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Covidien plc (NYSE:COV)

December 15, 2011 8:00 am ET

Executives

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

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

Coleman N. Lannum - Vice President of Investor Relations

Analysts

Matthew J. Dodds - Citigroup Inc, Research Division

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

Michael Matson - Mizuho Securities USA Inc., Research Division

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

Unknown Analyst

Frederick A. Wise - Leerink Swann LLC, Research Division

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

Matthew Taylor - Barclays Capital, Research Division

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

Robert A. Hopkins - BofA Merrill Lynch, Research Division

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

Kristen M. Stewart - Deutsche Bank AG, Research Division

Jason Wittes - Caris & Company, Inc., Research Division

David R. Lewis - Morgan Stanley, Research Division

Raj Denhoy - Jefferies & Company, Inc., Research Division

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

Operator

Good day, ladies and gentlemen, and welcome to the Covidien plc Investor Conference Call. My name is Tasha, and I will be your coordinator for today. [Operator Instructions] I would now like to turn the call over to Mr. Coleman Lannum, Vice President of Investor Relations. Please proceed.

Coleman N. Lannum

Thanks, Tasha, and good morning, everyone. Thank you for joining us this morning, particularly on such short notice, and my apologies for the fact that the call is starting a few minutes late. We're coming to you today from our pharmaceutical headquarters just outside of St. Louis. With me today are Joe Almeida, Covidien's President and CEO; and Chuck Dockendorff, our Chief Financial Officer. The press release announcing our intention to spin-off the pharmaceuticals business was issued earlier this morning and is available on our website and on the Newswires. We've also made some additional material available on our website to assist your analysis. During today's call, we'll make some forward-looking statements and it's possible that actual results could differ materially from our current expectations. Please refer to the cautionary statements contained in our SEC filings for more detailed explanation of the inherent limitations of such forward-looking statements.

Let me also discuss some non-GAAP financial measures with respect to our performance today. A discussion of our non-GAAP measures can be found in the Investor Relations section of our website, covidien.com. Following the brief comments this morning from Joe and Chuck, we'll open up the lines for Q&A. We're going to try to conclude the call promptly at 9:00, so we'd appreciate it if you can keep your questions focused specifically on today's announcement.

Now I'll turn it over to Joe for some initial commentary. Joe?

José E. Almeida

Thanks, Cole. In the next few minutes, Chuck and I will provide some background and address the 4 questions you'll likely have regarding today's announcement. Why? Why now? When? And what are the financial implications? I will handle the first 2 and Chuck will address the last 2. This morning's announcement regarding our pharmaceuticals segment comes after several years of planning and evaluation. As you know, there are significant differences between Medical Devices and Pharmaceuticals. Our Medical Devices and Pharmaceuticals both hold industry-leading positions. They have quite different business models, channels, customers, capital requirements and talent basis. They also have innovation pipelines that differ substantially in regulatory approval requirements, possible risks and potential returns. As you may know, we hold regular reviews of our entire portfolio to uncover strengths and areas of -- for investment and opportunities, be they internal or external.

These periodic evaluations have led us to identify a number of growth-driving investments, as well as several promising acquisitions opportunities. This process also helps us target underperforming areas of our business. To that end, looking back a few years, Pharmaceuticals was certainly on that list of underperformers. Our pharmaceuticals business suffered from a number of product recalls, on-again off-again shortages of key isotope to produce our generators, declining profit margins particularly in imaging a limit pipeline in this sluggish revenue growth. While we might have wanted to separate this business back then, the operating profile was not sufficient for a standalone public company. Today, the picture's very different. The business is well positioned in delivering good results. The pharma business currently ranks #1 globally in both Radiopharmaceuticals and Active Pharmaceutical Ingredients, and has top tier performing contracts for -- in Contrast Products and pain management. We are one of the world's largest producers of both acetaminophen and the largest U.S. supplier of opioid pain medications.

