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Covidien plc (NYSE:COV)

Q3 2014 Earnings Conference Call

July 25, 2014 8:30 AM ET

Executives

Coleman N. Lannum – Vice President-Investor Relations

José E. Almeida – Chairman, President and Chief Executive Officer

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

Analysts

Michael Weinstein – JPMorgan

David R. Lewis – Morgan Stanley & Co. LLC

Robert A. Hopkins – Bank of America Merrill Lynch

Matthew J. Dodds – Citigroup Inc.

Kristen Stewart – Deutsche Bank

Joanne K. Wuensch – BMO Capital Markets

Matthew Taylor – Barclays Capital

Lawrence Keusch – Raymond James & Associates, Inc.

Rick A. Wise – Stifel, Nicolaus & Co., Inc.

Glenn J. Novarro – RBC Capital Markets

Jason Wittes – Brean Capital, LLC

Mike Matson – Needham & Company, LLC

Anthony Petrone – Jefferies & Company, Inc.

Richard Newitter – Leerink Partners LLC

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Q3 2014 Covidien PLC Earnings Conference Call with Coleman Lannum. My name is Marie and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference is being recorded for replay purposes.

But now, I would like to hand the call over to Coleman Lannum, VP of Investor Relations. Please proceed.

Coleman N. Lannum

Thanks, Marie, and good morning, everyone. With me today are Joe Almeida, Covidien's Chairman, President and CEO; and Chuck Dockendorff, our Chief Financial Officer. We'll be making some brief introductory comments and then spend most of the time this morning answering your questions as usual.

I want to remind you that today’s call will focus on our third quarter results consistent with past practice we will not be updating our 2014 guidance today. During today's call, we may make some forward-looking statements, and it's possible that actual results could differ materially from our current expectations. Please refer to the cautionary statements contained in our SEC filings, including Form 10-K, for additional information about factors that could cause actual results to differ from those anticipated in such forward-looking statements.

We may 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 in the Investor Relations section of our website, covidien.com.

For the third quarter, we reported GAAP diluted earnings per share of $0.67. After adjusting for certain specified items, our non-GAAP earnings came in at $1.04 per share. The after-tax impact of amortization in the quarter was $0.10 per share.

Now I’ll turn it over to Joe, who’ll go into more detail on the third quarter results. Joe?

José E. Almeida

Thanks Cole. Overall, we’re pleased with our results in this quarter. Sales are on plan, up 4% both operationally and as reported, and that 5% in the Medical Devices segment. Generally conditions continue to be stable as we improved in developed markets, we are again pleased with our performance in the U.S. and in Europe, however, our developed market sales experience is slowdown throughout this quarter at firstly affecting many of our product lines. We believe this is a temporary issue resulting largely from the recently enacted consumption tax in Japan.

In emerging markets, we once again posted double-digit operational sales growth, overall we continue to grow significantly in the BRIC countries once again posted good growth in the high teens. This performance reflects investments rather we have made over the past few years in these countries, including recent acquisitions. We did experience sales declines in Saudi Arabia and Russia however, in Q4 we have already seen Saudi Arabia sales improve.

Let me now turn to our third quarter performance in individual product sales categories. As usual, I will discuss our growth on an operational basis excluding the impact of foreign exchange.

Within Surgical Solutions, advanced surgical sales were up 13%, aided by another double-digit gain from vessel sealing. Our vessel sealing business continue to benefit from prior year products launches including LigaSure Impact and Blunt Tip. In addition, we continue to be very pleased with the success of Barrett’s, was in the GI and interventional lung, which both grew more than 20%, organically once again this quarter.

Turning to the stapling, sales grew mid-single digit this quarter, compared to prior year, despite weakness in Japan. This growth resulted from the demand for Tri-Staple reloads outside the U.S. as we balance it from procedure shipping from open to MIS.

Overall, we continue to gain share in endomechanical stapling. We were also extremely pleased with our results in the hernia category, where we once again posted a double-digit increase in synthetic mesh. This solid performance was aided by the successful launch of our Symbotex composite mesh in the U.S.

Finally our acquisition of Given Imaging and recent joint venture in China, which are reported within Advanced Surgical are both performing well.

Within General Surgical, we once again had sizable gains in sutures in the emerging markets. However, the impact of our current year divestiture of Confluent biosurgery in a moderate decrease in sales of surgical instruments result in somewhat lower General Surgical sales this quarter.

Moving to Vascular Therapies, both peripheral and neurovascular sales were leveled with those of a year-ago. Peripheral Vascular increased sales of chronic venous insufficiency and procedural support products were offset by decreased sales in compression and dialysis and our exit from the renal denervation market. Compression was negatively impacted by a rebate adjustment, which reduced third quarter sales. Much of this was timing, so we expect both Compression and Peripheral Vascular to improve in the fourth quarter.

In Neurovascular double-digit growth and in U.S. was driven by flow diversion, this by the product recall we announced in April. We now expect the majority of our negative impact of the recall to record in the fourth quarter, although we plan that continue to do whatever we can to mitigate the impact. Neurovascular growth in the U.S. was offset by competitive pressures in Europe and a decline in emerging markets largely result from product supply issues. We expect Neurovascular sales globally to be challenged as we work to return the recalled products to the market.

We believe that the resolution rather of the recall along with fiscal year 2015 new product launches will help return this business to market growth rates in 2015. Regarding the recall, we have been actively working to resolve the issue and submit our first file to the FDA last week, while the timing of obtaining regulatory approvals and get back in the market remains uncertain, we are optimistic about our ability to get this issue resolved.

