t be negatively surprised that day.

Robert Hopkins - Bank of America

Structurally are there any impediments to how quickly that comes back, if they make a positive announcement in February, would the positive impact for you guys be immediate or structurally would it take a while to work through this system? I’m just trying to get some clarification on how you came up with May versus February.

Richard J. Meelia

Yes, I think it’s weeks not months, Bob. So, a couple to 3 weeks and I think we’ll be ready to go.

Charles J. Dockendorff

Bob, because of the May date, it’s admittedly somewhat arbitrary, but until we have a more concrete date from them, we would back to the fact that they said that there still could be several month delay, and that’s why we based the May start back on.

Robert Hopkins - Bank of America

Okay, fair enough.

Operator

Next question comes from the line of Kristen Stewart from Credit Suisse.

Kristen Stewart - Credit Suisse

I was just wondering if you can give us an update on a few changes if you’re thinking on hedging at all?

Charles J. Dockendorff

If we’ve changed hedging?

Kristen Stewart - Credit Suisse

Yes, if you’ve decided to enter into any sort of hedging contracts or just change the way you look at foreign exchange?

Charles J. Dockendorff

No, not really. We’re continuing on with the policy we had before. We felt that was the right way to go about it, and that is kind of hedging 100% of 6 months and 50% of the following 6 months’ activity on the transaction basis.

Kristen Stewart - Credit Suisse

Okay, and then any updates on the sale of especially chemical business. Just talk about the performance there. Looks like that hadn’t come at about $0.03 in the quarter, kind of worried thinking where that goes over the next year.

Charles J. Dockendorff

We’re actively involved in a process where we remain committed to that divestiture. Obviously these markets haven’t helped us, but we’re still focused on it, and fortunately we’ve got a really good management team, they are that is able to keep everybody focused on the business despite the distractions of an eventual divestiture; so, banker business is doing okay.

Kristen Stewart - Credit Suisse

Do you happen to have the sales number for that business in the quarter?

Richard J. Meelia

I’ll have to give that to you offline.

Operator

Your next question comes from the line of Joanne Wuensch from BMO Capital Markets.

Joanne Wuensch - BMO Capital Markets

I have two questions; you gave your tax rate guidance of 28% to 31%, I believe that was for the year, what makes the bottom range the right range, what makes the top range the right range?

Charles J. Dockendorff

We actually had raised our guidance when we saw the Oxy-ER sales coming in by a percentage point overall; that was because it was mostly sold in the US on a higher tax rate, but what we’ve initiated is some tax planning activity, so that’s why we’re at the lower end of the range there on the taxes, so we’ve begun some of the tax planning activity, but there’s a lot of things that impact the range of that rate going forward. Some of that is ongoing interest rates that we have and use internally, some of that is foreign exchange rates and where our income is earned, how that impacts it around the world. So, there’s a lot of variables to that, but right now, with the way things are, at this point we’re comfortable with the 28%; really 28% to 31% is what we have, and we’re at the lower end of that range.

Richard J. Meelia

We recognize that since we launched activity in July or end of June of 2007, we’ve been talking about potential tax planning benefit of 200 to 300 basis points over the next couple of years, and we realize that time has passed, and as we said in our earlier part of the call, we feel very confident about our ability to begin executing our math.

Charles J. Dockendorff

And that lower rate includes some of those planning activities which we’ve completed.

Joanne Wuensch - BMO Capital Markets

The second question is, whenever I talk to investors, they’re always worried about many things, but one that keeps coming up is tough comps in 2010 for you guys. Can you talk about how you think about managing your comp?

Charles J. Dockendorff

We committed to double-digit earnings growth, and the biggest issue clearly is the Oxy-ER which will go away, and this continues to have a significant impact in the year. To overcome that in one year is certainly going to be difficult, but I think if you go back to the base business, we see continued double-digit earnings growth, and as we mentioned before, we would expect gross margins to improve, and excluding Oxy, the gross margins to improve, continued leverage on SG&A, we see further improvements in the tax rate, our interest cost, and other things that we can do to drive that double-digit operational income growth.

