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Executives

Charles Dockendorff - Chief Financial Officer and Executive Vice President

José Almeida - Chief Executive officer, President and Director

Coleman Lannum - Vice President of Investor Relations

Analysts

Matthew Dodds - Citigroup Inc

Michael Matson - Mizuho Securities USA Inc.

David Turkaly - Susquehanna Financial Group, LLLP

David Roman - Goldman Sachs Group Inc.

Michael Weinstein - JP Morgan Chase & Co

Robert Hopkins

Jayson Bedford - Raymond James & Associates, Inc.

Kristen Stewart - Deutsche Bank AG

Frederick Wise - Leerink Swann LLC

Thomas Gunderson - Piper Jaffray Companies

David Lewis - Morgan Stanley

Lawrence Keusch - Morgan Keegan & Company, Inc.

Adam Feinstein - Barclays Capital

Covidien plc (COV) Q3 2011 Earnings Call July 26, 2011 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 Covidien plc Earnings Conference Call. My name is Anika and I will be your operator for today. [Operator Instructions] As a reminder, this conference call is being recorded for replay purposes. At this time, I would now like to turn the call over to Mr. Cole Lannum, Vice President, Investor Relations. Please proceed.

Coleman Lannum

Thanks, very much, Anika, and good morning, everyone. With me today are Joe Almeida, Covidien's 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 as usual answering your questions. The press release with details of our fiscal third quarter results was issued earlier this morning and is available on our website and on the newswires.

And during today's call, we'll be making 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. A reconciliation of non-GAAP to GAAP measures can be found in our press release and its related financial tables, as well as in the Investor Relations section of our website, covidien.com.

For the third quarter, we reported GAAP diluted earnings per share of $1.06. After adjusting for certain specified items, our non-GAAP earnings came in at $1.01 per share. Now I'll turn it over to Joe who will go in to more detail on third quarter results. Joe?

José Almeida

Thanks, Cole. Overall, we had another good quarter. Sales were strong with 14% growth. We again made a significant improvement in gross margin, delivered a 14% increase in adjusted operating income and a 19% gain in adjusted EPS. This is the fourth quarter in a row that we have exceeded our internal expectations on the bottom line. In our large Medical Devices segment, we had another solid quarter, with broad based growth led by Vascular and Energy products. We saw little impact from additional pricing pressures as a result of the austerity efforts in Europe. While we remain cautious on European markets given overall business conditions and austerity measures, we are pleasantly surprised that European results came in slightly ahead of expectations for the second quarter in a row.

In Endomechanical, we registered good growth for stapling, fueled by the success of Tri-Staple, which continues to perform very well. In the Soft Tissue Repair category, sales growth was led by sutures, aided by further success of the innovative V-Loc products. This growth more than offset lower sales of mesh and biosurgery products, but I'd like to highlight that in synthetic mesh and fixation, we showed positive growth as we likely took market share this quarter. Biologic mesh sales were well below a year ago.

Our Energy business again delivered a strong double-digit top line performance led by vessel sealing where new products such as the LigaSure 5mm and small jaw are having a positive impact. In Vascular, our traditional business was up mid-single digits, led by solid growth for Chronic Venous Insufficiency products. On an apples-to-apples basis, sales of ev3 were up more than 20%, though, as you know, we did not report ev3 in our results last year.

Turning to the Pharmaceuticals segment. We delivered a good quarter. Sales were ahead of expectations, though, somewhat below a year ago due to the initial restocking orders for EXALGO and PENNSAID that occurred in last year's third quarter, coupled with the U.S. nuclear pharmacy divestiture. The Generic business registered good growth, faced by increases for the fentanyl lozenge and the launch of the fentanyl patch. Operationally, sales of Contrast Products and the active pharmaceuticals ingredients were both above even with last year.

In Medical Supplies, sales were on plan this quarter and were again up sequentially. While margins were negatively impacted by higher raw material prices, the business continues to meet our expectations and provides good cash flow and ROIC. Before I turn the call over to Chuck for his comments, I'd like to take a moment, since this is my first call as President and CEO, to discuss my philosophy on running Covidien.

I am very pleased and honored to be succeeding Rich Meelia. I admire the great job that he did in transforming the company. He was a strong leader and set the stage for us to succeed. And we are fortunate that Rich will be staying involved as nonexecutive Chairman of the Board of Directors. Looking forward, you should expect no significant change to Covidien's strategic direction. Our 5 strategic imperatives: innovation, portfolio management, globalization, operational excellence and talent management, have not and will not change.

I recently met with our top 170 senior leaders to outline my vision for the company. At the meeting, we discussed the key initiatives that will drive our future growth in an increasingly challenging healthcare marketplace. Our focus remains on delivering long-term mid-single digit sales growth and double-digit EPS growth, achieved through a combination of operational and financial leverage. This growth will be achieved by delivering clinically and economically advantaged products and solutions.

We will continue to drive innovation with increased R&D investments to deliver a steady stream of new products in all of our businesses.

We will aggressively expand in emerging markets, particularly Asia and Latin America. We'll look for opportunities to expand our portfolio through tuck-in acquisitions and licensing agreements. And we remain committed to maintain our strong investment grade rating, to use our balance sheet flexibility and significant free cash flow to make investments necessary to grow the business, and to be prudent in our allocation of capital.