Over the last several years, we have made major strategic improvement in all aspects of our Pharmaceuticals operation. We've streamlined manufacturing, pruned low margin products from the portfolio, significantly improved the profitability of the imaging business, made investment in selling, marketing and research and development to support expansion in branded pain medication. We expanded Medical Affairs including the regulatory performance. We have embraced risk evaluation and mediation strategies, REMS and safe use initiatives including the establishment of our industry-leading CARES, Collaborating and Acting Responsibly to Ensure Safety, alliance to promote education, innovation and collaboration among healthcare professionals, people with pain, safe use advocacy groups and manufacturers. We also strengthened the business by reshaping the pharmaceuticals portfolio, diverse nonstrategic Specialty Chemicals business and the low profit U.S. radiopharmacies network. To address the limited pipeline, we licensed [indiscernible] technology that has brought us 2 new pain management products, EXALGO and PENNSAID. Both are performing well in the marketplace which was launched 18 months ago. We also launched generic versions of ACTIQ fentanyl lozenge and DURAGESIC fentanyl patch to complement our generics portfolio. We expect the continued performance of these new products to generate very good growth for our Specialty Pharmaceuticals line in 2012 and 2013. Our expanded research and development and Business Development organizations also have brought us several promising opportunities, currently clinical trials and in development for future pain management offerings, both branded and generic.

We've also entered into an agreement, which we expect will improve the domestic supply of Mo-99, a precursor to the most widely used radioisotope in the world from molecular imaging and nuclear medicine procedures. As a result of this turnaround, we recently evaluated a number of alternatives and believe that a spin-off at this time is our best course of action. We are making this announcement today because we're confident the business can now stand on its own and be a growing profitable -- independent enterprise. In short, this recession will give both businesses greater flexibility to focus on and pursue their respective growth strategies while potentially providing shareholders with greater value over the longer term.

Before I pass the call over to Chuck Dockendorff, I do want to mention one other item. We've identified a strong leader to run the pharmaceuticals business, a seasoned executive with broad pharmaceutical industry experience. We're excited about this individual joining company, and we'll be announcing his appointment in the not-too-distant future.

Thank you, and now Chuck will discuss the timing and address some of the financial aspects of today's announcement. Chuck?

Charles J. Dockendorff

Thanks, Joe. As Joe mentioned, the board and senior leadership team believe that this is the right time for the announcement. Our pharma business is a leader in pain management, with both generic and branded offerings. We're a full-line, vertically integrated supplier of Radiopharmaceuticals and have a number of high-value contrast in the imaging agents, coupled with unique technology in contrast delivery. We are the world leader in supplying active pharmaceutical ingredients. The moves we made in the past couple of years has significantly improved Pharma's gross margin, though the required investments necessary to strengthen the business have restrained operating margin improvement.

The repositioning of the business over the last few years, however, has made it more predictable, stronger and now able to stand on its own.

As we noted in the release, we currently anticipate that the transaction will take up to 18 months to complete. During that time, we'll be working behind the scenes to carve out financial results, staff corporate functions, identify a board of directors and establish the infrastructure necessary for the business to operate successfully as an independent public company.

In addition, we'll develop a target capital structure for the new business, including projected debt capacity, cash balance and credit ratings. As Joe said, the pharmaceutical business has different capital requirements and investment horizons, as well as varied M&A opportunities than those of the core traditional medical device category. An independent pharma company also will have a better opportunity for making its own licensing and investment decisions, without competing for capital with a much larger and more profitable device business.

Operationally, we'll be looking at a couple of areas where we have manufacturing and/or branding overlaps. The majority of the time will be spent separating back office systems, order-to-cash cycles and legal entities on a country-by-country basis in advance of the spin.

While we have established a timeline of deliverables, we know we still have much left to do. At this point, we are not yet prepared to provide any details of the cost we expect to incur for the spin-off. As we move through the process, we'll update you as the total cost and timing become clearer. In the meantime, it will be business as usual, and all of our reported results, as well as our guidance will continue to include the pharmaceuticals segment until we are much closer to the date of the spin.

Our current expectation is that we will file a Form 10 with the SEC in the first quarter of calendar 2013 and the spin-off will be completed within 18 months of today's announcement.

Obviously, this timetable is subject to change depending on regulatory and governmental reviews and approvals.

As we noted in the release, we do not intend to provide scheduled updates on our progress, but we'll certainly be announcing any material events as they occur. Now I'll turn the call over to Cole for Q&A.

Coleman N. Lannum

Thanks, Chuck. We wanted to dedicate most of this call to questions and answers. Obviously, there's a lot of things that you may want to know about. For Q&A, we are going to limit you to one question and a follow-up if needed, so we can give everyone a chance to get their questions in. If you have additional questions, you need to put yourself back in the queue please, or contact us after the call. We'd also ask that you try to respect the quiet -- to confine your questions to those related to today's announcement on the pharmaceuticals transaction. Can you please review the process once again for signaling a question, operator?

