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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

Adam T. Feinstein - Barclays Capital, Research Division

Matthew J. Dodds - Citigroup Inc, Research Division

Steve Beuchaw - Morgan Stanley, 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

Miroslava Minkova - Leerink Swann LLC, Research Division

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

Topher Orr - Goldman Sachs Group Inc., Research Division

Jayson T. Bedford - Raymond James & Associates, 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

Covidien plc (COV) Q1 2012 Earnings Call January 26, 2012 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 Covidien plc Earnings Conference Call. My name is Larry, and I will be your operator for today. [Operator Instructions] I would now like to turn the conference over to your host for today, Mr. Cole Lannum, Vice President of Investor Relations. Please proceed.

Coleman N. Lannum

Thanks, Larry. And good morning, everyone. With me today are Joe Almeida, Covidien's President and CEO; and Chuck Dockendorff, our Chief Financial Officer. We'll be making some brief introductory comments and then spend most of the time this morning answering your questions. The press release, with details of our first quarter results, was issued earlier this morning and is available on our website and on the newswires.

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 note that under the Safe Harbor rules, we are under no obligation to update these forward-looking statements, even if actual results or our future expectations change materially. We ask you to please refer to the cautionary statements contained in our SEC filings for a more detailed explanation of the inherent limitations of such forward-looking statements.

We'll also discuss some non-GAAP financial measures with respect to our performance. A reconciliation of non-GAAP to GAAP measures can be found in our press release and its related financial tables, as well as in the Investor Relations section of our website, covidien.com.

For the first quarter, we reported GAAP diluted earnings per share of $1.02. After adjusting for certain specified items, our non-GAAP earnings came in at $1.13 per share. Now I'll turn it over to Joe, who will go into more detail on the first quarter results. Joe?

José E. Almeida

Thanks, Cole. We're off to a very strong start in fiscal 2012. Our sales came in ahead of plan and we reported record gross and operating margins. We also delivered an outstanding 19% increase in adjusted EPS, making this 6 quarter in a row that we have exceeded our expectations on the bottom line.

In the Medical Devices segment, we had another solid quarter with broad-based growth led by Energy and Vascular products. In the Pharmaceuticals business, sales growth was paced by strong performance in Active Pharmaceutical Ingredients, favorable pricing in the Generic business and further gains for new products.

In Supply, sales were about even with a year ago. In the emerging markets, comprising Eastern Europe, Middle Eastern Africa, Asia and Latin America, sales grew at a double-digit pace in the first quarter with broad-based gains led by stapling and energy products. This excellent performance reflects our recent investments to accelerate growth in these geographies.

In our large Endomechanical business, we reported strong growth in stapling products, led by the innovative Tri-Staple reloads. We're making good progress increasing Tri-Staple capacity, however we experienced a strong demand for the product as we continue to gain market share.

Results in Soft Tissue Repair is slightly below a year ago. Sales advanced in the large circuit category, but were more than offset by declines in mechanical fixation and mesh. This was due in part to the impact from competitive product launches in both U.S. and Europe. As I mentioned last quarter, we have faced some challenge on our Soft Tissue franchise. We're addressing these shortfalls by launching 3 new products later this year to augment our synthetic mesh and fixation device portfolio.

Our Energy business had another exceptional quarter, as new products such as the LigaSure 5 and Small Jaw, coupled with growth in electrosurgery contributing to our performance. This was the 25th consecutive quarter where we have delivered a high teens or better operation increasing vessel sealing sales, as we continue to develop the market and gain share. This business continues to be a key growth engine for Covidien driven by low penetration, technology adoption and hospital in-patient economics and outcomes.

In Vascular, we again achieved excellent results. Quarterly growth was led by Neurovascular and Chronic Venous Insufficiency products. Both of which registered exceptional growth in the quarter. The Pipeline Embolization Device continues to perform ahead of expectations, and we now expect peak annual sales to be in the $100 million to $200 million range. We're making incremental investments in selling and marketing clinical trials to accelerate our growth in the Vascular category.

In Respiratory, sales of Oximetry & Monitoring products were above year ago, led by monitors as well as 3 of our franchises, Nellcor, BIS and INVOS, grew a double-digit pace.

In the Airway & Ventilation category, sales declined from last year due to lower ventilation sales reflecting capital pressures, primarily in Europe. We're on track to launch our new ventilator platform in 2013.

Turning to our Pharmaceuticals business, we benefited from year-end quarter issues at some of our competitors, policy pricing in the generics business and continued growth for PENNSAID, EXALGO and the fentanyl patch.

In Contrast Products, sales were ahead of a year ago, due to a onetime customer order this quarter and good growth outside the U.S. Sales of Active Pharmaceutical Ingredients jumped 21% in the quarter, reflecting the sharp increase in narcotic products as we had sufficient quota to supply customers in some -- rather, in some products based on significant market shortages at the calendar year end. We're pleased with the favorable developments in generic pricing, which had been a drag on our business. In addition, we recently received our initial 2012 quota from the DDA, and believe we are well positioned to deliver on our expectations for the year.