Turning to the Respiratory and Patient Care businesses; Patient Monitoring sales were up 6% above those of a year-ago led by capnography growth, which exceeded 30% yet again. We continue to be pleased with this business, which has consistently performed very well.

In the Airway & Ventilation category, we had sizable increase of sales of mid-tier and portable ventilators. In addition, we are starting to see positive tractions on the launch of PB980. Patient Care growth was driven by higher SharpSafety sales in the U.S. This increase primarily resulted from the continued impact of favorable pricing and a competitive shortage of pre-filled syringes.

Finally in Nursing Care, a modest increase in sales of Wound Care product was more than offset by lower sales of enteral feeding products in the U.S. We remain extremely focused on our key strategic initiatives, which include executing our customer-focused portfolio investment initiative in emerging markets growth strategy.

During the third quarter, we opened our fourth emerging markets training center. In addition, we continue to launch new products, including Pipeline Flex Europe. We remain very optimistic about the future prospect of our business. In fact, we expect our number of new product launches to increase 20% in fiscal 2015, positioning us well for future growth.

Before I turn the call over to Chuck, I am pleased to let you know that Bob White has been named President of Emerging Markets, reporting to Bryan Hanson, who will assume the newly created role of Group President, Covidien effective October 1. Bob previously served as President, Respiratory & Monitoring Solutions. His background within our industry coupled with his strong global experience makes him ideal to help grow our presence in emerging markets.

I will now pass the call over to Chuck who will discuss the third quarter financials in more detail. Chuck?

Charles J. Dockendorff

Thanks, Joe. We were pleased with the financial results in the quarter. As Joe mentioned, sales came in on plan and with improved financial metrics on all components of the P&L and improved foreign exchange impact over the prior year, the company was able to return strong double-digit EPS growth of 14% in the quarter.

Adjusted gross margin was relatively level with the prior year quarter and up 80 basis points sequentially. We believe our gross margin has returned to a more normalized level.

We continue to drive operational leverage through productivity improvements this quarter. Accordingly, adjusted SG&A as a percent of sales declined 130 basis points despite continued investments in emerging markets and some upward pressure from acquisitions.

We also continue to make incremental investments in research and development, which grew over 6% this quarter to $137 million or 5.1% of sales. Our third quarter adjusted operating margin of 22.7% was somewhat above our annual guidance range. As expected, net interest expense for the third quarter decreased 14% from the prior year because of the interest rate swaps we ended into early in the quarter.

The adjusted tax rate came in at the low end of our guidance. In addition, during the quarter we made a net payment of approximately $340 million related to pre-separation tax matters under the Tyco tax sharing agreement.

We did not buy back any shares this quarter. In addition to the restriction from the Medtronic transaction agreement entered into in June 2014 and under Irish Takeover Rules, we do not anticipate making any further purchases under our share repurchase program.

We delivered adjusted EPS of $1.04 for the quarter, a 14% increase over prior year. We are extremely pleased with our ability to get back to double-digit EPS growth. In addition, as Joe mentioned we remained very optimistic about the future growth potential of our business.

I’ll now turn the call back to Cole for a Q&A, Cole?

Coleman N. Lannum

Thanks Chuck. For Q&A we are going to do these things as we always have, you know the rules. But for anyone who maybe on the call that are not used the way we do it, we are going to limit you to one question and only if necessary a follow-up, so we give everyone a chance to get their questions in. If you have additional questions beyond that either put yourself back in the queue or contact us after the call. We will be ending the call promptly at 9:30 before the market opens, so please be consider of others on the call when asking your brief questions.

In addition there maybe some questions I understand around the pending transaction with Medtronic. And during Q&A we will do our best to address them, but please understand though that some of these questions are best answered by Medtronic, and we’ll only be able to speak to matters that are specifically Covidien related.

So Marie, could you just go through the instructions one more time and how is it to dial in for a question, please?

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Michael Weinstein from JPMorgan. Please proceed.

Coleman N. Lannum

Good morning, Mike.

Michael Weinstein – JPMorgan

Good morning, Joe and Chuck, I wanted to start with submission of the S4, which got decent amount of potential is looking to take this opportunity to describe the projects that were provided in the S4 in April, you provided to Medtronic's advisor your strat plan from July of 2013, and then in May you provided projections that will give a strat plan and I was hoping you could describe the difference between the first set of projections from the strat plan in which I think, we do realizes different than your budgeting plan and just describe the step down there from strat plan to the budgeting plan difference in the numbers from April to May, thank you?

Charles J. Dockendorff

Sure, Mike. This is Chuck. When we first met with Medtronic, we did give them a strat plan that we developed, right now, over a year ago fiscal 2013 strat plan that’s really all we had at that point that had a long term projection from the company. And we also at that point in time updated with our 2014 rate assessment and we had our first roll out from our operation on fiscal year 2015, as well. So we are trying to give them a picture of where the growth was and that plan – the fiscal year 2013 plan was mostly towline some of the strategic growth initiatives that we had looking forward.

I would tell you that as you look at the growth in fiscal year 2013, this was an aspirational plan that we presented to the Board. And when I say aspiration, I mean in these terms that typically strat plan, especially when you go to the out years, you’re assuming that most of your R&D programs are hitting at you’re watching these products on time, your strategic debts are going along as planned. There aren’t competitive market position changes, so it’s not, I want to say, overly optimistic, but as you forecast these things, they certainly are in a good environment.