Question-and-Answer Session

Operator

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

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Just 2 questions, one for Chuck and one for Joe. Chuck, to start off, I appreciate the detail in the PowerPoint presentation on the operating income split. It basically suggests you got about 90% of the segment operating income from the Device and Supply business and about 10% from the pharma business. Is there a big difference between that so when you work its way down into net income? In other words, is there a -- I assume there's a slightly higher tax rate for the pharma business. Could you give us a sense of that 90-10 split, basically flows all the way down? Or whether there's a big difference there?

Charles J. Dockendorff

We're still in the very beginning planning stages of this. And as we separate the 2 companies, we're still kind of developing the tax rates that will be there, as we look at them as separate companies. But I'm not really prepared to give any specifics on the specific tax rates. But I would tell you that most likely the pharma business will have a higher tax rate than what we're experiencing at Covidien today. Some of that is the mix of income and things like that, but we're leveraging all of this on a consolidated basis as part of Covidien, so I would expect that to be a little higher than the average.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Okay. Great. And then as my second question, just on the pharma business from a big picture perspective, Joe, can you give me your broad senses, too, when you look forward over the next 2 to 4 years, what kind of growth expectations do you have for that business? And also obviously, margins right now might be a little bit depressed and you're reporting at about 16% on a segment basis right now. What do you think a normalized margin might be looking out into the future? And again, what kind of top line growth expectations might you have for that business looking out long term?

José E. Almeida

Bob, I'm not going to give you guidance on the OI for that business, but I can tell you that with investment in the Specialty Pharmaceuticals business, you should continue to see improvement on the bottom line because those products have a higher margin -- higher gross margin as they become bigger and they start offsetting the expenses they initially were put in place to set that business up, sales force and R&D. I would say we'll continue to see the improvement. I will tell you that we have a pipeline in place. We have products that are either in Phase III or will go into Phase III in the next 12 months. So as that infrastructure starts to get leveraged, we should be seeing that bottom line becoming more and more attractive.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

And on the top line?

José E. Almeida

The top line goes along the same conversation. But I just want to make sure that we understand the dynamics of the market. The specialty business is still a small portion of the overall picture of our pharmaceuticals business. And we still have businesses, legacy business like the imaging and some of the bulk pharmaceutical business that have very low growth. So the strategy that, that business has to engage and we'll be discussing that with you folks later -- in the later date. We'll be more clarifying in terms of how do you make the top line accelerate and what will be the levers.

Operator

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

Matthew J. Dodds - Citigroup Inc, Research Division

Joe, when you look at spin versus sale, can you give us any color on how hard you look at the sale component and maybe why spin makes more sense?

José E. Almeida

Matt, we're focused. Our whole organization has now -- for some time now focused on the spin. The spin is something that we control. That is up -- and we're really down the path of engaging on this spin. But I have to tell you there is a tax efficiency component of the spin that cannot be ignored. So when we analyzed this whole thing, we look at the shareholders at the end of the day, and what would be the best for the shareholders. And we truly believe right now that the spin is the way to go.

Matthew J. Dodds - Citigroup Inc, Research Division

And then one question on that, I think Chuck for you. Is there any particular risk on spinning this tax-free based on your IRS domicile? Is this in your view, very high success? Or is there something we should be thinking about that might make this a little different for Covidien?

Charles J. Dockendorff

No, it shouldn't. I mean, we certainly have to get ruling from the IRS on this, but we would expect to get that ruling and comply with those regulations. So we don't see this as an issue or high risk issue event.

Operator

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

Kristen M. Stewart - Deutsche Bank AG, Research Division

Just following on Mr. Dodds' last question. But would this be a company that will be domiciled in Ireland? Or will it be a U.S.-based corporation?

Charles J. Dockendorff

Our plan right now, Kristen, is that it would be -- have the same structure as Covidien has today, so we have the same advantages, the tax advantages that we experienced as well. How that's finally organized and things like that, there's still some planning to do, but the basic underlying structure is that will most likely remain as an Irish company.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. And then I guess, why 18 months? Because it seems like these businesses were kind of separated within Covidien today? You guys have integrated Pharma and Imaging and it's kind of a little surprising just in terms of the length of time that you expect it to take. Could it come a little sooner? Or is really 18 months what we should expect?