In Medical Supplies, sales were little changed overall. With that said, we saw good growth for Nursing Care and Medical Surgical. Our innovative product launches, such as the Kendall DL, are providing positive momentum in market share gains, despite the fact that the markets in this segment are showing little or no growth. While we continue to feel some margin pressure from higher raw material prices, supplies continue to meet our expectations and provide good cash flow and ROIC.

Overall, we were very pleased with our results in the first quarter as we continue to experience progressive growth in areas such as stapling, vessel sealing and Vascular products. As I noted earlier, we're actively addressing those areas where we have opportunities for improvement, including mesh, mechanical fixation and ventilators.

I will now pass the call over to Chuck, who will discuss the first quarter in more detail and provide an update 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 and provide an update on our 2012 guidance. As Joe mentioned, we were very pleased with our performance in the quarter, as sales came in ahead of plan. We had improvements in gross margin percentage and achieved operating leverage and SG&A, while continuing to increase investments in research and development, selling and marketing.

Despite the continued investments, the gross margin and SG&A leverage resulted in an increase in operating margin. The tax rate also improved, which combined with the operational improvements and share repurchase, resulted in a 19% increase in earnings per share over the prior year, which exceeded our expectations.

As noted in the release, we registered a 120 basis point increase in adjusted gross margin this quarter, faced by favorable foreign exchange, manufacturing cost reductions, benefits from our restructuring programs and positive business mix. Pricing pressure continued, but was below the historical range.

On a sequential basis, adjusted gross margin improved 210 basis points, primarily due to favorable manufacturing performance. While we are pleased with our manufacturing cost reduction programs and the positive effects on gross margin, remember that these manufacturing benefits can be volatile from quarter-to-quarter.

Reported SG&A spending was up versus a year ago, almost entirely due to higher legal charges related to the Pelvic Mesh liability cases and continued spending on our growth initiatives, including the Asia growth plan, where we are expanding our sales and marketing presence.

SG&A, adjusted for the legal charge and separation cost, was down 160 basis points versus a year ago. The decrease in SG&A was a result of productivity improvements and the timing of expenses and investments. While we will continue to deliver productivity gains for the remainder of the year, we do expect that Q1 will be the low point of 2012 SG&A spending, as we increase our investments in selling and marketing for the Vascular, Energy and emerging market categories.

Research and development increased 21% to 5% of sales in the quarter, and we remain committed to our goal to further increase research and development over the next few years. We expect a steady quarterly increase on research and development spend for the remainder of fiscal 2012.

On an adjusted basis, our operating margin improved 210 basis points to 24.3% of sales, which was ahead of our annual guidance range, and at a record quarterly level. As we noted, in addition to favorable sales mix, a number of onetime factors contributed to the exceptional operating margin, including the positive foreign exchange impact on our gross margin, pricing better than historical norms and expense timing. As a result of these onetime factors and continued increase in investments, we do not anticipate that our operating margin will remain at this level throughout the year, and this is reflected in our guidance.

Interest expense was on plan. The tax rate, while in line with our annual guidance, improved by 100 basis points over the prior year as a result of tax planning activities. And we delivered a 19% increase in adjusted earnings per share to $1.13 in the quarter.

We did not buyback any shares under our repurchase program in the first quarter, due to the timing of our fourth quarter results and the subsequent announcement of the Pharmaceuticals spin-off.

Next, I'd like to make some comments on our 2012 outlook. As we noted in the release, we revised our sales guidance to reflect the recent strengthening of the dollar versus most currencies, and our strong operational performance in the first quarter.

Since our Investor Day last September, when we first issued 2012 guidance, the movement in exchange rates has negatively impacted our top line by about 250 to 300 basis points. As a result, we have lowered our expected sales growth at current exchange rates by about 200 basis points for the total company and for our Medical Devices segment. We have made smaller modifications to our Pharmaceuticals and Medical Supplies expectations, as these businesses are less susceptible to exchange fluctuations.

However, we now believe that operational growth, excluding the impact of foreign exchange, will be in the 3% to 5% range for 2012. This is about 100 basis points above our previously communicated expectation, and as a result of our better-than-expected performance and improved operational outlook.

We are not changing our operating margin or tax rate guidance, nor our guidance for free cash flow. We continue to expect operating margin to be in the 22% to 23% range; a tax rate, 17% to 18%; and free cash flow in excess of $1.9 billion. As always, these estimates are at current exchange rates and exclude the impact in any onetime items.

And while we do not provide quarterly guidance, you should be aware that we will see continued pressure from the timing of expenses, continued investments and the movement in foreign exchange, which will negatively impact earnings in the coming quarters.

We continue to expect to deliver year-over-year gross margin improvements due to cost reductions and mix benefits, but at current rates, do not anticipate a favorable contribution from foreign exchange going forward, as we received in Q1. We will incrementally increase research and development investments, fund our emerging market initiatives and look for opportunities to make growth-driving investments that will benefit us in the future.

A significant portion of the funds for these investments will come from our productivity initiatives, where we will also employ our restructuring program and manufacturing cost reduction efforts to free up funds to these investments. Despite the significant movement of the dollar since November, and these planned strategic investments, we remain comfortable with the current annual EPS consensus estimates. I'll now turn the call back to Cole for Q&A. Cole?

