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Covidien plc (NYSE:COV)

Q1 2011 Earnings Call

February 1, 2011 8:30 AM ET

Executives

Cole Lannum – Vice President, Investor Relations

Rich Meelia – Chairman, President and CEO

Chuck Dockendorff – Chief Financial Officer

Analysts

David Roman – Goldman Sachs

Bob Hopkins – Bank of America

David Lewis – Morgan Stanley

Matthew Dodds – Citigroup

Kristen Stewart – Deutsche Bank

Mike Weinstein – JP Morgan

Joanne Wuensch – BMO Capital Markets

Glenn Novarro – RBC Capital Markets

Rick Wise – Leerink Swann

Paul Choi – Caris & Company

Ben Yeoh – Atlantic Equities

Adam Feinstein – Barclays Capital

Jayson Bedford – Raymond James

Operator

Good day, ladies and gentlemen. And welcome to your First Quarter 2011 Covidien plc Earnings Conference Call. My name is Tania, and I will be your event manager today. Throughout the conference, you will remain on listen-only. (Operator Instructions)

I would like to advise all parties that this conference is being recorded for replay purposes. I’d now like to hand the conference over to Mr. Cole Lannum, Vice President of Investor Relations.

Cole Lannum

Thanks, Tania, and good morning, everyone. With me today are Rich Meelia, Covidien’s Chairman, President and CEO; and Chuck Dockendorff, our Chief Financial Officer. We will 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 first quarter results was issued earlier this morning and is available on our website and on the newswires. I’d like to highlight that starting with this quarter’s results, we’re now itemizing the impact of amortization and its effect on both cost of goods sold and SG&A in order to help you better understand the incremental non-cash effects of acquisitions made over the prior year.

During today’s call, we’ll make some forward-looking statements and it’s possible that actual results could differ materially from our current expectations. We ask 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. A reconciliation of such of this non-GAAP to GAAP measures can be found in our press release and its related financial tables, as well as the Investor Relations section of our website, Covidien.com.

For the first quarter, we reported GAAP diluted earnings per share of $0.87, after adjusting for certain specified items our non-GAAP earnings came in at $0.95 a share.

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

Rich Meelia

Thank you, Cole. To begin, I’ll talk a little bit about what we saw in the overall U.S. healthcare market in terms of utilization and demand. While we’re still collecting and analyzing the data and there is significant noise from quarter-to-quarter, recent data shows that hospital admissions were soft but procedure volume increased somewhat. While the demand trends are some much choppy, what we see suggests stabilization in 2010 versus 2009.

Third-party forecasts indicate a slow growth year in 2011, with admissions projected to hold flat and volumes and select procedures such as bariatric and general surgery expected to show some mild to modest growth.

We believe broad-based gains in utilization and demand are still more than 12 months out and these gains can only be driven by fundamental improvements in the relationship between the economy, unemployment and the uninsured.

In light of some of these challenges, we are very pleased with the first quarter. Revenues were somewhat ahead of our expectations. We significantly improved our gross margin. Operating margin came in slightly ahead of plan and for the fifth consecutive quarter, we delivered double-digit EPS growth on an adjusted basis.

These strong results came in spite of difficult comparisons with a very strong first quarter a year ago, when we had unusually high sales in our ventilator, Pulse Oximetry and supplies business related to H1N1, and good growth for generic pharmaceuticals as customers purchased for quarter management and year-end inventory stocking.

Overall, our business in the U.S. came in ahead of our expectations in the quarter. In Europe, we were sequentially better this quarter, though as we’ve said before procedures tend to be utilization driven and economic concerns especially in southern Europe persist. We expect this to continue through 2011 given significant cost containment and assuredly measures in single payer system markets.

In our large medical devices segment, broad-based growth was led by vascular, oximetry and monitoring, and energy products. First quarter results were aided by our acquisition of ev3, Aspect and Somanetics, but partially offset by the divestitures of sleep and oxygen.

In endomechanical, we registered good growth for our stapling products, paced by Duet TRS and Tri-Staple. Both these innovative products are doing very well in the marketplace and we believe we gained share in stapling this quarter.

Sales were flat in the laparoscopic instrumentation line, where we faced continued competitive pressure in trocars. In the soft tissue repair category, sales in the large suture business were above a year ago, while mesh and fixation sales growth slowed as we faced difficult comparisons in the U.S.

In Energy, our new products including LigaSure 5, Advance 2, Impact and Precise drove double-digit growth in vessel sealing for the 21st consecutive quarter. In particular, the Precise is performing very well in Europe and we are optimistic that it will be approved in the U.S. later this year.

The Precise is intended for use in surgeries where a small jaw footprint is needed, such as open head and neck procedures. We also registered good growth in electrosurgical products, as ForceTriad had a strong quarter and we recently shipped our 20,000 ForceTriad system just four years after launch.

Looking at vascular both the neurovascular and peripheral vascular product lines performed well this quarter, meeting our expectations for revenue with strong double-digit growth. The integration activities are proceeding as planned and we remain confident in the growth potential for this business. With a couple of quarters behind us, we now believe that we initially underestimated the positive earnings impact these product lines will deliver, which is significantly exceeding our plans.

We recently launched EverFlex+ Self-Expanding Peripheral Stent System in Europe and have received 510(k) clearance for the TurboHawk Peripheral Plaque Excision System, which will be launched in the U.S. shortly. We continue to be optimistic about ultimate opportunity in carotid artery stenting and expanding the indication to lower risk patients would be a positive development for us as well.