Charles J. Dockendorff

Yes. I think the gating item on it, Kristen, is really the development of the Form 10 and the breakout of the audited financial statements. It's been relatively separate in the U.S. from a manufacturing standpoint, but we've leveraged a lot of the back office systems around the world, and they're actually shared legal entities together around the world, and we have some work there separating out those entities. And you can imagine as you break them out and get audited financials, it's quite a complex process. We've been working on it. And we also expect that fiscal year '12 will be one of the audited years within the Form 10 that we filed. So it really is geared around developing the Form 10 and getting that filed with the SEC and then of course, it's going to go through its own review approval process in the SEC, which we can't predict. So the filing that we're going to look at would be towards the end of calendar '12, beginning of '13 and that's really the gating item.

Operator

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

David R. Lewis - Morgan Stanley, Research Division

Joe, one of the dynamics of the presentation was that R&D percentage for the new Covidien falls closer to 4%, which is materially below sort of what you talked about as a corporate Covidien level of R&D, which you've always talked about going up. I guess, as you look forward post the spin the next couple of years, do you think the new Covidien rate of R&D spending is something that's closer to 5% to 6%? Or do you think this adjusted rate is a level that we should be thinking about?

José E. Almeida

David, our aspiration is 5% to 6%. But let's not talk about the percentage, more how do we get there. Covidien has really derived a significant amount of our growth in the top line from investments that we made in R&D. And as we continue to look at the RemainCo and what are the investments that need to be made, I have discussed with a lot of you the white spaces that Covidien is going to be embarking and some of the markets that we want to participate that we currently are not there. Some are organic, some are inorganic opportunities. We continue to look at more investments today that we currently are funding. So there's always the need to be very, very conscientious about spending. But I tell you, we are not looking at setting a target for a certain year specifically. Our aspiration is 5% to 6%, but we want to make sure that our businesses are focused in developing those organic opportunities that come directly from investment and research and development.

David R. Lewis - Morgan Stanley, Research Division

Okay. Very clear. And then Chuck, maybe you can help us on the balance sheet. I know it's early days. Is there any reason to believe that the capital structure of the 2 independent entities would change materially either in terms of debt allocation or a liability allocation?

Charles J. Dockendorff

I don't think so. We're going to develop a capital plan for the pharmaceutical business that will certainly give it a strong capital position to carry out a strategic plan. The amount of debt that we put into that, the eventual rating it gets from agencies, a lot of that depends on how they perceive the size of the business and things like that. But I don't really see any major changes in the capital structures between the 2 companies.

Operator

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

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

Joe, just this one quick first question. The timing, why now in the announcement prior to having the new president in place for the business?

José E. Almeida

We -- no, as I described in the prepared statement, we had a significant amount of improvement to make in this business. We had some portfolio to be pruned, we were in the radiopharmacies that were highly -- no, were not profitable to the company. We were in industrial chemical business, which had nothing to do with our pharmaceuticals business that today stands in front of us. So we were not ready. We have some efficiencies to gain in operations. We have hired a significant -- very talented individuals who are today running our business. So we found now is the right time. We also would like to recognize Matt Harbaugh, who was the business' CFO who has been running that business for now over a year to the great job that he and the team did making this business even more efficient and doing so well. I tell you that this expanding on why now and the president that we went to or searched about a year ago, we knew that we're looking into alternatives for this business just to find the person who could be a CEO of this business, was very different than just finding the person to operate the business. So we now have found this individual. We have the business operating well, so now is the right time to make this business an independent unit that can take off and make the investments that are more relevant to them and be able to bring more value to our shareholders.

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

The specific timing of now versus waiting which sounds like a very short period of time to announce when you have the new person in place.

Charles J. Dockendorff

Mike, this is Chuck. This -- just to follow up in that a little bit. We've been doing a lot of work behind the scenes, and you can imagine the complexities involved in this. But this business is integrated with us around the world and for us to continue on with this, we need to bring more people in for the company and get things going and begin to build out the corporate functions here at Pharmaceuticals to develop as an independent public company. And we just didn't want to wait, we feel good about where we are at. And like Joe said, we have somebody on who knows what we're doing and he's all signed up to go. So we wanted to just make sure we can include it with the other people, so we can get the work done that needs to get done and get this thing going.

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

And just so we're clear on the incremental expenses that you'll incur over the next 12 to 18 months as you prepare for the spin, when will you have visibility on that? And how will you treat that relative to disclosures?

