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Covidien Ltd. (NYSE:COV)

F4Q10 (Qtr. End 09/30/10) Earnings Call

November 9, 2010 8:30 a.m. ET

Executives

Cole Lannum - VP of IR

Rich Meelia - Chairman, President and CEO

Chuck Dockendorff - EVP and CFO

Analysts

Matthew Dodds – Citi

Mike Weinstein – JP Morgan

Bob Hopkins - Banc of America

David Roman – Goldman Sachs

David Lewis – Morgan Stanley

Rick Wise – Leerick Swann

Christian Store – Deutsche Bank

Larry Keusch – Morgan Keegan

Adam Feinstein - Barclays Capital

Joanne Wuensch – BMO Capital

Tom Gunderson – Piper Jaffray

Josh Jennings – Jeffries & Company

Operator

Good day, Ladies and Gentlemen, and welcome to the fourth quarter 2010 Covidien Earnings Conference Call. My name is Janada and I will be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions)

I would now like to turn the conference over to your host for today, Mr. Cole Lannum, Vice President, Investor Relations. Please proceed.

Cole Lannum

Thanks, Janada, and good morning, everyone. With me today are Rich Meelia, 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. The press release with details of our fourth quarter results was issued earlier this morning and is available on our website and on the news wires.

During today’s call, we will make some forward-looking statements and it’s possible that actual results could differ materially from our current expectations. We ask that you please refer to the cautionary statements contained in our SEC filings for a more detailed explanation of the inherent limitations of such forward-looking statements.

We’ll also discuss some non-GAAP financial measures with respect to our performance, including in particular, operational growth, which is net sales growth excluding the effect of foreign exchange.

The 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 fourth fiscal quarter we reported GAAP diluted earnings per share of $0.77 after adjusting for certain one-time items, our non-GAAP earnings for the fourth quarter came in at $0.84 per share.

Now, I’ll turn it over to Rich, who will go into more detail in the fourth quarter results. Rich.

Rich Meelia

Thank you, Cole. Before I discuss our fourth quarter results, I’d like to spend a moment on the medical device market and pricing environments; two topics I know are of interest to many of you.

As we have said before, it’s very difficult to determine real time procedure trends for our end markets worldwide. We look at a number of factors and inputs, including data reported by our competitors, some of the service providers, and other third-party sources to get a rough estimate of product utilization.

After reviewing these data, we believe there was some small bounce back in U.S. procedures in the quarter, but they are still below normalized levels. While we won’t discuss monthly trends, there was somewhat of an improvement during the quarter. Overall, our business in the U.S. came in ahead of expectations, but we are definitely seeing more slowness in Europe where, as we said before, procedures tend to be utilization driven.

On pricing, we did not feel any significant impact this quarter in our devices or supplies businesses. As we noted in the second quarter, there has been significant pricing pressure in generic pharmaceuticals, but even this seems to moderate in the fourth quarter; although, still down year-over-year, generic pricing stabilized sequentially.

Further, as we noted at Investor Day, we have typically seen 50 to 100 basis points of pricing drag annually. Excluding generic pharmaceuticals, pricing in Fiscal 2010 came in significantly better than the negative 50 to 100 basis points normalized level.

Now, turning to the quarter, overall we had another positive quarter. Revenues were slightly ahead of our expectations. We improved our gross margin, operating margin came in right on plan. And for the fourth and second quarter, we delivered double-digit EPS growth on an adjusted basis.

We also continued our portfolio realignments, closing two strategic acquisitions, EV3 and Somanetics, and completing the divestitures of the Specialty Chemicals, and Sleep Therapy businesses. Our primarily focus in 2011 will be on integration, in looking for the smaller tuck-in opportunities.

In our large medical devices segment, we had another solid quarter with broad-based growth led by vascular, oximetry and monitoring, and energy products. Fourth quarter results were aided by a good performance for the EV3 and Aspect businesses, partially offset by the divestitures of sleep and oxygen.

In Endomechanical, we registered good growth for our Stapling Products, but smaller increases in the more competitive laparoscopic instrumentation line. In the Soft Tissue repair category, mesh sales slowed as we faced very difficult comparisons in the U.S.

That said, our Biologic products registered strong growth outside the U.S. partially offsetting slower domestic performance. Biosurgery again grew at a double-digit pace, and fixation sales grew mid-single digits after a couple of down quarters.

In our capital related businesses, which include energy hardware in imaging delivery systems, we started to see a bit of a pickup, and we registered sales gains off the lower base of a year ago. As expected however, our ventilation sales were below a year ago as a very strong h1n1 volume we received last year was not repeated.

Looking at vascular, both the neurovascular and peripheral vascular product lines at EV3 exceeded our expectations in sales and margins. For the full quarter, EV3 sales grew in the high teens, though we only booked the portion that occurred following the closing on July 12.

Gross margins also were above our expectations, primarily due to favorable product mix. EV3 has an outstanding product lineup in a robust pipeline of new offerings. The integration is proceeding well, and we’re even more confident that it will accelerate our top line growth rate and be accretive of our gross margins.

Chuck will have more to say about EV3 in a few minutes.

Turning to the Pharmaceutical segment, our top line results, while below a year ago, were in line with our expectations. The sales decrease was primarily due to the divestiture of U.S. nuclear pharmacies that occurred last quarter, coupled with a continued decline for Specialty Pharmaceuticals. Looking forward, we think this is the low point for the Specialty Product line.