In our respiratory product lines, we registered double-digit growth in our oximetry and monitoring, but sales were below last year in airway and ventilation due to the divestiture of the sleep therapy line and lower ventilator sales, as the very strong flu-related volume we received last year was not repeated.

Yesterday, we announced an agreement that reduces the royalties we’re paying on U.S. sales of Pulse Oximeters and related equipment beginning in March. While the agreement will provide us with a minor financial benefit, the primary advantage is that this agreement gives us much more freedom to innovate and to develop new products that enables us to focus our resources on developing and delivering innovative patient monitoring systems for our customers and the patients they serve with less distraction or disruption. We were pleased to be able to reach this agreement, it will have more to say about our product related innovations in later calls.

Turning to the pharmaceutical segment, our topline results while below a year ago were somewhat above our expectations. The sales decrease was primarily due to the divestiture of the U.S. nuclear pharmacies that occurred in last year’s third quarter, coupled with a continued year-over-year decline for specialty pharmaceuticals.

In the generics business, results were significantly above our expectations as volume was up in the quarter and we again saw a sequential stabilization of pricing. However, we believe some of this volume strength was due to end of year inventory stocking by customers.

As you know, the FDA recently announced new voluntary restrictions on the amount of acetaminophen it would allow in prescription drug products, due to our current product lineup, we do not anticipate this will have any material impact on us for 2011 as we already manufacture products that meet the new guidelines.

While our radiopharmaceuticals business benefited from an improved supply situation, customer efficiency measures implemented during last year’s shortages are restraining growth. 2011 will be a difficult year for the pharma business from a revenue standpoint as we face a combination of headwinds, including the nuclear pharmacies divestiture, anniversary of the generics price cuts and continued declines for our older branded products. Most of these headwinds will anniversary over the next quarter and we continue to be more optimistic about the second half revenue performance once these issues are behind us.

Turning to Medical Supplies, sales were down 5% from a year ago, a significant portion of the decline was due to difficult comparisons with last year’s flu-related volume and the resulting distributor inventory stocking. As you know, the flu season this year has been relatively mild so far, so we’ve not seen any positive volume impact.

While the supplies first quarter performance was somewhat below our expectations, we have conversions lined up and remain confident that we will see a turnaround in sales for the remainder of the year in this business.

In closing, we are off to a terrific start in fiscal 2011. We are delivering the topline results in line with our expectations, improving margins and integrating our recent acquisitions, while continuing to make necessary investments in R&D, growth initiatives and business expansion to broaden our robust pipeline and drive our future growth.

I’ll now pass the call over to Chuck who will discuss the first 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 current thinking on fiscal 2011. As Rich mentioned, we’re very pleased with our results this quarter as sales came somewhat above our expectations. We had continued improvement in gross margin combined with a lower tax rate, which allowed us to deliver double-digit adjusted EPS growth for the fifth consecutive quarter.

As noted in the release, we reported a 240 basis point increase in adjusted gross margin this quarter, well above our own expectations, paced by positive business mix, recent portfolio moves, manufacturing cost savings and benefits from our restructuring program.

First quarter SG&A spending was up somewhat versus a year ago, primarily due to acquisition related expenses including amortization and spending for new product launches and investments we made to expand our sales force and businesses such as pharmaceuticals and energy.

As we noted previously, continued spending for growth initiatives, such as our Asian expansion plan, expenses related to the launches of PENNSAID and EXALGO, any impact of acquisitions will all put some upward pressure on SG&A as we move through 2011.

R&D increased 21% to 4.3% 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 two years. As planned, we continue to make progress lowering our tax rate but did even better than we’d previously expected. Our Q1 rate benefited from the extension of the R&D tax credit, a favorable geographic mix of income and further tax planning activities.

These changes are not one time events and we believe that our Q1 rate is a good indicator for our future tax rate. As noted in the release, we have modified our tax rate guidance for 2011 from the previous 20% to 21% to at or below the first quarter rate of 18.4%.

We have several tax planning opportunities that if implemented could potentially reduce the rate further. As you may recall, our rate shortly after separation was in the low 30s, so we have made some very substantial progress in the last three and a half years, primarily through global tax planning initiatives.

Next, let me take you through some cash flow highlights. We again generated good cash flow this quarter in line with our expectations, though typically Q1 is our lowest cash flow quarter of the year. While expected tax and other accrual payments reduced cash this quarter, we remain comfortable with our guidance of at least $1.6 billion for the year.

During the quarter, we bought back approximately 2.3 million shares for $100 million. This is a continuation of the $1 billion buyback program we announced last March. In the past six months, we have bought back $350 million of stock at an average price of just over $39 per share. We continue to have a stated policy to return at least 25% to 40% of our cash to shareholders each and every year through a combination of share repurchases and dividends.

Historically, we have been able to add significant economic value to our business by taking advantage of M&A opportunities and scaling up these businesses by using our geographic footprint and sizable market presence. We continue to look for technologies that enhance our new product capability both through organic research, as well as opportunistic product and company acquisitions.

As we’ve noted, any M&A we’re likely to do in the near future will be smaller and more of a tuck-in nature. However, let me be clear that we do not have any intention of simply holding cash. Our businesses generate a significant amount of free cash flow that we intend to use exclusively to add value to our shareholders.

While high return acquisitions remain our priority, we understand that those opportunities may not present themselves appropriately every single year. To the extent that technology acquisitions with superior returns are not available, you should expect us to give back even more cash to shareholders than our stated 25% to 40% goal.

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. Our Q1 results were right in line with this goal.