José E. Almeida

We will call it out specifically. We don't -- we have, again a general idea where those are coming, but until we get a lot more people involved and kind of finalize our outside the U.S. structure, and there also could be some tax leakage as we separate some entities. We'll clarify that at a later date, but we will be identifying that and breaking that out separately through the call.

Charles J. Dockendorff

Yes, Mike, just to make sure you understand it. So because some of these incremental costs will start immediately, we will non-GAAP those so that they will not skew the underlying earnings power of the business so you understand what's really going on. And then as we get a better idea of what those numbers are over time, we'll communicate that to you appropriately.

Operator

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

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

Chuck, you'd mentioned the word complex and complexities several times on this call. Can you maybe talk about, and Joe as well, how confident you are that the actual spin process doesn't distract senior management? And then second, the company has been doing a few deals a year, again, given the complexity of doing the spin. Does M&A slow down a bit as well?

Charles J. Dockendorff

Yes. I think -- like I said, we've been doing a lot of work already behind the scenes this year and the organization, if you look into where the work is, a lot of it is in the financial and it will be a lot of it with the management team here as they get ready and build out the functions and get ready to become a public company and develop their investor base and things like that. But we don't see this as hampering anything that we need to do to run Covidien. We think that it's not going to impact our results at all in the course of this year other than some of those costs that we'll incur as a result of the separation. So I don't really see any slowdown in M&A or any impact to the business from an operational standpoint.

José E. Almeida

Yes. I would add that we have selected a very competent team that is independently working on this that does not have any other responsibility other than this project. So -- and because our business units in Medical Devices are not involved in this transaction whatsoever, does not hamper our ability. We have our former CFO for the Medical Devices business running this project and we're very confident that we have the right people there and will not be a distraction to the rest of the organization.

Operator

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

Frederick A. Wise - Leerink Swann LLC, Research Division

I'll just ask my 2 right upfront. When I think about the Covidien infrastructure, Chuck, will there be further restructuring or any restructuring required to rightsize the parent company after the spin? And just up until the time of spin, will you report the businesses differently or separating out pharma in some kind of way?

Charles J. Dockendorff

Well, the first question, I mean, certainly, Rick, with the loss of 20% -- a little under 20% -- of our revenue, we certainly will be looking at the resources we have to support that and making sure we're rightsized to support the device business going forward after the spin. But again, that's something that we've got productivity initiatives and things like that going on. As you know, we have restructuring programs underway. Pharma is part of that as well. So they've been restructuring some of their businesses in that way. We -- from a reporting standpoint, we will be reporting as we have been, up until we get closer to the spin. At that point, from my history with Covidien, we certainly will be including them probably more with the investor base and there'll be more discussion about the business, so that people are more familiar with the strategy behind it and things like that. But that's ways off. So I think for fiscal year '12, it will be business as usual with the same reporting that we have going out there.

Coleman N. Lannum

One thing to think about, too, is in September, we'll have as usual our annual Investor Day, where we'll talk about 2013. At that point, obviously, we'll be much further along in this process. And I think we'll be able to quantify a lot of things when we look into 2013 about reporting, and it will also give a chance for the new pharmaceutical team, the new leader there and his management team to discuss their strategy going forward.

Operator

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

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

I guess, perhaps for Chuck. As this process moves forward, do you foresee a situation where there may be shared service agreements between the 2 companies for a period of time post the spin?

Charles J. Dockendorff

There could be. I don't think they will be anything material. Our goal would be to get it as separate as we can once we do that. But I think from a practical standpoint, where it makes sense to do that, we will, and we don't -- we've gone through a lot of the systems and worked through that and there's still some questions about what we do, let's say the tax share agreement and things like that, that we have currently with our previous parent. And so we'll work through that thing. I don't think there'll be anything major though. They're pretty independent. The biggest problem area that we have some overlap is, again, international leverage stock distribution system, but we've already been working through our plan to separate that -- all of that business outside the U.S. And when and how we execute that, we'll do it in the most prudent way.

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

Okay. And then for either of you guys, and this has sort of been touched on but I just want to make sure I'm understanding it, I recognized that the pharma business does run separately. There are some, again, some back office and other functions that are combined. But as you think about the new Covidien, how should we think about the synergies that you may get from the spin-off here, either from the sales side or the cost side? I mean, you sort of indicated that with revenues going away, you may have to take a look at the cost structure again. But are there any discrete synergies that we should be thinking about?