In the Generics business, volume was up in the quarter and we saw a stabilization of pricing following the significant decline in the second and third quarters.

On the Branded side, we remain cautiously optimistic on PENNSAID and EXALGO. Both are doing somewhat better than we expected, and we’re starting to see some restocking orders. Overall all, however, their performance in the quarter did not offset as decline for our older brands, due to expanded generic competition.

Our Radiopharmaceutical lines should benefit from the improved supply situation, as all the reactors are back online. Our ongoing Contrast business was little changed, but we did get a onetime benefit from a customer order in the quarter.

Our current expectation for the Parma business are that 2011 will be a tough year from a revenue standpoint. We face a combination of headwinds including the divestiture anniversary of the generic price cuts, and continued declines of our older brands.

During the quarter we achieved a couple of significant milestones with our pipeline of new pain products. We completed the first human pharmacokinetics study for our first opiate-acetaminophen combination production using [inaudible], drug delivery technology.

Fishing for improvement is underway for additional Phase 1 studies, which will begin later this month. In addition, we are completing a human pharmacokinetics study of PENNSAID follow-on product, and patient improvement of Phase 2 studies is nearly complete.

Turning to Medical Supplies, sales were up slightly on our operational business this quarter. As we said, we have made significant progress this year in improving margins, holding the line in pricings, and pruning the portfolio of a number of low product lines.

In closing, we were very pleased with our overall performance in Fiscal 2010. For the year, we delivered mid-single digits sales growth and double-digit earnings growth, consistent with our long-term goals. We significantly reshaped our portfolio, requiring several high growth, high margin businesses, and divesting slower growth product lines.

We launched more than 20 new products including two new branded pain products in major advances in stapling and energy.

In addition, we continue to make the necessary investments in R&D, growth initiatives and business expansions to expand our robust pipeline and drive our future growth.

We are confident that we are well positioned for the 2011 and beyond.

I’ll now pass the call over to Chuck, who will discuss the fourth quarter in more detail, and provide an update on our thoughts for 2011.

Chuck Dockendorff

Thanks, Rich. I’ll focus the majority of my comments on the items below the sales line, and then discuss our latest thinking on 2011.

As Rich mentioned, we are pleased with our results this quarter as sales were somewhat above our expectations. We delivered double-digit adjusted earnings per share growth for the fourth consecutive quarter, and cash flow also significantly exceeded our plan.

As noted in the release, on an adjusted basis, despite some negative pressure from price in FX, we reported a 190 basis points increase in gross margin this quarter. Faced by a portfolio and management activities, favorable volume in mix, coupled with manufacturing cost reduction efforts and benefits from our restructuring program in medical devices.

Fourth quarter adjusted SG&A spending was up somewhat versus a year ago, primarily due to acquisition-related expenses, primarily amortization, partially offset by favorable foreign exchange on our cost.

As we noted previously, continued spending for growth initiatives, expenses related to the launches of PENNSAID and EXALGO, and the impact of acquisitions, will all put upward pressure on SG&A as we move into 2011; particularly in the first half of the year.

R&D increased 18% to 4.7% of sales in the quarter, and we remain committed to our goal to further increase R&D to 5 to 6% of sales over the next few years.

As planned, we condition to make progress lowering our tax rate as our Fiscal 2010 adjusted rate was nearly 650 basis points below a year ago.

As expected, there was some one-time tax planning strategies that we executed, which significantly lowered the fourth quarter rate. We expect the rate to return to a more normal level in the first quarter of 2011.

On Investor Day, we had lowered our original dilution estimate for the EV3 acquisition. Given the over performance versus our expectations that Rich mentioned, dilution was even less than our estimate, with EV3 having minimal impact on fourth quarter EPS.

Looking to 2011, we now believe that EV3 dilution will be at the lower end of our Investor Day guidance. In addition, we expect that the Q4 acceleration of our share buyback program will about offset this dilution.

Next, let me take you through some cash flow highlights. We again generated strong cash flow in the quarter exceeding our expectations. The improvements versus expectations was primarily due to higher net income coupled with lower working capital than we had estimated. Despite the difficult economic conditions, we are making excellent progress managing our working capital.

For 2010, operating cash flow was nearly $2.2 billion. Capital spending came in slightly below planned at $400 million, so free cash flow was nearly $1.8 billion, well above the $1.5 billion we estimated.

We continue to target returning 25 to 40% of our free cash flow to shareholders through dividends and share repurchases. As we noted at Investor Day 2010, 2010 was at the high end of this range.

Also as mentioned in September, we accelerated a share buyback program, buying back approximately 6.6 million shares in the quarter for $250 million. These shares were part of the $1 billion buy-back program we announced last March.

Finally, I’d like to briefly discuss our 2011 outlook. As we have communicated, our long-term goals are to deliver mid-single digit sales growth and double-digit EPS growth, achieved through a combination of operational and financial leverage.

At this time, we are not changing any of the 2011 guidance ranges we gave you a few weeks ago at our Investor Day in New York. Since that day in mid-September, as you know, the dollar has continued to be relatively weak against most of the major currencies.

In addition, we are pleased to see better operational results than we expected in the fourth quarter, both in revenues and profitability. Assuming this operational strength continues into 2011, and rates remain at current levels, these two factors will clearly put upward pressure on our revenue and profitability targets.

In addition, we continue to identify tax minimization opportunities as evidenced by the numbers we reported today. And we believe we may end up doing a little better than we previously thought on the tax rate next year as well.

