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Covidien plc (NYSE:COV)

February 26, 2013 3:00 pm ET

Executives

Coleman N. Lannum - Vice President of Investor Relations

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

Analysts

Matthew J. Dodds - Citigroup Inc, Research Division

Matthew J. Dodds - Citigroup Inc, Research Division

This is Matthew Dodds with Citigroup, for those of you on the webcast. And it is my pleasure to introduce once again for the Citi healthcare conference, Covidien. We have with us today Chuck Dockendorff, who's Executive Vice President and Chief Financial Officer; and Cole Lannum, Vice President, Investor Relations Officer. Cole was supposed to bring the pro forma slides of the 2 separate businesses, but I think he didn't get them done in time, so we're going to do full fireside Q&As through the session. So I definitely need some audience help, if I look like I start to flail about 20 minutes in, but I did have a few. So again, I encourage participation, and, Chuck and Cole, thanks for coming.

Coleman N. Lannum

Absolutely. Thank you.

Matthew J. Dodds - Citigroup Inc, Research Division

Yes. No problem.

Question-and-Answer Session

Matthew J. Dodds - Citigroup Inc, Research Division

Okay, so the first question I've been forced into asking, because I forgot in the last couple, we call it the Medtronic question. I know you don't give forward guidance -- or talk about the current quarter, so I'll have to wordsmith just a little bit. When you look at Europe and the way Europe works, my assumption has been, for some countries, there's a bit of a kind of "running out of gas" scenario towards the end of the year where they kind of push out procedures, they run out of budget and it kind of goes into early into the next calendar year. And then when you get there and some of the money comes in, you see kind of a nice -- or a decent rebound in the beginning of the year. When you gave your guidance for -- your fiscals was a little bit off, but when you gave your guidance looking at 2013 in Europe, I'm pretty sure you said stable, maybe slightly worse. Is that the way to characterize your thinking...

Charles J. Dockendorff

More of the same, more of what it's been. That's kind of what we felt about it, which is relatively flat.

Matthew J. Dodds - Citigroup Inc, Research Division

So looking at that, do you feel there's any skew in the year? Do you feel like the beginning of the year starts better, the end starts worse? Is there sort of anything to -- not you in particular, but a surprise of someone else that the beginning of the year doesn't start well?

Charles J. Dockendorff

No. I think that, typically, at the end of our fiscal year, which is September, you do have a little bit of a runoff in type of capital equipment sales and some of those things that salespeople are working on for a while, and contracts, some of the energy-based devices that have some capital components to it. There certainly is a subtle push in that as salespeople are trying to hit their quota in the end of the year and hit targets. And typically, as we go over to our new fiscal year, you would see a little lower sales volume in those bigger ticket items. But other than that, our business is pretty steady. The single-use disposable, for the most part, so it does stay pretty constant and pretty level for that period. We do have a little bit of seasonality in our international sales. Our second quarter is typically a little bit better, which would be the January quarter, and we've seen that historically but nothing that is dramatically, you would say, "Wow, that's a big change." I think it has something to do with vacations in the summer, whatever, a little bit. But I think from our standpoint, we're seeing Europe and all of that area pretty much the way it has been. We've got pockets of our business that are doing really well in Europe. Those products like energy and neurovascular, those products are still doing well even in a difficult environment, with the austerity programs going on and all of that. Other parts of the business are relatively flat. And you see that the government is trying to come out and do a little bit more on pricing, on tenders and things like that, but we're able to work around those and work with the governments to get through those issues. But for the most part, we're expecting Europe to be in kind of that status for a while. Just yesterday, we saw on the papers the whole issue over in Italy, so anti-austerity and what's going to happen there, more uncertainty. But for the most part, we feel like Europe is still going to be relatively -- I don't want to stay stable, but flat year-over-year until they can seem to solve their problems or the economy gets better and they begin to work their way out of some of those situations.

