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Covidien (NYSE:COV)

Q4 2012 Earnings Call

November 09, 2012 8:30 am ET

Executives

Coleman N. Lannum - Vice President of Investor Relations

Jose E. Almeida - Chairman of the Board, Chief Executive Officer and President

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

Analysts

Kristen M. Stewart - Deutsche Bank AG, Research Division

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

David R. Lewis - Morgan Stanley, Research Division

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

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Matthew J. Dodds - Citigroup Inc, Research Division

Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

Matthew Taylor - Barclays Capital, Research Division

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

Michael Matson - Mizuho Securities USA Inc., Research Division

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

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

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2012 Covidien Earnings Conference Call. My name is Deana, and I'll be the operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to your host, Mr. Cole Lannum, Vice President, Investor Relations. Please proceed.

Coleman N. Lannum

Thanks, Deana, and good morning, everyone. With me today are Joe Almeida, Covidien's Chairman, President and CEO; and Chuck Dockendorff, our Chief Financial Officer.

We'll be making some brief introductory comments and then spend most of the time this morning, as we usually do, answering your questions.

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

Now during today's call, we will be making some forward-looking statements, and it's always 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 that you please refer to the cautionary statements contained in our SEC filings for a more detailed explanation of the inherent limitations of such forward-looking statements.

We'll also be discussing 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.

As a reminder, the fourth quarter 2011 included an extra selling week, a phenomenon that occurs once every 5 or 6 years for us. While exact quantification of the impact of the extra week is difficult, we believe it negatively impacted the fourth quarter 2012 sales growth rate by approximately 7 to 8 percentage points and reduced our annual growth by about 2 percentage points. We provided the sales impact at the total Covidien level, but you should not impute it at a lower level to any segment or product line as that may give you an inaccurate picture of our performance for the quarter.

For the fourth quarter, we reported GAAP diluted earnings per share of $0.96. After adjusting for certain specified items, our non-GAAP earnings came in at $1.02 per share.

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

Jose E. Almeida

Thanks, Cole. While our reported results were negatively impacted by the extra week a year ago, we finished fiscal 2012 with a very solid performance. For the fourth quarter, sales are on plan, flat operationally and off 3% as reported.

Our recent acquisitions contributed about 1 point to our revenue growth in the quarter. In the Medical Devices segment, we had a strong quarter, with 2% operational growth led by Energy and Vascular products.

In the Pharmaceuticals business, we again registered a very good performance for Specialty Pharmaceuticals paced by EXALGO. And in supplies, reported sales were below a year ago, primarily reflecting the impact of the extra week.

Before I go into more detail on our fourth quarter results, I'd like to spend a brief moment in discussing the health care product marketplace. Overall, there has been very little change in the market environment over the last several months. Emerging markets are growing rapidly, and we expect this to continue as access to health care expense and the demographic trends are favorable.

In Power, emerging markets business comprising Eastern Europe, Middle East and Africa, Asia and Latin America, operational sales again grew at a double-digit pace with broad-based gains led by stapling, energy and respiratory products.

And we did not experience any negative impact to our business despite a slowing GDP growth in China and Brazil. We again registered exceptional growth in the BRIC countries, led by China and Brazil, where we will continue to make incremental investments to accelerate growth and expand our product offerings.

During the quarter, we launched our first product specifically tailored for emerging markets, the Reliamax reusable stapler.

Let me now turn to individual product categories. As done in the past, I will discuss our growth on an operational basis excluding the negative impact of foreign exchange. I'm doing this because I believe it provides a better picture of our progress and, of course, our reported results this quarter were negatively impacted by the extra week in the year-ago period.

In our large Endomechanical business, stapling products continued to perform very well, led by innovative Tri-Staple reloads. We're experiencing strong demand for Tri-Staple as we continue to grow above the market and gain incremental share in stapling.

In fact, sales of the Tri-Staple family of products are now annualized in a more than $0.5 billion. Our fourth quarter performance was negatively impacted somewhat by the Duet TRS recall.

Sales in Soft Tissue Repair were on track. We made good progress in BioSurgery, but the increase was offset by declines in mechanical fixation as expected. This was due in part to the continued impact from competitive product launches in both the U.S. and Europe.

Our Energy business had another excellent performance with double-digit gains in vessel sealing for the 28th consecutive quarter. New products such as Sonicision and the LigaSure Small Jaw contributed to our strong performance. While it is still early in the launch cycle for Sonicision, we're encouraged by the progress thus far.

During the quarter, we were pleased to receive FDA approval for the use of LigaSure Small Jaw in the ear, nose and throat procedures, such as thyroidectomies. As we look to 2013, we continue to expect low-double digit growth in Energy, as it is a key growth engine for Covidien, driven by low penetration, technology adoption and hospital patient economics and outcomes.

Turning to our Vascular franchise. We achieved very solid results this quarter. Our performance was led by exceptional growth for neurovascular products, where flow diversion and Solitaire drove our results. As we noted earlier, we're making substantial investments in selling, marketing and clinical trials to deliver further growth and new products in the Vascular category. This remains a key growth opportunity for Covidien.

