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Covidien plc (NYSE:COV)

Q4 2011 Earnings Call

November 15, 2011 8:30 am ET

Executives

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

Coleman N. Lannum - Vice President of Investor Relations

José E. Almeida - Chief Executive officer, President and Director

Analysts

Matthew J. Dodds - Citigroup Inc, Research Division

Adam T. Feinstein - Barclays Capital, Research Division

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

Michael Matson - Mizuho Securities USA Inc., Research Division

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Frederick A. Wise - Leerink Swann LLC, Research Division

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

David H. Roman - Goldman Sachs Group Inc., Research Division

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Anthony Petrone - Jefferies & Company, Inc., Research Division

Jonathan J. Palmer - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Thomas Kouchoukos - Stifel, Nicolaus & Co., Inc., Research Division

Joanne K. Wuensch - BMO Capital Markets U.S.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Sara Michelmore - Brean Murray, Carret & Co., LLC, Research Division

David R. Lewis - Morgan Stanley, Research Division

Lawrence S. Keusch - Morgan Keegan & Company, Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2011 Covidien plc Earnings Conference Call. My name is Kim, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the call over to your host for today's conference, Mr. Cole Lannum, Vice President, Investor Relations. Please proceed, Mr. Lannum.

Coleman N. Lannum

Thanks, Kim, 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 very brief introductory comments and then spend most of the time as usual this morning answering your questions.

The press release with details of our fourth quarter results was issued earlier this morning and is available on our website and the newswires.

Now during today's call, we'll make some forward-looking statements, and it's always 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 in its related financial tables, as well as in the Investor Relations section of our website, covidien.com.

As a reminder, the fourth quarter of 2011 included an extra selling week, a phenomenon that occurs once every 5 or 6 years for us. While the exact quantification of the impact of the extra week is extremely difficult, we believe it added approximately 7 to 8 percentage points to the quarterly sales growth rate of the company as a whole and about 2 percentage points to our annual sales growth.

We provided the sales impact to the total Covidien level, but you should not impute it at a lower level to any segment or product line, as that may give you an inaccurate picture of our performance. After the call, off-line, both Todd and I will be more than happy to take you through these details mathematically on a case-by-case basis.

For the fourth quarter, we reported GAAP diluted earnings per share of $0.93. After adjusting for certain specified items, our non-GAAP earnings came in at $1.08 per share.

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

José E. Almeida

Thanks, Cole. We had a strong finish to fiscal 2011, as sales came in slightly above our expectations. We again improved our growth and operating margins, and we delivered an exceptional 29% increase in adjusted EPS in the quarter. This is the fifth quarter in a row that we have exceeded our internal expectations on the bottom line.

In the Medical Devices segment, we had another solid quarter, with broad-based growth led by Vascular, Energy and stapling products.

Quarterly sales improved in our Pharmaceuticals business for the first time since the first quarter of 2010, paced by outstanding growth for specialty products. In Supplies, all 4 product lines advanced, led by incontinence, eenteral feeding and electrodes.

In emerging markets, sales in all 3 regions, Europe, Asia and Latin America, grew at a double-digit pace during the quarter. This excellent performance reflects our recent investments to accelerate growth in these regions.

Our fourth quarter sales gains were broad-based, led by stapling and Energy products.

In our Large Endomechanical business, we reported strong growth in stapling products led by the innovative Tri-Staple Reloads. Sales growth for Soft Tissue Repair was aided by V-Loc but partially offset lower sales for BioSurgery products. Sales of Mesh Fixation products were about even with a year ago, as we faced a competitive product launch in the U.S. We made good progress in Synthetic Mesh, but our Biologics sales were below last year.

We have faced some challenges in our Soft Tissue business recently. We are addressing these shortfalls, as well as some of other underperforming areas of our business, while implementing plans to improve their results as we move into fiscal 2012.

Our Energy business had another strong quarter as new products such as LigaSure 5 and the Small Jaw coupled with growth in Electrosurgery contribute to our performance.

In Vascular, we continued to achieve the excellent results we have reported over the last quarter. On an apples-to-apples basis, sales of ev3 were up more than 40%. Growth was led by flow diversion, plaque excision and peripheral stents products. Both Neurovascular and Peripheral Vascular sales were above planned this year, and the profitability of ev3 continues to be above our expectations.

Looking back at the full year, the ev3 acquisition was accretive to EPS by about $0.05. In respiratory, we registered strong double-digit growth in Oximetry & Monitoring, with broad-based gains for monitors and a strong growth for BIS and Invos sensors. These products came to us from the Aspect and Somanetics acquisitions, both of which are performing well and exceeding our expectations.

In the Airway & Ventilation category, a strong performance for airway products was partially offset by lower ventilator sales, primarily reflecting capital pressures.

Turning to Pharmaceuticals. We had a good quarter. Sales are on plan as we registered growth for EXALGO and PENNSAID. The Generic business reported outstanding growth, paced by increases for its fentanyl lozenge and the launch of its fentanyl patch.

In Contrast Products, sales were well below a year ago, as we had a large one-time customer order last year that was not repeated. Sales of Radiopharmaceuticals and Active Pharmaceutical Ingredients were both above a year ago driven by generators and acetaminophen respectively. Overall, we're pleased with the progress in Pharmaceuticals business. We are growing the business in those areas where we have made recent investments while seeing restrained growth in the areas where we have not invested.