As we noted on our last call, the combination of operational strength and foreign exchange rates will clearly put upward pressure on our revenue and profitability targets. However, despite the ebbs and flows, exchange rates are above where they were at the time of our last earnings calls. At present levels, currency will have virtually no impact on either revenue or earnings in fiscal 2011, thus we are not changing our sales or operating margin guidance for the year.

That said, with the current operational strength and the shares we have recently repurchased, we have now more than offset the combined dilutive effects of the ev3 and Somanetics acquisitions for 2011.

With the improved results we have delivered, coupled with the lower tax rate, we believe double-digit EPS growth is possible in fiscal 2011, if our operational strength or foreign exchange rates become more positive, we will likely take that opportunity to accelerate investments and/or restructuring programs to drive our future growth. Based on our Q1 results and our current outlook, we are very confident that we can deliver on all of our financial goals for 2011.

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

Cole Lannum

Thanks, Chuck. For Q&A, we’re going to limit you to one question and follow-up if needed so we can give everyone a chance to get their questions in. If you have additional question, either put yourself back in the queue or contact us after the call. Tania, can you please once again review the process for signaling a question?

Question-and-Answer Session

Operator

Sure. (Operator Instructions) Our first question will come from the line of David Roman with Goldman Sachs. Please proceed with your question.

David Roman – Goldman Sachs

Good morning, everyone. Thank you for taking the question. Maybe one product question and then one financial question, Rich, you walked through kind of the overview of the medical device business. There obviously were some gives and takes there, I think you talked about share loss in trocars but you’ve seen strength in some of the other business.

Maybe you could just give us kind of an update on some of the key upcoming product introductions that could help stem some of the share loss and then maybe the timing of when we can expect to get some more details and I have one financial follow-up?

Rich Meelia

Sure. The -- I think one of the brightest spots for the quarter was in neurovascular, peripheral vascular, those sales have been significant double-digit growth there and they’ve exceeded what we had projected in our pro forma and then the earnings are even greater than the sales increase on a percentage basis.

So that business is doing very well and, we do anticipate a panel review on the flow diverter a product, so and there’s been other pieces of good news that have made their way here in the last just month, month and a half. So feel really good about that business, David.

The energy business, LigaSure 5 is continuing a stellar performance, it will be the most successful new product launch out of energy and that’s a business that’s launched ForceTriad, Impact, a lot of very successful product launches. So that’s doing very well.

And then in surgical, the Tri-Staple is really beginning to take hold and we’ve seen -- we’ve been seeing the impact of Duet and that continues to do well, and Tri-Staple is now showing real traction, and I think that had a lot to do with our success in stapling.

When we launch or when we present it at SAGES, there will be new products that we will be talking about and they’ll be very exciting, I mean, we’re -- I don’t think we’re in a position to talk about those today but I will say that we were pretty excited last year when we launched 14 new products and we had buttons that reflected 14, but after having gone through that, it was really too much and it was difficult to control the cadence and the training and the sales force education and the focus.

And so, I don’t think you’ll see 14 and part of that is just there’s a normal cycle of new product flow but part of it as well is just managing the cadence of product launches so that you can, I think, we learned a few things with Tri-Staple and now almost a year later we’re starting to see some new traction from that.

David Roman – Goldman Sachs

Okay. And actually, I was hoping you could expand a little bit more on international, I mean the 2% constant currency growth in Medical Devices, I think that’s the lowest growth rate since the company has been public or close to it, I know that you exited Greece in the fourth quarter, which obviously had a negative impact, but I still think adjusting for that, this was a pretty tough quarter.

Can you maybe just help us understand a little bit what’s happening in the operating environment there, I think on the November call you said that you were starting to see signs of weakness in Europe? Did that get worse this quarter and how are you thinking about that for the rest of the year?

Rich Meelia

I think Europe is -- it’s a big business for us. It’s a mature market and what we’ve seen, historically, it’s been kind of a low to mid single-digit growing market for us. And over the last couple quarters, we’ve seen basically flat environment and it’s clearly reflective of what’s happening with the government concerns about health care spending.

But and so overall, that’s what you’ve seen just kind of a flat performance. It varies by product category product category and by geographical region within Europe. So, we do believe it’s cyclical and I think what’s helped us is that we’ve got some really good growth engines despite the difficult environment in neurovascular and energy, there’s just still lots more -- there’s quite a bit more upside in energy in Europe, if you look at the penetration of energy in Europe versus penetration in the U.S.

So, the overall international business is doing very well, just we’ve got a big piece that’s slowing. It’s not declining but it’s been flat to slow growth over the last couple of quarters and we think it will be more toward the end of the year before we start to see a return to the normal growth.

David Roman – Goldman Sachs

Okay. Thank you.

Operator

Our next question comes from the line of Bob Hopkins with Bank of America. You may proceed with your question.

Bob Hopkins – Bank of America

Thanks. Can you hear me okay?

Cole Lannum

Yeah.

Rich Meelia

Yeah.

Chuck Dockendorff

Yeah, Bob.

Bob Hopkins – Bank of America

Great. Good morning. First, for Chuck, a question on gross margin, of the strong 240 basis point improvement over last year, could you comment on how much of that was related to mix, in other words, how much of that was related to devices growing nicely but the other divisions shrinking a little bit and what I’m trying to get at is how much of that might reverse as we work our way through the rest of the year and those other divisions start to grow again?

Chuck Dockendorff

Yeah. Bob, the 240 increase, what was nice too is we also saw a nice increase from Q4. It was up 140 basis points in Q4, so sequentially it was a nice improvement in gross margin and that’s where a little exceeded our expectations on that piece of it.