Sales of Oximetry & Monitoring products were above a year ago as we continue to make progress in this category. Our 3 franchises, Nellcor, BIS and INVOS, provide us a broad platform for growth, and our Monitor business grew at double-digit pace this quarter.

Our expansion into capnography adds a market-leading, fast growing monitoring platform to complement our portfolio.

In the Airway & Ventilation category, sales were above a year ago. We registered double-digit growth in ventilators for the second consecutive quarter, led by strong sales in emerging markets aided by the mid-range ventilator from Newport, a recent acquisition.

Turning to Pharmaceuticals, we again registered exceptional growth in our specialty product line paced by EXALGO and higher generic sales, and grew sales of our Active Pharmaceutical Ingredients.

In Contrast Products, as expected, sales were below last year largely due to lower device sales. As we noted last quarter, we expect this weakness in Contrast to continue into early next year. Sales of Radiopharmaceuticals were below a year ago, primarily from tougher competition in Europe and the extra week comparison.

We are on track for the planned spin-off of the business in mid-2013. We've recently made several moves to improve the growth potential of Pharma in advance of the spin with 2 co-promotion agreements and the acquisition of Roxicodone and CNS Therapeutics.

Turning to the Medical Supplies, sales were well below a year ago, largely reflecting the negative impact of the extra week. While the business faces strong pricing and competitive pressures, it continues to meet our expectations and provide us good cash flow and return on invested capital.

Overall, we are very pleased with our fourth quarter and FY '12 results. We continue to experience above market growth this year in areas such as stapling, vessel sealing, vascular and specialty pharmaceuticals. Our broad product portfolio and geographic diversity are keys to driving growth.

We will continue to make investments in expanding our capabilities and to capitalize on opportunities we are capturing from increased penetration of our products, particularly in Vascular and Energy. The portfolio additions we made in 2012 also contribute -- or will contribute rather, positively to our performance as each one offers a fast-growing market opportunity that we'll capitalize on our capabilities. These factors all contribute to our belief that Covidien is very well positioned to further growth as we expand our global share in our current categories, grow our business in adjacencies and look for additional opportunities to accelerate our performance.

I will now pass the call over to Chuck, who will discuss the fourth quarter in more detail and discuss our outlook for FY 2013. Chuck?

Charles J. Dockendorff

Thanks, Joe. As you know, all our comparisons are impacted by the extra week last year, which reduced our fourth quarter sales growth by 7 to 8 percentage points and had a leverage impact throughout our P&L.

The leverage impact from the extra week makes it difficult to compare the fourth quarter financial metrics with the prior year. While the extra selling week also had an impact on the full year comparisons, the full year results better reflect the improvements we have made in the business and represent the positive trends we continue to see.

As Joe noted, we're pleased with our performance in the quarter as sales came in largely on track with our expectations. During the quarter, we made further investments in R&D, selling and marketing to ensure our future growth.

As noted in the release, we registered a 20-basis-point decline in adjusted gross margin this quarter, as unfavorable foreign exchange rate movement more than offset positive business mix and excellent progress in our ongoing manufacturing cost-reduction program.

Pricing was a bit better than historical norms, but we also had a negative impact from the Duet recall. To quantify, Duet lowered our Q4 sales by about $20 million and was detrimental to our overall gross margin.

Reported SG&A spending was below a year ago, largely reflecting the impact of the extra week. We continue to make investments in our growth initiatives this quarter to expand our sales and marketing presence. The growth investments were largely funded by our productivity improvements and leverage on our back-office costs and base business SG&A.

The growth investments we've made over the last couple of years have driven organic revenue growth, and we will make additional incremental investments in SG&A to accelerate our growth going forward.

Research and development represented 5.1% of sales in the quarter. Since spin, research and development has increased at a 19% compounded annual rate as we developed and launched products that are clinically relevant and economically valuable. Looking forward, while we still expect R&D to grow ahead of sales, our plans call for more moderate growth than we have had in the last few years.

On an adjusted basis, our fourth quarter operating margin was 21.2% of sales, and we finished the year at 22.5%, up 30 basis points from a year ago and in line with our guidance.

Net interest expense was slightly higher, reflecting lower interest rates on our invested cash. The adjusted tax rate was in line with our annual guidance, and we delivered adjusted EPS of $1.02.

During the quarter, we repurchased about $550 million of stock and announced a 16% increase in our dividend. In the last 12 months, we have returned nearly $1.4 billion in cash to shareholders, representing more than 70% of our free cash flow. This is the second consecutive year we have returned more than 70% of free cash flow, and note that we returned this cash in 2012 in addition to investing nearly $1.2 billion in strategic acquisitions and license agreements.

Looking to 2013, we remain comfortable with the overall guidance we gave at Investor Day in September for sales, operating margin and tax rate. I will, however, make a couple of comments on items that will impact the quarterly flow.