Coleman N. Lannum

Thanks, Chuck. For questions and answers, we're going to limit you to, please, one question and a follow-up, if needed, so we can give everyone a chance to get their question in. I know there are competing calls going on out there, and a lot of you want to get on other earnings as well. If you have additional questions, you can either put yourself back in the queue or contact us after the call. Larry, could you please start with the first question?

Question-and-Answer Session

Operator

And our first question comes from the line of Kristen Stewart of Deutsche Bank.

Kristen M. Stewart - Deutsche Bank AG, Research Division

I just wanted to start off real quickly, just in terms of the fact there continues to be a pretty big perception by the investment community, you have a significant exposure to the euro, I just wanted to confirm your euro exposure. Is 17% about right? I think that was kind of in the last K.

Charles J. Dockendorff

Kristen, this is Chuck. When we look at, as a percentage of sales, our euro sales in 2012 are forecasted to be around 15% of our total revenue.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. That's perfect. And then I guess just secondly, if looking at the raise in organic sales growth, this quarter was right around 5%. If you adjust for the extra selling week comp, it looks like you're expecting apples to apples to be up about 4.5% to 7%. Can you maybe just talk a little bit about what gives you confidence that we're going to see growth perhaps accelerate. I realize 5% is within the range, but what could be some of the drivers that move it higher throughout the course of the year?

José E. Almeida

Kristen, this is Joe. We are ending the first quarter and we have some really good product launches coming down the pipe. A couple of them in Energy and Vascular. So if you think about the engines of growth for Covidien, the Neurovascular business; the Energy business, primarily the vessel sealing, which has experienced a phenomenal growth, we don't see that going anywhere else other than up; as well as our Tri-Staple, we continue to improve our market share gains and penetration, primarily MIS; and lastly, emerging markets. We're experiencing significant amount of growth in Brazil, China, emerging markets in Europe, Middle East and Africa. So we feel confident that the growth engines for Covidien, they are able to provide this incremental 100 basis points in our guidance.

Kristen M. Stewart - Deutsche Bank AG, Research Division

And it's just the strength of these businesses, relative to September, that give you the confidence to increase it today?

José E. Almeida

Yes. Sequentially, we see a good momentum. So we do feel comfortable with our estimates.

Charles J. Dockendorff

And Kris, remember, in this current quarter we're announcing today, those businesses did better than we expected on the top line as well.

Operator

Our next question comes from the line of Mike Weinstein of JPMorgan.

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

So just to follow that up, so everybody's on the same page on the numbers. So the 3% to 5%, doesn't adjust for the extra selling week. If you adjust for that, our math, and Kris was suggesting 150 bps, ours is like 170. So in organic comparison, it will be like 4.7% to 6.7% organic. So that's up from the, let's call it, 3% organic that fits our math that you have for FY '11. Can we focus on 2 businesses in particular, Joe. One, the Peripheral Vascular business, which is obviously very, very strong and it's a high-margin business. And then second, Advance Energy, you made a couple of comments on it, but if you could just drill down a little bit more into the performance for this quarter and the products that are driving it?

José E. Almeida

Our peripheral business is doing well. It's a business that is growing slightly better than market. There are pressures in the biliary stent market, but Covidien is doing extremely well with our Hawker [ph], which is our plaque excision. That product pulls a lot of volume in the Vascular suites. So we're confident that our focus on that business will not -- is off to continue to accelerate. We have new products to be launched that are easier to use, and combined all the features that we think will continue to bring attractive new business for Covidien a bright future. When it comes to advanced energy -- I tell you, we have the launch of Sonicision in April, and we are very happy with the performance of vessel sealing. If you think about vessel sealing, there's a couple of things that are happening, not only are we gaining market share but also, we're developing under-penetrated market. So that provides that business with growth, for instance, in this quarter, way over -- way above 20%. Okay. But I also wanted to highlight that the Energy category, our Electrosurgery business did extremely well, as we continued to leverage our ability to provide to hospitals, across the globe, one energy company solution.

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

Joe, let me just follow-up on that, and then I'll let others jump in here. But you said that the advanced energy piece -- that the sealing part was growing well north of 20%, can you just maybe highlight what procedures, which you have visibility, are driving that? And then on the question on the broader Peripheral Vascular, it was actually -- I'm interested in the Neurovascular piece, and if you could give us any sense of how Neurovascular is growing relative to the peripheral side of ev3?

José E. Almeida

Okay. The procedures are traditional. The GYN procedures, in general surgery as well. Okay. So with Impact that was launched a few years ago, the new 5, that small jaw, those products are tools that are used now vastly in many different procedures that go from the OB-GYN space, all the way to general surgery. A lot of them open an MIS. So we see the adoption of that technology and have our generators now placed in so many different places. Allows us to really have our sales rep focus on 2 factors, which are the key in selling this technology. First of all, the clinical effect of that technology. Second, is the economical aspect of using energy versus other sources of ligation. So I think we have found the right formula to have this business continue to penetrate in the markets and continue to inch up on our share gains. When we talk about the Neurovascular, the Neurovascular growth is a multiplier, many times the growth of Peripheral Vascular as a percentage of sales. The Neurovascular business is doing so well across the globe. I'm not talking about U.S. I'm talking about Europe. Everybody talks about issues in Europe. The technology still gets paid in Europe and it's important to understand that the Neurovascular business has worldwide growth that is well north of 20%. So we're very, very happy. I would tell you that for this quarter, the Neuro business was over 35% growth. And the peripheral business was high-single digits. So we're very happy with that franchise. That's why the investment of the company -- that's why we need to continue to invest in the clinicals, in the sales and marketing efforts, to be able to continue to capitalize it, because the market spend there is growing well and we are gaining share.