As you look at that plan in fiscal year 2013, if you look at the first three years of growth, it was roughly around 4% to 5%. And you look at this the last three years of that plan, the growth rate increased to 6% to 8%.

And when we said with our Board and then threw it over a year ago, we looked at those growth rates. And again, we are not overly concerned with the out years. But what we did was outside of that plan, we built a contingency plan, and we said hey, what happens if we miss these things by one percentage or two percentage points on the top line growth, not so much in the near-term but in the out years. How do we still go after our mid, single-digit sales growth and double-digit EPS growth, how do we develop that.

And what we, in essence, did was develop a internal contingency plan to drive through some of the productivity initiatives and SG&A and cost of sales, to make sure we achieved those goals. That was never layered into the plan, but we have that identified and we will start by the outside of that.

When we sat down and provided to our financial advisor that the kind of evaluation on the company, we put together a plan that kind of put together little bit more of a conservative growth rate, especially in the out years, but also layered in the productivity programs that we felt pretty comfortable about to again drive the profits that were in the original plan. We felt this was more consistent with our historical and current performance, that was a better reflection of probably how the financials would play out.

So that is really the difference in the two plans, from the sales growth perspective. If you look at just a couple of comments, I think if you look at our fiscal year 2015 estimate that we provided to Medtronic and you compare to the 2013 strat plan, you’ll see that sales are little lower and the dollar size. But the earnings are actually a little higher. And also I think if you look at the Medtronic estimates that they laid out based upon that 2013 strat plan, they also mitigated some of the sales growth in the out years.

So what you can see is that, when you compare our internal valuation that we provided to our financial advisor, and you look at the plan that Medtronic used in the valuation from in perspective and very, very close in terms of sales and profits. I think in the sales and the sixth year out, they may be a couple of hundred million higher than us, but from a profit standpoint, we’re right on target.

So, we feel very comfortable about the plan that Medtronic used, we feel very comfortable with the plan that we use in reflecting the value of Covidien. And I think some of the concern, they have been that, because that 2014 plan that we did at top level had a little lower sales growth and there may have been change in the marketplace, but that still was not we feel no change in the competitive positions, project the launches of products anything like that, more just a reflection of bringing trying to back – bring it back into what we had actually achieved.

I hope that answered your question. Joe, if you want to…

José E. Almeida

Yes sure. Mike we have full confidence in the plans that we put together. In the last couple of years have expanded our strat plan to include more years we really focus on the first three and then we look at the next two or three in terms of aspiration what will be there for us. With the only thing we did was the simple exercise of bringing the outer years to a more short-term knowledge of the marketing, so we will see that to be more a consistent trend with what we have delivered. We have all the plans in place to deliver that 6% to 8%, but we also understand the significant amount of risk and lot of the initiatives that will deliver in the longer term.

So we have advanced MIS programs that can significant our growth in the plan in the outer years, but we are adjust it some of that down, because the risk of uncertainty of guiding that program finalize like anybody would, time creates risk and as the time get shorter the risk gets mitigated. So there is a very normal course of action for Covidien. We’re doing this for a while now, and we’re very confident in the portfolio of products that we have and the initiatives that we can deliver on both top and bottom line.

Michael Weinstein – JPMorgan

Thank you, Joe. If I could ask one…

Operator

Thank you. And our next question comes from the line of David Lewis from Morgan Stanley, please proceed.

David R. Lewis – Morgan Stanley & Co. LLC

Okay, good morning. May be just a two quick questions. Chuck, you obviously just went through the strat plan and we appreciate that. The piece of that that was interesting is just the operating profitability, you think, about that. Obviously this good quarter you returned to double-digit earnings growth. I just wonder if you could share, whether you said before the confidence in double-digit earnings next, as you get back to, I think, 14% growth this quarter you look for confidence that those levels are sustainable or double-digit earnings sustainable into next year.

And then, maybe one for Joe. Obviously a big focus of the business has been emerging markets and will be for the pro forma entity as well. If you think about your EM business the last five quarters, it has declined incrementally. Maybe you could talk about whether that’s geographic-specific that’s more structural and what were some of the plans that still keep you optimistic that EM growth rates can recover. Thank you.

Charles J. Dockendorff

David, just on the double-digit, I mean I think as you look at the quarter, we mentioned last earnings call that we are hoping to get back to the double-digit growth hopefully in the third quarter, but as you can see, we did quite better than that. And that was about 2 percentage points. So if you look at 14% growth about 2 percentage points of that came from actual positive FX. And as you know, we’ve been up against. So we had negative situation prior to this on the FX as well as the device tax, which we’ve now annualized.

So, having FX remain neutral. We feel very good about driving to the double-digit growth on the bottom line. We have great productivity programs underway. You can see how they are fitting within our P&L today, and some of the leverage that we’re able to drive in SG&A. We have more programs out there that we can execute on and have plans in our 2015 numbers to drive through. We don’t want to give guidance on 2015, but I would tell you that we feel very comfortable about achieving the double-digit EPS growth in 2015 and that’s the goal we set out as an organization to drive through.

So we have more opportunities and tax rates, SG&A and manufacturing to drive through these initiatives. So the sales growth rate too is at a level where we think we can leverage off of that and achieve that goal. Joe?

José E. Almeida

And on the emerging markets, we feel very comfortable with emerging markets. This quarter the numbers were skewed by Russia. I don’t think we need to elaborate very much there, but we also have the Middle East SARS that kept people from going to the hospitals, primarily in Saudi Arabia. We already see the numbers suddenly picking up. We feel very comfortable that our business in China and Brazil continue to do well and South Africa as well.