In the Supplies business, we reported a good performance in our Nursing Care and Medical Surgical products lines. While the markets in this segment are showing little or no growth, we're seeing some positive momentum and made some modest share gains in enteral feeding, electrodes and neurology.

While margins continue to be under pressure from higher raw material prices, the business continues to meet our expectations and provides good cash flow and ROIC.

Overall, we are pleased with our performance in the quarter. Though as we noted, there are a few areas where the business is not meeting our expectations, I can assure you that these are being addressed and, we'll look to turn them around in the near future.

I will now pass the call over to Chuck, who will discuss the fourth quarter in more detail and provide some commentary on our 2012 outlook. Chuck?

Charles J. 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 in this quarter, as sales came in slightly ahead of plan and we had another good improvement in gross margin, and both our operating margin and EPS exceeded our expectations.

As noted in the release, we reported a 50 basis point increase in adjusted gross margin this quarter, paced by positive business mix, benefits from our restructuring programs and favorable foreign exchange. This improvement was again restrained by higher raw material prices primarily in the Supplies business.

On a sequential basis, gross margin was down about 40 basis points. This was primarily due to higher raw material cost, coupled with the faster growth of our lower margined Supplies and Pharmaceuticals segments in the quarter versus Q3.

Fourth quarter SG&A spending was up versus a year ago, primarily due to acquisition-related expenses, coupled with unfavorable foreign exchange. As a percentage of sales, SG&A was down versus last year due to leverage and productivity improvements, partially offset by investments in emerging markets.

Research and development increased 33% to 5.4% of sales in the quarter, and we remain committed to our goal to further increase research and development over the next few years.

On an adjusted basis, our operating margin improved 180 basis points to 22.3% of sales, which was slightly ahead of our guidance range.

Interest expense and the tax rate were both right on plan, resulting in a 29% increase in adjusted EPS to $1.08. For the year, adjusted EPS of $3.97 was up 17%.

We again generated a strong cash flow this quarter, with free cash flow in excess of $400 million and for the year, about $1.7 billion. This was after making a payment of approximately $250 million in the quarter for a legacy tax liability.

During the quarter, we repurchased about $575 million of stock. During fiscal 2011, we returned $1.3 billion in cash to shareholders through dividends and share repurchases, representing more than 75% of our free cash flow over that period.

This is significantly above our goal of returning 25% to 40% of free cash flow to shareholders. As we've stated, high return acquisitions remain our priority, but those opportunities do not present themselves in 2011. As Joe mentioned, our 2010 acquisitions -- ev3, Somanetics and Aspect -- have all performed better than expected in revenue, earnings and return on invested capital.

Finally, let me make some brief comments on our 2012 outlook. Despite the headwinds we are seeing on foreign currency and the fact that we finished 2011 above our expectations, the underlying operational strength of the business remained strong. And along with a lower tax rate, we remain comfortable with the guidance ranges we gave in September.

As we noted at that time, we expected about 100 basis points of tailwind from foreign exchange rates on fiscal 2012 net sales. While that benefit has now disappeared at current rates, we are confident that we can offset this FX weakness and are holding our sales ranges for each segment and in total, as well as the previous operating margin and free cash flow guidance.

We are going to take this opportunity to revise the tax rate guidance. Our original 2012 guidance was for a tax rate of 18% to 19%. We now think our rate will be about 100 basis points lower, so anticipate the rate will be in the 17% to 18% range at current exchange rates and excluding the impact of one-time items.

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

Question-and-Answer Session

Coleman N. Lannum

Thanks, Chuck. To those of you on the line, we have a very packed house today. [Operator Instructions]

Operator

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

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Chuck, I just want to ask a quick question about guidance. And first of all, just what to make sure my math is right on Q4 for the top line. When you exclude the extra week and exclude currency and M&A extras, I get to about 3% to 3.5% constant currency underlying growth. Does that foot with your math as well?

Charles J. Dockendorff

Yes, that's in the range. We're saying it's approximately 7% for the impact for the quarter for the extra week in general, in total, and then I think we've expressed the FX is around 400 basis points. So that's about right.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Okay, so 3% to 3.5% roughly for Q4 underlying growth. Now just in terms of 2012, in September you gave guidance of 3% to 5% reported, but if you excluded FX at the time and the headwind from the extra week in 2012, I think you guys suggested at the Analyst Day that your underlying assumptions were for roughly 3.75% and 5.75% true underlying growth for 2012. Is that correct?

Charles J. Dockendorff

Yes, 3% to 5%, in that range. Right, Bob.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Well, no. But it's a little higher than that when you net out the currency and the extra week, But now the currency has gone against you over 100 basis points. So I guess my bottom line question is you need to grow underlying about 5% to 7% in 2012 to get to your new guidance. And yet now you're growing 3% to 4%. So it appears like in 2012, you're expecting an acceleration in true underlying growth. And I'm just curious if you could comment on where you think that acceleration will come from in 2012.