Operator

Next we have Matthew Dodds of Citigroup.

Matthew J. Dodds - Citigroup Inc, Research Division

Just a follow-up on the Vascular question Mike just asked. Joe, when you look at the 16% growth over all, neuro is obviously a big part, but it looked like some of the other pieces also did better like venous. And I was wondering just broadly, are you seeing better growth outside the U.S. as you take these businesses into your infrastructure. So is the 16% actually higher internationally?

José E. Almeida

Well, I would tell you the bigger business, the bigger base for the CVI business is in the U.S. And we have now -- I will speak in a little bit about the international portion, but in the U.S. we have launched significant amount of campaigns with the society to create awareness of Chronic Venous Insufficiency that, that is not just a cosmetic procedure, but that is a very needed procedure that will prevent the patient to have significant amount of issues if the disease did continues. So our CVI business, it's up 32%. And is being driven by the U.S. and Europe. And we're starting to see penetration in emerging markets. It's early still, but we're still building the case in terms of healthcare economics and clinicals that will allow us to penetrate with this business in many different countries in emerging markets.

Matthew J. Dodds - Citigroup Inc, Research Division

Great. And just one quick follow-up, Joe. On Endomechanical, it grew 2% in constant currency, it's a little lower than what it's doing last year. I'm pretty sure stapling is still strong.

José E. Almeida

It's still strong.

Matthew J. Dodds - Citigroup Inc, Research Division

What's going on with the other pieces? Is that trocars, is there a pricing pressure or volume? What's changing outside the stapling?

José E. Almeida

Trocars are hand instruments, disposable hand instruments. Significant mark price pressure across the board in the U.S. and Europe has depressed that category, which brings the whole Endomechanical category down. I want to highlight to you that the Endomechanical, the stapling part of it, primarily the Tri-Staple, for the year, we're looking a near double-digit growth in a market that's probably low-single digit. So the unfortunate part is we continue to fight hard on the trocar and hand instruments, and the competition is stiff and the price is tough. But we have the ability to really continue to penetrate it with our Tri-Staple across, not only in the U.S., it's highly successful in Japan, in emerging markets, as well as Europe.

Operator

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

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

So in the past, you've talked about being relatively less affected by some of the utilization issues that others have noted. And yet, we still see economic issues pressuring some of the hospitals, the payers are under more pressure, and you've got entire governments both here and abroad. So the question is, separate from the procedure side of this, how are you seeing hospital behavior change either in the U.S. or in Western Europe, and maybe a little bit on the lower pricing pressure which seems odd given the environment?

José E. Almeida

So I'm going to comment on the general market and then specific to Covidien, because our Vascular products is quite different than most companies. So I'll explain to you our take on that. In general, we haven't seen a significant change in the U.S. in terms of how hospitals are behaving. I will say to you that the price pressure was always there. There's always a very competitive environment. Hospitals are becoming very driven by economical evidence associated with clinical evidence. So the ability to take new technology to a hospital and the adoption curve being, what used to be 3, 4 years ago, quite rapidly in the U.S. is lower in Europe. You would see that much different today. With the significant amount of impediments, if you don't have the right economical story to discuss with the administrators of the hospital, as you see more of these physicians becoming employees of a hospital. I think the significant amount of change in the U.S. in terms of test and learn about ACOs, everybody -- you have the flavor of the month. And I think that good things will eventually come out of this, in terms of improving patient care and the overall system, which Covidien is a proponent of it. If you go to Europe, Europe is -- now you have in Spain and in Italy, continuous significant amount of pressure price and volume-wise. In the U.K, we see slightly low-single digit growth market. Good growth in Germany. France is always a mature market. It has low growth as well. Good growth up in the Nordic countries, also Holland and some in Belgium. So it's a mixed bag. But I want to make sure that people understand that Covidien products, which are technology-driven, are growing double digit in all these markets. And to close on the Covidien basket, we are privileged by having a basket of products that are less susceptible to price erosions that you've seen some of the categories out there, 50 -- 500, 700 basis points of erosion. We continue to be on our low end of our guidance in terms of price erosion. But that has to do with the way we design our portfolio and how we -- knowing where we are investing money today.

Operator

Next question comes from Jason Wittes of Caris.

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

I wanted to ask about how you're faring versus some competition. I noticed that you mentioned that you have some initiatives in mesh, in fixation in particular. Those are 2 areas that have become very competitive. I know mesh in particular has gotten a lot of pricing pressure. Are you looking to offset that as the year progresses in new products, and how should we be thinking about growth going forward in those businesses?