The acquisitions we made in 2012 have not had a material dilutive impact individually. But on a combined basis, they will be dilutive by a few cents per share over the next couple of quarters. Also, the medical device tax will kick in beginning in the second fiscal quarter. As a reminder, this will be a component of SG&A for us and will be on the order of $25 million or so per quarter.

As we all know, foreign exchange rates have been volatile. Current rates are slightly down from those in place at Investor Day, but are somewhat more favorable than they were at their lows in the summer. At today's rates, FX will be quite negative to EPS in the first half of the year versus 2012. But the impact will improve as we move to the second half of the year.

If we see favorability from FX or improvements in the business during the year, we are planning to spend it back on growth initiatives. As we discussed at Investor Day, we have a number of opportunities on deck to reinvest in SG&A and R&D that will drive future top line growth.

We are on track to continue to deliver strong operational performance in fiscal year '13 with further productivity improvements and positive momentum from the investments we've made in new market opportunities. We will continue to balance investments for future growth of the business while staying focused on delivering short-term earnings growth.

We continue to feel good about our prospects given our expanding product portfolio, geographic diversity, growth-driving investments, new product pipeline and strong cash flow. I'll now turn the call back to Cole for Q&A. Cole?

Coleman N. Lannum

Thanks, Chuck. [Operator Instructions] Deana, could you please review the process for signaling a question and go to the first question, please?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of Kristen Stewart, Deutsche Bank.

Kristen M. Stewart - Deutsche Bank AG, Research Division

I just wanted to touch base on your comments around pricing. I know in the press release, there was a mention that there was some pricing pressure within Endomechanical. But I believe you had said that pricing overall came in a little bit better. But maybe you can just kind of help us understand where exactly is price better, and what gives you the comfort looking ahead given all the macro trends that pricing is not going to deteriorate.

Charles J. Dockendorff

We've always -- Kristen, this is Chuck. We've always talked about pricing being in the 50- to 100-basis-point impact on our gross margin. And in the quarter, it came in a little lower than that. It does swing up and down in the quarter, so it was a little better than what we've had historically. And then for the year, it came right in line with that kind of estimate that we've had historically. As we look across pricing amongst the different product lines, certainly the more products that are more commoditized are facing tougher pricing pressure. We're realizing that with some of the competition out there. However, a lot of the new technology that were launched out there is getting the price that we see, and we're seeing price improvement on some of those areas as well. So overall, again, as we look at the mix of our business, while we see pricing pressures and we expect it to continue to increase over the next year, the results that we have, have been pretty good.

Coleman N. Lannum

Kristen, and on the comments on Endomechanical, I want to make that clear, this is around, as Chuck said, the instrumentation side of things. That's nothing new. We've been seeing pricing pressure there for really the last 2 years. And in our more technology-oriented stapling business, pricing has not changed and it actually remains fairly robust.

Kristen M. Stewart - Deutsche Bank AG, Research Division

And then just real quickly, just on the gross margin. Is there any way to better quantify the impact from FX? And just looking ahead, it seems that the first quarter is a pretty difficult comp so maybe just help us understand maybe cadence with gross margin through the year?

Charles J. Dockendorff

Yes, I think on the foreign exchange, the fourth quarter -- our fourth quarter this year had the biggest year-over-year negative. We had approximately 100-basis-point decline in our gross margin just from FX, and that's why you saw it down 20 basis points from the prior year. The other part of that, offsetting that huge hit from FX, is we're still getting the positive mix component. As I mentioned, pricing was a little lower, and we've really had some real good progress in our manufacturing cost reduction, which added significantly into Q4. As you look at FX, as you look at it this year in '12, it got worse throughout the year where our fourth quarter is our biggest hit throughout the P&L on this thing, as well as gross margin. If you look at next year, based on today's rates, it's essentially the opposite of that. The first couple of quarters, we'll have the toughest compare, and then it starts to even out in the back half of the year.

Operator

Next question comes from the line of David Roman, Goldman Sachs.

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

I wanted to start with one of the individual product lines, which is the Soft Tissue Repair business. That's a franchise that's been under continued pressure for you guys for some time. Could you maybe just give us some update on where you are from a product launch perspective? And when you think we can start to see an improvement in that growth rate?

Jose E. Almeida

David, we have a couple of products being launched in 2013 in terms of mesh and those are synthetic mesh. And Soft Tissue also have sutures. Our suture business is growing slightly above the market. But I don't think you're going to see a significant improvement in growth in this franchise that will be twice as fast as the market. I expect our product launches to just bring Covidien up to par with the competition and continue to grow at market or slightly above market, but that's where -- what our prediction is.

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

Okay. And then just a follow-up to that. Joe, one of the comments that you made in the release is that despite difficult end markets, you remain confident in the guidance that you had provided. Can you maybe just provide some perspective and have the markets worsened, and maybe more specifically, if you could just sort of walk through the big geographic buckets, U.S., emerging markets and Europe, that would be helpful.