Charles J. Dockendorff

Yes. Just a couple of comments. I mean, one of the things is I think you'll see some improvement in the Pharmaceuticals business. We had some portfolio moves there and divesting the radiopharmacies and things like that which drilled down some growth in 2011. So as the Pharmaceutical returns to a more normal growth rate, that will help our overall growth rate as well. We continue to see strength in the Vascular group. They finished very strong within 2011. We expect very good growth from them as well in 2012. We also saw a very good growth in the emerging markets area. That's a smaller piece of our business, but it is becoming a bigger piece each year as that growth continues to accelerate. And Energy is another area that we think will continue with strong growth in becoming a bigger part of our business and expanding to those areas outside of the U.S. And finally, in Surgical, we have a number of product launches. We launched the Tri-Staple and some other products, and we've had some controlled rollouts of those sales, but we see more of those products coming out in 2012 with better, I guess, production or more availability of the product to our customers.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

And then just lastly as a follow-up, can you talk to me a little bit about how growth is going in Europe currently and what assumptions you make for 2012 as far as Europe? Do you assume it gets worse or better or stays the same?

José E. Almeida

Bob, this is Joe. I will answer that. Our assumptions for Europe and what we've seen in this quarter has not changed. The situation has not improved. It's still a tough market. We didn't see it going down from what we have reported before. So our assumptions for Europe is very modest growth into 2012, very low single digits.

Operator

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

Adam T. Feinstein - Barclays Capital, Research Division

I guess, my question really has to do with your thoughts around pricing. And clearly, as we think about overall pricing for the overall sector, things have been challenging. You guys have done a good job of managing through that. And I guess at the Analyst Day when you gave the puts and takes for future margins, you talked about your anticipation that pricing wouldn't necessarily come back just yet. But just wanted to get to some color on pricing and mix in the quarter and how that impacted numbers?

José E. Almeida

Adam, we have been speaking about price and pricing pressures for a while now. This is nothing new to us. When we gave our guidance and, I repeated that recently, we see a 50 to 100 basis points of price erosion on any specific year, and we are still within the range that we have spoken to you guys about. I want to make clear that, that because we've been talking about pricing for a while, price has not eased off. It didn't get worse than it was before. The dynamics, they're highly competitive. But we've been talking about this for the last 12 months, and our guidance of 50 to 100 basis points stays.

Adam T. Feinstein - Barclays Capital, Research Division

Okay. And then just in terms of mix, I guess in the quarter, just maybe just any commentary around any benefit from a more favorable mix in the quarter?

Charles J. Dockendorff

Yes, we had very good mix in the quarter. It's been a continuation of that each of the quarters, and it far offset anything we had as far as pricing pressures and some raw material cost increases. So this is something that's continued on for all 4 quarters of 2011. We expect that favorable mix to continue into 2012, probably not at the same rate, only because '11 included some portfolios we moved in getting out of some low-margin businesses which have been annualized now in 2011. But the favorable mix, and that is driven again by our product portfolio, and where our products are growing, the margins that they're at and where they're growing around the world continues to be favorable and should be in fiscal year '12.

Operator

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

Matthew J. Dodds - Citigroup Inc, Research Division

First question on the gross margin, Chuck. When you look at next year, you just said mix is going to be slightly positive. For the other components, should we assume that FX next year is a slight negative versus being a benefit in fiscal '11? But then amortization is also a little bit less. Is it incremental hit than it was in fiscal '11?

Charles J. Dockendorff

No. As we look to next year again, we've mentioned that we're expecting an improvement in gross margin and fiscal '12. I guess that the mix will be favorable to a lesser extent than it was in '11. Pricing, as Joe mentioned, will be in a range of 50 to 100 basis points impact to gross margin. And then FX will actually be right now slightly favorable. They're almost neutral at this point where the rates are today. There is some volatility in the rates, so we'll watch that, but that's about where we're at there . But we also have some cost reductions coming through as a result of the restructuring programs that we've launched and talked about. So we have 3 programs in place. One of them is pretty much completed. The other one, we have about 70% done, so those restructuring things, along with our other cost reductions, are driving through some nice improvements in gross margin as we look to 2012.

Matthew J. Dodds - Citigroup Inc, Research Division

Okay. Then one quick follow-up, Joe, for you on vessel sealing. It still did really well, but it was a little slower, right? It looks like organically than prior quarters. Is that just the market -- you've gained a lot of relative share versus ultrasound? Or is J&J pushing harder on RF?

Charles J. Dockendorff

I will let Joe take the market dynamics. But just do keep in mind you're trying to calculate an organic number, you can't really allocate that 7% to 8% number when you get down to that level, Matt. There's a much bigger error factor around that. Having said that, Joe, why don't you talk about the competitor?

José E. Almeida

Yes, we had 2 launches in 2011, the new 5 and the Small Jaw product, and those are doing very well. So as we continue to launch technology that continues to work on the premise of either clinical and/or economic advantage to the system, I don't see us losing share. With that said, there are a lot of products in the market. There's a great deal of competitors out there, but we continue to have a great product and a great sales force. And between the 2 of them, we have done quite well.

Operator

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

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

I'm going to touch on just 2 businesses if I can: the Peripheral Vascular and Neurovascular business. If I look at your competitors in aggregate, like the Peripheral Vascular end market slowed, but you reported very strong results here. Can you give us a sense of how much of that was from Peripheral Vascular side versus the Neuro? And is the pipeline product contributing more than you originally expected?