So all in all, you can expect to see us do what we've been doing successfully for the last 4 years, with no major changes in the strategic direction. I'll now pass the call over to Chuck who will discuss the third quarter in more detail. Chuck?

Charles Dockendorff

Thanks, Joe. I'll focus the majority of my comments on the items below the sales line. As Joe mentioned, we are pleased with our performance this quarter as sales came in on plan, we had strong improvement in gross margin, and our operating margin and EPS both exceeded our expectations.

As noted in the release, we reported a 150 basis point increase in gross margin this quarter, paced by positive business mix, recent portfolio moves, benefits from our restructuring programs and favorable foreign exchange. This improvement was restrained somewhat by an uptick in raw material prices, primarily in the supplies business.

Third quarter SG&A spending was up versus a year ago, primarily due to acquisition-related expenses, including amortization, coupled with unfavorable foreign exchange. R&D increased 27% to 4.7% of sales in the quarter and we remain committed to our goal to further increase R&D over the next few years.

Our third quarter adjusted tax rate was below prior quarters as we executed some tax planning activities and had a more favorable geographic mix of income. Overall, though, our year-to-date rate is consistent with the guidance we gave last quarter.

During the quarter, we launched a new restructuring program as we continue to see opportunities to improve our cost structure. We expect to incur a pretax charges of approximately $275 million for this program between now and the end of fiscal 2014. The previously announced restructuring programs have been as successful in reducing our manufacturing footprint to 53 factories, a decrease from the 64 we reported in 2007. This translates into a 17% reduction in square footage. The reduced footprint lowers our manufacturing costs as reflected in increased gross margin, and also lowers our ongoing capital expenditures and the maintenance expense for our facilities.

Once completed, annualized savings from this new restructuring program are currently estimated at $175 million to $225 million. This incremental set of initiatives should help us continue to leverage our profitability higher over time.

We again generated strong cash flow this quarter, with free cash flow of about $575 million. During the quarter, we repurchased $276 million of stock. Over the last 12 months, we returned more than $1 billion in cash to shareholders, representing more than 50% of our free cash flow over that period.

This is well above our stated goal of returning 25% to 40% of free cash flow to shareholders, but is consistent with our prior comments on capital allocation. While high return acquisitions remain our priority, those opportunities have not presented themselves appropriately this year. Our recently acquired assets, ev3, Somanetics and Aspect, have all performed better than expected in revenue, earnings and return on invested capital.

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 as we have over the last 12 months. While we need to retain a certain level of liquidity on our balance sheet, we have no intention of accumulating cash.

Next, I'd like to briefly discuss our 2011 outlook. As you know, our long-term goals remain to deliver mid single-digit sales growth and double-digit earnings per share growth, achieved through a combination of operational and financial leverage. We have met these goals since going public in 2007, and once again achieved them this quarter. Consistent with past practice, we will not be updating our guidance for 2011 today. As you can see, our year-to-date results are right in line with the guidance we provided in April and we do not expect any significant changes for the fourth quarter.

As always, these comments assume foreign exchange remains constant at today's rates and exclude the impact of any onetime items. As a reminder, under GAAP rules, our fourth quarter 2011 will include an extra selling week. The extra week will mean that both revenues and expenses, including SG&A, will be higher than they otherwise would be. During the quarter, we will continue to make incremental investments in cost-orientated growth initiatives across the organization where appropriate to ensure continued competitive revenue growth as we look into 2012 and beyond.

Finally, as you may recall, last quarter, we mentioned that we expected to be paying out about $400 million, net, sometime this fiscal year related to pre-spend tax matters, including the tax sharing agreement. The timing of a portion of this payment has changed, and we now expect that only about $200 million will be paid in fiscal 2011. As we have discussed before, the timing of these payments are very unpredictable and will affect our operating cash flow.

I'll now turn the call back to Cole for Q&A. Cole?

Coleman Lannum

Thanks, Chuck. For questions and answers, I'm going to remind everyone again that we're 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 and we'll be stopping the call probably at 9:30 a.m. If you have additional questions, either put yourself back in queue or contact us after the call. Anika, one more time, can you please review the process for signaling a question?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Bob Hopkins with Bank of America.

Robert Hopkins

So first, a question for Joe, and first of all, congratulations on a solid performance in a very challenging environment. But, Joe, I was wondering if we could get your take on the current operating environment. There's lots of conflicting data points out there. So my question to you is, do you see the market environment for your device business as basically similar to what we saw last quarter or has it deteriorated a bit and your strong performance is due simply to your product pipeline delivering above expectations?

José Almeida

Bob, I tell you that I see unchanged environmental forces between Q2 and Q3. We saw no further deterioration of the market, not only in Europe, but also in the U.S. And I have to add that our performance has been aided by launch of new products and again market share, primarily in endostapling, and some other categories such as some Vascular products as well as Energy products.