José E. Almeida

We have decided that in the Mesh business, Covidien will focus its product launches and our attention commercially speaking on the synthetic mesh. We have spoken about the biologic mesh became a very difficult market in terms of growth. And the ability to create indications for use for specifically very sick patients, which have contaminated wounds and things like that. Because the difficulty and the cost of getting into those markets in terms of clinical studies, Covidien has decided to shift its priorities to make sure that we continue to grow in the synthetic mesh and continue to gain share. We have a significant opportunity there, as we are not #1 and neither #2 in those categories. And we also are providing the market with new products in fixation to be able to keep our high market share. Covidien is #1 market shareholder in that and we are making every effort possible to maintain our share. There's about 6 new Soft Tissue products in 2012, and we are very eager to get those products into market and have a commercial organizations get on with them.

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

And then in fixation, I mean there has been a lot of competition. You cited it last quarter, it looks like you're citing it this quarter. That's actually a big market share area for you. Is that something you expect to turnaround quickly or what's the outlook there?

José E. Almeida

Well, we probably will turn this around towards the end of the year. I think with the product launches and some of our commercial efforts, we're going to be able to demonstrate the effectiveness of our product versus the competition.

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

Last quick follow-up, also within tissue sealing. You had very strong numbers, but there is also competition there. It sounds like it's been not much of a threat or is this everybody growing because the market is so under penetrated?

José E. Almeida

I think there is a significant amount of under penetration in the market, but I've got to say that Covidien has a portfolio of products, and technology, that in my point of view is superior to whatever is in the market today. So I feel confident about our technology and our ability -- our commercial ability, to penetrate new markets across the globe.

Operator

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

Robert A. Hopkins - BofA Merrill Lynch, Research Division

So first question is on buybacks. I understand the reason why there weren't any in the first quarter, that's very understandable. But I'm just curious as to why you aren't assuming any buybacks in your guidance for the year, given the ample cash flow that you generate? And might we read into that, that you're maybe slightly more optimistic on some of the M&A opportunities that might be out there?

Charles J. Dockendorff

I think on the buybacks, Bob, we go with our 25% to 40% of return of capital from free cash flow to investors, and we increase our dividend every year. We're going to continue on that mode and we'll use some of that probably for share repurchase in the coming year. We don't give EPS guidance, but we do reflect some of the outstanding shares and the dilution from that. Some of that is also impacted by the stock price, as far as the number of outstanding shares and those components within it. So we feel comfortable with the guidance that we give and the level of capital we will return to shareholders. As far as acquisitions, I'll let Joe comment also, but we're seeing a lot of opportunities out there. We just completed BARRX and we see other opportunities out there, and see some ability to continue to invest in that as well.

José E. Almeida

Bob, it's very opportunistic, at any given time, we have a significant amount of opportunities in front of us. But we'll do what's -- we're very disciplined about how we go about deciding, and then how much we're going to pay for an acquisition. So that discipline prevent us from doing 2 or 3 deals last year. And looking back, I have no regrets. We're very happy with BARRX. We had a couple of smaller deals that we just acquire a couple of product lines into our Vascular business. And we're going to continue to look for those opportunities.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Great. And then as a follow-up, Joe, I'd like to ask a macro question. First, you saw good strength in Europe this quarter despite a lot of economic uncertainty over there. Can you give us some updated thoughts on your outlook for Europe throughout the course of the year, how confident are you that things can continue to be okay in Europe for you guys? And then also, and from another macro perspective, you seem to see pretty good growth in Medical Devices and some of your more generic businesses like electrosurgery and sutures. Should we read into that, that from your perspective, the general surgery markets feel a little bit better?

José E. Almeida

Bob, in terms of Europe, I want to clarify that a lot of our growth came from the emerging countries in Europe. So what I spoke to Gunderson about, when I answered his question, about what I see in Europe in terms of the traditional big 5 and Nordic and Benelux, I was able to describe that is a mixed bag, and has not changed since a couple of quarters that we've been talking about Europe. So what Covidien is doing is really accelerating the growth in emerging economies in Europe, Middle East and Africa, and develop them as we continue to go on. I would say, that in terms of your question in electrosurgery and sutures, I will read a couple of things into it. One is, there is very little change in terms of market dynamics and growth. I don't think we have -- we now improved significantly, but we are not very different from last quarter. We've been very consistent how we're talking about the procedures and how we see them flat quarter-over-quarter. What we've been doing is we've been providing commercial focus in some of these areas. The ability to provide energy, and the energy portfolio for a hospital is very important. So when Covidien brings a vessel sealing, it also brings the electrosurgery, the generator is the same. So standardization is a big thing in hospitals to reduce their cost of operating. So Covidien plays into that. Sutures plays along the same lines.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Okay. Great. So it's more pull through than actually signs of an overall recovery?

Operator

Our next question comes from the line of Joanne Wuensch of BMO.

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

Can you give us what the ev3 contribution was in the first quarter? And an update on Solitaire.

Coleman N. Lannum

Joanne, this is Cole. First of all, it's hard to talk ev3 because, obviously, those business now are integrated in with what Covidien -- the legacy businesses are. I could tell you, and I think Joe mentioned earlier, that the Neurovascular business was up in excess of 30% in the quarter. And the Peripheral Vascular business was up high-single digits.