Coleman N. Lannum

And let me add one thing too, Matt, this might help as well. Recall that we reported our first quarter results in the fourth week of January. And on that call, we, across the board, raised guidance for all of our businesses on a revenue basis. And obviously, we took all of the effects that we knew at that time in account. So do understand that we do kind of see through some of these things. And while you're always going to see day-to-day, week-to-week, month-to-month fluctuations, the underlying trend has been relatively steady for us really for the last couple of years.

Matthew J. Dodds - Citigroup Inc, Research Division

All right. So the second one that I also forgot to ask a few times yesterday but maybe more applicable to you because of your mix, the Venezuela devaluation question. You actually have a pretty strong business in South America. I don't know how big Venezuela is to you. My impression was is that it may be bigger than I thought for some companies. Does that have an impact on Covidien in 2013?

Charles J. Dockendorff

No. I guess the good news is we don't have a lot of business in Valenzuela, probably roughly around $1 million a month. Most of it is billed in U.S. dollars, so subject to credit risk, of course, but the devaluation is less of a factor. So for us, we don't see really any impact at all from the Venezuela devaluation, I'll say.

Matthew J. Dodds - Citigroup Inc, Research Division

All right, no help on those. So...

Coleman N. Lannum

Nipped that one in the bud.

Matthew J. Dodds - Citigroup Inc, Research Division

Operating margins. You're one of the few stories I cover that has a natural mix benefit, I would say, on the product side. I think that's pretty clear, and you can kind of see how that works. How about on the geographic side. I know, in the past, we've asked the annals of that. Emerging markets, are these profitable as corporate average? I think the answer has been yes. How about specifically on the gross margin? Can emerging markets have gross margins at the same level as the U.S. and Japan which I know have pretty good margins in a lot of businesses, or is it more that they're there on the -- the cost side, there's -- because I would think the cost side will be a little bit tougher, I'm just trying to rectify how we get to that comment. Either that or it means Europe is really bad, or there's some country I don't know about.

Charles J. Dockendorff

Yes, I think -- the whole emerging markets thing, I think, we get a lot of questions on that. And people don't understand, but actually our gross margins in those areas are higher than the Covidien average. And when you think about it, the kind of products that are -- we're selling over there are mostly around the surgical and the Energy product line, respiratory. And those within our portfolio have higher margins. So we're actually able to continue and generate those high margins on those products. When you get down into the SG&A components, because we're starting to build out some R&D there, some of that is to support R&D back in the States but a lot of it is to develop products in the emerging markets for the emerging markets. So we're beginning to ramp up a bit there on R&D. But on the SG&A piece of it, the selling costs are in-line, probably a little lower than what we have in the States. However, we're making investments as we go along. So as we have those investments out in front of us, the SG&A is a little higher than usual. As those investments catch up and become productive, it enables to sell the business. So our margins right now, operating margins, in the emerging markets, and we've been able to grow this business, we were at 15% last year. I think we started the first quarter a little over 19%. The operating margins themselves are right in line with Covidien. So we have a nice vehicle there to really drive the growth at a profitable basis. And what we're looking at now in emerging markets is a lot of what we sell or the products that we develop for the developed markets. And we have another strategy behind that, which says, "Okay, there is a Tier 2 marketplace over in emerging markets that we need to get into." These are probably going to be lower-cost products or pricing products, but they will be products developed and manufactured in that area for bigger areas. But the one thing that's, I think, surprised us more than anything, we've always had this kind of runway, I think we have about $1.5 billion in emerging markets right now. We're going to hit that this year. We're growing double digits. We really wonder where the cap is on this area because it seems like almost anywhere we put people in a real rollout way, in a professional way, they're able to generate these revenues on a pretty consistent basis and a relatively quickly basis. So we went into the year, we sat here, we had some opportunities we saw in Latin America. We had a big debate about, do we sit here and funnel this money in now? We have the same thing where we want to have the requirements to increase our earnings year-over-year as well, being a public company, but we said let's see how the first quarter comes out. The first quarter came out really well. We got a little windfall from some -- one of our farmer businesses, on CONCERTA. And so we really took a big piece of this and now reinvesting it down in Latin America, primarily Brazil, we see big opportunity there. So I just -- we sit here as an organization and say, where is the cap on this real Tier 1 type spending that we think is very profitable and very well accepted into the marketplace? We think there's still a lot of runway to go and a lot of capability to go. So if we can continue to pursue that and those other strategies to get into even the bigger marketplace of emerging markets, we think it's going to be a very good situation. And underlying it all, when you think of the relatively large wealth shift that's going to occur, I think, over the next 20 to 30 years between developed and emerging markets and the population sciences, it really is quite an opportunity that we see for a long time to continue to grow the business, drive favorable mix and improve profits.