Robert Hopkins

Okay. Great. For my second question, I wanted to ask Chuck a few quick things. One, from a big picture perspective, I know we'll have to wait until September 2012 for a detailed guidance, but you do have a tougher comparison next week based on the good performance this year or next year based on the good performance this year and the one less selling week next year. So can you still deliver double-digit EPS growth in fiscal 2012? And then for a more detailed question on the tax rate, what do you think is a sustainable rate? And if you could give us some perspective on what percentage of your profits run through Ireland, that would be very helpful for us as we consider things in the future.

Charles Dockendorff

Sure. Just for the big picture, we will be giving guidance at Investor Day. I think you've heard both Joe and I say in our prepared comments that we want to drive towards this double-digit EPS growth on a consistent basis. And it's a little early to commit to that for '12, but certainly that is our goal. There's a lot of factors that come into that with any one year, foreign exchange, and of course, the environment and things like that, but we are committed to drive to that over time and see that as achievable in the foreseeable future based upon the strategic plan we have and some of the planning activities we've gone through. As far as the tax rate, in the quarter, it was low and you can see that, that really is the year-to-date catch-up of some tax planning activities that we initiated within the quarter. I think if you look at the year-to-date rate, it is 18.3%. It's more of a rate that we see going on this year, and it's consistent with the guidance we gave in the past. The comment we've made about taxes -- we've had significant decrease in our tax rate over the last couple of years and we don't see that happening again. But we see opportunities for improvement in the tax rate going forward, but at a much more marginal level. That's, again, I think, there's a lot of talk going around at various companies about tax range, so that's assuming the environment stays as it is. And finally on Ireland, there does seem to be confusion on that. Our tax system or the way we are situated is a little different. We pay taxes where we earned the income, in the countries we earned the income. So any change in any country on the tax rate will have an impact on our tax rate, overall, for Covidien. However, in Ireland and that's where our headquarters are, we only pay income on the tax we earned in Ireland. And while there could be changes in the tax rate in that country and there's discussions about it, we would pay those increased taxes in that country, but it would be immaterial to Covidien's overall rate. And that's where we are a little bit unique from the other multinational companies located in the U.S.

Robert Hopkins

But the percentage of profits that runs through Ireland is roughly...

Charles Dockendorff

We're not really disclosing that but, Bob, it's really immaterial to us overall.

Coleman Lannum

Bob, think of it is not being disproportionate to the overall size of Ireland from a GDP standpoint as part of the world.

Operator

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

Adam Feinstein - Barclays Capital

Adam Feinstein with Barclays Capital. I just wanted to say, first of all, good quarter. And then just wanted to ask, there is a lot in the press about strategic alternatives around the pharma business, and I just wanted to get your thoughts in terms of what you can say and if that's something you can't answer, maybe just help us think about your thought process in terms of how you evaluate your businesses and as you think about returning thresholds and things like that. So just curious to hear as you go through your strategic planning, how you would go about evaluating things?

José Almeida

Adam, we evaluate our businesses based on several differing strategic parameters, as well financials. Specifically to Pharmaceuticals, Pharmaceuticals's part of Covidien, we don't comment on rumors that are in the marketplace. But I can tell you that we work very hard to run the Pharmaceuticals business to the best of our ability. And I think the results have shown that. That business is important to Covidien. But like any business of Covidien, if there's an interest from an outside party that is more valuable to them than to us, we'll have the responsibility to take that to our board and to our shareholders. But Covidien and in its Pharmaceutical businesses is still an active part of the company and we'll continue to manage as such.

Adam Feinstein - Barclays Capital

Okay. And just a follow-up, if I may. Just as you guys, in the past, have divested businesses, and such, you've done a good job with that, as you guys, I guess, came to the conclusion in terms of selling some of those businesses, maybe just, once again, is there a certain sort of return threshold that you guys target for all of your businesses or does it vary?

José Almeida

Well, I'll answer, I am going to pass to Chuck. Our responsibility is to take every businesses, returning invested capital and move more on a yearly basis. So our strategy is designed as such. In terms of, as I said, the portfolio of Covidien is established as such to provide the shareholders the best value that we can provide them. The point that we think a business is not part or is not providing that value to the shareholders, we'll think about these strategic options for that business. At this point in time, there's nothing that Covidien needs to report in this area. I'll pass on to Chuck.

Charles Dockendorff

Yes, I think, Adam, just the way we think about it is, we certainly look at all our divestitures and acquisitions. We really look at it on a cash basis. So we're looking on the cash and cash returns and all of these businesses, we see generating a certain cash return for Covidien and we can discount that in our rate and come up with what we think the value is to Covidien and its shareholders. And then we'll assess if there are other people out there that are willing to pay more than that or that will step up to the play on that, and certainly that's an opportunity. There is certainly qualitative factors that we take into it. We've divested business in the past that just were not healthcare related. One of those was specialty chemicals, the other one was retail where we did not want to invest in those businesses going forward. One of the more difficult things as you look at the type of a Pharma business we have is the level of investments that it requires is different than what you have in devices. So that's one of the qualitative factors we will take into consideration as we think about that.

Operator

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

David Lewis - Morgan Stanley

Chuck, just a quick clarification on the buyback. Obviously, capital deployment is a major focus of this morning. As you think going forward, it sounds like 50% obviously is higher than the 25% to 40% rate. But are you now comfortable on a kind of going forward basis heading into fiscal '12 with returns to shareholders that are probably on the upper end of that 25% to 40% range?