Coleman Lannum

I think one thing to keep in mind is now that we have a pretty good handle on the total amount of sales of Oxy we’re going to have this year and now that we know that the vast majority is going to be done by the second quarter, you’re going to get a very unusual spike of sales in the second quarter which is going to make the second quarter particularly large. Some people have come back to me and said they’re going to take a look at the impact both of Oxy in the second quarter as well as the base business, which we absolutely support. From day 1, we’ve talked about the fact that while Oxy is a great benefit for our shareholders, it’s going to mean a lot of money, a lot of cash flow that we’re going to be able to use for the benefit of shareholders. It is a fleeting event, and eventually it’s very important that people understand what is going to happen to the base business. If people are going to pay for investing in stock based on what’s going on with all the business, it’s going to still be here after the second quarter that we continue to manage and invest in, etc., after Oxy goes away.

Joanne Wuensch - BMO Capital Markets

Let me ask you in a slightly different way; if I think about Oxy as a lottery ticket that you’ve just won, do you think of it as, “okay I used this cash to pay it on debt or to make acquisitions” or is that just too simple?

Charles J. Dockendorff

No, it’s certainly going to help our cash flow, but it’s not that we need cash flow to do anything else to fund our investment growth or to do what we’ve set out to do and grow this business operationally. We will not pay down any more debt. Our debt levels are at the right level. So, we don’t see any cash going to that. So, as Rich mentioned, the cash will either go towards investments and be returned to the shareholders in some form.

Operator

Your next question comes from the line of Jayson Bedford from Raymond James.

Jayson Bedford - Raymond James

I apologize if it’s done in here, but I guess I was under the impression that FX would have about a $0.30 impact on fiscal ’09. It looks like it’s kind of neutral in the first quarter. So, if you’ve done anything different in the first quarter and is the expectation you’re still going to see that $0.30 hit?

Charles J. Dockendorff

Yes, a little less than that, but it is going to hit in the three quarters to follow, and it just is the year-over-year comps in this particular quarter and it’s because of the timing of how we roll out our inventory and capitalization it has not had a major impact when we look at this quarter versus the prior quarter. Some of that has to do is well with the year-over-year comps of the FX rates themselves. So, the majority of that impact will be felt in the out quarters, but it is a little less but roughly the same amounts as before.

Jayson Bedford - Raymond James

Okay that’s helpful. And then just secondly, the improvement in margin, is it all coming from the pharma segment, are you seeing any improvement in the device or supply segments?

Charles J. Dockendorff

I think what you’re seeing is in the device segment continued improvement as the mix there has helped us quite a bit. On the supply segment it is down because they got more impacted by the raw material cost year-over-year. So, that margin has decreased and our overall margin growth as well. But again, in that area of raw materials, specifically to the supply segment we’re seeing improvements in that or decreases in those costs.

Richard J. Meelia

Yes, and with respect to mixes, we continue to do well, as an example, hernia mesh bio-surgery, laparoscopic instruments, these are very profitable pieces of our business, and this is what helps drive the improved margin both of the device segment itself as well as overall.

Operator

Your next question comes from the line of Glen Navarro from RBC Capital Markets.

Glen Navarro - RBC Capital Markets

Two questions, one, on the call you mentioned, it sounds like there’s going to be some businesses with medical supplies that either get discontinued or divested, can you clarify and may be quantify what those businesses represent? And then the second question I have is on your interest expense and your other expense lines, will fiscal 1Q represent the highest level for the year?