And another thing that gives me confidence going forward is we now have established an infrastructure in the emerging markets, primarily with having the sales reps now hired with one of the lowest turnovers in the industry, if not the lowest turnover in our Chinese business. Alex Gu who runs that business for us is doing a super job, keeping our people in place, is now to get efficiency for sales reps, meaning more sales per sales reps. So now we are beyond the phase of hiring and training. Now how do we get improvement and throughout for sales reps in China as well as Brazil.

I think we’re going to continue to see good progress in the Middle East. I will reserve my comments on Russia as I think the situation is quite fluid there, and we are reevaluating our investments in Russia as we speak, but that is a very, very small – but that’s a sub $100 million business for Covidien, and it is not going to emerging market in the long-term. So I feel highly confident about the emerging markets and now with Bob White the helm, we will continue to have that kind of focus and leadership in the region.

Operator

Thank you. And our next question comes from the line of Bob Hopkins from Bank of America. Please proceed.

Robert A. Hopkins – Bank of America Merrill Lynch

Thank you and good morning. My first question, I just wanted to ask about some revenue growth for this particular quarter. It seems to me there were two one-time issues impacting revenue growth this quarter. I was wondering, if you could give us a rough sense of the dollar impact of the Japanese tax issue and the rebate adjustment issue in Peripheral. Just trying to get a good understanding of the impact of these two things and your organic growth rate this quarter?

Charles J. Dockendorff

I’m Chuck. Yes, I think in total, Bob, it’s roughly $15 million to $20 million. We estimate that to be from both the Japan and the rebate issue that we’re early in the quarter that would normalize the growth. Bob, we feel very comfortable with the organic and growth rate for the fourth quarter returning to Covidien’s normal. So this was really one-time impact, we signed the system rebound already.

Robert A. Hopkins - Bank of America Merrill Lynch

Great. Thank you. And then one other follow-up. There’s been a lot of talk lately about oncoming central competition from Johnson & Johnson. And I was just wondering, if you could give a sense as to what you think about maybe a sustainable growth rate for your advanced energy and then the mechanical businesses as we look forward. Obviously those have been two great performers historically. I’m just curious as to what you think the sustainable growth rates might be for those businesses, as the half the competitive landscape gets a little more intense here over the next couple of years.

Charles J. Dockendorff

Bob, with all the respect competition has never eased off. Sometimes it looks because Covidien continue to grow, I think for the last four, five years we’ve been – or longer than that have been double-digits in energy. And by doing that it looks like that the competition went sleeping. Then it’s trying to come back now. It was never the case.

So, I think the efforts that our competitors are putting forth are no different today than were before despite the fact as we’re talking about. If you would ask any of our sales reps, he would tell you that.

So I feel very confident in Covidien’s energy portfolio going forward. And I don’t see anything in the horizon that tells me right now, that we are not going to be around 10%, 9% to 10%, 11%, 12% in that area, because we have product lines. They are doing very well and the refresh rates of these products in the future meaning coming with new products and variations in more areas of therapy within energy will continue, when it comes to the statement, we even with the Japan at this quarter with Japan being so weak, the Endo statement business meaning, the MIS statement was still across mid-single digits, which tells me that looking at a competition. We continue to gain shares by the fact we had this hiccup in Japan.

So we are not stopping right at any efforts or MIS, we have new products launching and we are very excited about the advanced MIS programs that will fast forcing couple of years.

Coleman N. Lannum

Thanks, Bob. Next question please.

Operator

Okay. And our next question comes from the line of Matthew Dodds from Citigroup. Please proceed.

Matthew J. Dodds – Citigroup Inc.

Hi, good morning. On the emerging markets since you now breaking out a lot more by division. If you look at a three pieces, Joe you already highlighted in Vascular, what happen this quarter, but if you look at surgical solutions that it seems like has slowed in the emerging market growth. But respiratory patient care has been picking up. Is there anything unique there that’s driving that change other than maybe Saudi Arabia, Russia anything product wise or infrastructure wise you’ve done.

José E. Almeida

Not that we can put a trend and I was talking to Alex Gu about two weeks ago about the specific need the surgical business would call surgical to be Advanced Surgical and General instrumentation, and the growth is to high teens into the twenties. So I don’t see anything in that would had highlighted to us that we have a problem. I think we have moved significantly in Russia in business that used to be primarily capital intensive business, calculators and hardware for energy to a disposable business. So talking to our leader in Easter Europe. He relates to me they are now shift to a much more disposable business in Russia.

So if the numbers are right now we are attributing to this slowdown in Russia Saudi Arabia which is a very strong surgical business for Covidien.

Matthew J. Dodds - Citigroup Inc.

And so again in the Respiratory patient care, Joe, western drive and acceleration in the emerging markets.

José E. Almeida

We have launched mid-tier ventilation which has done very, very well. I think the acquisition of Newport was spot on, because you still a product line that Covidien did not have. We have high end ventilators or high acuity, I would say, and we are lacking that mid-tier and now we do have that and you will see that in the results. I also would highlight that on a global basis the patient monitoring is doing extremely well with the acquisition of Oridion, now it’s going about two years now by the expansion of that market.

Coleman N. Lannum

Next question please.

Operator

Our next question comes from the line of Kristen Stewart from Deutsche Bank. Please proceed.

Kristen Stewart – Deutsche Bank

Hi thanks for taking the question. I was wondering, if you could just provide maybe an update on some of the longer term growth initiatives. Last year you’d outlined at the investor conference five particular areas of strategic interest where you promptly represented opportunities in excess of $1 billion.