Matthew J. Dodds - Citigroup Inc, Research Division

And then just quickly, for Europe, broadly. I assume that margins are lower there, but my also assumption is that costs are getting lower, as more of it is tender, there's less sales, specialty sales, things like that. Is that enough to offset the Europe pricing? Or is -- are Europe margins broadly under pressure?

Charles J. Dockendorff

We're not seeing huge margin pressure in Europe, or pricing pressure, any more than we've seen in the past. We certainly are seeing governments come out with tenders. They are bidding those tenders in. But we've been in those competitive bids for many years, so it's nothing new to our marketplace. In the meantime, we look at what's growing over there, and it's Energy, it's Vascular, and those are more than offsetting any kind of margin declines you have within a tender-bidding process. And so there's very few companies that can have the breadth of portfolio of products that we have, they can come to a hospital and put that kind of big tender together on these things. You're not individually pricing them. So certainly, every year, in that portfolio of products that you continue to invoice or continue to sell, there's certainly always going to be pricing pressure within that -- those components. But the things that are coming out and the growth of the products and where they are growing and the new products we've launched haven't offset that pricing that we've -- any pricing pressure over in Europe that we've experienced.

Coleman N. Lannum

And let me add something too, because I think this comes back to you have to continue to remember the kinds of products that we sell. They tend to be skewed dramatically towards low-electivity types of procedures. They tend to be relatively low priced compared to the overall procedure and they tend to be vital to get the procedure done. So if you don't have our product, you can't operate on the patient or you can't deal with the patient's stroke or you can't put the patient in a ventilator. These are life-saving kinds of things. And the hospitals know that. They know that they have to have these things or they'll have to shut down. And so we just don't get that same hit on things that other companies may be getting.

Charles J. Dockendorff

And one thing I would say, that we recognize that some of our product line is going to come under -- in surgical, in Energy, it will be coming under more pricing pressure as a result of -- I don't want to say more commodity, but maybe less physician influence and preference. And we're developing different go-to-market strategies for those products. And we've actually reorganized them, and this will be reorganizing some of our sales efforts. Because if we can go in there and if they are true to the tender and they will comply with the contract, then we need less salespeople in certain products to help us sell that and still retain the strong sales presence on the neurological products, the Vascular products, the high-physician-preference products on the surgical and the Energy-based products. So we think it's a good mixture because we can offset -- again, if there is margin pressure from pricing on some of the commodity things, we can offset that with some of the savings we generate through how we go to market.

Matthew J. Dodds - Citigroup Inc, Research Division

You jumped ahead of my next question. And what I'm seeing in med tech is -- and especially in surgery, I'm starting to see more of this kind of dual sales force: one group that's focusing on a lot of products, less unique; and then the specialty sales forces. I was -- my question was going to be, where do you, in particular, have you really built out a very specialized sales force? I think Energy is one of them, but what else are you doing there? And I mean, new areas you're considering, and does that apply to Europe and the U.S.? Which I think you kind of half answered.