José E. Almeida

Mike, I would say both franchises are doing well. Their success are driven by specific technologies to look at Peripheral Vascular, we're doing quite well with Black excision. The TurboHawk and the SilverHawk are doing well. And when we lead with those products in the Vascular OR the gas lab, we do well with the accessories, so those products are doing very well. When it comes to the Neurovascular, clearly and we're doing well with coils and accessories, but the Pipeline Embolization Device has helped us drive market share, because, again, you're leading with that product. You have a great ability to use your products, as well as all the accessories that we offer. So our technology has done quite well in helping us gain market share.

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

So, Cole, having a pipeline is driving the share gains in the rest of the Neuro business?

José E. Almeida

It's one of the factors. I want to highlight to you that we're doing extremely well in emerging markets as well with these products.

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Okay. Then Joe, let me ask about the hernia repair side, I mean, it stuck out to a handful of us at the SAGES meeting that you guys didn't spend any time on the pipeline there, and that business is struggling now. So can you talk about what turns that business around and what is in the pipeline, particularly in the Biologics side that we should be looking forward to?

José E. Almeida

If we just divide the business in a couple of various areas, one is the biologic mesh, the synthetic, as well as the fixation, I'd say that in the Biologics' where the struggle resides. We have one product and we continue to look to get augmentation in that product line. I would say that the synthetic mesh, we have new products launching in this year. We had some in 2011. We're going to have more coming in 2012. And our growth in that business has varied between inguinal and ventral, but we are doing as well as the market is doing. We're going a little share there. Go into the Fixation, we saw competitive pressure this quarter. We did not see it in Q3, but we saw in Q4. We have a couple of new products coming up, and we're starting to see a momentum. In the month of September specifically we saw a little bit of a turnaround in our Fixation business coming back after some of the trials to the new competitive product in the marketplace. So I'm not concerned with that. And as I said with synthetic mesh, we're doing well as well. And I just want to highlight that we had no significant replacement of Exact ribs in the commercial side for that business, now that we have Surgical Devices as well as Energy under one management. And that management has one of the best management in Covidien, in terms of execution in the field, I expect and I hope that this will be turned around.

Operator

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

Kristen M. Stewart - Deutsche Bank AG, Research Division

Just wondering if you could touch on R&D. This quarter came in substantially higher both in absolute dollars as well as a percentage of sales. So kind of were there any one-time items included in that number? Is this the new rate of sales that we should expect going forward or was there just little extra spending given the extra selling week?

Charles J. Dockendorff

It was a little extra spending in the quarter, Kristen. I don't think it will continue with this rate into Q1 next year. But I think that again, as I mentioned in my remarks, that we will be increasing R&D over time. But I don't think it's at the 5.5% level now to stay. So it's more year end in some of these programs and just some spending that went on in some good programs that we have on research and development.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. And then Chuck, you'd mentioned, I think it was, $250 million on that legacy tax items. Can you just give us an update on kind of where that stands as of today and then what the implications could be in income and expense line going forward?

Coleman N. Lannum

Sure, Kris. This is Cole. Let me take that. We stated on the third quarter call that we did expect to pay out some on that tax-sharing agreement. We didn't pay a little bit more than we expected this year. We do think that there will be some small payments next year. But at this point, we don't think there will be anything major in that same magnitude level until 2013. We can give you more details once the K is filed and we have our full balance sheet information out there. But I think it is true that we're certainly making progress along those lines.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. Then just a last quick one. Ultrasonic device, is that still expected to be launched for calendar '12?

Charles J. Dockendorff

Absolutely, yes.

Operator

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

David H. Roman - Goldman Sachs Group Inc., Research Division

Chuck, in your prepared remarks you talked a little bit about SG&A and you referenced leverage in the quarter. This is the first time we've seen any leverage really on the SG&A line in quite some time. Could you maybe talk about the dynamics that drove the leverage in the quarter? How much of that might have come from optics around percentages of revenue associated with the extra weeks versus our starting to see you guys focus more on driving that SG&A number down?

Charles J. Dockendorff

Yes. I think in the quarter we had an adjusted basis of about 190 basis points of leverage in SG&A, and a little under half of that came from the 53rd week. So it's a hard thing to gauge specifically what that number is, but I'm comfortable in that range. The other parts come from productivity initiatives we've launched. We've talked about consolidations of some of our back-office systems, and we're going to continue on with some of the productivity going into '12. But that was part of it. We are beginning to get some good revenue from our pharmaceutical-branded sales, so we made an investment there, and we're beginning to leverage those components as well. And then just across the business, our selling and marketing just went up at a little slower pace than our other revenue growth. So we've got some leverage just in the base operating. But that's kind of how we break it down as far as that leverage for the quarter.

David H. Roman - Goldman Sachs Group Inc., Research Division

And then looking at the top line, just following up on Bob's question from earlier regarding accelerating growth in fiscal 2012. As we look at the underlying organic growth rates in sort of that 3% to 4% percent range this quarter and we think about what gets added next year, is it fair to say that the pieces that you acquired in 2010, like ev3 and Somanetics, were all growing fast. The [indiscernible] that you divested had been growing more slowly or declining, such that the mix of business continues to shift toward a higher growth for the items for the portfolio. Is that essentially what you're saying here?

José E. Almeida

That is correct David. That is correct.