For currency alone, we have said that the rates in effect in September were going to provide revenue headwinds of between 100 and 200 basis points; skewed much more negatively in the first half of the year than the second.

While the impact will still be more positive in the second half of the year than the first, with the recent moves and various currencies, we now expect the overall 2011 impact will be closer to flat.

All of these factors give us much higher confidence that we can deliver on all of our financial goals for 2011. Nonetheless, with the various cross currents of utilization trends in the overall market and given how early it is in the year, for now we are going to stick with the ranges we gave you on Investor Day.

I also want to note that the cost in the first half, particularly in the first quarter, are much tougher than the remainder of the year. This not only relates to currency, but also a difficult comparison with the strong first quarter of 2010, as well as the impact of generic pricing pressures we’ve seen in the last couple of quarters.

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

Cole Lannum

Thanks, Chuck. Once again, we’re trying to do our best to cut back on prepared remarks to allow you more time for your questions. However, for Q&A we are going to limit you to one question and a follow-up if needed so we can give everyone a chance to get their questions in. If you have additional questions, either put yourself back into the queue or please contact us after the call. Janada, can you once again review the process for signaling a question?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) You first question comes from Matthew Dodds with Citi. Please proceed.

Matthew Dodds - Citi

Hi. Good morning. Rich, I don’t want to go month to month on you, but on your comments on the quarter in general for medical device and medic slide, saying that you thought things were a little bit better. Can you potentially break out if that was volume or distributor patterns? I mean, how much visibility do you have on underlying volume trends with the comments of a modest improvement?

Rich Meelia

Well, I mean, most of our visibility is not at the end-user level because most, in the U.S. especially, it goes through distributors. But we didn’t see anything, Matt, significantly changing with respect to inventory levels with distributors. So you know, our assumption is what we were shipping in the pickup was a reflection of what they were then shipping into the providers themselves.

So that’s why we felt that it was a somewhat of a bounce back. And the reason in the past why we didn’t get too concerned when things were slowing down, it was a very board-based slowdown, this is kind of a broad-based bounce back and so we do think it’s reflecting procedural improvement in the marketplace in the U.S. In Europe, we saw the fourth quarter actually slow down more than any other quarter all year. So you know, it varies around the world.

But I think, Matt, the one thing that we’re learning is that it’s probably a little concerning when people make too much out of a quarter – quarterly results. I think, you know, things can move in one direction or the other from quarter to quarter.

But we feel very good about what we’re seeing, and you know, we said – we were pretty good about what we’re doing with supplies and we can get that back to a more reasonable market according to growth rate and devices continues to do very well, and then we know what the problems are in pharma and we kind of got those bottomed out. We think they’re manageable going forward.

Matthew Dodds - Citi

All right. I got a long answer, so I’ll cut it at one. Thanks, Rich.

Rich Meelia

Okay.

Operator

Your next question comes from the line of Mike Weinstein from JP Morgan. Please proceed.

Mike Weinstein – JP Morgan

Thank you. Rich, can I get your comments on two business in some great detail? One, the soft tissue repair business, which had been decelerating over the last two quarters, bounced back this quarter. So if you could just give us an update on your view of the competitive environment.

And then second, EV3, which certainly appeared to have a very strong quarter, you know, I was hoping you could just give us some greater insights into performance.

Rich Meelia

Sure. Well, let me take EV3 first and then we’ll cover the rest. As we said in the prepared remarks, we had high-teens growth rate at EV3. Gross margins came in fairly, you know, substantially as planned as well. You know, they’d been performing at a high level. This year they’d launched a couple above-the-knee turbo hoc products. In Europe we launched the solitaire mechanical [inaudible] device. And there are other launches planned for 2011 and a very robust clinical pipeline.

So the integration is going really, really well. I personally sit in on a steering committee once every two to three weeks to see how we’re doing on the different issues throughout the organization relative to this integration. We feel really good about it. We looked at the whole landscape before we made the call on EV3 and we felt like it wasn’t the least expensive for sure, but we just thought in terms of getting us in the peripheral and neurovascular, and the quality of the pipeline, it was the best call for us.

So you know, we said we’d continue to give you folks some visibility to how we’re doing because it’s such a big deal, so we’re really pleased that it’s doing this well as it is.

With respect to hernia, we had an opportunity because of competitive troubles, you know, a year or two ago, since then all the competitors were on the market. We’re doing well with the biologic mesh. We’re doing okay with the synthetic mesh. We had a nice bounce back in terms of the mechanical business. And so it just tends to flow from quarter to quarter. We still feel very good about double-digit growth, overall position in hernia. But that 20% growth that we were seeing a while back, I think that was more reflection of some competitive difficulties. In the normal market, you know, I think we’ll see the kind of growth rates that we’ve been seeing, you know, if you normalize the last three or four quarters.

Mike Weinstein – JP Morgan

And Rich, just to follow up to that, the decision to leave your guidance unchanged versus just obviously a few weeks ago despite the fact your quarter came in stronger than was expected at least, and the dollar is week – is that’s the function of the volitility in the business we’ve seen over the last few quarters?

And then second, you made a comment about the first quarter being particularly tough comp. Can you provide any sense of how [inaudible]? Thanks.