Jose E. Almeida

Yes, I think my comfort level with the guidance and the reason we are reaffirming the guidance is twofold. One is we are confident that the choices we've made in terms of portfolio, the best of products that we have and the execution of our people are assuring us that we can deliver on our promise. The second part is environmental challenges. Nothing got easier in the U.S. or Europe, okay? And I think that the important thing to note is that we still see technology being paid for. Second, commoditized products take a harder hit, or products that have a very high cost to the system that is close to being a great deal of the DRG. Covidien has some of those but has very little in terms of our competitors. So I think the ability to manage the best of products that we have, the size of Covidien in terms of negotiating contracts, always brings to bear an advantage. We -- I want to now underscore that we have not seen any improvement or deterioration between Europe and U.S. The situation is tough. What I have also to highlight is the fact that in emerging markets, our performance has been second to none. We've been executing -- our team in emerging markets, Brian and his team, has done a phenomenal job in executing on all the investments that we put forth. So those are the reasons why I believe that at this moment, we feel very comfortable with the guidance.

Operator

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

David R. Lewis - Morgan Stanley, Research Division

Two product-specific questions here. First, Joe, Energy strength has remained strong throughout the year despite multiple competitive entrants. I wonder if you could tell us, do you see the strength coming more from the U.S.? Is this more coming from emerging markets? And as the comparables get more challenging heading into next year, what can we expect?

Jose E. Almeida

The growth is good across all segments. I would say that in terms of potential, David, emerging markets offer a phenomenal opportunity to Covidien. However, no, that's market development and the amount of work it takes to continue to develop the market is phenomenal. But in terms of potential opportunity, I think that is second to none. When you look at penetration in general for Energy, still a great opportunity for Covidien and its competitors, because there's only about 50%, 60% penetration of Energy into total potential. I think what does Covidien bring to the game that is different that perhaps a significant amount of competitors that you mentioned entered the market, we offer a full basket of RF microwave in our ultrasonic solutions. And when we go talk to an institution, we talk to an institution from a point of view that we can cover, if not all, most of their needs. So it is -- I see that despite tough comps that we will always have, we just mentioned 28 consecutive quarters, it was not lack of a competitor's activity because we have no exceptional competitors coming at us. I think our ability to continue to have the technology, which we believe is superior than what is out there in the marketplace today from anybody else; second, the ability to have the offering of products that we have, will continue to give us an advantage. In terms of growing the business next year, as I said, we're comfortable with our guidance, which has good growth, low-double digit growth of the Energy business.

David R. Lewis - Morgan Stanley, Research Division

Okay, very clear. And then, Joe, just another one on stapling. It was pretty clear that you're continuing to gain share in stapling. I wonder if you just take out the direct sales loss from Duet, is there any sense that Duet has arrested any stapling share gains? That's sort of part one. And then if you think about the $500 million in sales, where do you think we are in terms of the Tri-Staple conversion on a percentage basis?

Jose E. Almeida

The Duet departure from the market was felt 2 ways: was felt in the gross margin but also in terms of the replacement of a Duet by just a Tri-Staple was achieved. Now to a certain degree, some accounts that we were there just because we had a proprietary product such as Duet, maybe there's an opportunity for the competition to come in and fill that void. But I think our sales force was very, very good in executing the plan that offer a superior solution to what's in the market today, not as good as Duet, but superior to what's in the market with Tri-Staple, and we're able to retain a significant amount of accounts. In terms of run rate for Tri-Staple, I would say that if you look at unit volume, market share, there's significant upside for Covidien.

Operator

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

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

First question. The Oximetry & Monitoring business came in a fair amount above what we were expecting. If you could just provide some additional color on the performance this quarter?

Jose E. Almeida

Yes. We -- yes, I point to our ability to execute, I point also to our ability to convert accounts back from the competition. For a while, Covidien was losing many more accounts, than was able to gain for. At one point in time a few years ago, we were losing accounts and not gaining any. And I think Covidien today, with the suite of new parameters and offerings, are able to get back into those accounts in a position that is more competitive with technology that is as competitive, in some cases. In some cases a technology does not exist by any other competitor, and bring some of these accounts back. So we have some recent conversions that I thought that were done extremely well. So it's still very competitive out there, and don't let the numbers fool you, it's going to be very difficult.

Coleman N. Lannum

Mike, let me add just one thing there. You'll remember, we started talking about this several quarters ago. There's clearly been a stabilization in what we're doing in the market out there. So this is not really anything new this quarter. You've really seen it almost really for the last year or so, as the things that Joe has talked about, is really coming through I think both in our numbers and what you're seeing competitively out there as well.

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

[indiscernible] add to this, this was a tough comp, it wasn't an easy comp. And if I adjust for the extra selling week, I would say it seems like your best quarter in several quarters in that business. So I mean, I would -- I actually think it was relative to our expectations, it was I think the best out-performer relative to our model. Let me step back, Joe, you're putting up with a very strong quarter and relative to a number of peers, not in the same end markets necessarily, but in the medical device space that are struggling, most companies are posting low-single digit revenue growth, you're comfortably well into the mid-single digit territory here. Can you just talk about what you want to do strategically from here? Your growth has accelerated meaningfully over the last 12 months, the ev3 acquisition has paid off, you're executing in your key end markets of your base business. What strategically do you want to do in order to sustain this or further accelerate growth that maybe we should paying more attention to?