Charles J. Dockendorff

This is Chuck. I just want to make one comment related to Bob's question and yours. We've stated in the comments that the underlying business has remained strong, that the operational growth has not changed. The FX is changed here about 100 basis points. It's swung negative from us from the Investor Day. But this FX is very volatile and it moves quickly and rapidly. So even though within that change, we are still within our guidance that we gave in September. and I would just say that we're not sitting here escalating the underlying operational growth for September. It just remains strong, and we feel good about where we were then.

Operator

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

Frederick A. Wise - Leerink Swann LLC, Research Division

Back to the fiscal '12 EPS outlook. I just want to think through it a little bit, Chuck. So you're basically reiterating guidance except the tax rate guidance has moderated. On the fleet pull, that seems to me that wherever EPS consensus numbers are, they might go up. But you're saying given the strength operationally, FX is worse. You're still confident or comfortable with those numbers. Let me take the opposite case. If FX is better than you currently see it, would that be further upside or would you prefer to reinvest in the business? Just help me think through that logic.

Charles J. Dockendorff

Yes, one of the most -- I'd say overall, we look at the guidance for '12. I mean, certainly FX is going a little bit negative on us, but it is pretty volatile. There's a lot of changes going on here. [indiscernible] one currency, as with many. We've seen the euro go up and down significantly with the troubles they've had that over there. The yen has changed dramatically in one day during the quarter. So those things go on, and I think that's going to continue for a while and it's a difficult thing to manage for a us as a lot of our revenues and operating income are outside the U.S. Having said that, we see a little better rate on the tax rate. There's other things with that. Again, the P&L we'll be trying to drive through productivity improvements in things. So we're trying to manage all phases of it, and that's why we feel comfortable with the overall guidance that we gave in September, that we can still achieve those components. As far as FX, certainly if that turns favorable, that will give us some upward pressure on the earnings and revenue growth as well. And we are -- again, we've stated that our goal here is to drive double-digit growth. And in our guidance, when you take adjustment with the 53rd week

we're still there. We've done it in '12. -- I'm sorry, '11 and '10, and the investments in the business, we balance that off with the long-term growth as we go along.

Frederick A. Wise - Leerink Swann LLC, Research Division

And just one last quick one for Joe. Joe, I may have missed this, but at the Analyst Day you were emphatic about your hopes for a new Pharma head. Any update there? Did I just missed something?

José E. Almeida

Well, no, I didn't give an update on this, so you didn't miss anything. We're in the midst of it. We're in the second round of interviews, and we hope to have something soon. I will tell you that it is a very competitive job to recruit for because this is not a Specialty Pharma job. If that was the case, it would be easier, but it's not. So we have to get somebody operationally very strong, because the business requires that.

Operator

.

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

David R. Lewis - Morgan Stanley, Research Division

Chuck, one of the dynamics of the Analyst Day you focused on which we are assuming is a driver of acceleration in your operating performance for '12 was emerging markets. Could you just kind of help us understand the emerging market growth for '12 versus '11? And additionally, what do you think SG&A growth on that number is going to be in '12 versus '11?

Charles J. Dockendorff

Yes. I think one of the comments was, and it might have been our perception on it on the Investor Day that the emerging markets has a lower operating margin compared to the SG&A, and that's what we're making over there. It actually has a rate that's slightly above the overall Covidien on an operating margin basis. So as that grows even with the investments, we're picking up favorable operating income. But the growth rates that we've had double-digits, we expect that to continue going into '12 in those regions and feel very comfortable about that continued growth within emerging markets.

José E. Almeida

I just want to add that I get this question all the time about our gross margins and our margins in emerging markets. I want to remind you all that we do not sell most medical supplies and some of the pharmaceutical products in emerging markets. So we are very selective in what we sell, and then the products we're selling there are higher technology products that command still a good margin. Now we're making investments. But like Chuck said, the overall gross margin, operating margin, of that business is better than Covidien overall.

David R. Lewis - Morgan Stanley, Research Division

I'm sorry, just to be clear, Chuck, you're actually growing your SG&A slower than sales in emerging markets currently?

Charles J. Dockendorff

Yes. The operating margin in the business is at a rate that's higher than what we have in Covidien overall.

David R. Lewis - Morgan Stanley, Research Division

Okay. And then maybe just one quick follow-up. On Energy, you talked about Energy as being a positive driver for 2012. Does your Energy business forecast any disruption at a major competitor in the Energy franchise or are you assuming this is just organic pipeline improvement heading into '12?

José E. Almeida

It is organic pipeline improvement. We are very aware of the landscape. We understand the competitiveness in the marketplace. We respect them all. They all have good products, but we believe our technology in many aspects is superior. So we continue to move forward with the growth and capturing market share in most areas that we participate. So we don't see much change in that dynamic into '12.

Operator

.

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

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

Some of your competitors not just Vash [indiscernible] there is -- reported in the USA what they were calling a stronger summer seasonality, a little bit slower summer than expected. You just obviously didn't show us so far any indication of that. But if you tease away some of the businesses or if you look at July, which seemed to be the weakest of the months for some of the other players, did you see any changes in demand in your business for the U.S. side?

José E. Almeida

Tom, we forecast our business with seasonality in. So we did not see any additional seasonality that was not forecasted in our business by the regions of the world. We always know we have in Europe, you have a slower month of July and August, and we have a stronger September, but those things are factored in. I don't recall from any of the business reviews that we had in preparation for our calls that any comment about a stronger demand in a weaker, traditionally weaker seasonality driven quarter.