Rich Meelia

Sure. Chuck, do you want to –

Chuck Dockendorff

Yeah. I think, you know, certainly the fourth quarter came in much better than we expected operationally; the sales are better, the gross margin was better, we commented on that, our tax rate was lower. So those are all certainly good signs and certainly that changed favorably for us since Investor Day with the weakening of the dollar.

So all of those things would tend to, for me, as we look at Fiscal ’11, I would expect that our EPS to move up in Fiscal ’11 after this call with the consensus out there and things like that.

We decided really not to change guidance because the FX has been relatively volital. That was a pretty significant change even within one month. There’s also a delay in the process of this as these things get capitalized and roll out to our capitalization policy.

And the other thing is that it’s very still early in the year. So these things have the impact on the full year and because of the volitility, we just wanted to some of these currencies settle down before we really get confident in them.

You know, the other item too is, our goal as we stated has always been to drive this double-digit earnings per share growth, but make investments for the long term as well. And we still see opportunities out there for investments and growth opportunities around the world. We also see opportunities for further restructuring of which, you know, we’ve call out a couple of programs here in the past that have been very successful; one for 150 million, one for 200 million. And you can kind of see the impact they’ve had on gross margin that we’ve been able to achieve. We’ve had further opportunities for restructuring and I think going forward we like to build some of these into our normal recurring type of activities in the [inaudible].

So as we see these opportunities come up, we’ll retain the flexibility to balance off those investments for long-term growth as well as going after our double-digit earnings growth.

Rich Meelia

And as far as Q1, I think the key there is we had a very, very strong first quarter last year for a number of reasons in the sales growth. We had h1n1 and helped the respiratory group quite a bit. So I think – and the FX rates, as you look year over year as we mentioned, and mostly the second half of the year, so I think that’s where the first quarter, why we think we’ll be good.

Thanks, Mike. Next question please.

Operator

Your next question comes from the line of Bob Hopkins with Bank of America.

Bob Hopkins – Bank of America

Hi. Thanks. Can you hear me okay?

Rich Meelia

Perfect, Bob.

Bob Hopkins – Bank of America

Okay, great. So two things. First for Chuck, I was wondering, again, around not changing 2011 guidance. I totally understand the logic, but I’m just curious on the tax rate, which seems a little bit more structural why you wouldn’t be comfortable suggesting you’ll have a little bit better tax rate going forward.

And then also for Chuck, could you just give us suture growth rate? And then I have one for Rich. Thanks.

Chuck Dockendorff

As far as the tax rate, Bob, you know, we do expect – the guidance range that we gave on Investor Day, there’s certainly enough room in there to expect the EPS to move up a little bit for 2011 based on those rates we have.

The tax rate, you know, we are having those planning activities, we were able to execute one in the fourth quarter. If you look at the year-to-date rate, it’s 19 ½% and that’s the better rate to use rather than the fourth quarter rate itself because in the fourth quarter rate, which was relatively low, there is a catch-up period because of that planning activity that’s always reflected in that fourth quarter. So it’s a full-year impact reflected in there.

So the best way to think about our tax rate is based upon the full-year rate, which is 19 ½, which is a little below where we’re giving guidance for next year. A lot our tax grade is dependent on where we earned income around the world and things like that. So we feel comfortable with the tax rate guidance we’ve given. We do probably, you know, expect to do a little better than that in the next year.

On your question, Bob, about sutures growth, you know, it is important to note that sutures is, by far, the biggest piece of that soft tissue line and it did bounce back a little bit this quarter. I think we’re getting a little more traction on our B-lock launch and that’s coming through. So it’s a little – it was low single digits, slightly positive on a reported basis, and a little bit better than that on an operational basis.

Bob Hopkins – Bank of America

Okay. And then basically as a follow-up to that comment on sutures for Rich, you mentioned the pickup in procedures and I was wondering, do you have a sense of – to what do you attribute the bounce in procedures? Is it any particular business, any particular reason you’re getting from the businesses as it’s driving the uptick here?

Rich Meelia

You know, Bob, it was really board based. When we see that – because occasionally, we’ve been out now for a little over three years, and so we’ve had certain parts of our business that have struggled and some have done better. So we know there’s a problem in a part of our business or there’s a lot of tailwind supporting some of them. And these most recent fluctuations have really been broad based, which leads us to believe that it’s kind of structural to be in markets. So you know, as we saw the bounce back across pretty much across the line, you know, whether it be – I mean, supplies is very much a barometer. It’s just a general kind of floor – general floor, [inaudible] related consumption within the provider and then certainly we get into the general surgery products associated with surgical devices and energy. And then the critical care units, you know, with respiratory monitoring. We do have a diversified business that is a little bit of a canary-in-the-coal-mine scenario.

Chuck Dockendorff

Thanks, Bob. Next question please.

Operator

Your next question comes from the line of David Roman with Goldman Sachs. Please proceed.

David Roman – Goldman Sachs

Good morning everyone. I had one question on the revenue side and then a follow up on the P&L. First, with respect to revenue, Rich, you mentioned in your opening remarks, while you did see a bounce back trend, we’re still below where you thought the normalized levels were. Maybe you could help us characterize that as you look across some of your businesses within devices, for example Endomechanical, soft tissue and energy, which grew 5, 3, and 12 constant currency for the full year. Could you maybe give us some sense as to how we should think about the normalized growth rate in those segments on a go-forward basis and how you think you tracked in those markets versus your competitors in – as you exited Fiscal ’10?