Charles J. Dockendorff

It does. It pertains to both of them, both the U.S. and in Europe. And what we've done is we've taken a look and we get into some of the surgical products. We know that some of these, such as trocars and some of the instruments, these are more aggressive-type bidding programs that the hospitals are going after. And we can certainly compete with that, but if you need a full sales force to force compliance, that requires a different price than if you can get it and the hospital will drive compliance for you. The thing about Covidien, I think one of the skills we have is we have this supplies business, and this is probably more at the lower end type of products. And we've been able to really leverage our sales force and our contract negotiations to really -- our sales per rep there, I think, is around $4 million which is quite high. And so they were able to generate that through our supply chain contacts, GPO contracts and IDNs and the things we contracted in those things, but it's got to be something where you have that strong relationship. So if the hospital wants to save money, they have to be willing to comply with the products once you get the contract. Conversely, a lot of our, as you know, surgical products, Tri-Staple, Energy projects -- products, they really have a close relationships between the surgeon and the physician, and there is -- that will continue, we think, as well as the neurological. These are very close relationships. They work with them every day, they talk to them. And it's a nice relationship, and it also helps us in the development of a product. But we've made these major changes. We've looked at the portfolio of the products. We've built them into these 2 kind of -- I don't want to say supplies, but we've said this is more of one that we're going to drive a little bit more through contract compliance than we need a specialty sales force. So both of these are going well so far, and we think it's going to be successful.

Matthew J. Dodds - Citigroup Inc, Research Division

So, I mean, Energy is the one that stands out, but it's a -- are there -- stapling, you have a specialty sales force. It seems like -- and the competition seems to be focused on energy, biosurgicals, and then there's a big other. But it seems like you're still -- you're a little bit more specialized than that.

Charles J. Dockendorff

Yes, I think, on the -- certainly, for the open stapling and some of those things, that's probably going to be more in line with, can we get contract compliance? Can we do that with some of the Tri-Staples and some of the specialty that we radically have coming out, the Tri-Staple route. These are things that are going to be -- physicians are going to want to use, they're going to want to try, they're going to want to know about as we come out with those products. And that part the stapling, I think, we'll continue with a specialty sales force.

Matthew J. Dodds - Citigroup Inc, Research Division

And then I assume, Vascular, there's at least 1, if not 2, specialty sales forces.

Charles J. Dockendorff

Well, we have, certainly, in neurovascular. And then you've got atherectomy. And when you get into the sequential compression and some of the dialysis, those are turning into more -- I don't want to say generalists, but bigger quarters that they have for the sales force on those pieces.

Matthew J. Dodds - Citigroup Inc, Research Division

And then Oximetry, monitoring, anything there? Or no, that's mostly contracts?

Charles J. Dockendorff

Oximetry, we have a sales force. Again, there's where we've taken some of the resources and redirected it towards some of the higher-end products. But Oximetry will move more towards probably the general sales force. But we do have, certainly, specialty sales forces at capnography, for the BIS and those kind of things that really need the detailing that's required in order to sell those products.

Matthew J. Dodds - Citigroup Inc, Research Division

Well, if there aren't any questions, I can keep going. So surgical, you've done extremely well in Energy and stapling, not as well in hernia and biosurgicals. What's the expectations for those businesses? You haven't highlighted a lot of new product growth coming out of them, but should we assume that -- at next year's Analyst meeting, year after that, that these are still businesses where there's a lot of R&D going into?

Charles J. Dockendorff

Want to take that, Cole?

Coleman N. Lannum

Yes. So probably, not as much. I mean, let's take each of those businesses separately. If you take a look at the BioSurgery market, we still don't have the right critical mass there. We've got a couple of specialty products but not enough things to really drive that business a lot higher. And we are spending R&D there, but it's going to still be, I think, a niche business. And I'm sorry, the other one was hernia...

Matthew J. Dodds - Citigroup Inc, Research Division

Yes, the hernia is...