Charles Dockendorff

Again, I think, it's all dependent, this is Chuck, it's just all dependent on the amount of acquisitions that present themselves. I mean our preference, quite frankly, is to find these acquisitions that meet our return thresholds. I think we've done, have been very successful in the past in doing this and drive more value to the shareholders by executing on these acquisitions and bringing them into Covidien. ev3, Somanetics, Aspect, some of the ones we've done in surgical have really paid off well and have nice returns and are generating the results that you see today and the growth that we're able to achieve. But again, we have financial returns around that and the amount of cash that we return to shareholders will be dictated by what acquisitions and opportunities present themselves. So I would not commit to a higher end to that range. I think with any particular year, it's going to shift. But over time, I think that range is reasonable to assume.

David Lewis - Morgan Stanley

Okay. Maybe a revenue question follow-up, I mean clearly there is a lot of strength in Endomechanical this quarter but Vascular accelerated on a sequential basis. I wonder if you could talk about the contribution of pipeline in this particular quarter and what we can think about in terms of a sustainable trend? Is there any sort of exaggerated growth in this particular quarter because it was extraordinarily strong?

José Almeida

David, no, pipeline is still in its early stages. One thing that we noticed is the accounts that are using pipeline, you have a pull-through on the rest of the products in neurovascular, so that is of some help. I think the business, overall, in terms of our neurovascular portfolio is quite rich. And also the Peripheral Vascular business is doing quite well. And within the Vascular business that as we said in our prepared remarks about our acquisition of VNUS, recall that the Venous Insufficiency business is doing extremely well. So it's doing well across the board.

David Lewis - Morgan Stanley

And Chuck, just as a follow-up to Joe's comments, in terms of Endomechanical, Energy and Vascular, they're all extremely strong in the quarter, was there anything that worked against gross margin from a mix perspective that we're sort of not aware of?

Charles Dockendorff

No, again, mix was very favorable within the quarter. It trended in the quarter pretty much like it has done year-to-date. So I didn't see anything there that drove our ratio down. I mean, when you look at the supplies business grew at 2%, that certainly has a lower gross margin than our device business so you have a little bit of mix there. No, I think, again, we stated in the past, our higher gross margin products are growing the fastest in our portfolio and that will continue into the foreseeable future.

Coleman Lannum

David, it really wasn't mix, but remember too, we did have a about a 30 basis point headwind from incremental amortization that hit us in the quarter in the gross margin line.

Operator

Your next question comes from the line of Michael Matson with Mizuho Securities.

Michael Matson - Mizuho Securities USA Inc.

I guess I just want a little more detail on the restructuring plans. I know you gave the numbers about the plants consolidation from 64 to 53, so is it going to continue to be more manufacturing, gross margin oriented or is it going to be oriented toward SG&A spending as well?

José Almeida

Michael, we've done very well in the last 2 restructuring programs and those are primarily operations driven. I think this third one that we have is continues to be driven by operation, but has a good mix of overall productivity improvement across the company, in other areas, they're not operations related.

Michael Matson - Mizuho Securities USA Inc.

Okay. And just the timing on the savings that you called out for that program, I guess, I would tend to assume that would be sort of back end loaded. Are you coming more toward the latter part of the 3-year period, I mean, is that a fair assumption?

Coleman Lannum

I think the way you should think of it is, spending will primarily be 2012, '13, '14. And the savings will come in 2013, '14 and '15, that kind of things. So yes, it gets back to you after the spending happens, you get the savings after that.

Michael Matson - Mizuho Securities USA Inc.

Okay. And just given the number of moving parts from acquisition divestiture standpoint, trying to get to your organic growth rate, so I'm estimating that you had about around $85 million net benefit from acquisitions in the quarter adjusting for the divestitures as well or about 3% growth impact. Does that sound reasonable to you?

Charles Dockendorff

I think what we've given because there are a lot of moving pieces with divestitures and acquisitions, and then there's actually growth within the acquisitions when you compare it apples-to-apples and all of that. So we went through this on Investor Day and talked about that our underlying growth of the business was 2% to 4% after we adjusted for all of those. And if you remember, we had even kind of taken that down by about 1% as we relate to the -- what we saw as a difficult environment and some austerity measures. And in the device business itself, we saw a 3% to 5% of basic, what we would call organic growth. And we see that pretty much in line and that's what we've achieved in these quarters and that has not significantly changed from that. That's the way to think about it.

Michael Matson - Mizuho Securities USA Inc.

Okay. And then just one product question. The Sonicision product in your Energy business, can you just provide an update on the timing around that and if any thing has changed there?

José Almeida

We still thinking about end of first quarter 2012.

Coleman Lannum

There is no change beyond that, Mike.

José Almeida

There's no change from what we spoke to you before.

Operator

The next question comes from the line of Kristen Stewart with Deutsche Bank.