Two, there is neurovascular and peripheral that were – those business were clearly under pressure this quarter as well as Barrx and invest along in advanced Maya. Can you just maybe give us an update on your thoughts on if you still see those as five key areas with $1 billion plus opportunity and what within they are going to be some of the products that you think we should really be focusing on?

José E. Almeida

Kristen, I will start with open to MIS, we’re doing quite well there, I just review the programs, it’s going very well. It’s a global program, you can see but our numbers in end of stapling like I mention before. That we had done a great job despite the fact, it’s been so weak this quarter. It’s still growing now multiple times the competition of global basis, so that program is being successful because Covidien has higher market share and being in market share in MIS procedures. So that is going well, our advanced MIS our programs is still – the program that I cannot talk about, but the program is going very well, and we’ll be great thing for the future.

The second, talking about neurovascular, we are dealing with the short term issues with this recall on the pipeline, most prominent on this coating of PTFE or some of our products the pipeline was in most prominent among the products that were taken off the market and have to be reprocessed with the new PTFE coating.

But if you take that on the side that Brett Wall and their global team are presenting to me on August 5 actually. Our plan update and which we’re very comfortable with a pipeline of products, no pun intended, the Pipeline Embolization devices. We just launched Pipeline Flex in Europe is going extremely well. So we feel very confident on that, so those programs, despite the short-term issues on the recall we feel very confident when it goes to our Peripheral Vascular.

I just want to highlight there was really obfuscated the result this quarter on Peripheral Vascular is the fact that we had this rebate adjustment in compression. If you look at the endovascular business grew 6%. So we are quite happy then, we stabilized our artherectomy devices. And the DCB program is going very, very well and we are very confident on that program.

I would just highlight a couple more another ones that we are very focused on is the capnography, we are developing market development program across the globe with this kind of growth is demonstrating that business has huge potential, the standard of care in the U.S which is need to be that on a global basis. When it comes to Barrx, I just highlight on my script that business is growing over 20% on organic basis extremely well. And now with the acquisition of Given is turbo charging that business.

And lastly, I will talk about the like superDimension. superDimension has been a success. We have a new navigation tool that is coming up, very, very excited about it. And now we just launched the ablation that subcutaneous ablation through the skin. And I am very excited about the fact that we – in a couple of years we’ll come up with the – and the way of doing it going through the trachea, down the lung, instead of going through the skin, so all of them are doing very, very well.

As I spoke before, when we spoke about the S-4 that these long-term programs, they are going well and we adequately risk adjust them, and you’re going to see them becoming bigger part of the pie, as the time goes by and the risk gets retired in all of them.

Coleman N. Lannum

Thanks operator. Next question, please.

Operator

Thank you. And our next question to complete his follow-up question is Mike Weinstein from JPMorgan. Please proceed.

Coleman N. Lannum

Yes, go ahead Mike. And my apologies for cutting you off earlier, please go ahead.

Michael Weinstein – JPMorgan

That is unlawful. Joe and Chuck, I think David did a good job of picking up the thread from the discussion on the S-4. And there really were kind of two items that to me – really were worth noting. One was you guys had a more rapid rate of margin expansion modeled in, in your projection that you gave to your financial advisor in May. You basically had EBIT growing 10% versus the Street like at 7% to 8%.

And then, in the strat plan, the more aggressive top-line. And so, Joe, maybe spend a minute on the upside drivers in your view to the strat plan versus the projections you gave to the financial advisors that your top-line was 4.5%, 5% over the plan period, which is very consistent with the Street. The strat plan suggests the potential for acceleration in the out years. So could you just spend a couple minutes on what could drive an acceleration beyond what the Street has expected and beyond the forecast which you gave?

José E. Almeida

So, Mike, you captured that message quite well. The early years, the three years we have more confidence what’s happening. Also we have what we call a strategic bets. Covidien has eight strategic bets that we dedicate a significant amount of resources of the Company in terms of research and development as well as sales and marketing and G&A when it comes to some post-market studies. So what we have here is simply the risk factor of having those initiatives being more or less successfully depending upon the rate by which we retire the risk.

So let’s talk about advanced MIS and open to MIS. We have an internal program developing some very interesting technologies that will be launched in couple of years. If we can retire the risk of that technology earlier, the launch will be probably more successful. DCB, the same thing. We put a rate on DCB that will be third to market, but Covidien has the largest basket of peripheral products. If that product perform better than the competition, or as good as the top end player in the marketplace with the products that we have we play with the risk factor here. So the difference between them is just risk adjustments of the portfolio, simply put.

Coleman N. Lannum

Mike, anything else?

Michael Weinstein – JPMorgan

No. That’s perfect. Thank you, Joe. Thanks for coming back to me.

Coleman N. Lannum

Thanks Mike. Next question please.

Operator

Okay. Thank you. And our next question comes from the line of Joanne Wuensch, BMO Capital Markets. Please proceed.

Joanne K. Wuensch – BMO Capital Markets

Thank you very much for taking the question. Two things. One, could you please remind us of the pathway to bringing Pipeline back to market? You did state on the call earlier that you had submitted a filing to the FDA.

And then the second question, this is a little bit more nitpick, so apologies in advance. The nursing care business in respiratory and patient care was down about 2% constant currency. I know this moves around a little bit, but anything in there that we should know about? Thank you.