Charles J. Dockendorff

Hernia has been very, very interesting because we continue to have a lot of success in the synthetic mesh market. I don't see that as changing. And in fact, we are launching small interactive new products there that you're going to be seeing throughout the year. The other 2 components of hernia, though, have been really interesting. So biological mesh has just hit a brick wall for a lot of different reasons. The lack of being able to claim differentiation in infected patients has really made a difference in how everybody, not just us, but everyone is going to market there. And here's a case where people are pushing back on pricing. Obviously, the biological mesh is significantly more expensive than synthetic mesh. And while there was a case to be paid when people were using them in highly infected tissue patients, without that claim and without that marketing behind it, that market has just collapsed across-the-board. So we're going to continue to have a nice business there. It's not going away anytime soon, but it certainly not going to be growing significantly. And you're not going to see a lot of R&D there, and that really is one-off product sort of situation there. And without the promise for continued growth in the market, we're just -- we're going to -- there are better opportunities elsewhere. The last piece of the hernia market is the fixation market. And the situation there is we've had another competitor enter the market. We've had greater-than-70% market share there for an extended number of years. I think the market has spoken, as far as what a good-quality product we continue to have there, and we have driven new product introductions. But a very effective competitor has come out and it's taken a little bit of the market share away from us. Interestingly, it looks like it's taking even more mortgage share away from our single competitor. But that's put a lid on some of the growth there. One of the things we've done to address that is that there are more and more procedures going to mesh that doesn't require tax and fixation. And of course, we're a leader there in our ProGrip mesh that doesn't require a tack in the first place. So a little bit of a dynamic of the market changing a little bit there.

Matthew J. Dodds - Citigroup Inc, Research Division

It doesn't seem like that there's any radical innovation in fixation that's coming. I mean, let's say, it looks pretty well.

Coleman N. Lannum

I'd say the biggest -- from our standpoint, the biggest innovation has been the new mesh that doesn't require fixation in the first place. And then developing, I mean, that was -- that has been extremely successful on the open side of things. What we've been doing recently is innovating it on the laparoscopic side. Because of a sticky mesh, it makes it more difficult to deal with when you're dealing with a minimally invasive kind of environment, we've come out with new technology to allow more use of that in MIS. And a lot of the drive in hernia surgery, again, like many other areas of our business, is how do we drive things from open surgery to MIS. It's less expensive, it's better for patients and it makes us more money. So it hits on all 3 of those things. So innovation from a fixation standpoint, we've got the tackless mesh that's made a real difference.

Matthew J. Dodds - Citigroup Inc, Research Division

So on that theme, rather than calling this robotics, my sense is that one of the big advantages of robotics is the visualization. So with that going whole hog on a massive system, where -- where does Covidien think about improvements or incorporating a visualization technology into laparoscopic, less invasive? I mean, how much easier is that to do for you than a big system?

Charles J. Dockendorff

I think there's a couple of things around that on -- first of all, we think of it as automation. So we think that there's different things that we can do with our instruments. Visualization is one of those things that can enhance and improve the whole laparoscopic-type surgical units. So we're continuing to develop, and we have things in the pipeline to come out with these automation-type things, whether it's power stapling, other things that we have, that will give better dexterity and movement to the surgeons and allow them to do those procedures easier. I think one of the things in robotics is, and we get a lot of questions on this and they've been able to grow their business very well, but our products are still used within those robotic surgeries. So surgeons will get up and actually grab one of our instruments, move over to the patient, use the instrument, and go back to the robot and continue on with the procedure. So even though that has grown, that has helped us as well. And Cole hit on it before, but this minimally invasive and the move towards that, there's still opportunity through this robotics and automation to drive more of the minimally invasive surgery. And we see that as a big growth rate that we have an opportunity to. In fact, recently, when we were over in Japan -- Japan is the first developed country that we've seen that has actually increased the reimbursement rate and payment to physicians for them to go and work on minimally invasive surgery. So they've looked at the whole continuum of care, they've made their economic assessment. They've decided that, because of the better outcomes and the short stays and less complications, that minimally invasive surgery is a more economical and better way to go. So we're seeing great growth in Japan. And the reason I bring that is, anything that is out there, whether it's robotics or automation or anything that will drive that adoption rate higher, is better for Covidien going forward.