Kristen Stewart - Deutsche Bank AG

I just wanted to, maybe, Chuck, if you could explain a little bit more on the gross margin, obviously, as Cole mentioned, you had the 30 basis points of incremental. Sounds like mix was favorable, you did mention a little bit in the prepared remarks pricing seemingly was a little bit worse, I just wanted to explore that a little bit more, too, but maybe help us bridge the year-to-year expansion in gross margin and include FX benefit, too.

Charles Dockendorff

Yes, I think as far as gross margin, we looked at the Q3 components that the -- it was and I compare that to what we've done year-to-date. Mix was pretty much in line with what we've done year-to-date. It was a little lower but pretty much in line with that. Pricing, again, I think year-to-date, we've had 40% to 50% of pricing declines that were right in line with that for Q3 as well. So we didn't see a major increase in price deterioration. The portfolio move was consistent. We had good cost reduction in the quarter that's coming through as part of the capital we've invested in some of these restructuring programs. And then FX is probably a bigger change. We had a favorable FX in the quarter, where it's been negative on a year-to-date basis. But that is beginning to change. If you think about how the currencies are year-over-year, we knew we would have negative kind of FX in the first half of the year and it would turn favorable for us here in the second half of the year, which it has. So those are kind of the drivers, pretty consistent, maybe just a little bit less on the mix and more favorable FX is the big difference in this quarter versus the year-to-date.

Kristen Stewart - Deutsche Bank AG

And could you give maybe FX on a year-over-year basis, how much that contributed?

Charles Dockendorff

Yes, I think if you -- it's interesting because it was negative in the first half. Like I said, in the total earnings so if you look through 3 quarters, it's about neutral year-over-year and that we are going to have some favorability in the fourth quarter. But on a year-to-date basis, it is neutral. But that would be negative Q1, Q2, and we have select positive in Q3.

Kristen Stewart - Deutsche Bank AG

Okay. And then just on the extra week in the fourth quarter, what generally I guess should we think about in terms of from an expense perspective? Would you -- obviously you're going to have higher sales just given the extra selling week and there must be some portion of fixed expenses, but would you be inclined to kind of spend a little bit more maybe in the fourth quarter just by virtue of having the extra selling week or should we just think about the extra week contributing what we would expect kind of if we were to normalize out for a regular quarter?

Charles Dockendorff

Yes. I would tell you it's a little difficult as we look into the fourth quarter, trying to forecast out these expenses a bit because you're right, Kristen, some of it is fixed, some of it is variable and we try to take a shot at that and do our best in this thing but this happens once every 7 years. So we're kind of going through that. And on the revenue side, in certain parts, it will have a bigger impact than others, so we're trying to gauge all of that. But we think if you just do the math on the annual basis, it's a little over 1% on revenue growth, [indiscernible] on this thing, and expenses will be a little lower than that. But we are looking for opportunities to invest. We are still looking at emerging markets and other opportunities in expanding the salesforce in Energy in places where we have some good opportunities to grow. And the earnings have been pretty good this year. So we want to make sure we are continuing to invest in the long-term of the company.

Coleman Lannum

Let me just add one thing, Kris. I think it's important that people look at this on a holistic basis. Chuck is exactly right. It's hard to completely get our arms around that. We tried to give you an idea of what we think it's going to be. We'll have a better idea, obviously, once we report the fourth quarter. But it's important to understand, whatever the benefit is in the fourth quarter of 2011, it will be completely and exactly offset in the fourth quarter of 2012. It's a zero-sum gain here. So if you look at it on a full basis, there is no benefit, there is no detriment. It all evens out in the end.

Operator

The next question comes from the line of Mike Weinstein with JPMorgan.

Michael Weinstein - JP Morgan Chase & Co

I'd like to focus on ev3, the performance this quarter is obviously very strong and that's where a decent amount of your upside is coming from within the overall device business. So I was hoping you could just shed a little bit more light on the performance between the Peripheral Vascular segment and the Neurovascular segment. If we look at the reports over the last week from some of your competitors, J&J's Peripheral Vascular business was flat, Bard's was flat. You're obviously outperforming in that segment of the business pretty strongly. Can you just give us any insight into how those 2 subsegments are performing?

José Almeida

The Neurovascular business growth is higher than the Peripheral Vascular business. But the Peripheral Vascular business, remember, we have products that not everybody has. The atherectomy business, the TurboHawk and the rest of the Hawk family there is doing quite well. So if there is, if you heard weaknesses in the other competitors in terms of their biliary stenting business, we have other levers for growth. And I think the team at ev3, primarily the Minneapolis team that manages the Peripheral Vascular has done a great job growing that business. Neurovascular, a bit different story, a very complete portfolio and it continued to gain share not only in the U.S., but overseas. And I think that completeness of the portfolio now, with pipeline has helped us become more present at the Neurovascular suite.

Michael Weinstein - JP Morgan Chase & Co

Joe, I guess my question on the Neurovascular side is because you have pipeline out there now in the U.S. and obviously that's been ramping for a while in Europe, are you gaining incremental share in coils because you have pipeline as well?

José Almeida

It looks like we are. It's a little early to say as the products, its pipeline is not everywhere. As you know, the learning curve is quite steep for the physician using that product. I would say that we've seen some positive signs of other products within the family picking up when we are there doing pipeline cases.