José E. Almeida

Okay. Joanne, I’ll take the first one. Chuck will take the second one. The pathway is this. We submitted last week, last week to the FDA our new and revised process for coating the delivery system for Pipeline, okay. Now the FDA has exactly 30 days for. So once the 30 days expire, at that moment we will know did they approve the classes within 30 days or are we going to an extended length process.

I can’t handicap the probability. The only thing that I can tell is that we hope that it’s 30 days, first. Second, this is a unique product in the marketplace and I think the FDA understands the therapeutic need for this product. So I hope between the two of them we end up with 30 days. But we can’t control the agency and the agency is fully independent. So it may come up to be the second path, which is 131 days, 130 days as a second path to resolution. We think we did everything correct and now it’s just a matter of waiting for 30 days to know what’s the outcome. And I’ll pass for Chuck.

Charles J. Dockendorff

Yes, on the nursing care, principally it was the last year, we had a pretty big launch of some of the capital around enteral feeding. As you remember, Abbott was exiting that business and we were able to capitalize on a big part of that and having nice increase in that last year. And I think, as you know as well, we had a good second quarter in that business as well. So I think if you look at the year-to-date growth, FX, a little under 2%. I think that’s more indicative of where that business is and will continue to be.

Coleman N. Lannum

Next question please.

Operator

Okay. And our next question comes from the line of Matt Taylor from Barclays. Please proceed.

Matthew Taylor – Barclays Capital

Hi, thanks for taking the question. I just was hoping you could provide some additional color and clarity around the tax settlement this quarter and what the remaining liability or potential liabilities would be under some of the tax sharing agreements that you have?

Charles J. Dockendorff

Yes. Basically, I think we mentioned in the script and the call, we settled above $340 million that we paid on pre-tax liabilities. As you look at that, that puts our remaining pre-spend liabilities, I should say, a little under $1 billion for Tyco and that was $1.3 billion last quarter. So, again, we’ve mentioned that we expect that to continue to be paid down periodically and feel more medically reserved in this area. Does that answer your question?

Matthew Taylor – Barclays Capital

Yes, I think so. I guess in the release you talked about a favorable audit impact on the GAAP results. And I was just trying to square that with the $340 million. How do those two pieces fit together?

Charles J. Dockendorff

That’s a little different because we had a favorable settlement on one of our audits that we reflected. Those are our liabilities. So there we just put that into that non-GAAP schedule.

Coleman N. Lannum

There was a prior-period adjustment, Matt. So to preserve and understanding what the earnings power was, we pulled those prior period pieces out so you can understand what’s happening to the underlying business.

Matthew Taylor – Barclays Capital

Okay, thanks. So essentially, you are just working through that formerly $1.3 billion, now $1 billion of liability and you expect that’s a good number.

Charles J. Dockendorff

Yes. It’s now below $1 billion after that payment.

Matthew Taylor – Barclays Capital

Okay, great. Thanks.

Operator

Okay. Thank you. And our next question comes from the line of Larry Keusch from Raymond James. Please proceed.

Lawrence Keusch – Raymond James & Associates, Inc.

Good morning. Two questions. First, if I could start on the Pipeline. Obviously, you guys have done a really nice job of managing the inventory globally for that product and sort of satisfying your demand, certainly in the U.S. But I want to just make sure I understand what occurs in the fourth quarter. Should the 30-day period go longer relative to the FDA review? So how do we think about sort of your availability of product at this point? And remind us again of that sort of financial impact of the Pipeline product. And I have one other question.

José E. Almeida

Larry, if this gets approved in 30 days we’ll still be scrambling a little bit with inventory because we depleted the supply chain as much as we could by the launch of Pipeline Flex in Europe. We took a lot of products from Europe and shipped back to the U.S., okay. There are implications – despite the fact that the FDA may approve this in 30 days and it will be a great thing for the U.S. We still need to go to the regulatory pathway outside the U.S. in places where we have strong sales growth such as China, such as Brazil.

So we would have to file in those places. It’ll take a little longer because the way the regulatory system is there. So at this moment in time I don’t want to speculate much other than that we should probably not expect much different performance of the neurovascular business in the fourth quarter that we had in the third. And then you should see acceleration in 2015, which will get back to market growth rates, or a little better, because we have some product launches and some stuff that we’re doing with the business. And so this is how it would handicap at this moment in time.

Lawrence Keusch – Raymond James & Associates, Inc.

Okay. And then also for you, Joe, I know that in your prepared comments you sort of said it is certainly the developed regions, it appears that dynamics continue to be fairly stable. But again, just if you were to drill down to the U.S., which has certainly been weaker than other regions, any hints at all this quarter of anything at the margin getting better? Certainly we are seeing hospital EBITDA coming in ahead of expectations. So again, I'm just trying to get a sense of if you are seeing anything that at the margin is maybe a bit more positive?

José E. Almeida

I will look at the two indicators. One is this volume and the volume is pretty stable and we’ve been doing a great job in some specific contracts like oximetry and even endomechanical. So we’re seeing business as usual in the U.S. when comes to volume. I’m not seeing grew significant and either went the other way. But there’s nothing there that makes me lose a sleep over.

The second indicator is a positive one. On the global basis, but U.S. drives a lot of that. Our pricing, our price erosion has been under very low end of our usual range. So we have – our range is 50 basis points or 100 basis points a year. This quarter was in the very low end. And we haven’t seen a lot of issues across the board. I always said the categories seen there, they had a lot more pressure for being commoditized. But I’m very happy with the price erosion being so low at a very low end of our range. That gives me some hint of optimism.