Coleman N. Lannum

And just a number, real quick, we think the MIS penetration in Japan is around 10%. If we could -- if either through these incentives or continued educational outreach that we have in Japan or better outcomes, if we could move that needle just from 10% to 20%, the impact financially to Covidien will be very, very significant. And it would happen while saving the Japanese healthcare system money and having better outcomes for patients. Again, it's a triple-threat situation. It's one of the reasons why we're so excited about it.

Matthew J. Dodds - Citigroup Inc, Research Division

Yes, I was seeing that just on the last call that, yes, Japan has always seemed, to me, to be somewhat focused on cosmesis, less open scarring. How did general surgery not get adopted there? It's just bizarre to me.

Charles J. Dockendorff

I don't know the ramification to that. I do know they came out with this new -- and we started a program called lapa-rush [ph], but we started -- they came out with a new reimbursement scheme only recently, so...

Matthew J. Dodds - Citigroup Inc, Research Division

And it's a meaningful increase in reimbursement, enough to incentivize the physicians to give it a try?

Coleman N. Lannum

We believe it is. I don't have the exact dollars in front of me, but we believe it is. The only caveat I would give is that it's early. We need to see how this goes. So it was initiated not that long ago. But anything that gives incentives for surgeons to do one thing or another, and if those incentives also corroborate with the kind of products that we sell, we don't think that's going to be a bad thing.

Matthew J. Dodds - Citigroup Inc, Research Division

And the one thing about Japan is it seems a lot of your products don't get caught up in these biannual price cuts. Is that fair?

Charles J. Dockendorff

They don't. We don't have the pricing, big pricing pressures over in Japan. They're pretty stable, as they are in the rest of the world.

Matthew J. Dodds - Citigroup Inc, Research Division

And then one last thing on surgery. The next move would be -- I don't want to get too far ahead, but laparoscopy to endoscopy. It's still pretty early out there in terms of what I see, but you did buy superDimension, which is a kind of an interesting platform. Where does Covidien see endoscopy being the next frontier of doing these procedures? And is superDimension the thing to focus on for us, or is there other stuff going on behind the scenes that there's more to it than that?

Charles J. Dockendorff

Endoscopy was really probably a lot hotter a couple of years ago. There seems to be...

Matthew J. Dodds - Citigroup Inc, Research Division

Yes, I wasn't going to qualify, it's a old name, I figured it was a bad connotation.

Charles J. Dockendorff

Yes. But it seems like a lot more talked about it a few years ago. And clearly, I think there's technology and development going through. Any way you can do that, it seems to have better outcomes and cosmetics and things like that. So it's a better way of going through it. But there doesn't seem to be a huge demand or request for it at this point in time, but I think it's something that we're aware of. We're looking at development opportunities. We're staying abreast of it. And I think we'll come out with some products that can work that way, so -- but then when you look at superD, I mean, this is typically kind of a major change from both pain and discomfort. When you think of the way you'd go in and remove that node, there's 2 different ways of doing it, and that's kind of the a real leap, and we think it's going to be very beneficial in the long run for that kind of surgery. So I think you'll see more of those come out. I don't think there's a mad rush to go into it, but I think, again, those opportunities will be there and we'll be able to exploit them.

Matthew J. Dodds - Citigroup Inc, Research Division

Okay. So shifting to Oximetry. When are we going to have the multiparameter concept start making a difference in the market? I mean, how far along are you? A lot of stuff kind of happened last year, but if you look at kind of how do you put it together, where is it, what's the surprise at launch? What kind of phase do you think you're in with getting kind of a multiparameter concept together, and how is it a competitive weapon?