Jose E. Almeida

Thank you, Mike. I think if you think about the success that we have achieved, and I want to be very clear that a great deal of what we are achieving here is due to the phenomenal execution of our people. When it comes to portfolio choices and I think that makes a difference and by choosing the right acquisitions, either pre-revenue or a small revenue to augment our product portfolio, makes a huge difference. So if you look at the 7 acquisitions we made in 2012, we are not slowing down in 2013 and looking those small opportunities. We're going to continue to look at those. I think if we continue to execute in adjacencies and new technologies that will supplement our mature product lines, we'll continue to be successful. We cannot fall asleep at the switch here and just go a year taking a break from looking at those opportunities because the market is highly competitive today. And if we don't get an edge on areas that we want to be #1 or #2, and we do it through internal development and external development, those are the types of acquisitions that we made, we're not going to be successful in the future.

Operator

The next question comes from the line of Bob Hopkins, Bank of America.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

So just a quick first question on the Pharma spin. Can you just give us a timing update there? And then more importantly, as we've seen recently with Abbott and then a few years ago with Tyco, there are typically tax rate dissynergies with these spins. And so my question is in an attempt here to try to avoid some of the confusion when we actually get up to the spin, can you give us at least some sense as to the magnitude of the dissynergy, or at least a sense as to whether the dissynergies will be primarily in your Pharma business?

Jose E. Almeida

Bob, I will take just the first part of your question, and the most difficult, Chuck will take. So in terms of timing, we're in good shape. We are exactly where we want to be. We're thinking about the Form 10 towards the end of January, early February. We are on schedule with the IRS letter that we should receive in terms of clearing this deal. We have a significant amount of work behind the scenes that we're very engaged in, in terms of our hiring plan to make sure that Mallinckrodt Pharmaceuticals has the right people there when they spin off, and they can close their books and pay their people and collect money, is all in process. So let me pass on to Chuck to talk about the second part of your question.

Charles J. Dockendorff

Yes, as far as the whole spin process, Bob, we came out, and we first started talking about this, we said it would be dilutive to earnings. We just -- when you sit here and build out 2 structures like that, 2 corporate structures, it's just -- and we had Pharma very well leveraged into our back office systems around the world and we have to break that apart, and it just causes more increased expense as you do that. Specifically, as it relates to tax dissynergies, and we saw this in a recent spin from another company, as you do the planning to separate legal entities, which you have to do, and then you move assets from different legal entities into the new ones, you do break up some of the tax planning that you would put in place and some of the leverage you have in those areas. So there will be some dissynergy from taxes, it will affect both companies. But we don't think that it's going to be significant, we don't have the cash repatriation issues that other companies have. And Pharma will also be an Irish company when it's set up as well, so it will have the availability of its cash around the world to have to invest in its capital and things like that. But those dissynergies that we get from the taxes, over the course both groups will reinstall tax planning, which should bring the rates back down to where they were over the long-term on a combined basis.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Great, that's helpful. But nothing specific on amounts at this point?

Charles J. Dockendorff

No, we're going to update that, I think, later on when we file a Form 10 in January, which is on track.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Okay, that's helpful. And then just a quick follow-up on the guidance you provided. And you gave some suggestions as to EPS over the course of the quarter. And I was just wondering roughly, what percentage of earnings do you think will fall in the first half of the year versus second? And is there anything you want to mention in terms of top line growth rates organically throughout the course of the year relative to product launches and things like that? Anything you want to mention around the cadence of growth over the course of the year on the top line in addition to maybe commenting on percentage of earnings first half versus second?

Coleman N. Lannum

Yes, the thing I would throw out there, Bob, is -- and I think Chuck talked about it earlier, we are going to get hit by another big FX impact in the first quarter from a gross margin standpoint. And then starting in the second quarter, we have the med tech tax we'll have to start paying. So the first half of the year, we've got both those things driving us. The good news is FX, if it remains where it is today, starts to get much better in the second half of the year. So that's something to keep in mind. The other point I'd note is in the Energy business, as we noted earlier, we had another fantastic quarter there. The comps are a little bit tougher in the first quarter, and that's something to keep in mind as well as we go into that quarter. Those would be the only 2 things that I would point out.

Operator

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

Matthew J. Dodds - Citigroup Inc, Research Division

Joe, for you first. At the recent ACS meeting, you launched the iDrive Ultra and the ENDO GIA radio. When you look at kind of the impact of Duet this fiscal year, can those 2 products offset Duet? Or are they going to be more of a controlled launch and hit more in '14?