José E. Almeida

So Joanne, the Solitaire we filed for the 5- and 10-K, if you just add the number of days they usually take the FDA to return would probably put us in, probably in the April, May time frame. Okay. So I want to make sure that we understand that Solitaire is a great product. It's a life-saving product. Covidien is going to put a lot of resources behind that product in terms of sales and marketing, but it is not only a product they put in a sales rep bag and this rep is going to go sell the product and walk away and just convert another account. This is a matter of developing the stroke centers, making sure there's a significant amount of resources. The physicians in the stroke centers are trained to use the device. So I expect to be a great device, life-saving device, but it's going to be a slow uptake. And it's going to be a few years for Covidien to be able to get this product to peak sales, because the market development is so complex and so expensive as well.

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

As a follow-up question, people are starting to talk now about how they're managing the med tech tax in 2013. Is your plan to absorb it or to adjust and plan for it?

Charles J. Dockendorff

We're looking at that, approximately half our revenue is going to be tied into that tax. And we've talked about hitting our net income of about 70 to 80 basis points of our sales impact of it. We're looking at it, we're looking at a number of different options right now. But again, our commitment has been to long-term, double-digit EPS growth over time. And we don't think that something like that, particularly, should knock us off that goal. We get these kind of increases in raw materials or currency that are far greater than that all the time. So it's just another business issue, that we will deal with as we look in 2013.

Operator

Our next question comes from the line of Rick Wise of Leerink.

Miroslava Minkova - Leerink Swann LLC, Research Division

It's Miroslava for Rick Wise today. Maybe if I could -- talk briefly about how you see the quarterly flow for the rest of the year. Obviously, foreign currency turns negative and you just beat estimate by a $0.10, but you're comfortable with consensus. I guess if you could sort of walk us through a little bit how you see foreign currency flowing through the P&L. And obviously, you just reported 18% EPS growth for the first quarter, basically how you see the quarterly flow for the remainder of the year?

Charles J. Dockendorff

Again, I just want to start off, we don't give quarterly guidance per se. But clearly, Q1 was a very good quarter for us. Higher than what we've given for a range in the operating income. I think if you go back and you look at the currencies and FX and how it flew -- went through last year, most of these currencies strengthened during the second and third quarter, actually they peaked in the third quarter last year. So the biggest differences will come in the third quarter year-over-year comparison, based on rates were they are today. So we see further pressure from FX, where it was a favorable in the first quarter. To the full year, right now, from an earnings standpoint, it will be a negative. So we're going to see that turnaround in the second, mostly in the third and fourth quarter, again that's at today's rates. Another thing is, as far as the timing of expenses, we did -- we talked about having some onetime events in the quarter. We had some real nice pickup in our Pharmaceutical business related to some quarter issues and some margin improvements there. We also had the favorable mark to market on the FX hedges that we have and that flew through our manufacturing. So I think from those standpoint, those will not continue. And then on top of that, we are going to increase our investments in research and development, that will continue to grow throughout the year. We also will continue to invest, as Joe mentioned, in the Neurovascular sales force around the world to capitalize on the growth of those products and capture that. And we're also going to be investing in clinicals in that area. So we have a lot of investments that we think have very, very good returns and that we will be investing in the following quarters, especially with the good start we've had here in Q1. So I think that's going to be the trending you see and they will have an impact on it. And that's why we feel comfortable right now with the EPS consensus that we have out there.

Miroslava Minkova - Leerink Swann LLC, Research Division

Okay. Great. And maybe a quick follow-up, how much exactly was the FX favorable on gross margin this quarter? And if we exclude that, is this how we should think about your gross margin essentially going forward?

Charles J. Dockendorff

I think the gross margin improvement was -- the FX component was more than half of that improvement year-over-year. But in that quarter we've had, there was still some manufacturing cost reduction. I think kind of price and mix offset themselves. And I would just like to talk a minute about the gross margin improvement because it has been relatively significant over the last couple of years, but we've talked about our restructuring programs and we have 3 programs. One is complete, 2 are underway. But when you look at the work that this manufacturing group has done, just to give you some statistics of the result of those restructuring programs, our manufacturing facilities at the beginning of 2008, we had 67 facilities. And we expect by 2012, will be down to 48. We've cut out more than 10% of our workforce as a result of that. And our distribution facilities, we had 57 in 2008 and we expect to be down to around 44. In addition, we've moved a lot of our manufacturing into low-cost countries. So in 2008, about 9% of our cost of production was in low-cost countries and now we're up over 17%. So these are just some of the accomplishments that our manufacturing group has done. And a lot of this is reflected in our gross margin already, and will continue to be a big driver of the gross margin improvement going forward. And I would tell you that they've been able to make these major transformations, plant closures and relocation of our manufacturing with very little impact to quality or supply issues. So they did a great job on this part of it.

Operator

Next we have Jayson Bedford of Raymond James.

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

Just a couple of very quick ones, you mentioned double-digit growth in emerging markets. How big is emerging markets as a percent of sales, maybe in the quarter?

José E. Almeida

Emerging markets for Covidien is close to $1.1 billion, on an annual basis. So you can probably do the math for the quarter.

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

It's about the same?

José E. Almeida

No. It's the same 10%.