Charles J. Dockendorff

Yes, that's a good question. I mean, we work with our OEM partners on these multiparameters. They have them. We have a number of them as well. The key ones that we look at -- and we just acquired capnography. But the key ones we look at, certainly the pulse ox with the respiration rate and the capnography, if there's -- we don't have this yet. But certainly, if there's a way that we can grab those sensors and bring that information together in a way that informs the clinician better about the status of the patient, and all of those parameters are very important, it can certainly alert that staff to when something is going to go wrong with the patient or he needs some kind of attention. So we're working on this, we have some products that are trying to combine this. And we're going through clinicals and things like that, but I would say we're not going to have anything out within a year or so but we're working on these with our ORM partners as well, trying to get to that. We think it's going to be very variable if we can point it out there and drive it to this patient safety concept.

Coleman N. Lannum

Yes, and let me also, I mean, it has -- it's made a difference already. And this is definitely gone from a pulse oximetry market to a greater vital sign measurement kind of parameter market, and that's not going to change. And I think it's worth reminding people -- and I'll never forget, about a year ago on our earnings call, we came out and we said that the market had stabilized significantly. And I think -- and we've got a lot of pushback on that from people who didn't really believe that it happened. I think the numbers that we continue to put up over the last year, combined quite frankly with the numbers that our major competitors put up over that period of time, has made it quite clear that the market has stabilized. And I think that's good for everyone. And I think it helps people understand that this is not just about pulse ox anymore. When you look at our BIS business, when you look at our cerebral oximetry, when you look at capnography, that's where a lot of our growth is coming from. And the potential in each of those markets, the penetration rates are still very, very low. And we see that growth continue to drive this year and next year and the year beyond.

Matthew J. Dodds - Citigroup Inc, Research Division

So the standalone is fine for now, really, but if there's one combination, it's pulse ox with respiration in a single sensor. That's the most likely one we should see next...

Charles J. Dockendorff

That is being integrated. That would be very beneficial.

Coleman N. Lannum

That's already there. We've got that now. We have respiration rate with pulse ox in a single sensor today.

Matthew J. Dodds - Citigroup Inc, Research Division

And I -- and it's in a -- is it a different box? Is this an approved box?

Coleman N. Lannum

Yes, it is. It is -- on our standard box, you can get a combined entity today.

Matthew J. Dodds - Citigroup Inc, Research Division

So how does that -- how is the interest in that product since its launch?

Coleman N. Lannum

It's been very successful in relation to our Oximetry & Monitoring business. Respiration rate is still very, very small compared to pulse oximetry and the big bases out there. But it's been a very successful product launch.

Matthew J. Dodds - Citigroup Inc, Research Division

Okay. I've got a few more. So Vascular. How much room is left? Because pipeline Solitaire have been big additions to the business. You've gained share and grown a lot above the market. Do you still think there's a lot of room left for those 2 products to continue to grow above market rates?

Charles J. Dockendorff

We've had a big windfall from both of those products, they launched recently. The business has been growing at 40%. We don't think the business is going to continue to grow at 40%.

Matthew J. Dodds - Citigroup Inc, Research Division

I'll just take above market.

Charles J. Dockendorff

Yes, above market, it would be good. But they are competitive markets, they're good products. We have other things in the pipeline that are similar to the pipeline, different kind of aneurysms, different kind of configurations that we feel very good about, an acquisition we just did. It has to go through clinicals and things like that. But again, our sales force is tightly aligned with neurologists, they see this stuff every day. And while there are certainly some competition coming out on some of the products with -- against our Solitaire and things like that, we recognize that, the whole stroke market is, again, a market that is underpenetrated. 5% of the people that could get this treatment actually get it at the stroke centers. And it's, again, an effort of market development and getting more and more of these products out there so that people realize these mechanical devices can be good as tPA, that some of the success the pipeline has had. And to get indications for it. We'll open up new markets and opportunities for that product as we go forward, but the clinicals have to be done and have to be successful. So we think, again, it's a market that is only getting touched right now and it has a huge opportunity to grow and that there can be a lot of players in that market that grow with the market and continue to raise revenue. We're not going to see 40% growth again, but again we see this as healthy growth in Europe and in U.S. and even emerging markets growing over there.