Michael Weinstein - JP Morgan Chase & Co

Okay. And Joe, you haven't commented yet on Solitaire since trial was stopped. Could you update us on where you are with that submission? Has that gone in and when we might see that trial data?

José Almeida

There is no change since we spoke to you last. We are still working on the submission, the paperwork, and so I have nothing new to report on that specifically.

Michael Weinstein - JP Morgan Chase & Co

Okay. And any idea when we might see the data at a meeting?

José Almeida

Not yet. Not yet. I hope if we hear anything, and it's relevant enough, we'll let everybody know. But at this point in time, we don't have a fixed timing.

Coleman Lannum

Mike, I can tell you it definitely is being compiled and we're trying to accelerate it as quickly as possible. But obviously, you want to make sure we get the submission correct and we're going to do it in -- from a timeframe that is consistent with that.

Operator

Your next question comes from the line of Matthew Dodds with Citigroup.

Matthew Dodds - Citigroup Inc

For the emerging markets in Japan, can you comment, Joe, sequentially how they look versus the fiscal second quarter?

José Almeida

Matt, Japan, in all interesting, we thought that Japan, we would see a drop on the demand because the earthquake surged in demand in March, and we did not see that. So our business in Japan continues to do well and their volume did not appear to offset anything in the third quarter. In terms of Asia and overall emerging markets, we are doing well, very strong growth out of China, extremely strong growth out of Brazil, primarily Endomechanical and Energy. So we are quite happy with those 2 markets -- double-digit, low 20s, mid 20s, in those areas in revenue, very, very happy.

Matthew Dodds - Citigroup Inc

Okay. And then one divisional question. On soft tissue, kind of spent [ph] a lot of time there. Sutures, that was -- even if you guys think adjust for any reclassifications, it still had its best performance in a long time. So is that share? Do you think that emerging markets are driving more of that? How did the number show such an improvement?

José Almeida

Emerging markets, clearly, have been a strong performer in sutures. But don't discount the fact that sutures are doing better in the U.S. for us, primarily driven by V-Loc. V-Loc is starting to take a shape in terms of being a good product for us in soft tissue repair within the sutures, it's not a home run type of product, but it's a product that is solid and it's bringing some good growth to that business.

Operator

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

Thomas Gunderson - Piper Jaffray Companies

I'll keep it to one question. The economy in the U.S. has kept some procedures down. Perspective patients are postponing. We've talked about this in that past but it's been a couple of years now, and I'm wondering if you're seeing some of these patients come back sicker as some doctors have noted? And if you've been able to measure any change in average revenue per procedure not in something relatively simple like a lab coli but maybe larger amounts of hernia mesh or more instrumentation use in bariatric surgery? Can you comment on that a little bitearnings release

José Almeida

It is tough to get to the granularity that you were describing. What I have to tell you is that we have not seen any significant changes from quarter-over-quarter in terms of procedure volume. Now if I dig into our numbers and I look at the Endomechanical category, per se, within Endomechanical, we have endostapling, which the growth has been close to 10%, driven primarily by Tri-Staples. So for us, to be able to get the granularity that you're speaking about, about patients coming back to the hospital with more acute illnesses and happen to be operated using more supplies, I don't think we can affirmatively speak about that. But I can tell you that the procedures have not changed in terms of growth and because some of our product launches, as well as in Energy, we've seen uptick in growth for us versus what we're hearing from other competitors.

Operator

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

David Roman - Goldman Sachs Group Inc.

Chuck, I was hoping, I know, we've come back to gross margins a couple of times here but obviously, you're up quite significantly year-over-year, but sequentially, the gross margin has now been coming down each of the past 2 quarters. But when I take to the business mix, it looks as though Vascular is becoming a larger percentage of total revenue as is overall Medical Devices, and currency is having a greater impact on the top line quarter-by-quarter as you've gone through the year. Can you maybe just help us understand the difference between looking at gross margin sequentially versus year-over-year and then what sort of moving parts are there as we head into the fourth quarter into next year?

Charles Dockendorff

Yes. I would say, too, our gross margins do fluctuate quarter-to-quarter depending on the mix of business we have and things like, it's occurred last year and is a little bit this year as well. But I think in my other comments, as we look at it, what we see is the currency turning favorable and that should continue next quarter as well, if rates stay where they are. The mix was off a little bit on a year-to-date basis, what we had in Q3 so that seems to be down a bit. And that could be somewhat of the more supplies growth coming into our business. The other thing that's probably impacting manufacturing or gross margin is raw material. We're seeing some significant increases in raw material costs which we cannot pass on to the customer. Most of these are in the supplies area. But for the most part, what we see going forward is being able to offset these raw material costs with the cost reduction programs and things like that we have in place. But that would be one trend we see where we see some headwind on the manufacturing side.

David Roman - Goldman Sachs Group Inc.

And can you maybe give us something to which of the most significant raw materials and their size and then a corollary status, we look at the restructuring program, should we look at this restructuring program as keeping things net neutral to offset some of these increasing cost pressures or in fact, a net reduction in costs over time?