José E. Almeida

Larry, there's not anything that is material at this point in time that we have seen. We discussed areas in the buy side, raw materials and things of this sort. There's very little there, and there's a lot of work. But that's not anything material in terms of financial impact.

Operator

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

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

Two questions. The first is, of your current restructuring program, how much of that is designated to pharma and how much to med devices?

Charles J. Dockendorff

I don't have those specific numbers. I would tell you there's a couple of programs within the pharma business that we're doing restructuring around the manufacturing facilities, which are underway. And they have a couple of other opportunities which we're vetting now. But the majority of it is clearly with the device group.

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

Okay. And the second question is, once spun out, will the "new" Covidien maintain a stakeholder or ownership structure in any way with pharma or is it a complete spinout?

José E. Almeida

It's a complete spinout.

Operator

Your next question comes from the line of Jason Wittes with Caris.

Jason Wittes - Caris & Company, Inc., Research Division

You guys had mentioned that the capital structure of the 2 companies will be pretty similar, but I guess we've seen in the past that, if possible, all of the debt gets pushed off to the spin-off. The question is, presumably if you have much debt in 18 months, are you going to be able to push some of that towards the pharma company? And related, if I look at Specialty CapEx, what kind of cash flow comes out of the pharma company right now?

Charles J. Dockendorff

Yes, I think if you look at the information that we provided, you can see the operating income and we also provided the amortization. So it would be all relative to that standpoint as to the total Covidien cash flow. The pharma business probably has a slightly higher capital equipment investment rate, but not substantially than Covidien's. So I think that it would be -- cash flows would be very similar. As far as the similar debt structure, we're going to set it up and there's a lot of questions about the liabilities that get transferred over and the amount of debt that we put into it, clearly, is up to us. So we want to make sure that the business has capital structure to perform and carry out its strategy. So it's got a strong capital structure to do that, as well as handle any risk that could be out there, something like liabilities or things like that. So I think that's the way to think about it.

Jason Wittes - Caris & Company, Inc., Research Division

Okay. And secondly, you guys had mentioned there's really not a lot of -- when the 2 businesses don't interact that much, but I still imagine that there's some bundling that goes on between pharma and devices with a lot of hospitals. Is that the right assumption? And related, would those kind of relationships be able to continue once the 2 companies separate through some type of agreement or it's just not relevant?

José E. Almeida

Jason, Covidien does not engage in bundling of any of our products with any constituents or customers in the U.S. With that said, there's very little interface between the pharmaceutical business, even the imaging business with the rest of Covidien. Covidien corporate -- the corporate counsel group provide a little bit of support, but that would be probably easily duplicated within the pharmaceutical group. And you said, it's de minimis, the amount of support.

Operator

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

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

Just one quick one, and I apologize if I missed this earlier, but on the pharma margins, I realize that there's a mixed benefit from some of the new products. But are there new restructuring initiatives? Or is there anything else that you can identify to expand the margin profile much beyond the kind of 16% level you're at right now?

Charles J. Dockendorff

I think as you look at it there are some, like we said, some restructuring opportunities underway today in the pharmaceuticals business. There's a couple other that we're looking at that will improve the manufacturing footprint and cost structure of the pharmaceuticals business. But that's kind of ongoing improvements that we do anyway. As far as the margin, I think the only thing there, and Joe mentioned it a little bit on the Specialty Pharmaceuticals right now as we're beginning to ramp up that business, it's really in an investment mode. So as those products begin to grow, as well as new products launched within that segment or that area of the pharmaceuticals business, the profitability would -- expansion of profitability will be driven off of that growth.

Operator

You're next question comes from the line of David Roman with Goldman Sachs.

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

In the release, you talked a little bit about the comparable operating margin between the 2 businesses, but Chuck, can you provide some perspective as to some of the different return metrics of the 2 franchise, what the comparable return on invested capital is, and what the new company would look like approximately?

Charles J. Dockendorff

I don't want to give those numbers out now because, as you break out the final numbers and there's different allocations that will go on and things like that, it will be a little different than what you see today. So I just want to stay away from that at this point. I think the biggest thing and Joe mentioned it a little bit, I did too, was the investment horizon from some of the divisions. They're a little longer in the pharmaceuticals business and they tend to be in the device area. And I think that's where, as we look at some of these specialty pharma launches and things like that, they take a little bit longer time to drive to the profitability. So I think those are the different things that we deal with on the business.