Matthew J. Dodds - Citigroup Inc, Research Division

And Japan, too, right, business?

Charles J. Dockendorff

Japan, we have to get approvals and things like that, but yes.

Matthew J. Dodds - Citigroup Inc, Research Division

Okay. And then last one for me, more of a metric question. ROIC. It seems like, when I talk to Joe about it, it's a lot more focus on ROIC in the conversations about, how do you look at your returns? How much from your perspective has the ROIC equation changed with Joe as CEO? And is there -- are other metrics that you kind of combine in with ROIC? Or is that the primary driver of how you're looking at acquisitions, how you're looking at funding divisions, all the components?

Charles J. Dockendorff

The ROIC is certainly one factor and it's very important. But you just can't sit there and say, well, I'm going to increase ROIC, because as you do an acquisition, by its nature, you're going to have a lower ROIC initially within that acquisition. ev3 was a case of that. Most of our deals are that, as you put the money upfront and wait for the sales or the clinical to come through and generate enough revenue growth to justify the amount of capital you put into it. But we do look at it typically, in an acquisition or an R&D project, we look at where it is in the fifth year out. And that's the year we want to see it, where it's beneficial to Covidien, it's certainly going to be higher than our cost of capital. But that's where you really want to see that, if I'm not getting it by then, then this is probably not something that I want to do. But that is one component...

Matthew J. Dodds - Citigroup Inc, Research Division

So the 5-year outlook didn't change.

Charles J. Dockendorff

What's that?

Matthew J. Dodds - Citigroup Inc, Research Division

Joe didn't push that out?

Charles J. Dockendorff

No, no, no. But I think Joe -- what Joe's discussed a little bit is we have this broken down by our class of trade. So as you look at it, it drives you to different decisions around different product lines. So if you have a mature product line that has a high ROIC, you want to maintain that. If you have something that -- a product line, and we ran into this a few years ago in our nuclear business which had a low ROIC, he said, look, we're going to get out of this business. We're not going to invest in it. So I think, I mean, Joe is trying to bring focus to that. He's trying to have the managers look at it, think about it, think about the asset utilization that we have going into this. Are there smarter ways to invest in this but doesn't require as much capital? So there's a component of that and it's something that we've always driven to. And it's -- the other part of it is better utilization of the assets you have. The other part of it is growth that drives ROIC. So all of those components bring it along. And he is -- if you look at his background, I mean, he's started in manufacturing. A lot of the capital we do has ROIC impacts. He ran our international business, made investments, he always looked at it. So it's something that, I don't want to say the company wasn't focused on, I think he's trying to bring it down to the managers and just make sure they stay in front of it and understand the value of it and why it does create shareholder value over the long term.

Coleman N. Lannum

If I could add one more thing. I think one thing that has changed is, when Joe came in, he increased the amount of senior management compensation that gets paid out, the percentage, that's based on long-term total shareholder return. And as Chuck talked about, we believe that increasing ROICs are correlated with total shareholder return. But total shareholder return, ultimately, is how all of you also get paid. At the end of the day, if we generate a number over a long period of time that comes in better than our other large-cap competitors, from a TSR standpoint, we get paid. If we come in, in the bottom quartile, we get paid 0. And one of the things that Joe has done is implemented that and extend -- increased it and emphasized that, at the end of the day, we want to make sure that, if we're going to get paid, we want to make sure that shareholders get paid as well.

Matthew J. Dodds - Citigroup Inc, Research Division

You'll let Cole get the final word?

Charles J. Dockendorff

I don't know. He always does.

Matthew J. Dodds - Citigroup Inc, Research Division

So and if there's any -- no more audience questions, we can wrap there.

All right, Chuck, Cole, thank you very much.

Coleman N. Lannum

Yes, thanks.

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