Lawrence Keusch – Raymond James & Associates, Inc.

Okay terrific, thank you very much for the comments.

Coleman N. Lannum

Thanks Larry. Next question please.

Operator

Our next question comes from the line of Rick Wise from Stifel. Please proceed.

Rick A. Wise – Stifel, Nicolaus & Co., Inc.

Good morning everybody. Two separate product area questions. You reported yet another strong capnography quarter, up 30%. You have highlighted in the past that you have made substantial investments that are starting to pay off for you here. Can you be more specific about drivers and sustainability of the growth, that kind of growth anyway? And you also highlighted that synthetic mesh is gaining share. I know there have been investments there. Can you also do the same thing there, Joe, and maybe help us understand what the drivers are, what the products are and where to go from here? Thanks.

José E. Almeida

Thank you Rick. Capnography is a tale of two different worlds. In the U.S., you have significant support from societies and guidelines about adoption. So for us in the U.S. is, let’s get the product in every hospital, in every ward that is possible because it is recommended by guidelines. Outside the U.S. the conversation is a bit different, is more of a missionary sale in some other countries, because the guidelines don’t exist there. We’re working hard to get those guidelines there.

So I would say that the current rate of growth is sustainable. I don’t know if it’s going to be a 30% or 20%, but it’s going to be well into the double-digits, beyond the teens. And we are just putting together – I just reviewed about two weeks ago, a market development growth plan that the team put together to accelerate growth of this business, because the market potential for this business on a global basis is about $800 million. So it behooves us to put a lot of effort behind it and that’s why we moved this product into Covidien’s what we call our strategic bets as we dropped renal denervation.

On synthetic mesh, we have spoken about 12 months ago that we’re going to have significant model launches, a renewed effort. The team at Surgical that runs this, our team under Steve Blazejewski, is doing a super job. This business has grown over 15% this quarter. We are number three in the marketplace and it is a great place to be and is a sweet spot for us. Being number three gives you enough upward mobility to go into number two and eventually number one. We’re going to work very hard as we continue to launch fantastic products, Symbotex is just one of them. We have more launches and I congratulate that team at Surgical which manages got business for taking market share and growing so well.

Rick A. Wise – Stifel, Nicolaus & Co., Inc.

Thank you, Joe.

Operator

Okay. Thank you. And our next question comes from the line of Glenn Novarro from RBC Capital Markets. Please proceed.

Glenn J. Novarro – RBC Capital Markets

Thanks. Two questions for Chuck. First, SG&A spend came in below our expectations. So, Chuck, maybe talk about how sustainable that is. And then also as you mentioned, operating margins came in ahead of plan. So as we update our near-term or our models for the near-term how should we be thinking about the operating margin? Thanks.

Charles J. Dockendorff

I think on the SG&A, we did have a very good quarter on the productivity. We drove over of 130 basis points on the productivity.

In addition to that, we’re getting a leverage as well with the sales growth and holding the other expenses flat. This is where we’re still making some investments in the areas of emerging markets. And we’ve done a couple of acquisitions with so and so adds upward pressure to that. So you can see the kind of leverage that we’re able to get through SG&A.

So this is something I mentioned – I think earlier in the questions. We did a program in place, it’s pretty aggressive to continue this into next quarter and next year. So we are ready to take more funds out of these areas, as well as drive through productivity.

Now we are at the high end of our operational guidance, we don’t want to give guidance for the year. And with the guidance we have is out there. I think if you look at the year-to-date numbers they are more probably more respective of where we’ll be for the year, as we finish this year going forward.

But clearly for us to achieve a double-digit growth on EPS with the sales growth rates we’ve now. We know we need to drive some productivity and improve the operating margin going forward.

Glenn J. Novarro – RBC Capital Markets

Okay, thank you Joe.

Operator

Okay, thank you. And our next question comes from the line of Jason Wittes from Brean Capital. Please proceed.

Jason Wittes – Brean Capital, LLC

Hi, thanks a lot. At least one of your competitors, and I also noted your optimism about drug eluting balloons earlier in at least one of your comments. And I guess the question I have is with additional data it looks as if there has been a pickup in Europe in that market. And, a, have you seen that or noticed that? And b, kind of what is your general outlook over the next few years in terms of how that market might develop?

Charles J. Dockendorff

Jason, we are always optimistic about this market and we know is all about data. So we are not surprised to see what is happening in Europe. I would say that our preliminary data shows good performance of this product. We will wait to see the rest of it, which incoming much of the data that is coming forward. But we are happy with the performance of our product. And we see that not leaving anything behind when treating those regions is the right thing to do.

So we had opportunities in the past to go buy stent companies for the periphery. As recent as about six months ago. We did not engage in acquiring those companies, despite the fact being an investor in one of these companies. We have the full confidence in the drug-coated balloon, these has been a very – the efficacy within Covidien is very big. And now it’s time to see the pick up in Europe destined to it. So we are all there. You know we are not commercializing this product, yet.

Jason Wittes – Brean Capital, LLC

Right. But you are in those markets and I was just wondering, if you had noticed a shift in attitudes of some of the docs over there.

José E. Almeida

I think there is some of the numbers that we saw from competitors it looks like there is an understanding of the products capabilities in general and also, the results are showing that the clinicals versus what people are experiencing in Europe since will be correlated. I can’t comment more on it. I think we need to give some time, because you know how those technologies are and it takes time to make sure that they are not change in the armor here, but we feel very comfortable with the technology that we have and we see what’s happening in the Europe as collaboration of it.