Coleman N. Lannum

Remember too and this quarter makes it exceptionally difficult because of the extra week. It did mess up a little bit of the sequencing within the quarter. What I am comfortable saying is that revenues overall for the quarter did come in better than we expected.

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

Yes. And then a couple of people have kind of gone around this, but I wonder if we could zero in a little bit better on Sonicision. If relative to the guidance, relative to the strength in Energy in 2012, does that need to be out by SAGES to get that ramp or are there other strengths within Energy that would make up for that?

José E. Almeida

We always have contingency plans for things that don't work 100%. Things don't work 100% every single product launch. So we have contingencies for that. We're trying very hard to get that product out. We think it's a great product, and the commentary made by us on a prior question about this as a 2012 event is still holding.

Operator

Your next question comes from the line of Glenn Novarro with RBC Capital Markets.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

Just had a follow-up question on guidance. From the Analyst Day, when you rolled up your sales operating margin and tax-rate guidance, by my math, you got an EPS range for fiscal '12 between $4 and $4.40. Consensus is at $4.28. And now we're lowering the tax rate. And by my math, it looks like that will add another $0.05 to EPS. So my question is are you comfortable with consensus going up by at least $0.05 for the tax rate and now being toward the upper end of your guidance? That's my question and I have a follow-up.

Charles J. Dockendorff

No. I think you got to look at the different components as well. You need to look at FX, because that is a headwind to us. The tax rate is favorable, so both of those components, I think, as we said, pretty much other than that, our guidance is staying the same and we see the same underlying operational growth of business as it remains strong. So at this point, I would not sit here and recommend an increase on that kind of range just based on the tax rate, since the FX is very volatile as we go into the year.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

Okay. And then just one, just to clarify on the FX. What you were saying is at Analyst Day, 100 basis point tailwind. Now you're seeing flat, 0 benefit, 0 tailwind, correct?

Coleman N. Lannum

Just to be clear, it was 100 basis points at the Investor Day. It was actually a little bit south of 100 at that time. It's now going to be a little bit of a negative, so there's going to be more of a headwind on the top line at current rates.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

Okay. So more like a 50-basis-point headwind?

Coleman N. Lannum

That's the right ballpark.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

And then just quickly on buyback. You, at the Analyst Day, talked about buying back stock. Can you give us an update on the buyback? Are you doing more aggressive buyback this quarter? Is buyback ahead of schedule? Any commentary would be great.

Charles J. Dockendorff

I'm not going to comment on within the quarter itself, but I think given as we start fiscal year 12, and we haven't bought any back because of the fact that we haven't released earnings or things like that. But as far as fiscal 2012, we're going to stick with our capital plan of 25% to 40%. Like we said, we'd like to look at acquisitions. But even in years when we've done big acquisitions, I think you've seen that we still bought back quite a few shares back in 2010. So I think you'll see more of the same of what we had in the past. We have an authorization for it going forward. But it is opportunistic around acquisitions, and we'll see how they play out in 2012 as well.

Operator

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

Joanne K. Wuensch - BMO Capital Markets U.S.

I have 2 questions. The first one is you did not own ev3 for the full quarter last year. So it's saying more than 40% growth rate. I'm trying to think of an apples-to-apples growth rate so I can think about forecasting. The second question has to do about tax rate. What was the reason behind the lower tax rate and can we think about it as a go-forward rate?

Charles J. Dockendorff

This is Chuck. I'll just mention on tax rate. The lowering of it was as we finished 2011, and looked at that mix of income and some of the planning activity that we put in, we then looked at our forecast one more detail around the income and where we earned it around the world. And so we're able to refine that a little better once we finished '11. And so what's a big driver of our tax rate is where we earn our income. And so based on that, we felt that the new range was more in line with where we should go, which is the 17% to 18%. Ev3, do you have?

José E. Almeida

Joanne, you got us off thinking about the ev3 for next year in our Neurovascular and Peripheral Vascular business. I'll look into mid to high teens for 2012.

Operator

Your next question comes from the line of Raj Denhoy with Jefferies.

Anthony Petrone - Jefferies & Company, Inc., Research Division

This is Anthony for Raj. I have 2 financial questions and one on Pharma. Can you just walk us through the restructuring program? You mentioned last quarter, $175 million to $225 million in total cost savings by 2014? What percentage should we expect through this year? And on the cash policy, you mentioned the authorization. Is that still at $2 billion and is the dividend policy up for change? And then lastly on Pharma, the DEA announced a quota increase for oxymorphone. I'm just wondering how they played it out in the Pharma business?

Charles J. Dockendorff

Yes, just to go through, first of all the restructuring program. We have 2 programs.

The first one is pretty much complete. The second one for $200 million, which we launched in 2009. We think the savings in there are $50 million or $75 million, which is we're beginning to see if a big portion of that in fiscal year '12. We've spent closer to $200 million, about $170 million of that, so pretty much down on that one. And then the new one, we launched in '11. We're just really beginning that, and most of those savings of $175 million to $225 million will come through more in fiscal year '14. But as I mentioned on a gross margin outlook for '12, we have some significant cost reductions in there driving an increase in gross margin and a big piece of that came from the restructuring programs. As far as our dividend policy, we raised it in September at 12%. We raised it the prior year at 10%. The board approves it, but it's pretty much as you can see that the thought would be that most likely we would continue to increase the dividend commensurate with our results as a business and drive it through that portion of it.