Rich Meelia

I mean, I guess first thing I do is I refer you back to Investor Day where we looked at the specific markets in a fair amount of detail. With respect to the ones you talked about just now, David, you know, energy we see growing in the low double digits, you know, 12, 13% overall growth rate. And the Endomechanical, you know, it’s 4 to 6% kind of market, hernia a little bit higher than that, neurovascular is a 10 to 12% kind of growth, peripheral vascular 6 to 8, respiratory lower, 4 to 5% and supplies is kind of 0 to 2%.

So those are what we think will be kind of the normalized growth rates of these marketplaces and that’s what we’ve been trying to do with our whole portfolio. It’s been a little bit painful because of pollution associated with these fields, but once we were through and we feel like most of that work is behind us now, we’ve put ourselves in what we believe are more attractive long-term growth franchise than we were in the when we started the whole Covidien launch.

David Roman – Goldman Sachs

Okay. And then for Chuck, on SG&A, you talked a little bit about there being some upward pressure. This quarter there was an uptick, but I think somewhat lower than what people were expecting. Can you maybe help us think about the trends in absolute dollars or as percentage of revenue as we move into 2011, at least directionally speaking?

Chuck Dockendorff

Yeah. I think the guidance we’ve given on SG&A as far as 2011, it would be kind of consistent with were we were in 2010. You know, we’re still going to have upward pressure from EV3 and the full impact of that as well as PENNSAID and EXALGO, we’re continuing with the investment of sales force there so the revenues need to catch up with that level of investment we’ve made. And you know, the other thing is some of the portfolio moves we made which were neutral to EPS and have driven up the SG&A component have also benefited the margin rate as well to kind of offset that. That’s more where it is on the P&L.

You know, and then FX will probably have a slight favorability to it since we move into 2011, but we see this as an area that will probably be flat with where we were in 2010.

Chuck Dockendorff

Go ahead, next question please.

Operator

Your next question comes from the line of David Lewis with Morgan Stanley. Please proceed.

David Lewis – Morgan Stanley

Good morning. Two quick questions. First for Chuck, just thinking about gross margins in a quarter, obviously they were very strong in the quarter driving most of the up slide. They’re up about 200 basis points year on year. I wonder if you could just talk to us about the mix of that 200 basis point improvement? Really, what I’m looking for is how much of that was EV3 and how much in your mind was core operational improvements?

Chuck Dockendorff

You know, some of that was EV3, but as you know EV3 revenues were not that significant within the quarter because we acquired them on July 12 and it’s only a partial quarter in there. But the volume and the mix is a significant contributor to the improvement in gross margin in the quarter. There’s no question about it. That has been throughout the year, it’s the same in the quarter and we truly expect that to continue going forward. And when you think about that mix, remember that we’re also – all these portfolio moves we’ve made, we’ve eliminated a lot of lower growth, lower margin businesses out of our portfolio and you are replacing it with higher margin, higher growth products. So that will continue going forward. That is one of the big drivers.

You know, the other one is clearly we’ve had these cost reductions and restructuring programs that are paying off as we go forward as well. So you know, as we said on Investor Day, we would expect gross margins to continue to improve going forward. I don’t think they’re going to improve at the level we saw in 2010, but we would expect them to improve for all of those factors.

Cole Lannum

David, I’m sorry. Just one more thing I want to add here. Remember, while obviously EV3 gross margins are accretive to our business, remember, we also have the amortization piece included that takes EV3 gross margins down somewhat versus what they would have been as a free-standing company.

David Lewis – Morgan Stanley

Thank you, Cole. And I guess the second question, Rich, you talked about U.S. trends being somewhat stronger, some stabilization, if not even improvement, but it doesn’t sound like we’re seeing the same thing in international markets. Can you kind of compare and contrast in your mind the two different markets and any sense of kind of forward outlook in international device growth versus U.S.? Thank you.

Rich Meelia

Yeah. I think we’ve got to break down that David, just you know, by the different regions of the world. As I mentioned previously, we definitely saw a shift in Europe. The austerity measures they’re taking are clearly effecting the consumption of healthcare products, I think for the industry in Europe. So we saw that.

But then if you look at our emerging market activity, whether it be Latin America, Asia, Eastern and Central Europe, you know, they continue to do very well. Japan is acting more like kind of U.S. as it’s a very developed market.

So the problem in international has been primarily the European markets. And until they get through some of these austerity measures, I think you’re going to see some slowness continue there.

Chuck Dockendorff

Thank, David. Next question please.

Operator

Your next question comes from the line of Rick Wise with Leerick Swann. Please proceed.

Rick Wise – Leerick Swann

Good morning, everybody. Let me start off maybe on the pharma side. Pharma products did less bad than I feared, and Rich, you talked about, especially on the pharma side, that fourth quarter is the low point. Maybe just talk us through where we go from here, the factors that could drive further improvement, some of the new products, just touch on the key points that are going to make that look better as we go through Fiscal ’11.

Rich Meelia

Sure. I think, you know, you won’t see a repeat of a new entrance, which is what we saw in the [inaudible] space. That’s part of the reason why we’re confident. The second reason is it was a little bit of a surprise, DEA does tell competitors ahead of time of new entrance, so we’ve had a chance to kind of respond, get to our bigger customers and leverage our capabilities with the customer in a competitive fashion so that we think we will solidify our position. So we think we’re in pretty good shape in terms of what was leaking out the bottom.