Charles Dockendorff

Yes, some of the big things are really in the commodities that we see in the supplies business, in cotton, pulp, resins, things like that. It's not material to overall Covidien. It certainly is to supplies business. But maybe in the tune of $15 million to $25 million, we're seeing some increases on an annual basis in some of those raw materials. So certainly, nothing that we can't mitigate at this point, overall, for Covidien through cost reduction programs. And I would say that the restructuring program we have, would be incremental. So we currently have some pretty good cost reduction programs targeted within our facilities. We've been very successful in that and that's a combination of capital reinvest for our productivity improvements, as well as some of the restructuring savings we've got from past programs. So those are offsetting inflation and raw material costs as we see it. This new restructuring program we'll add to that, but we see this as incremental. And I think, as Joe mentioned, this new restructuring program, some of this is in manufacturing, some of this also is in our distribution. So those kinds of costs as well we'll see some opportunities for improvement in that area. And also in SG&A, we've made a lot of improvements in SG&A and productivity improvements in our shared services. We've reallocated funds from various entities, so that will be a constant process going forward and those will have a quicker payback.

David Roman - Goldman Sachs Group Inc.

Okay. And then last thing on the tax rate, obviously 18.3% year-to-date and that's where I guess your assumption is that it will end up for the full year and that was the adjustment in the quarter. Is the tax rate still structurally moving lower as we think longer term?

Charles Dockendorff

Well, again, I think our goal here is to move it lower, but on a marginal rate. I mean it's kind of -- we've taken significant amount of tax reduction out over the last couple of years where we still see opportunities to reduce it further, but the rate of reduction will be much less than what we've had in the past.

Operator

Your next question comes from the line of Rick Weiss with Leerink Swann.

Frederick Wise - Leerink Swann LLC

Maybe, Joe, I'll start off with a question for you. You talked, if I heard you correctly, on the soft tissue side about biologics being down, and if I heard you correctly, some share gains in the fixation hernia side of things. I think that's a change. Could you maybe give us a little more color there and what's driving it? And what makes biologics better and what keeps fixation going?

José Almeida

For the biologics, just prefacing by saying is a very small part of our portfolio. Second, we don't have a complete product portfolio to compete well in this area. So through internal development and external opportunities, we are looking to augment that product line and become a better competitor in that area. In terms of the fixation, we have launched a couple of products in the last few months that have made a difference. So also, we were well equipped with a good salesforce, that it has a product that has leadership in market share. So for us, was more about -- just about execution on the fixation as we augment our product lines. So we've seen growth there and that is clearly coming from taking share. Second, the synthetic business, the synthetic mesh on hernia repair, we've been doing well for a longtime and we've been taking share for longtime despite the market has, in terms of growth reduced a little bit, but is still a positive for Covidien on the synthetic. And then we also have launched a product in the last 2 months and have 2 or 3 coming out in the next 12 months. So continue to invest in our product portfolio.

Frederick Wise - Leerink Swann LLC

Okay. And just second product related question, Joe. Can you update us on your sales initiatives, and just what we are looking for or expecting over the next 12 months? And maybe if you could, I'd really be interested in your perspectives on the use of robotics in general surgery, one robotic product has obviously launched there in sales in Europe. And just how is Covidien going to be involved long term, is it important to you? Is it going to have an impact on the business longer term? Just again, your broader perspectives there.

José Almeida

Sure, Rick. In terms of sales, we would be saying all along, sales is a single for Covidien, I think, until a couple of years ago when prior to the economic financial crisis, SILS was doing very well. I think sales continues to do well. It's a great alternative to multi-port surgery. But there is a significant concern about what are the clinical benefits of that. And despite Covidien has studies and you can go now in searches and find reduction in pain and cosmesis that is a good thing for us, but is still a single. You've got to have nowadays a significant amount of clinical behind every innovation that you have out there. That drives me to answer the second question you have about robotics. Covidien will adopt changes in our portfolio of initiatives regarding robotics. When we think robotics has clinically relevant data that proves that, that is now benefiting the patient and also economically is beneficial for the providers. We have a significant amount of research right now in power. Power, we think with the resposable products that are coming out from our surgical business is a great alternative not only to improved dexterity of our physicians, but also provide a better economical equation for the providers.

Frederick Wise - Leerink Swann LLC

And when will we see those resposable products, Joe?

José Almeida

We already test launch the first one, [indiscernible], which was the biomedical product that we modified, and we fitted with our stapling technology and we have a series of launches in the next 12 to 24 months of new power products that will come in that allows for not only a full command of the location and closing and stapling, but also it's actually visualization for the physicians.

Operator

Your next question comes from the line of Dave Turkaly with SIG.

David Turkaly - Susquehanna Financial Group, LLLP

I believe you mentioned that European growth was a little better than you thought for the second quarter in a row. Can you share with us what the growth was, maybe what your expectations were, and any countries that you would highlight that were particularly good or conversely more recent as you look ahead?

José Almeida

I would say that the growth was low single digits. And I would say that countries that are doing well, the Nordic part of Europe, Scandinavia is doing well. Germany continues to be solid for us for 2 reasons. One, the market, second, we are gaining market share in some of our products there. I would say France is neutral for us. And I see my concern is with Spain and Italy and I've said that before as it becomes more difficult in terms of their financial and economic situation, it affects healthcare, how healthcare is consumed. So those are the 2 countries that I would say I have my concerns. But all of Europe is not the same. So as I've said, we still have some bright spots within Europe.