Coleman N. Lannum

Thanks, Jason. Next question, please.

Operator

Okay, thank you. And our next question comes from the line of Mike Matson from Needham and Co. Please proceed.

Mike Matson – Needham & Company, LLC

Hi, thanks for taking my question. I have a couple on some of your clinical studies. I guess, first I was wondering if you could give us an update on the timing of the definitive AR study results? I think you’ve completed enrollment earlier this year. And then is there any chance we would see that data at TCT? And then I was wondering if you could give us an update on enrollment in the SWIFT PRIME study.

Charles J. Dockendorff

Yes. You know what, I am going to have to get back to you on those off-line. I apologize I don’t have the data in front of me. But, let’s follow-up after the call and I’ll give it for you, and again I just don’t have in front of me.

Mike Matson – Needham & Company, LLC

All right. Just in terms of the Solitaire product though, can you give us maybe an update on how that's growing these days?

José E. Almeida

It’s been doing actually very, very well. We are through most of the tough comps and we got a little bit of it – because we launch that the U.S. early last year. Little bit of a tough comp start going into fourth quarter still, but the underlying growth rates, the normalize growth rates are actually doing very, very well. Quite frankly better than we thought there it was going to be doing earlier in the year, just given those tough comparisons.

Charles J. Dockendorff

Yes. Mike I think that we will see a different picture once our study is out and this is going to be not in the short-term, but I think our study will prove a lot of the points that we are trying to make in the last 18 months.

Mike Matson – Needham & Company, LLC

Thanks.

Operator

Okay, thank you. And our next question comes from the line of Anthony Petrone from Jefferies. Please proceed.

Anthony Petrone – Jefferies & Company, Inc.

Thanks, and good morning. One quick housekeeping. Just wondering if the calendar 4Q is still a good time frame for the deal close? And then one follow-up for Joe.

Charles J. Dockendorff

What we said is either late calendar 2014 or early calendar 2015, we haven’t changed that and we are not going to update at this time.

Anthony Petrone – Jefferies & Company, Inc.

Great. And then for Joe, maybe just one high-level question on shareholder value creation. When we look at Covidien, the Company has generated above peer average growth pretty consistently for the past several years. You guys were early to invest in emerging markets and you have a favorable tax structure. Maybe just share with us why this was the right time for the Company to go for a deal with Medtronic as opposed to staying a standalone competitor. Thanks.

José E. Almeida

We would not have done this if we didn’t have a conviction that both companies together will be better off than both companies independently. I think a lot has to do with the environment on a global basis. It helps the environment. This Company will have an opportunity to be in six out of 10 top buying categories in any hospital across the globe. The ability to negotiate deals, the ability to deploy more dollars across a portfolio of initiatives, there is more of synergies in terms of our Vascular business, which is going to be phenomenal between the both companies.

And lastly, if you think about the healthcare environment going forward, what is important beyond organic growth is also to have a cost structure that is consistent with the marketplace and the ability to generate money that goes to the shareholders as well as steering the Company to few investment.

If you think these two companies and ability to synergize on the G&A and make a smaller G&A with a $27 billion, $28 billion in sales company, Covidien by itself could not generate that kind of leverage. And despite the fact that we have a very good program, our eight initiatives, there’s much more that we could do and together with Medtronic we’re able to tackle those unfunded initiatives that we have forward. So, we are very conscientious about total shareholder return. This is how our long-term incentive comp is. And we would not have done then this if we did not have a conviction that this is the best deal for our shareholders going forward.

Coleman N. Lannum

Thanks, Anthony. Operator, we’re coming at the bottom of the hour. Let’s try to get two quick more questions in guys. If it goes quickly as possible we’re trying to slip through this and then we’ll have to call it. Go ahead, please.

Operator

Okay. Our next questionnaire is Richard Newitter from Leerink Partners. Please proceed.

Richard Newitter – Leerink Partners LLC

Hi, thanks for the question. Joe, just a quick one. The advanced and minimally invasive programs, specifically the program you can’t talk about. Can you just say whether this is IP or assets that you’ve acquired or is it something that is homegrown? And then, are we looking at a timeline here like one to two years possibly or is it more like kind of two to four years? And any color there would be helpful.

José E. Almeida

Richard, in a second I’ll talk about and you just ask question.

Richard Newitter – Leerink Partners LLC

That’s what I do.

José E. Almeida

I just tell you that is you think about Covidien as a leader in laparoscopic surgery and think about the evolution that we saw in the stapling technology. Now think about automation that stapling technology, you’ll think about sensing what Covidien can do in sensing. What Covidien can do in bringing together the far medical acquisition that we forgot about, but we’ve been working very hard and in iterations of that technology that will keep Covidien a much better place in the marketplace.

And lastly, we will license. We will require IP to be able to make this business much more clinically relevant and economically feasible for hospitals to operate in the future to be able to detect and cut seizure in a much wiser way than we do today. So we will use every architect that we have in front of us to be able to continue to lead this space.

Richard Newitter – Leerink Partners LLC

Thank you.

Coleman N. Lannum

Operator, I think we are going to cut it off there as promised, I hear the ringing bell opening New York Stock Exchange. So we are going to have to cut off everyone else that’s in queue. Thank you so much for the good questions. As far as, sorry, just one moment – as far as replay on the call that will be available afterwards of this call. And we thank everyone for participating today. Have a good day.

Operator

Thank you, ladies and gentlemen. That concludes your conference call for today. Thank you for joining us and you may now disconnect. Thank you.

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