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

And then in the release , you mentioned kind of outsized customer orders in API and Contrast. Anyway you can quantify the impact of those orders?

José E. Almeida

We will not quantify that. As we said, it was a onetime effect and that you can see that kind of growth is not sustainable. That's why we've clearly indicated, it was because that specific order pattern.

Charles J. Dockendorff

You may remember, Jason, we had a similar effect in the contrast business in fourth quarter of 2010. It's sizable enough, so I think you should do your modeling for the rest of the year in contrast. You should certainly expect a much lower nominal quarterly revenue rate than you saw in this quarter. Same thing on the API side of things. We showed more than 20% operational growth in API this quarter. This is not a 20% normalized long-term growth business, it's much closer to low-single digit numbers. I want to make sure that you understand that and you don't just extrapolate from these numbers.

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

That's helpful. And just lastly for me, just clarifying an earlier comment on Endomechanical. You mentioned that you expect double-digit growth and I wasn't sure, was that just for stapling as a whole or the Tri-Staple platform?

José E. Almeida

We expect for the stapling franchise of Endomechanical for 2012 to grow near double-digit growth.

Charles J. Dockendorff

And that's on a normalized basis, that's correcting for the extra week.

Operator

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

Michael Matson - Mizuho Securities USA Inc., Research Division

My first question is on Sonicision. I think the commentary was made in the prepared remarks, that's going to be launched in April, and I was just wondering if you could comment on the patent litigation with J&J and whether or not that changes anything? And then I have a follow-up question.

José E. Almeida

We have no comments on any litigation the company is currently undergoing. And that has no impact on the launch of the product whatsoever.

Charles J. Dockendorff

And as far as launch of Sonicision, it is a good time to give a little commercial for our mini Investor Day that we'll be having out at SAGES in San Diego. The Sonicision launch will be part of the key stone on all those. Certainly, not the only thing that we'll be presenting to surgeons at SAGES. And any of you who come out to that meeting, you'll be able to see exactly what we're doing and some of the plans around the launch.

Michael Matson - Mizuho Securities USA Inc., Research Division

Okay. And then my second question was just on pipeline. It seems like the product is doing extremely well. I was just wondering whether that is starting to maybe cannibalize some of the other coiling products and things like that and some of the smaller aneurysms maybe. I mean even if it's not cannibalizing your own business necessarily, is it cannibalizing some of the other products that are out there on the market? And is that why the product is doing so well or is it really just limited to the larger aneurysms.

José E. Almeida

The indication for the product, and how we sell the product, is exactly per the label and per the instructions for use. So the product is sold strictly on that base. Our sales force are not advert or sell this product for any other indication other than what is on the label. Okay? So once you use a pipeline, you would remove the use of coils that in one point in time would be used for that procedure. So because Covidien is now the #1 and the #2 in the coil market. There's almost no cannibalization of our own product. So we are, if there is a market share shift or loss here, it's not coming at the expense of Covidien's coils.

Charles J. Dockendorff

And I think that's pretty consistent. If you take a look at what's going on in the coil market of the last 6 months, I think you've seen that, that market growth has slowed somewhat. I don't think that's only because of the Pipeline Embolization Device, but certainly there could be some effect there.

Operator

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

Adam T. Feinstein - Barclays Capital, Research Division

And I guess my first question is more of a housekeeping question. With the form 10 for the spinoff, is it still the same timeline that you guys outlined when you had the last conference call?

Charles J. Dockendorff

It is. Yes. We planned on the same timeline.

Adam T. Feinstein - Barclays Capital, Research Division

Okay. Great. And then my question is on the pricing side, we've been talking about challenging pricing environment for all of med tech for the last few years now. You guys have a diversified portfolio, and certainly have been able to manage through it better than others. But a lot of antidotes during the fourth quarter and some of the other segments -- and about a little bit of the step down in the fourth quarter. I'm just curious in terms of whether you guys saw anything like that and just updated thoughts on pricing?

José E. Almeida

Adam, we, for the fourth quarter, came at the lower end of what we talked about, in terms of the numbers that we discussed in terms of price erosion. So I'll go back to the point you made and I made before, is the Vascular products that Covidien has, and the ability that we have to sell our products and how much of the DRG those products are part of. So in the procedure, does Covidien demand a higher slice of the DRG for that procedure or a smaller? And Covidien usually, our products, are either used in supplies generally used across the hospitals, or we sell tools that are used in multiple different surgeries. So we have designed the company's portfolio exactly to be able to deal with this. With that said, you've got to be able to bring to the table clinical evidence and economical evidence, both to be able to continue to provide a positive mix shift that we experienced since our spin-off.

Charles J. Dockendorff

Adam, also I think that the pricing -- I just want to reiterate this, that it does not include the impact from new products. So when we launched the Tri-Staple or a pipeline device, those are at much higher prices than the existing product. And those are not reflected in that price calculation. So we are continuing to get improvements in that area as we launch more and more new products.

Operator

Glenn Novarro of RBC Capital Markets.