But, again, it’s consistent with what we’ve seen in the past is the breakdown of gross margin, I mean, a big component of it is the mix, we think we had the device business here growing at 11% and we had declines in pharma and supplies in the quarter and certainly, the gross margin is well above our average in the medical device area, so that is driving it.

The portfolio moves we’ve made about the same as mix, where you’ve got the divestiture of some of the lower margin business in the radio pharmacies and sleep and oxygen and of course, you’re adding in some of the higher margin businesses on ev3.

We also had good cost reductions year over year, about 80 basis points of that improvement is from cost reductions. And we continued on, I think we gave guidance of price degradation of 50 to 100 basis points in a year. We’re right around 60 and a bigger portion of that was related to the pharmaceuticals business, which was in the generics or the specialty generic side of it as we anniversary that kind of price decline we took in the third quarter.

So it’s a continuation of the same components we’ve seen in the past and I would expect that through the course of the year, the mix and the portfolio moves will continue to go up. The portfolio moves I guess by the end of the year will drop off a bit as we anniversary some of those deals.

Bob Hopkins – Bank of America

So throughout the rest – throughout the next three quarters of the year then you wouldn’t expect more than a 50 basis point or 60 basis point drop-off from what you’ve seen here in the first quarter? Is that a fair way to think about it?

Chuck Dockendorff

No. We don’t want to give guidance specifically, I think we see an improvement in gross margin over the prior year and I think, what will drive that improvement in the gross margin is the mix of the portfolio moves and the cost reductions overall.

Bob Hopkins – Bank of America

Okay. And then just real quickly, Chuck on, could you just give me a sense as to if you kind of look at real underlying growth rates in the quarter, excluding divestitures and acquisitions, in the medical device division, what was the growth rate excluding the acquisitions? And then for the whole company maybe relative to that 5%, what was the real underlying growth rate if you exclude the one-time acquisition divestitures?

Chuck Dockendorff

Yeah. I think we gave guidance of an underlying growth in devices of 3% to 5%. With all of those portfolio moves, I think we’re right in there and as well as overall we gave 2% to 4%, and I think the company is right in the middle there. So I think we right, hit it right on where we thought we would be.

Bob Hopkins – Bank of America

Great. Thanks very much.

Operator

Our next question comes from the line of David Lewis with Morgan Stanley. You may proceed with your question.

David Lewis – Morgan Stanley

Good morning.

Rich Meelia

Good morning.

Chuck Dockendorff

Good morning, David.

David Lewis – Morgan Stanley

Chuck, I want to focus or maybe either or maybe Joe, if he’s on the call, I could not recall. In terms of ev3 results as we think about a couple quarters here post the integration, maybe talk about? Is the strength coming from their two coil business? Is it coming from the U.S. pipeline product or are we seeing some of those vascular synergies start to take hold?

And a related note, there have been some competitive product launches here in the early part of the quarter. Have you seen any of those product launches impact the coil business at all here in the early part of the year?

Rich Meelia

Yeah. This is Rich, David. It -- the growth that we are seeing is, I’d like to say it’s synergies with Covidien, but we have integrated backoffice functions and things that don’t affect customer facing things. So, it really is the inherent strength of that business, I mean, its integration has gone well. I believe long-term our ability to bring their product line throughout the world in a much more effective fashion and support some of the product development and physician training efforts will bear fruit and they’re probably doing some positive things right now.

But this is a strong and well-managed business, and you’re seeing growth in their stenting, in their coils, I mean they continue to take share in the coil segment. The flow diverter has done well in Europe we hope to see that approved in that tradition future in the U.S.

So I think it’s basically the strength of the business and we’ve been able to keep the management team intact. They just had their sales meeting, their peripheral vascular folks they just recently are extremely enthusiastic about their new role on the committee. And so it’s continues to do really, really well and as we said in our opening comments, we underestimated I think the earnings potential of the business.

Chuck Dockendorff

David, this is Chuck. And I think, when I was going through the results, I mean, the thing that surprised me was the growth of neurovascular outside the U.S., it was really strong. And the margins in the business, the gross margins were higher than what we had anticipated, so we see improvement there as well, so it’s nice.

David Lewis – Morgan Stanley

And Chuck, just a quick follow-up on capital deployment, obviously the messaging there at 25% to 40% of free cash has been much more encouraging. As you think about your dividend rate over the next 18 to 24 months, is there any reason to expect we could see an acceleration of that dividend in excess of the earnings growth rate? Thank you.

Chuck Dockendorff

That’s a decision we make every September, we’re committed to a dividend increase, I think commensurate with the growth we have in the business. We had an increase last year and we have one coming up this year. So, I think, any how well the business does will dictate on where that dividend moves to.

Cole Lannum

Next question, please.

Operator

Our next question comes from the line of Matthew Dodds with Citigroup. You may proceed with your question.

Matthew Dodds – Citigroup

Good morning. Just a couple questions on energy. First, can you say with the total growth of 13%, whether it was skewed U.S. or U.S., just to get an idea of where the trend is?

Rich Meelia

It’s currently, this is Rich. It’s kind of a mix. It’s doing well all around the globe and it’s, I think it’s a real tribute to the inherent strength of that franchise. The -- one of the phenomena that maybe people don’t fully understand is, in Europe we are probably 50% is penetrated in terms of energy use versus the United States and there’s no reason why those should not mirror one another.

And I think it’s a function of just our need to have prioritized things as we have expanded Covidien and we in fact just this year for the first time now have a focused energy sales force in Europe, before, it was surgical and energy combined, we just had to do other things before we could get to this because you just need to focus. And so we see the penetration in Europe at about half the rate as it is in the U.S. and so, I think you’ll start to see that more penetration in some of these outside U.S. markets, but it’s pretty strong everywhere.