Coleman N. Lannum

Let me take the question on Pharma, and I'm glad you brought that up. This time of the year is always very, very difficult around quota issues. I think you can appreciate, for competitive reasons, we don't like to discuss publicly the issues of quota. But I would have everyone take a look back seasonality at in that specialty Generics business over the last several years. You often get a lot of seasonality in our December quarter as quota tends to dry up and we have to ask for additional quota. And then things tend to loosen a bit after the first of calendar year, when the DEA traditionally gives its annual quota. I will tell you some of the strength we saw in that Specialty Pharma business in the September quarter, the one we just announced, was because of some strength that we saw competitively. You wouldn't -- I would not expect to see that kind of strength in our fiscal first quarter because of some of these quota issues. But some of these things are day-to-day. We won't know for sure until the end of the quarter. So for modeling purposes, you should expect some volatility in that line over the next couple of quarters.

Operator

Your next question comes from the line of Thomas Kouchoukos with Stifel, Nicolaus.

Thomas Kouchoukos - Stifel, Nicolaus & Co., Inc., Research Division

I want to just go back to the tissue line in hernia repair and ask it looks like the market leader had some pretty strong growth. The ancillary players looked like they struggled a bit. I'm just wondering if you could comment on the push that you've seen from the market leader in recent quarters versus market dynamics, in terms of overall market growth in tissue. And then maybe just a follow-up, could you talk about what you're seeing in pricing in that market segment as well? I'll leave it at that.

José E. Almeida

In terms of Soft Tissue Repair, as I said, we have -- if you look at just mesh, which is the hernia repair part of it, there are a strong growth in the market on Biologicals. We are not seeing that growth as we have a limited product line. We have one product. When it comes to the synthetic mesh, we then grew with the market and the market growth for those [indiscernible] low single digits. And the fixation part of it is also low single digits, but there's a new competitor in the marketplace. We did not feel any pressure in the third quarter. We felt some of in the fourth quarter. But we feel that pressure is temporary. We're going to probably regain some of that market share during 2012. In terms of pricing in this segment, it's no different than pricing everywhere. It's a pretty -- it's high-pressure but no different than we have reported before.

Operator

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

Lawrence S. Keusch - Morgan Keegan & Company, Inc., Research Division

Any preliminary thoughts on how you guys are thinking about the offsets for the excise tax in 2013, if that remains in place? Obviously, one company in this space has already announced a series of headcount reductions to help offset that. But any broad thoughts around that will be helpful.

José E. Almeida

Larry, this is something that Covidien has been doing for a long time. We're in our third tranche of restructuring. And we usually don't announce specific amounts of layoffs and workforce reduction. We've been very diligent in the last 4 years in removing cost out of our operation. Our last tranche has a good balance of SG&A as well as manufacturing. So we will do the best we can to offset it. I don't know if we're going to be able to offset the whole thing, but we are working hard to get that.

Lawrence S. Keusch - Morgan Keegan & Company, Inc., Research Division

Okay. And then the other question is, again, as we think about a Vascular business, it's obviously been a very strong growth, or you've indicated that it's been accretive and ahead of expectations. The President of that business recently resigned. And, just trying to understand what happened there and what do you guys do to ensure that there aren't any disruptions for that business, again, as we move into 2012 as this is being an important growth driver for you guys?

José E. Almeida

Yes, we are a $12 billion company and we have a deep bench. Change in management happens quite often. So we have internal process to replace Joe Woody, and that's going to take its place. Remember that business reporting to Joe Woody also reports up to, to Peter Wehrly, who is a very experienced executive, so I don't see that as a problem at all. The departure of an executive of a $12 billion company should not affect the results of any division specifically.

Lawrence S. Keusch - Morgan Keegan & Company, Inc., Research Division

Okay. And then lastly, super quick. I know, Cole, you talked about again some of the issues around the DEA quotas and how that impacts the Pharma business. And I know you don't give quarterly guidance per se, but are there any moving parts that we should think about just as we think broadly gating through the year?

Coleman N. Lannum

I think it's always the hardest business to forecast and model on a quarter-by-quarter basis. I think I'm comfortable saying is that always the fiscal first quarter and fiscal second quarters are the most volatile as we get around that typical quota season. And I think the 30% number that you saw this quarter is not consistent going forward. You certainly should not expect that kind of growth going forward. It will be a much weaker comp in the [indiscernible].

Lawrence S. Keusch - Morgan Keegan & Company, Inc., Research Division

What about -- I was just talking, sorry, I was talking just broadly for the overall business, whether it be sales or expenses, just how we should be through the year?

Charles J. Dockendorff

I think in general, we're still comfortable with that overall Pharma guidance that we gave. And I think you'll see much and better growth in that Specialty Pharma line this year than you have over the last couple of years, but, again, it will be volatile.

Operator

Your next question comes from the line of Sara Michelmore with Brean Murray.

Sara Michelmore - Brean Murray, Carret & Co., LLC, Research Division

Just to go back on the Pharmaceutical business. I know there's a lot of moving parts in there. But just wondering if you could clarify, it does seem like it did come in ahead of your expectations. And so if you could a, confirm that's true. And just in terms of the moving parts you're going after the next couple of quarters, it does sound like we should be thinking about EXALGO and PENNSAID continue to scale their contributions. But in terms of that Specialty Generics business, I guess I'm unclear on how sustainable you think that double-digit growth trend could or may not be in the coming quarters. If you could just provide some clarification?