Jose E. Almeida

More of the controlled launch and a '14 impact. No. we're going to do the best we can to have those products come in and make a big impact, like we did with Sonicision. But I tell you, they're very different products. One is a -- the iDrive is an evolutionary product. This is not the endgame. We're going to continue to look at automation of the stapling process and how things evolve. So it's more of a bridge going into the future. The second one, the radio reload, is a phenomenal product. It's very specific to one type of surgeon -- surgery. And the clinical outcomes are very good. So very different, the second would be more niche. But we're going to do the best we can to try to offset. But the Duet was a good solid product line. And on top of it, it had a very, very high gross margin. Let me tell you that our people are working very hard, and we're hopeful to come up with the right product in the marketplace in about 18 to 24 months to replace the Duet.

Matthew J. Dodds - Citigroup Inc, Research Division

And then, Chuck, a quick one for you. When you talk about the ASP pressure and being focused in the commodity businesses, when we kind of think about those businesses, you said -- and Joe said Medical Supplies early on, you said Endomechanical instruments, the lower-end stuff. What else falls in that we should think about? Is it Oximetry, like your legacy Vascular business? What are some of the other pieces we should kind of bucket in that broad comment?

Charles J. Dockendorff

We have some -- a lot of it is in the Contrast area for Pharmaceuticals. It's...

Robert A. Hopkins - BofA Merrill Lynch, Research Division

I wasn't counting that. I was counting that as someone else's issue next year.

Charles J. Dockendorff

That's one of our bigger issues that we face truly from price, but -- that's an area. But I think it's -- the one thing that we don't factor into that price number, it is based on same-store sales. So when we launch new products like a Duet or Tri-Staple, we intend to come out with a higher price. That's not necessarily factored into that pricing number that we give. So on all of our products that we sell that have been out there a year or a couple years or contracts are renewed on, there is clearly pricing pressure on every single one of those. They don't -- if it's the same product with the same technology and it's been out there a couple of years, the hospitals are driving through professional purchasing services and they're negotiating as they should to reduce the price on all of those sales. But as we come out with new products, with new technology, those price points are different, and that's where you see improved margins and offsetting some of that price, and it's coming through on mix number. And that's why we've been able to generate that positive mix over the long term. So it really is more on the how long the product has been out there as opposed to any specific product line itself.

Operator

Next question comes from line of Lawrence Keusch, Raymond James.

Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division

Joe, just a question for you. With Intuitive beginning to push more into general surgery now that they've gotten their stapler approved, can you help us think about what you guys are doing currently, and certainly the iDrive falls into this, as well as in the future? And how do you anticipate sort of bridging the gap between minimally invasive manual procedures to something that's more automated, if you will?

Jose E. Almeida

Larry, we see this as an evolution and are working very hard. And we have internal programs, we have co-developments. So there's a lot going on. And because of the competitive nature of the business, we're not going to get into detail at this early stage. But I can tell you that Covidien is focused on that, and we think that a significant advantage of, I'll say, automating -- the automation of it. And just think about robot as a component of automation, it's not the whole thing. But when we look at this, Covidien's objectives is not to come up with technology that will cost the provider an enormous amount of money and have no benefit, clinically speaking, whatsoever. So Covidien is focused on -- our mission and vision is to deliver value clinically and economically to our customers and patients. So we will continue to work hard to be able to come up with technology that eventually reduces the unit cost of procedures while creating a clinical advantage that reflects into getting that patient out of the hospital with less blood loss faster.

Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division

Okay, great. And then I guess for Chuck. Sounds like Abbott is now moving to a cash EPS convention where they're excluding deal-related amortization post the spin. Given that you guys have been serial acquirers, and I know you provide some of the information to help bridge it, but just wanted to get your thoughts on potentially going in that direction more formally? And then the other quick one was if you were just to exclude the Oridion acquisition, do you have any sense of the organic growth for that Oximetry & Monitoring business?

Charles J. Dockendorff

As far as the -- I don't see us moving to a cash EPS, we'll continue to do acquisitions. People can see what the amortization piece of it and can make their own decisions on how they want to treat that. Again, what we look for on the deals is cash-on-cash returns. That's what we're focused on, that's what we look at for the returns on these things, NPV IRS. So we still focus on that as we make any kind of investment across-the-board, R&D, selling and marketing, expansion, clinicals, all of that stuff. It all is focused around that metric. So we do -- and to drive up the return on invested capital as well. So we all try to stay focused on that. But from an earning standpoint, people can see what our amortization is, it does have an impact from these deals. But it's a cost that we need to live with as we go forward. As far as Oridion, I don't have that specific number.

Coleman N. Lannum

We can -- let us get that for you after the call, if that's okay.

Operator

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

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

So Joe, I'll just ask one question here. I've noticed at VIVA and at other meetings, a bigger footprint for your Vascular business. And you mentioned in your prepared remarks that you are increasing sales marketing and clinical trial expenses. Can you put some numbers around that and maybe some of the opportunity that you see in this marketplace going forward?