Coleman Lannum

Remember that low single-digit number doesn't take into account the fact that we made the discretionary decision to exit Greece late last year. So that we're still comping against that and will for another a couple of quarters so it was even better than that if you adjust for that.

David Turkaly - Susquehanna Financial Group, LLLP

And then just one clarification. I think 40 to 50 basis points was, I believe, what you said the worldwide pricing deterioration was. Is that year-to-date? And is there any color you can give us on that in regards to whether geographically, U.S. vers kind of o U.S. deterioration on a pricing standpoint?

Charles Dockendorff

Yes. I think that's what we did confirm, it was in that 40, 50 which is in our historical rate that we've seen for price declines. We don't really have it by what geographic areas are driving it and things like that.

Operator

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

Lawrence Keusch - Morgan Keegan & Company, Inc.

Just a question on the M&A strategy. Joe, you mentioned in your prepared remarks that there was no significant change in the strategy and you'll be looking at tuck ins, and you talked about licensing agreements as well. And I understand that this remains your preferred use of capital. But how do you put the comments of tuck-in acquisitions into the context relative to size of ev3 as we look forward?

José Almeida

Well, I don't think ev3 is a tuck-in acquisition, but we will continue to look at the landscape. I want to -- always preface when we talk about acquisitions to the fact that acquisitions are opportunistic and despite the fact that we have a strategy in areas that we want to get in, areas that we want to augment the business with, everything depends upon having the company ready for that moment. So as we have business developments spread throughout the company and their objective is to find acquisitions for Covidien, they are financially sound and strategically purposed, we are not all the time successful in doing it so. So our intention is when we don't do it is to be able to focus what matters a lot to us which is return of cash to shareholders. It is important for us to return cash to shareholders, if we don't find better, a more profitable way of using that cash. So don't think that we're not looking for acquisitions, we are. We, this year, didn't find anything that was a good match for Covidien, hence, our distribution of cash and we continue to do it so.

Lawrence Keusch - Morgan Keegan & Company, Inc.

Okay. And just 2 other quick ones. Obviously, there's a lot of focus in on trying to figure out what's going on out there with surgical procedures, and I know you cannot necessarily compare one company with another at any given quarter. But if you were to look at your businesses that are perhaps most representative of the general surgical procedures that are done out there, again, I'm wondering if you saw any changes in this last quarter. And then secondarily, any update or comments as it relates to the strategy for looking for a President for the Pharmaceutical business?

José Almeida

If I take, if I look at my surgical instrumentation, it's probably a good indicator that, that business had almost no change from quarter-to-quarter. That tells me the procedure volumes had not been out now sequentially from Q1, Q2 and Q3. So I tell you that no, as I said in the beginning, we are not seeing a significant change. I'm not seeing improvement, but neither the situation getting worse. In terms of President for Pharma, we are in probably later stages of interviews and I hope by Investor Day, we'll have somebody on board.

Operator

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

Jayson Bedford - Raymond James & Associates, Inc.

Just a couple of quickies. In Energy, I realize the capital is not a big piece of the business, but to the extent that's a leading indicator of future use, can you just maybe comment on capital trends in the quarter? I think you alluded to some strength last quarter?

José Almeida

The capital has been flat, approximately flat. Although it is an indication of use, what we report in terms of capital not necessarily mean how much capital is going to the field because there is financial options and there are other things that go behind us raising capital into accounts. So that is not a sole indication of the health of that business. I can tell you that our vessel sealing business is still growing more than 20% quarter now versus last year. So there is a very healthy growth on our vessel sealing business despite the fact that our capital may be flat.

Jayson Bedford - Raymond James & Associates, Inc.

Okay, great. And then just lastly maybe for Chuck, what was the impact of FX on EPS in the quarter?

Charles Dockendorff

It was positive. I mentioned that before. So on a year-to-date basis, it's neutral and we had negative impact in Q1 and Q2, and it turned favorable for us in Q3.

Operator

And I would now like to turn the call back over to Mr. Cole Lannum for our closing remarks.

Coleman Lannum

Thanks, again, Anika, and thanks for everyone. Before we wrap up, I just want to take a moment to mention again our September 8 Investor Day meeting. We'll have more information going out in the next few weeks including an agenda, but it will be on September 8 at the Plaza in New York City. We'll start around noon with product displays and you'll have an opportunity for some one-on-one time with executive management.

During the formal program, we'll have management presentations and plenty of time for Q&A. It's going to be similar to the ones we've had in the past where we try to expand the amount of time that you have or individual one-on-one time with members deep into our management team because we know that's something we've gotten a lot of feedback from you in the past that you enjoyed doing. We're looking forward to seeing many of you there.

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 would listen to the call and have additional questions, please contact Eric Kraus, our Head of Corporate Communications. For analysts having more detailed questions involving non-material information, both Todd and I will be available to take your calls throughout the day. Thanks and have a great day.

Operator

Ladies and gentlemen, this concludes the presentation, and you may now disconnect. Thank you and have a great day.

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