Coleman N. Lannum

Yes. So let me clarify. If the specialty generics business and the narcotics business is very volatile, PENNSAID and EXALGO will continue to do very well, growing significantly both on a sequential basis and on a year-over-year basis, and we expect that to continue throughout the year. And will it will be big part of the driver of the growth. We've also had some very good response from our fentanyl patch and the fentanyl lozenge. Having said that, the Narcotics part of the business is where we get into that quota volatility. And because of that, we certainly had a very, very good quarter this quarter. We probably saw some movement of revenues from the fiscal first quarter to the fourth quarter because of the opportunity out there and the demand. I would not expect that kind of growth at all in the first quarter because of quota issues.

Sara Michelmore - Brean Murray, Carret & Co., LLC, Research Division

Okay. And then just a clarification on raw materials costs for Chuck. It had come up in fiscal Q3, and when you were going through your sort of sequential commentary on the gross margins, I guess I was surprised to hear you call that out again. So if you could just give us a quick update about raw materials and kind of what you're assuming for fiscal '12 at this point.

Charles J. Dockendorff

I think that during the year, we've had pressure, and, as I mentioned before, mostly in the Supplies area. There is roughly about $30 million to $35 million of increase in raw material cost that grew during the course of the year, with the worst impacted here in the fourth quarter, when you do a year-over-year compare. But that progressed from Q3 and Q4. What we are beginning to see is while those costs have increased, we don't see further cost increases going. And we're doing some things to mitigate any further increase in our materials cost in that area. But I think you've seen kind of a ramp up here. We started coming early in the year. Inside the 3-tier in Q4 and we expect it forward to flatten out, and we're going to try to do things that drive it down in '12.

Operator

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

Michael Matson - Mizuho Securities USA Inc., Research Division

Just wanted to ask about the $46 million that you set aside for legal expenses related to the pelvic mesh products. It's a little higher than I would have expected. What percentage of your sales do you generate from those products? And then my follow-up would just be on Solitaire. Have you submitted a PMA for that product? And what's the latest on the expectations around approval?

José E. Almeida

Michael, the reserve that we took is related to the pelvic mesh products. And we supply these products to one of the manufacturers named in the litigation. And the company is identifying on certain claims. There are no sales of these products in '10 or '11 and either going forward for Covidien, okay? We're not in that business. We were the suppliers of this product. We were a very, very small player many years ago, and that is related to the period that we supplied the product to the manufacturer. And the other question that you had was specifically the Solitaire. We're a little ahead in pulling out the data to submit it to the FDA. So you should be looking at the calendar '12, second half of calendar '12 probably to get the product approved and in the marketplace.

Coleman N. Lannum

And to be clear there, we saw -- we are certain Solitaire will be a 510(k), not a PMA.

Operator

Your next question comes from the line of Jonathan Palmer with CLSA.

Jonathan J. Palmer - Credit Agricole Securities (USA) Inc., Research Division

Joe, I was wondering if you could just touch on emerging markets again, where you are with your infrastructure improvements and specifically the sales force build out?

José E. Almeida

We're actually slightly ahead of schedule. I was just at the sales kick-off meeting in Beijing about a month ago, and there were about 1,100 people there. So we are hiring pretty fast. We should probably finish this year with another couple of hundred people onboard, 200 or 300 people onboard. In terms of the infrastructure in the back office, we're moving along putting the systems in. And the growth is slightly ahead of our expectations. So things are going well. And we should have our first new product design for emerging markets launched at the end of '12.

Operator

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

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

Just very quickly. On the international business, can you give us a flavor for growth in the fourth quarter in Europe versus growth in the rest of the International business? And if you could exclude that extra week, that would be helpful as well.

Coleman N. Lannum

Jayson, we -- I may have to give you that number offline. We don't have it here in front of us. I apologize.

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

Okay. And then I guess then just for modeling purposes, the impact of FX in the extra week on the fourth quarter EPS?

Coleman N. Lannum

Let me take the EPS number and I'll let Chuck talk [indiscernible] the rest. On EPS for the extra week, that is impossible for us to calculate. I think the one thing -- if you know the -- if you could take the top line impact of 7% to 8%, I guess it's reasonable to say that the marginal operating margin on those sales were at least at or above our corporate average. But beyond that, trying to calculate what the actual EPS number is, it's just very difficult to do, so we're not going to go there.

Charles J. Dockendorff

On the FX for the year, we were up in the fourth quarter. It was the strongest quarter in the year.

We're up close to $0.07 to $0.08 on FX favorable within the quarter.

Operator

.

There are no further questions at this time. I would now like to turn the call back over to Mr. Cole Lannum for closing remarks.

Coleman N. Lannum

Thank you very much, Kim. I want to thank everyone now for doing this. We've got through 19 questions today. That may be a record, at least for us. Starting at noon Eastern time today, a replay of this 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 listened to the call and have additional questions, please contact Eric Kraus, our head of Corporate Communications. For analysts having more detailed questions involving nonmaterial information, both Todd and I will be available throughout the afternoon to take your call. Thanks and have a great day.

Operator

.

Ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may now disconnect and have a great day.

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