Jose E. Almeida

Tom, I tell you that -- I don't want to get into how we split the R&D, but I would tell you, 50% of our R&D for Vascular is in clinical trials. That gives you an idea how much is going into it. Second, Vascular for Covidien is a very important franchise and is strategic to us. So we will be focused in looking at all aspects of the vasculature. But we need to understand areas that Covidien can win and areas that will be detrimental to our shareholders, because there's a price for everything, there's a price for every area that we can access and get in. But our shareholders' ROIC and how we manage our shareholders' cash is very important to us. So we're going to continue to look at disruptive ways of getting into every Vascular opportunity that are out there. And the opportunities may not be on the table today, they'll be something that will be coming up in 4, 5 years from now. But we're going to continue to be very focused on Vascular. Covidien will transform itself in a very strong Vascular player above and beyond what it is today.

Operator

Next question comes from the line of Matt Taylor, Barclays.

Matthew Taylor - Barclays Capital, Research Division

Just wanted to ask, I guess, a quick one on Vascular and how you're thinking about the neuro growth rate. Stryker has certainly made some moves here to, I guess, try to compete more effectively in terms of matching your product portfolio. So could you give us some thoughts on how you think that, that growth rate could trend going forward?

Jose E. Almeida

Matt, we had an extraordinary year in neurovascular. And I think you need to look at the main drivers of Covidien's growth, the ability to have pipeline and then Solitaire and the ability to pull our products in. If you look at the acquisitions that we're making even pre-revenue, they are, a lot of them, into neurovascular. So our objective, Covidien's objective, is to become #1 in neurovascular, without a doubt. When it comes to competition, when it comes for instance to ischemic stroke and the ability to remove a clot from one's brain, it is such an emerging technology and such an emerging area. There's so much work to be done in terms of awareness of stroke and awareness of physicians and training that we more than welcome Stryker coming into this market because we think there is going to be a great opportunity for both companies because the products are phenomenal and it's almost a miracle when these patients are able to walk out of the hospital without having any side effects of the ischemic stroke that they had, or very few or very little of it. So some of it is all boats rise, and we welcome. But don't let this fool you, that Covidien has a very strong objective. And our people in Irvine have that etched in their objectives, Covidien will be #1 in neurovascular.

Matthew Taylor - Barclays Capital, Research Division

And I just wanted to ask one about margins. I mean, you've had a lot of nice operating leverage over the past couple of years. How are you planning for the pace of that margin expansion going forward? I mean, you've got med tech tax. Certainly, you have some more positive mix here. But can you help us in terms of what we should see in '13 and beyond from an operating leverage perspective?

Charles J. Dockendorff

Yes, I think if you take our guidance, we are guiding to 22% to 23% on operating margin. And as we talked in Investor Day, we're balancing off investments in driving some earnings growth for the short term but investing for the long-term health of the business. We're driving through productivity on SG&A. We are also at the same time making investments that we think have real good paybacks: investing in emerging markets, investing in our Vascular business and selling and marketing clinicals for new areas and outcomes. And so we're continuing to drive there, we're continuing to see the positive leverage on our gross margin. When you take off FX, you see it for the year, it's up 80 basis points year-over-year driven to a positive mix. Cost reductions, we're funneling through our manufacturing, through restructuring efforts. We expect those to continue. We don't see those stopping in the next year or 2. So it's going to be -- what we wrestle with all the time is the level of investment that we make into these new opportunities. We have a lot of opportunities for growth. We have them in front of us. We know what they are. We prioritize them among the business. And so we're going to continue to invest in those right areas. But we think there could be marginally operating income expansion over time.

Coleman N. Lannum

Deana, before you go to the next question, Larry, back on your question on Oridion. When we acquired that asset, we said the run rate on a revenue basis was in the $15 million to $20 million a quarter range. I could tell you in the fourth quarter, it hit right in that, in fact probably at the higher end of that range for the fourth quarter. So hopefully, that answers your question.

Operator

Your next question will come from the line of Joanne Wuensch, BMO Capital Markets.

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

In your press release, you talked about double-digit increase in your ventilator business. Is that your Oridion portion of your business, or is that something else that is happening?

Coleman N. Lannum

Yes, similar to what I just said with Oridion, let's start with that. So on the vent side of things, that would have been impacted by Newport, not Oridion. Oridion is in our Oximetry & Monitoring business. And Newport is writing between $5 million and $10 million a quarter. So you can back that out to get you a general idea of how its underlying business was doing.

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

Is there a way to quantify how much the Duet recall impacted gross margins this quarter?

Coleman N. Lannum

Well, we said the revenues were about $20 million. You can assume that it's a very high-margin product. We don't want to quantify it beyond that.

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

Okay. And then finally, many managements are starting to comment on the possibility that Hurricane Sandy may or may not have an impact on their quarters. Would you like to throw your hat into the ring on that one?

Jose E. Almeida

Joanne, you have Hurricane Sandy, we've had tsunamis, we've have the Japanese earthquake, you have distributors who are timing the market, we have Easter. We can go on and give you a list of things that would impact our quarter, okay? We tend to be a company that tends to focus on operational issues. If the Hurricane Sandy becomes a real issue for us, we clearly will tell you. It will come up in our second quarter release in January: "Now listen, that was an impact to us." We hope that it's not an impact. It's an awful, awful disaster that has affected so many people in the New York, Connecticut and New Jersey area, and we hope they all recover well. And it's going to be a long recovery. But in terms of the impact, it's too early to evaluate, and if there's any, we'll tell you.