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

And then, if I look at the new company operating margin 60% and new Covidien adjusted gross margin and operating margin in the high 20% range, that's pretty high relative to the peer group and relative to some of the other names within healthcare. Can those numbers actually move higher from here? And if so, what drives that?

Charles J. Dockendorff

Yes, I think the one thing those numbers -- and if you see at this footnote in the bottom but it doesn't include our corporate expenses so our corporate expenses are not listed there. And so when you do that, I think you'll see us more down lower for the standalone Covidien after that fact. But the -- yes, I mean, our goal has been to grow the net income at double digits and in order to do that, we need to find some leverage through the P&L off of our sales growth rate, so we think there's still capabilities there in the business.

Coleman N. Lannum

And David, the other thing to keep in mind is, when you take a look at the current Covidien, including pharmaceuticals, a lot of the -- in fact, the vast majority of expansion we've seen in gross margins and operating margins over the last 4-plus years have come from what will be the new Covidien.

Operator

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

Charles J. Dockendorff

Adam, are you there? Okay. Let's come back to him.

Operator

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

Michael Matson - Mizuho Securities USA Inc., Research Division

Just given the corporate and allocated cost, can you give us any sense of how that would be split up between the businesses? I mean, should we just assume it's roughly proportional to the revenues of the businesses?

Charles J. Dockendorff

Well, I mean, that would strictly be an allocation. What's going to happen is, there's going to be an increase in corporate cost as you build that structure to support the Pharmaceuticals as a separate entity. Once it is separate, conversely we'll look at the cost that we have remaining with Covidien and try to rationalize those in relation to the size of the business and the standard of the pharma business. So if you look at it, after it's all said and done and you have 2 separate companies because you are -- have those 2 duplicate functions within each one, you are going to have a higher cost base that exists after both companies are split than what exists today.

Coleman N. Lannum

Yes, Mike, you really have to be careful trying to project what those real numbers are going to be. That's the exact reason why we have to do the financials and get the Form 10 out there. And we'll help you at a later date when we have a better idea around it. But I would be very careful about just taking the current corporate numbers and splitting it among the 2 businesses, that's probably not a wise idea.

Michael Matson - Mizuho Securities USA Inc., Research Division

All right. And then just given that this process is going to take up to 18 months, is there going to be any change in how you put cash to work? I mean, are you still going to be -- I assume you'll still be looking at M&A? And would you put share repurchases, for example, on hold until this is all resolved or not?

José E. Almeida

We are not changing, Adam, our capital allocation policy. When we talk about returning to the shareholders 25% to 40% of net cash flow, it is -- we're going to continue to do that. So in terms of share repurchases, we're very specific about our philosophy there. We're not changing that. Because the business is going to separate up to 18 months, then we'll look, no, and we have a new president coming on board, that business is going to create a more robust strategy to become a solid public traded company and continue to grow in their market segments. I expect that some acquisitions and some modest acquisitions that enhance their pipeline will come to bear. So if they come to the surface, we'll discuss. If we think it's an interesting thing for the company to do at this moment instead of waiting for them to become a public traded company, we'll do.

Operator

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

Matthew Taylor - Barclays Capital, Research Division

It's Matt for Adam. I just wanted to clarify something. You talked really about business as usual until the spin happens, but clearly, part of the motivation is the different timelines, the different strategic focuses for the 2 businesses. Are you going to start treating them differently now? Are we going to see anything different in terms of your focus on the pharma side to prep that for a more robust spinout or anything like that?

José E. Almeida

The answer for 2012 is no. We need to keep our focus in delivering on our commitments. And our primary reason for being here is to deliver shareholder value and do what we're paid to do. With that said, I will tell you that with the new president coming on board early in the new calendar year, I expect that the strategy will be shored up and ready to go when we talk to folks in September. So I expect the focus to be shifting more towards the strategy that is under Covidien today. But I want to make sure that everybody understands, not only in the investment community but also our employees, it's business as usual, and we're here to make sure the business delivers on its commitments.

Matthew Taylor - Barclays Capital, Research Division

Okay. And I'm just curious, you said before it's a complete spin so I'm curious why you're choosing to do that versus have sort of an Opco [ph], Spinco and lever it up or pay back a dividend or some other kind of structure?