Richard J. Meelia

We looked at the very compelling portfolio moves that we got made sense that take time, but given the disconnect that we’re trying to do, both baby diapers type of business, it warranted a full-fledged effort to reconstruct the portfolio and divestate. Now, we still have a very diversified portfolio of businesses, some of which are doing very well and some of which are struggling as is the case with most businesses, and we constantly look at the portfolio, and the physicians aren’t necessarily, if it’s not doing well then you automatically divest or you exit, there’re also other strategies, and I would say, there would be others that we constantly evaluate and we make decisions on a regular basis as we evaluate the portfolio because it’s all about investing and managing our portfolio that drives the highest ROIC and ultimately translates them to higher shareholder value, and that’s how we focus on it and it’s not a matter of, if something’s not working then we automatically divest itself. It’s an ongoing process.

Charles J. Dockendorff

Let me take the question on interest, Glen. It is true that overall net interest expense took an uptake sequentially from last quarter. One thing to keep in mind is we do have a fair amount of cash on our balance sheet. We do tend to invest that in risk-free instruments. As I’m sure all of you have realized, treasuries have taken a significant dive from the standpoint of interest rates, and that is hitting us a little bit on the interest income side of things. Assuming that short-term rates here hover around 0, then you probably are going to have total interest expense that are close to what we saw in this quarter going forward.

Glen Navarro - RBC Capital Markets

Okay, and what about the other line?

Richard J. Meelia

On the other line most of that is, as you may recall, we have through our tax sharing agreement, a receivable from Tyco International and Tyco Electronics, the interest of which flows through the other income line, that’s most of the other in there, and we would expect that on a quarterly basis to be a similar kind of number going forward.

Operator

We have a followup question from the line of Kristen Stewart from Credit Suisse.

Kristen Stewart - Credit Suisse

I just want to go back to the kind of 2010 commentary, and I think earlier you had made a mention in you plan for acquisitions that you’re targeting something anywhere from 500 to a billion, and that’s on an annual basis, would you be considering doing a larger deal if it could help a little bit of the whole in 2010?

Richard J. Meelia

Every time we talk about this subject, we always role out the caveat that if the right deal came along that would provide long-term shareholder value, we considered we understand how to do larger acquisitions. We just felt that the strategy we’ve employed in the last couple of years is working well and that’s the plate we’re going forward to. If the right deal came along, we would do it because it was the right deal, not just to fill a gap. I think we were pretty committed to using M&A to kind of compliment our overall patient strategy and to build out our capabilities in the areas where it makes sense in the long term for us.

Kristen Stewart - Credit Suisse

And on the deal side, do you have a preference at this stage on doing more within the medical device business or in the pharma side since at your Investor Day it seemed that pharma seem to be a more impressing area that you were looking to do deals?

Charles J. Dockendorff

Yes, I wouldn’t say it’s more impressing, Kristen, but I would say that with the new management team that’s in place and it really is just about every major function has leadership. They’re looking at the business a little bit differently. We’re starting to look at options that we had and considered before, the majority of which stay focused in controlled substances, and so for the first time, we’re looking at possible adjacent types of deals at pharma, but the majority still are in medical devices.

Kristen Stewart - Credit Suisse

And last, did you guys give an update on any of the new filings or new products that could come out of pharma over the next year?

Charles J. Dockendorff

No, we haven’t.

Kristen Stewart - Credit Suisse

Could you update us on any?

Charles J. Dockendorff

No, we don’t get into the specific nature of those but I believe we have 3 NDAs right now, and I would also say that the activity in the R&D function at pharma is a lot higher and we’re spending more money than we ever did previously as well. So, we anticipate to see more activity coming out of there.

Richard J. Meelia

To all of you thank you very much for joining us. A replay of the call will be available starting at noon eastern time today. In addition to that, the replay will be available on our corporate website www.covidien.com a few hours from now. For members of the media who have listened to the call and have additional questions, please contact Eric Kraus, our head of Corporate Communications, and for those of you having more detailed questions involving non-material information, Wayde will be available later this morning to take your calls.

Thanks again, have a great Monday.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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