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

Two clarifying questions for Chuck. Chuck, the question on you beat $0.10, how should we be modeling this? Are you saying because fiscal 3Q represents the toughest comp from a currency point of view, we should be taking most of that $0.10 and reducing it from the fiscal 3Q number? That's question number one. And then on the gross margin you said, in fiscal 1Q -- let's just say the margin, gross margin is 59, 200 basis point improvement, half of that was FX. So the starting point, as we go forward, 58% as a base gross margin and should be lower than that for the rest of the year.

Charles J. Dockendorff

I think the way to think about it is those were year-over-year comparisons on the FX. So when we report our actual results in Q3, based again on today's rates, that's going to be the biggest difference between where they were a year ago, as far as the dollar strengthening. But as you look going forward from Q1, the rate as it finished at the end of the quarter, was a little lower than the average. So there is some downward pressure going forward from our Q1 results. But I didn't want to imply that it's going to go down more because Q3 last year was higher. So there is some pressure going forward and that's part of it, and I think it's more probably the pressure coming out in the back half of the year. The quarter 1, when you look at the gross margin -- like we said more than half of that benefit came from the foreign exchange benefit we received, which is a big piece of that is the mark to market on the hedges that we have in the quarter. So that is a onetime event and that will not continue. So we need to model down the gross margin going forward a little bit for that, as well as the fact that the rate at the end of the quarter was lower than what it was during the average of the first quarter.

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

But just clarifying on gross margin for the rest of the year, closer to 57% is that kind of...

Charles J. Dockendorff

We're not giving guidance. I mean if you look at our gross margin, this is a little -- it goes up and down, it did last year, and depends on the mix of revenues and some of our products. So I think I'll leave it at that.

José E. Almeida

I think what Cole was saying that for the year, gross margin will be higher in 2012 than it was in 2011. But beyond that we don't want to quantify.

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

Okay. Just one more follow-up, because obviously you look at consensus because you said you’re comfortable with consensus for the full year. Are you comfortable with where consensus EPS is for fiscal 2Q?

Charles J. Dockendorff

I'm not going to comment on that.

Operator

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

Topher Orr - Goldman Sachs Group Inc., Research Division

It's actually Topher in for David. I was looking to get back to the FX-neutral guidance you guys provided. Of that 100 basis point increase, I was hoping you guys could help us quantify what portion was coming from which of your 3 business segments?

Coleman N. Lannum

Topher, I mean, just starting to cut it a little bit too precise than what we're willing to talk about. Take a look at this quarter, you certainly saw strength in the Vascular business and Energy franchise, you saw strength in the Pharma business. We think that's the big part of it. To quantify how much for each of that, I think the error factor around each of those estimates is a little bit too high to be able to quantify that number with any degree of accuracy.

Topher Orr - Goldman Sachs Group Inc., Research Division

Yes. I guess, just more directionally, would you say the majority of that is coming from Med Devices?

Coleman N. Lannum

I'd say more out of the Medical Devices. Remember, Medical Devices is more than 2/3 of the revenues. So on a weighted basis, that will be the case. But I don't want to discount the Pharma business either. Pharma is also doing well.

Operator

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

Steve Beuchaw - Morgan Stanley, Research Division

It's Steve Beuchaw here for David. Joe, on the Pharma spin, how close are you to getting to a view on how you might assign debt or liabilities to that business, can you give us a view to how your thinking about those issues? And could we see any strategic activity in Pharma prior to the spin, whether that's M&A or any operating restructuring?

Charles J. Dockendorff

As far as developing the capital plan for the Pharmaceutical spin, we're going to make sure that they have a balance sheet and the strength to watch themselves so they can carry out their strategic plan. And that will include some investments along the way and acquisitions. And we have not yet fully decided on that. We have a number of ideas underway, and options that we have, but we want to make sure -- it depends what liabilities get split out between the companies and things like that. So there's a lot of options that we have as we do that. But the underlying point that is we want to make sure that the company has a good strong balance sheet where it can carry out its activities. And as far as investments from now until spin, we will continue to look at opportunities there, probably small ones, to continue to build and offer opportunities to improve their pipeline on their brand and specialty pharmaceuticals. I would not expect anything significant in the way of acquisitions on the business.

Steve Beuchaw - Morgan Stanley, Research Division

That's helpful. And then a very quick one on Duet recall, sounds like very modest exposure. Can you confirm at this point that there's been no derivative pressure in abdominal indications? And how are you going about managing that possibility and then I'll drop.

José E. Almeida

We are counter-indicating the product for the thoracic. And we, at this point in time, don't have any information that will move us to do the same thing for abdominal indication. So there is no -- there is not the same correlation. They are not the same kinds of MDRs, it's completely different set of circumstances. So at this point in time, we feel comfortable that abdominal use of the Duet is safe.

Coleman N. Lannum

And Steve, I do want to clarify one thing too. While we've made clear on the Duet recall that overall, we do not expect it to be material from a financial standpoint, that recall did negatively affect our stapling business from a revenue standpoint in the first quarter. So keep that in mind, okay?

Operator

With no further questions, I'd like to turn the call back over to Mr. Cole Lannum for closing remarks.

Coleman N. Lannum

Thank you very much. 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've 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 to take your calls. Thanks a lot and have a great day.

Operator

This concludes today's conference. Thank you for your participation. You may disconnect at this time. Have a great day.

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