Charles J. Dockendorff

We just felt that this would be a tax-free situation. They'll develop their own investor base that's primarily focused around the pharmaceutical industry and compete with other companies in that area, and it'll be clearer to the investors how they perform against those people. It's a tax-free spin, and we felt that was the best value driver going forward.

Coleman N. Lannum

Keep in mind, Matt, we don't need cash. We already generate so much free cash flow, there's no need for us to construct a transaction like this in order to bring cash to the business. So we can just give this to shareholders, let them benefit from it and then let the shareholders decide what's best to do with the assets.

Operator

[Operator Instructions] Your next question comes from the line of Raj Denhoy with Jefferies.

Raj Denhoy - Jefferies & Company, Inc., Research Division

A couple questions. I think you've largely addressed this, but I think you had mentioned in the past that you're adding to the sales force for EXALGO and PENNSAID pretty aggressively. It sounds like that is going to continue unabated here. I just wanted to confirm that.

José E. Almeida

The investment that we made was made. And at this point in time, our commitment to that invest is complete -- investment is complete. Other than filling open positions and adjusting territory sizes. At this point in time, we don't have any short-term plan to invest in more sales force and infrastructure for that business. But like I said before, this is going to be a publicly traded company. It's going have its own strategy with the new president coming on board so they need to devise what's the strategy for their businesses. At this point in time, Covidien is not going to make any further investments in sales force for the specialty business.

Raj Denhoy - Jefferies & Company, Inc., Research Division

Okay, fair enough. And just lastly on the idea of the sale versus spin again, there been various times conjecture that a sale was being contemplated or was -- the company was perhaps been shopped around. Did that, in fact, take place? Was there a process by which strategics looked at this? Maybe you could talk a little bit about whether that actually took place or not?

José E. Almeida

I will not comment on any rumors that were out in the market. Let's talk about the future, not what happened in the past. I tell you that the decision to spin this business came through a very detailed work in our portfolio management and I tell every time that I have this question asked to me, I say that the same way we evaluate our business on an ongoing basis and our decisions are the ones that we'll make to ensure that our shareholders are the first ones in our mind. So if there's any questions in the future, during this call, about the process in the past, the question, we're not going to talk about it.

Charles J. Dockendorff

Operator, we're coming up on the top of the hour. We've got time for 2 more questions. We'll hit 2 more and then we're going to wrap things up, please.

Operator

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

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

You said that the -- in the presentation your margins do not include corporate expenses. What are -- how should we think about those corporate expenses?

Charles J. Dockendorff

That's primarily on the SG&A and operating margin side of things, Joanne. There is very little to none on the gross margin side of things.

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

Okay. I'll follow up more with you offline on that one.

Charles J. Dockendorff

Yes, we list our corporate expenses separately. They are between $350 million and $400 million a year, and then those are allocated to the current Covidien operating margins. We don't allocate them down to the individual businesses, and they're not included in the numbers that we presented in the presentation.

Operator

You're next question comes from the line of Scott Marics [ph] with Samelin [ph].

Unknown Analyst

Just a quick question. The person you're bringing on board to run the division -- or to run the pharma business, I think in the past you guys have had some people identify that you thought you'd bring on and they fell through. Is this ironclad and we should expect him or her at the beginning of the year?

José E. Almeida

It is a done deal. We're just working on the announcement between the company this individual is coming from and Covidien. And we didn't think there was any need to wait to announce our decision on the spin to the fact they're running the announcement on the president.

Operator

I'd now like to turn the call over for any closing remarks.

Coleman N. Lannum

Thank you. Thank you very much. Thanks, everyone, again for joining us on such short notice. We really do appreciate it and respect for the fact that it's the holiday season, and they are a lot of other things going on. Starting at noon, Eastern time today, a replay of this call will be available. And additionally, the replay will be available on our corporate website, covidien.com, at the same time. For members of the media who've listened to the call and have additional questions, please contact Eric Kraus, our Head of Corporate Communications. Now, as I noted at the beginning of the call, we are in St. Louis today, so we will be traveling part of the day and out-of-pocket. For those of you having more detailed questions involving nonmaterial information, both Todd and I will be available later on today to take them. Probably the best way to reach us is send us an e-mail, and we'll get back to you as soon as we can. Thanks very much. Have a great holiday, and we'll talk to you soon. Bye bye.

Operator

Thank you for your participation in today's conference. This concludes the presentation, and you may all now disconnect. Good day.

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