And secondly, while it’s still early for sure, the PENNSAID and EXALGO numbers are on track. The prescription data we see is actually a little bit ahead of plan and so that’s where the growth is going to be. And then if we can land the approval of the AMDA that we’re hopeful for in the first couple quarters of this year, then we’ll feel very confident about pharma, take out the radiopharmaceutical divestiture, then we feel comfortable with pharma being a contributor from an overall sales and profit improvement standpoint.

Rick Wise – Leerick Swann

On the SILS, it seemed like sales was a bigger topic than we expected at America College of Surgeons and some big meetings. Was that a factor in driving the – are the new products in SILS driving the pre – strong performance in surgical devices?

Rich Meelia

Yeah, I don’t know if I’d attribute to SILS. I mean, SILS continues to grow, but it’s still pretty small. I think we’ve been saying the numbers are in that 50 to $100 million category. But a lot of interest, continues to be all kinds of clinical work being done not by us but just by other people experimenting and then writing about what they’re doing with the procedures. We definitely think you’re starting to see the impact of [inaudible]. Cole talked about the B-lock. We’ve got the full line launched now. We think we understand the market position better and the Tri-Staple line is still early, but the reaction continues to be very positive, and we’re starting to see conversions as a result of the Tri-Staple.

Cole Lannum

Thanks. Next question please.

Operator

Your next question comes from the line of Adam Feinstein with Barclays Capital. Please proceed.

Adam Feinstein – Barclays Capital

Thank you. Good morning, everyone. Just to maybe go back to the margins, I just wanted to get some more clarity. I know you guys break it out in the 10-Q filing, but if we think about margins by segment, I just wanted to get a better sense in terms of the trends there and really focus on when to better understand the trends in margins performance. You guys highlighted that trends appear to have stabilized in terms of revenue, but just curious in terms of what’s going on with the margin profile of the pharma business.

Chuck Dockendorff

Sure, Adam. Yeah, you know, this is our fiscal fourth quarter. We are still putting it together. It won’t come out for probably a couple of weeks. We don’t have all the final details on that. We will get that up on the K. I think it’s safe to say that across the board, you know, we obviously saw good profitability growth and we benefited in all the businesses. But you’ll get a better breakout whenever we file the K.

Adam Feinstein – Barclays Capital

Okay. And on the pharma side, do you think things were relatively stable in terms of what you said last quarter and at the analyst day with respect to margins?

Chuck Dockendorff

Yeah, again, sorry, but we’re going to have to wait on the K to get specifically into that.

Operator

Your next question comes from the line of Christian Store with Deutsche Bank. Please proceed.

Christian Store – Deutsche Bank

Thank you for taking my question. I was just wondering if you could, Chuck, give us the impact of incremental amortization in the quarter and where it fell? I know that you had mentioned at one point there was a little extra within gross margin and also I thought you had mentioned it was SG&A. So kind of how should we think about EV3 I guess being the most impactful, and Somanetics as well.

Chuck Dockendorff

Yeah. I don’t have the actual amortization numbers within the quarter for those two acquisitions, but I know in EV3 we talked about Investor Day, we thought the amortization was 87 million. It’s even a little less than that. I think it’s going to come in around 84 million for 2011. So you would take that number and you could prorate it into our fourth quarter. It would be a straight line based up on when we acquired the business. We can get that information for you later, Christian.

Christian Store – Deutsche Bank

Okay. And is amortization in both, are you including it both within SG&A and gross margins?

Chuck Dockendorff

Yes. It’s combined in both. I don’t have the specific breakout of what’s in what, but again, we can get that for you.

Rich Meelia

Hey, Christian, this is a good time to interject and let everyone know, remind everyone, starting in the first quarter, we’ll be breaking out that amortization component both in SG&A and gross margin so you can see where that’s coming from, how that’s affecting both of those dynamics starting in 2011.

Christian Store – Deutsche Bank

Okay, Chuck, do you have total amortization depreciation on the quarter?

Chuck Dockendorff

I do. Why don’t you bear with us, Christian. Let’s take the next call and we’ll get that number and we’ll jump in in a moment.

Operator

Your next question comes from the line of Larry Keusch with Morgan Keegan. Please proceed.

Larry Keusch – Morgan Keegan

Hi. Good morning. I guess two questions for Chuck if I could. On the tax rate, Chuck, you know, you mentioned the 19 1/2 % sort of being the base of where we should be thinking on a go-forward basis. I’m sort of curious as you guys work through your tax planning strategies and you’ve got the NOLs coming in from EV3, where do you think that can ultimately go? I know it’s also driven by where the composition of your profits around the globe, but how are you thinking about directionally where that should head?

Chuck Dockendorff

You know, what we’re looking for in our tax rate, you know, we’ve had significant improvements here in the last couple of years, you know, without 650 basis points with in the year and that was a lot of tax planning strategies that we really identified and initiated very close to [inaudible] date and then executed.

Going forward, you know, the EV3 NOLs, we’ll be using those in certain ways. It necessarily won’t impact their ongoing non-GAAP effective tax rate. But what we do expect to do is continue on with some opportunities that we see that will drive down the tax rate over time, probably at a much more marginal level than what you’ve seen in the past.

Now you know, there’s a lot of things out there, these rates, these investments don’t include R&D tax credits, which have not been approved yet by the government. And there’s also, as you know, I think other revenue-raising issues with the government right now that you can’t predict. So those certainly would have impact on the rate going forward, which is just like I said, impossible to predict at this time.