Matthew Dodds – Citigroup

Thanks, Rich. And then, one quick follow-up on that. On the total energy business, did capital have a better performance than usual this quarter?

Rich Meelia

Yeah. It did. It did, Matt. And we’ve kind of stopped talking about our products being long with capital just because it’s so small, but both ForceTriad and other parts of the business where you saw capital. So if you were to ask us based on our business being a harbinger of what’s happening in the capital markets, we’d say it’s kind of turning a little bit.

Matthew Dodds – Citigroup

All right. Thank you, Rich.

Operator

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

Kristen Stewart – Deutsche Bank

Thanks for taking the question. Nice results. Chuck, I just wanted to go back and expand upon your guidance commentary, make sure I understood you correctly. I think you had basically said that the current operational strength completely now offsets what was the dilution from ev3 and Somanetics. And then if operational or FX becomes more positive, you said you’re likely to reinvest the results, is that correct?

Chuck Dockendorff

Yeah. I think the comment we wanted to get across was our goal is the double-digit earnings per share growth off of our baseline sales growth and we began this year -- we weren’t quite into that goal, a big piece of that was FX, a little over 5% earnings per share growth. And I think now, as we see the benefit we’re getting from FX and some of the better results in the acquisitions we are doing and just better underlying base business strength and gross margin improvement, we feel very comfortable about achieving that double-digit earnings per share growth this year. So that’s probably the biggest change we’ve made here in the guidance and still within the parameters of the guidance ranges we gave down the P&L.

But, we want to reserve the right, as we go through here to, that’s our goal and there are other opportunities that we could invest in. We could accelerate plans in Asia and things like that to drive even more investment to get better results there. So at this point, we’re comfortable achieving a double-digit EPS growth and continuing to invest in the business and there may be further opportunities.

Kristen Stewart – Deutsche Bank

Okay. So that would be reinvesting in your current businesses, not necessarily using some of that upside to fund maybe a more accelerated tuck-in acquisition strategy, is that how we…

Chuck Dockendorff

That’s more funding of the existing businesses. That’s correct, Kristen.

Kristen Stewart – Deutsche Bank

Okay. And then just in terms of the individual sales guidance, are you still comfortable with the Med Device, pharma and supply guidance that you outlined earlier?

Chuck Dockendorff

Yeah. We are, we are very comfortable with the guidance that we’ve given.

Kristen Stewart – Deutsche Bank

Okay. Perfect. Thank you.

Cole Lannum

Thanks, Kristen. Next question, please.

Operator

Our next question comes from the line of Mike Weinstein with JP Morgan. You may proceed with your question.

Mike Weinstein – JP Morgan

Good morning. Thanks for taking the question. Just, if you could just spend a minute on the pharmaceutical business, you mentioned you thought you had some inventory stocking during the quarter, could you just touch on that a little bit more?

Rich Meelia

Yeah. Mike, it’s Rich. It seems like every year, as the quotas get finalized, dealers tend to take in more or less based on how much quota gets approved. And so, we sometimes see this type of activity at the end of the year and that’s what -- at the end of the calendar year, end of our first quarter. So it’s nothing exceptional, nothing that is unprecedented. It’s just something that typically happens and it happened again.

Mike Weinstein – JP Morgan

Understood. The resolution of the, well, I guess, the resolution of your dispute with Masimo and then the extension of your agreement with them under the new terms. Beyond just the change of the economics that appears under the agreements if you have a little bit more latitude to introduce new products and not necessary always be stuck with the older technology, which was basically your existence under the prior agreement. Can you talk about how that might impact your competitiveness and when you might start to benefit from that?

Rich Meelia

Yeah. I mean, we do believe it’s a -- there’s two benefits from the deal. One is the low royalty rate that’s very calculable. The other piece, does is like you said, the ability to innovate more freely than we could in the past, especially as you think about the other monitoring parameters that we brought into the company with Somanetics and Aspect.

And, when will you see it, it will probably be quarters away, but this definitely breathes new life into the, I think the product development capability and opportunity at the monitoring business. So it was a big deal and it was -- we believe this was a win-win for both parties and I think, it’s going to help us on.

Mike Weinstein – JP Morgan

Okay. Last item, can you just comment on the progress on hiring a replacement for Tim?

Rich Meelia

Well, we’re moving along quite well. There’s the level of interest as I mentioned. I think, previously we spoke in San Francisco is quite high, especially as compared to three, four years ago. So, I think we are looking probably in the next 60 days, we believe we will have been through -- we’ve got people scheduled for interviews coming up in the next four to six weeks. So I’m hoping by the next 60 days we should have be very close if not have made some announcement.

Cole Lannum

Thanks Mike. Next question, please.

Operator

(Operator Instructions) Our next question will come from the line of Joanne Wuensch with BMO Capital Markets. You may proceed with your question.

Joanne Wuensch – BMO Capital Markets

Thank you very much for taking the question. I have two, could you please share with us what the Med Device division’s organic growth rate was, ex-acquisitions, ex-foreign exchange?

Chuck Dockendorff

Yeah. I think we answered that earlier in the call. We had given guidance at the beginning year of 3% to 5%, ex all of the portfolio moves and deals and everything we’re right in line with that.

Joanne Wuensch – BMO Capital Markets

So you’re not giving me a specific number, just somewhere between 3% and 5% in the first quarter?

Chuck Dockendorff

That is correct.