But again, we have people that have identified opportunities, that’s the means to bring this tax rate down over time at a reasonable level.

Larry Keusch – Morgan Keegan

And just – I’ve got one other question, but just to calibrate on that, it sounds like you’re saying – not to put words in your mouth, but maybe there’s a couple hundred basis points over time? Is that fair?

Chuck Dockendorff

That’s quite a bit. I mean, that’s pretty low, but I think you would see some improvement into next year.

Cole Lannum

I want to clarify that that’s a bigger decline than what we would expect. Your number is more bigger than we would expect.

Operator

Your next question comes from the line of Joanne Wuensch with BMO Capital. Please proceed.

Joanne Wuensch – BMO Capital

Thank you very much for taking my question. Two parts; one, anything new on the pricing front that you’d like to comment on? You did comment well on volumes, thank you. And then second of all, anything on the sort of competitive landscape, particularly I’m thinking with some of your new stapling systems launched in that area? Thank you.

Rich Meelia

Yeah, Joanne, this is Rich. Pricing, you know, as we said on Investor Day, we were looking at 50 to 100 basis points of degradation based on kind of what had happened historically and putting that in context of some of the new products and the margin enhancement that we see as a result of the mix improvements. And you know, this quarter we actually – it was not as bad as we had said. It was quite a bit less than the 200. And if you pull the pharma piece out, especially which as we said we think we’ve kind of hit the trough of that, you know, then we probably overestimated the impact of pricing, at least relative to the fourth quarter.

A lot of volitility out there as we look into total 2011, but we’ve continued to state that, you know, the kind of products that we sell are generally part of the DRG. They don’t have the visibility of the high-ticket items and we just don’t think we’ve got the typical exposure. So that’s why we’ve kind of continued with the 50 to 100 basis points, which is where the comp of the business is historically.

And then in terms of how we’re doing in the statement line, you know, you want to be careful before you talk about share gains on a quarter-by-quarter basis. It can change, but we did have a very good quarter in the U.S. in Endomechanical and we think it clearly is a result of some of the stuff we’re seeing relative to Tri-Staple and B-Lock and some of the other new product introductions that we’ve made as well, but to a lesser extent.

So you know, when we’re not – there’s no finish line in this race and I think with EXALGO and people have backorders, but of course, we think this reflects some of the benefit and productivity coming out of the new product launches. That’s why we’re really pleased to see RD continue to increase and it’s because the investments we’re making are turning out some really exciting new product opportunities, especially in surgical and energy-based cash flow.

Chuck Dockendorff

This is Chuck. I just want to follow up on Christian’s question. The amortization for the year, the depreciation amortization for the year is close to 500 million and in the quarter was approximately 140 million.

Operator

Your next question comes from the line of Tom Gunderson with Piper Jaffray. Please proceed.

Tom Gunderson – Piper Jaffray

Hi. Good morning. Chuck, just a quick follow up on the tax rate. Your guidance assumes a net-zero effect from Puerto Rico excise take, is that right?

Chuck Dockendorff

At this point, we’ve run those numbers, Tom, and it’s a relatively small effect. It would be slightly negative, but we’ve incorporated that into guidance.

Tom Gunderson – Piper Jaffray

Got it. Thanks. And then sort of a piggyback off of the R&D investment comments that have been made so far, a number of your competitors have commented on the slow down at the FDA and the frustration with that. We haven’t talked about that much on the public calls here. Could you comment a little bit on how you’re seeing your launches, particularly in medical devices being impacted or not by issues with the FDA?

Rich Meelia

Yeah, I have – we’ve seen the same thing here as well. We won’t get into details of actual products, Tom, but you know, it’s clearly a new world. This is before 5 or 10-K changes have been made, as you know. But there’s a lot of concern about the quality and integrity of the data and we’ve had products that we assumed would be approved by now that have not been approved, and we’re seeing pushback from the FDA. It’s not significant, but I think we’re in concert with the rest of the industry that we’re in for tougher times with the FDA reviews.

Operator

Your next question comes from the line of Paul Cho [ph] [Inaudible]. Please Proceed.

Paul Cho [ph]

Thank you for taking the question. My first question is on SG&A and Chuck, maybe you can help us with this. I think you mentioned at the analyst day that you still had some room to go in terms of reducing sort of the back office stuff on the G&A side. Can you maybe update us on where you stand with that as to maybe how much run room you have with consolidating some of the back office SG&A functions?

Chuck Dockendorff

Sure. You know, we again have pretty much completed our European back office system and we have a lot of savings in the plan for that. We are in the process of doing more in the U.S. and certainly have some room to improve that as well. I would tell you as you look at SG&A and we commented on this at the investor day, the G&A portion, which is about 1/3 of it, is down year over year. So we’ve made savings on that end of it. Where it’s up is in the selling and marketing side of it and these are the investments that we’re making along [inaudible], which have higher selling and marketing rates than our average. And in the case of EV3, it’s the nature of the product and some on the analization that we’ve had. And in addition, we’re investing in emerging markets, which we’ll be building sales force out in those areas of the world.

So when you look at it, we’re still planning on reductions in G&A in 2011 and leveraging some of that, but offsetting that with investments in the other areas I just talked about.

Paul Cho [ph]

Okay, great. Thank you for that. And then, Rich, on the airway and ventilation business, obviously you guys face a tough comp because of the flu-related sales that you benefited from last year. But could you maybe give us a sense of what that business growth at a more normalized rate when you address these sort of one-time seasonal effect? Thank you.