Joanne Wuensch – BMO Capital Markets

Okay. Second question I had to with ev3, could you please provide us an update on some of the new products that they have in the pipeline, like pipeline?

Rich Meelia

Yeah. I mean, pipeline is one of the more exciting ones and that’s for wide-neck aneurysms and it’s been approved in Europe and I believe our sales were somewhere around $20 million or so last year. And we have heard from the FDA that there’s been no announcement but I believe there’s, we should see something scheduled in the very near future relative to approval, panel approval. So we feel pretty good about that.

And then there’s, they continued to launch new stents and new coils. There’s a multitude of clinical trials that are designed to either introduce new products or strengthen clinical evidence for hepatectomy itself, as an example. I mean, the penetration for these technologies is still very, very low and so our ability just to develop the markets more for the current products that are on the market is a huge growth driver too.

So it’s not -- it’s, in many respects it’s like bariatric surgery, where there’s tremendous growth. You see new technologies coming in but that all just means there’s more opportunity because there is -- it’s such an under penetrated market, this is very similar.

Joanne Wuensch – BMO Capital Markets

Okay. Thank you very much.

Rich Meelia

Yeah.

Cole Lannum

Before the next question, I just want to clarify one thing. We expect to hear from the FDA soon on the panel meeting. Obviously, FDA approval will be at some point beyond that. Next question, please.

Operator

Our next question comes from the line of Glenn Novarro with RBC Capital Markets. You may proceed with your question.

Glenn Novarro – RBC Capital Markets

Thank you. Good morning, guys. Two questions for Chuck. First, Chuck, I’m wondering if you can expand a little bit more on the tax rate going lower. Early this year, we’ve seen most of the companies in the group raise their tax rate, you’re actually lowering your tax rate and it looks like there’s more room to go. So perhaps expand a little bit more on how you are able to bring the tax rate lower in the face of most of the companies in the group raising tax rates?

And then the second question has to do just with R&D. R&D did come in a little bit lighter, the ratio is closer to 4% to 4.5%, is this ratio going to move higher throughout the rest of the year? Thanks.

Chuck Dockendorff

Yeah. Two comments, first of all on the tax rate, I think Glenn, we’ve been doing some, well, let me just back up a little bit. Our tax rate, again, is based upon where we earn income around the world. And we certainly do put tax planning initiatives to take advantage of that situation and I think, one of the things that’s unique about Covidien being that we are outside the U.S., is that these are really permanent kind of tax differences. A lot of other multinational companies earn money around the world and have cash sitting there, but as they take that cash back into the U.S., they have to take taxes, and that’s not always built into their rate whereas ours is a permanent rate that you see down there. And it gives us access to the cash around the world so we can be a little bit more aggressive on our balance sheet and get access to that cash for investment.

But the tax rate itself, we came out of the fourth quarter at 19.5%. That was a little bit below our guidance and that we had given for the year. And since that point in time, as you know, the R&D tax credit got approved. So that brought our rate down by about 0.5 basis point.

The other components of that relate to where again with the stronger currency, we have higher income outside of the U.S., which is typically in lower tax jurisdictions, so that’s driving the rate down as we look at that mix of income and it’s based on a full year forecast. So, those are kind of the drivers that can take that rate up or down as we move towards them. So those are the drivers and what we do is through, again the tax planning initiatives, it’s all driven around where we earn the income around the world.

As far as R&D, you are correct, the 4.3% is a little lower than what we have had in the past and it was really one of the reasons our operating income was even higher in the first quarter. I think it was 4.7% in the fourth quarter, so it was a little lower and that’s typical as you get to the end of the year, people are finishing off programs and things like that. But it’s more timing of the spending and we would expect the R&D percentage to increase during the course of the year by quarter.

Glenn Novarro – RBC Capital Markets

Just one quick follow-up on the tax rate, so as long as your U.S. sales remain strong, we should assume the tax rate remains low and I guess it sounds like there’s still room to move lower not just this year but fiscal 2012 as well. Is that correct?

Chuck Dockendorff

I think yeah. We would see, then again is barring any changes in tax laws and regulations and all of that. There’s a lot of talk around that. But yeah, our goal is that we see opportunities for further reductions as we go forward.

Glenn Novarro – RBC Capital Markets

Okay. Thank you, Chuck.

Operator

Our next question comes from the line of Rick Wise with Leerink Swann. Your may proceed with your question.

Rick Wise – Leerink Swann

Thank you. Good morning, Rich. Good morning, Chuck. I mean, if we could talk about operating margins for a minute, if I recall correctly, your operating margin guidance for the year was 21% to 22% range. You’ve really had an amazing start to the year on the gross margin front and operating margins in the first quarter were 22.2%.

Can you update us, I mean, it seems to suggest that if you’re going to spend a lot more on SG&A and R&D than we’ve modeled or that operating margins for the year could maybe be similar at the end if not higher, how do we think about that?

Chuck Dockendorff

Yeah. I think we had a great quarter in operating margin and I think I just mentioned on the R&D that was a little lower than what we anticipate going forward and just on the timing of some of the expenses around that. But I think, Rick, if you go back and look at our quarters in the prior year. Gross margin is going to fluctuate a little bit quarter by quarter because of the mix of our own business. So if you think about the first quarter, we had very strong growth in devices, we had declines in pharma and supplies in the sales growth for the quarter. We expect, especially in supplies, we’d have to turn around later on. So, supplies will become a bigger piece of that overall mix.

And I think that’s where you’re going to see potentially some fluctuations right now. Certainly, we’ve started off on the quarter with a very good improvement in gross margin but I would tell you to go back and look at the gross margins we achieved by quarter last year and you see 140 basis point difference quarter-by-quarter and that’s what can happen. Now we’re very comfortable with kind of an improvement in gross margins for the year because the trends that we mentioned will continue on in that way, the mix and the cost reductions and the moderate pricing declines and things like that. But, with the fluctuations, we’re not sitting here ready to go and say that we’re ready to move up the operating margin.

And again, I think the key comment that I wanted to get across today is that we’ve moved earnings per share growth, if you look at consensus a little over 5% prior to the call. We think now that we have a very good shot getting to that double-digit earnings per share growth with these better operating results within the business.

Rick Wise – Leerink Swann

Okay. And maybe for the second question, some points on the pharma division. Couple things, I know you have an ANDA pending, can you update us there? And I think, Rich, you had mentioned that the second half to state the obvious that you anniversary some of the issues and we get back to more normal growth, I think were your words. How do we think about normal growth for the near-term, ex some of these pricing et cetera issues? Thanks.

Rich Meelia

Yeah. And well, to answer the second question first, if you were to remove the radiopharmacies -- of that, then I think, the overall pharmaceutical business would be kind of low 1%, 2% growth. So, a big part of the decline is that and so when that goes away, you will see a pretty big swing back to a positive sales growth.

I think once we begin to get I think the benefit of some of the sales from the branded pain products and to answer your first question, feedback from FDA continues to be very positive. We’ve said that we had hoped to have that product approved within the first two quarters of our fiscal year. We still believe that’s possible but you just never know with a regulatory approval, but we still believe that’s very, very possible and quite probable.

And so once everything settles in, we do believe that that if you look historically, that’s been kind of a 5% growing business in the aggregate over the last several years and a combination of new product launches and erosion on the generics side that is inevitable, that we should see that growing including the imaging business at that mid single-digit, 4%, 5%, 6% rate.

Rick Wise – Leerink Swann

I appreciate that. Thanks.

Cole Lannum

Thanks.

Operator

Our next question comes from the line of Paul Choi with Caris & Company. Please proceed with your question.

Paul Choi – Caris & Company

Thank you. Good morning and thanks for taking the question. Rich, maybe on endomechanical instruments, I think you’ve indicated that you expected a bit of a pickup in GI procedures over the course of this year. Could you maybe just sort of indicate how you’re feeling about the product pipeline right now in that area and is there anything else that we should look for that might sort of help that area where I think you’ve indicated you’ve said -- you’ve seen a little bit of competition there?

Rich Meelia

Yeah. Well, I mean, first of all is I think it’s important to remember that these are global markets and these -- the new products that we launched still have huge runway. The full launch of Tri-Staple, which we believe to be a fairly revolutionary change in the ability to ensure stable closure, staple -- good solid staple lines. It is just -- it was designed to be a phased in launch and we’re just coming to the point where we’ll have most of the product line converted.

And so we’ve been launching primarily U.S., Europe but then we go into the emerging markets as well, so I just want to make sure people understand that we have $1 billion in product revenue I total, not just surgical, outside the U.S. in what we call emerging markets, Asia, including Japan, Australia, Latin America, Eastern, Central Europe and the Middle East. That’s $1 billion and growing at double-digit and just is happening in the whole company, it’s devices that’s driving that business.

So, but you’ll also see some interesting things from surgical relative to the use of power and instruments. I don’t believe we’ve made any announcements relative to some of the pretty exciting things that we expect in energy and so, other than the Precise – [Precise plus], which has been launched in Europe for head and neck uses, and that will be launched later this year in the U.S.

And that’s typical of what happens in energy, they either find new procedures for existing products where energy can provide more security and efficiency and faster throughput or we’re finding new products that open up procedure use. So, the product throughput coming on at both surgical and energy is really, really strong.

Paul Choi – Caris & Company

Okay. Thank you for that. And then a question for Chuck, on the restructuring charge you took this quarter little larger than we were thinking. Is it just more sort of one-time sort of compensation or separation expenses or how should we think about perhaps the incremental savings on sort of a run rate going forward?

Chuck Dockendorff

Yeah. I think that’s the second part of our restructuring program, which is $200 million and the timing of those charges, a lot of it is built around the announcements and things like that and includes asset write-offs and intangible write-offs, as well as severance and things like that. So, I think we’re about $140 million through that program, a lot of those savings of the other program we did, which is the origin one $150 million are flowing through and some of these -- and the second program we have, the $200 million program, they were also flowing through and that’s what’s driving some of the margin increase there.

And when I talk about an 80 basis point reduction in manufacturing costs, a lot of that is from those restructuring programs we’ve instituted. So we’re very well along on that program. We also have other opportunities outside of it but we feel pretty good about those programs. And the timing and the expenses of that again will fluctuate quarter-to-quarter based upon as we execute the programs themselves.

Paul Choi – Caris & Company

Okay. Thank you very much.

Cole Lannum

Thanks Paul. Next question, please.

Operator

Our next question comes from the line of Ben Yeoh with Atlantic Equities. Please proceed with your question.

Ben Yeoh – Atlantic Equities

Thanks for taking my question and hello from London. I think you mentioned that a lot of your recent acquisitions are going at or above expectations. I thought maybe could you detail what is perhaps going at above expectations and maybe if anything is going maybe below expectations and how those trends could play out over the rest of 2011? Thanks.

Rich Meelia

Sure. We have been a pretty active acquirer over our entire history the last 10 or 15 years. So we believe our acquisition capability is a core competency and part to that skill base is we carefully do post-deal evaluations every three months, six months, nine months, et cetera, just to see how we’re doing, so we track it carefully.