Rich Meelia

Yeah, the ventilation is kind of a mid-to-low single digit and airways probably about the same. You know, we’re trying to do some things with improving the – or reducing the risk of that, you know, with different features that we offer in the airway line and that may allow us, perhaps some share.

But I think the overall franchise, segments themselves are kind of that 3, 4% markets.

Operator

Your next question comes from the line of Josh Jennings with Jeffries & Company. Please proceed.

Josh Jennings – Jeffries & Company

Hi, good morning. Thanks for taking the questions. Just first of all, just to move back over to EV3, if we could just talk about this outperformance from initial expectations post acquisition. Was it more on the neurovascular side or the peripheral vascular side, or a combination of both? And then if you could just comment as well on with the new makeup of the competitive landscape with smaller neurovascular companies under larger umbrellas, how you see the ability to continue to gain market share on the neurovascular segment. And any update on the pipeline to buy us into the potential panel before the end of the year, or early next year would be great. Thanks a lot.

Rich Meelia

The performance has been pretty much across the board, peripheral and neurovascular, and across the globe as well. Their sales have been right in line with expectations. The achieving of expectations primarily on the market side of things, so you see amortization interest and reduction amortization interest as well, that’s going to grow well.

Pipeline, you know, we can’t – we did get an expedited review from the FDA a few months back and obviously that was a good indication. We’re in the process of working with FDA trying to get this to panel and get this approved. I would remind you again that our conservative approach has slowed the product coming in in 2013. So we feel pretty confident that we’re going to beat that schedule, but this is obviously a big opportunity for upside in our model. So we’re watching this closely.

And then the final question about – I mean, I do think that it’s the kind of business, and we said this from the very beginning, that we wanted to get more strong position in vascular because we would be in a position to start doing more kind of tuck ins like we’ve been doing, you know, for the past several years whether it be in hernia, respiratory or stapling, whatever. And so we are looking at those smaller technologies that could be part of now what has been created as a worldwide infrastructure. And I will reiterate that we looked at every – we do landscape review when we make a decision to move more aggressively into vascular specifically, peripheral and neurovascular and we looked at everything that was available. And we feel very confident, and continue to feel very confident that the asset that we acquired is the one that best positions us for long-term good, solid, profitable growth. We’ve never said that we want to get in good markets without competitors. What we want to do is get ourselves better positioned in good markets and then just we’ll compete with these other good competitors.

Operator

You next question comes from the line of Edward Hemburtis [ph] with Raymond James. Please proceed.

Edward Hemburtis [ph] Raymond James

Hi, good morning. It’s Jason. Thanks for taking the questions. Just a couple quickies. I think you mentioned the one time order in the pharma segment, anyway you can quantify that order, if it was meaningful at all?

Rich Meelia

Yeah, it was single-digit millions of dollars. It was enough to move that business a little bit. You know, you see it as well in the API and the generic business, but this is actually on our imaging side of things.

Edward Hemburtis with Raymond James

Okay. And then secondly, on the stapler business, have you fully launched the Tri-Staple technology? Is there anything left to do related to the launch? And then, do you expect this product line to move the needle in Fiscal ’11 or is it more of a Fiscal ’12 driver? Thank you.

Rich Meelia

Yeah, it’s – I mean, to the first question, it’s not fully launched. It will take us probably a year to launch all the sizes and all the different capabilities relative to tissue strength or the ability to close tissue. So it will take all year. But what we’ve launched has been very favorable. At Investor Day, we did a little bit of calibration of pricing and until we feel real good about it – I think the bigger impact will be probably FY12 versus FY11. We’re going to look at some, and I intent to see some pickup and I’ve seen it already.

Cole Lannum

Jason, you know, I want to make sure that everyone understands, Tri-Staple was never intended to move the needle in 2010 or 2011, rarely do we have a single product that we launch that’s ever big enough to – you know, that’s one of the advantages of being as diversified as we are, you know, to significantly move the needle. So you know, so far it’s going very, very well.

And Operator, we’re coming down to the bottom on the hour. We have time for one more question please and then we’re going to wrap it up.

Operator

We have a follow up question from the line of Christian Store with Deutsche Bank. Please proceed.

Christian Store – Deutsche Bank

Hi. Thanks for taking my question again. Chuck, I guess you had kind of mentioned this earlier too on the pricing, I just want to reconfirm. Your guidance still includes 50 to 100 basis points of headwind, is that correct?

Chuck Dockendorff

Yes. That’s correct. Yes.

Christian Store – Deutsche Bank

Okay. And then Chuck, just in terms of looking at the underlying organic, there’s lot of moving parts, the divestiture of radiopharma as well as Somanetics, can you help us maybe for just the gap between what the net impact of portfolio management was in the quarter?

Chuck Dockendorff

Within the quarter, I think it was roughly around 2% or so.

Cole Lannum

Maybe a little bit less than that.

Operator

At this time, we have no further questions. I would now like to turn the call back over to Cole Lannum for any closing remarks.

Cole Lannum

Thank you very much. Everyone, starting at noon Eastern Time today, a replay of the call will be available. And additional replay of the call will be available on our corporate website, Covidien.com a few hours from now.

For members of the media who listened to the call and have additional questions, please contact Erick Krause, our Head of Corporate Communications. For analysts having more detailed questions involving non-material information, both Brian and I will be available to take your calls throughout the day. Thanks, and have a great day.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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