And, if you look at the three most recent ones, which would be ev3 and Somanetics and ev3, all of them are exceeding their sales pro forma and we do base case, worst case, best case on all of these pro forma’s and so we, then they are measured off the base case.

And the operating equipment -- mostly operating margin is exceeding the pro forma as well and so, I think, it’s just been a matter of, I think, in the respiratory ones, Aspect and Somanetics the business did a very nice job of bringing them in, integrating the sales forces, integrating it into our international infrastructure, whereas ev3, it really has been just the solid performance of that business continuing what they did prior to -- being prior to Covidien and then as we brought them into Covidien, we had a pretty seamless integration, less so of an integration than Somanetics and Aspect.

And as I said, before more just I think a continued strong performance, as they understand their markets, their customers, their products and just do a good job of executing, and so we feel pretty good that you’ll see that continuing throughout 2011.

Ben Yeoh – Atlantic Equities

Thanks. So you’re saying versus topline is doing better than expected, but also that the margin and I guess on the expense side is doing a little bit better as well?

Chuck Dockendorff

Yeah.

Ben Yeoh – Atlantic Equities

Okay. Thank you.

Chuck Dockendorff

Yeah.

Cole Lannum

Thank you. Next question, please.

Operator

Our next question comes from the line of Adam Feinstein with Barclays Capital. Your may proceed your question.

Adam Feinstein – Barclays Capital

Thank you. Good morning, everyone. Everything looked really strong, but just maybe a couple of just quick questions here. I guess first, do you think the market growth rate picked up slightly relative to last quarter, just curious or do you guys think you took market share here, so just wanted to get some color there?

And I know you talked about pricing being down about 60 basis points, but couldn’t recall what that number was last quarter. I know your guidance was for it to be down 50 to 100 basis points but was just curious if pricing had picked up slightly?

Rich Meelia

Yeah.

Chuck Dockendorff

Yeah. On the pricing – on the pricing side, Adam, it was about the same maybe a little bit less, but we’re talking about basis points of a difference.

Adam Feinstein – Barclays Capital

Okay. And what about the market share gains, it was relative?

Rich Meelia

Yeah. I mean, first of all, we make these are observations, Adam, and it’s hard to know with great certainty what’s happening within a quarter, especially as you gauge share gains. But, our stapling results were really strong and I don’t believe that they reflected just a market pickup. And so that’s why we said in our opening comments we do believe that there may have been some share gains in stapling just because the numbers were strong in the U.S.

Adam Feinstein – Barclays Capital

Okay. And I guess just maybe a quick follow-up. Last year was a big year for deals and you guys had said at the Analyst Day that this would be -- you anticipated fewer deals this year, but just a lot of the things we’re hearing broadly is about increased M&A just overall. So just curious what your appetite is, it seems like things have gone really well with what you guys acquired last fiscal year. So to the extent that there were more assets for sale, I guess, how are you guys thinking about that and just wanted to get updated thoughts there? Thank you.

Rich Meelia

Yeah. I don’t think our interest and level of activity pursuing deals has changed. It’s just, it’s unpredictable how deal flow will go because it takes two parties to make a deal a reality. We don’t -- we haven’t obviously announced a deal and I’d have to say there’s nothing really pending at this point, we’re looking at things, but it’s really focused on staying within our franchises and identifying technologies and/or commercialized products that with technology that can add to our capability within our franchises. That’s really where we’re focused and it tends to kind of come in bunches.

And so, we’re actively looking and when the right deal comes along then we’ll execute on it. But we’re not concerned. We, obviously, our first quarter is very strong and I think it’s a function of the strength of the franchises in which we compete and so the deals that we have done have gone well and are providing lots of growth right now.

Adam Feinstein – Barclays Capital

Okay. Thank you very much.

Cole Lannum

Operator, it’s getting close to 9.30. We’ve time for one more call. For all the rest of you that are still in queue my apologies. We’ll take your calls offline. Go ahead, please.

Operator

Our final question will come from the line of Jayson Bedford with Raymond James. Please proceed with your question.

Jayson Bedford – Raymond James

Thanks. And good morning and thanks for squeezing me in here. Just one quick one to follow-up on your commentary on the Tri-Staple launch. Have you now introduced all the sizes and maybe kind of what percentage of your accounts have you introduced it to and maybe on a percentage basis, how many have converted to the technology? Thank you.

Rich Meelia

Yeah. I can tell you, Jayson, we have introduced all the sizes. I can’t, I wish I had that kind of detail at my fingertips, but the number of accounts that, I mean, certainly not all. I mean, one of our challenges when we introduce something like that is your current customers want to get the new technology and then once you satisfy those people, you’re wanting to go into competitive accounts and so just a constant push and pull of those phenomena. But, suffice to say, I mean, this is very early days with this conversion. And I would say that we have successfully oversold our anticipated forecast for that entire product line.

Jayson Bedford – Raymond James

Fair enough. Thank you.

Rich Meelia

Okay.

Cole Lannum

Okay, Operator. Everyone, thank you for joining us. Starting at noon Eastern Time today, a replay of the call will be available. Additionally, the replay will be available on our corporate website, covidien.com, a few hours from now. For members of the media who have listened to the call, have additional questions please contact Eric Kraus, our Head of Corporate Communications. For those of you still left in queue, my apologies and for anyone else having more detailed questions involving non-material information, I will be available to take your calls throughout the day. Thanks and have a great day.

Operator

Thank you for attending today’s conference. This concludes the presentation. You may now disconnect and have a great day.

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