Operator

Next question comes from the line of Michael Matson, Mizuho Securities.

Michael Matson - Mizuho Securities USA Inc., Research Division

I just had a question on your renal denervation program, the OneShot product. Can you comment at all about your plan for getting that approved in the U.S., in other words, running a pivotal trial and things like that? What is the timing? And when do you expect to start that and so forth?

Jose E. Almeida

Yes, Mike, we don't have any immediate plans to bring that specific technology in the U.S. It doesn't mean that we're going to have a different technology in the U.S. But we don't have -- at this point in time, we're very aggressive going after markets outside the U.S., including developed markets. But in the U.S., at this point in time, it will be a variation of a different kind of technology when it comes to the U.S., will not be Maya.

Michael Matson - Mizuho Securities USA Inc., Research Division

Okay. And then you commented that there -- if there was upside during fiscal '13, you'd look to reinvest that. And I was just wondering, you referred back to some commentary from your investor meeting but I was wondering if you could just remind us on what's the top priorities in terms of those areas you've looked to reinvest in?

Charles J. Dockendorff

Yes, we still have some real good growth opportunities in some of the emerging markets in South America, Brazil, those areas, that we have invested in the past and they really paid off well. And we think there's more opportunities there to grow those, as well as just investing in some other clinicals to bring out, open up some products to some new markets that we think could be very rewarding, those have been longer term. And just some new product development that we have out there in our various product categories. So it's a whole host of it. We look at it, like I said, we have a whole group here that goes through all of our investments around the company worldwide. They prioritize them. And we have these that are very attractive and are kind of in the bull pen, and we think we can invest in these and have a nice return on them as well.

Operator

Next question comes from Glenn Novarro, RBC Capital Markets.

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

Two questions. First, for Joe, Joe, can you elaborate a little bit more on your emerging markets growth in the quarter? I think in fiscal 3Q, you grew emerging markets low to mid teens. Can you tell us if that was for the fourth quarter a similar rate? Did you accelerate? And then maybe some guidance for fiscal '13 in terms of emerging markets growth. And then I had a follow-up for Chuck.

Jose E. Almeida

Glenn, we don't release the numbers the way you're asking. But I can give you an indication that the momentum in our emerging markets has actually increased, not decreased. Second, we're starting to see the effects of a real good execution by our folks in China, Brazil, Russia, unbelievable execution in Russia. So we're starting to see the effect of the investment plans that were put in place. Covidien now has 2 R&D centers in emerging markets. I have a commitment from Brian King who runs that business to have 4 products minimum, a minimum launched a year for emerging markets. We're looking at potential acquisitions in emerging markets. So a combination of all these factors will give new -- give me a real good level of comfort that there is no Dx, no change in the dynamics of how that business is growing.

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

Okay, great...

Coleman N. Lannum

Glenn, just real quick. Because you bring it up. There's a perfect example of how the mathematics is difficult to glean when you look at year-over-year annualized growth rates because of the 53rd week the prior year. But as Joe said, all the underlying things that we're seeing there, no reason to step back from all the things that we've seen good going on in that business for the last couple of years going forward.

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

Okay, great. And then just quick for Chuck. The R&D ratio ticked down to about 5.1%. Was R&D -- was that just a function of timing on projects in the quarter? And should we assume it ticks back up into the 5.5% range for next year?

Charles J. Dockendorff

Yes, it was timing, Glenn. We're still investing in that. And as we said in the call, we plan to increase it going forward. So it will go up next year. It's not going to probably go up at the same pace as what we've had in the past. But it will be increased. Again, some of those opportunities that we see out there for investments are in the R&D area, so we could put more money into that as well going forward.

Jose E. Almeida

Glenn, I just want to add to Chuck's comments that we are investing in inorganic R&D as well. If you think about some of the acquisitions that we did this past year in 2012, there were -- some of them are pre-revenue, a tremendous amount of R&D. So Covidien is coming to a point now where we're getting -- having a blend of internal R&D and purchased R&D.

Operator

Your final question will come from the line of Jonathan Palmer, CLSA.

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

Joe, one of the major discussion topics at [indiscernible] Med last month was not surprisingly the med device tax. Now that the elections are over, could we just get your latest view on how it's changing the way you're managing your business and how Covidien and the industry as a whole are working to get the tax repealed?

Jose E. Almeida

Well, I'll talk about Covidien first. It changes nothing because we already had assumed that in and some of the efforts in leveraging our SG&A were aimed at partially offsetting that tax. So we didn't think that the election in the short term was going to cause a major change in the outlook for the tax implementation. The second thing is the industry continues to be very actively pursuing a change in the implementation, all the way to the repeal of the tax. Now clearly, with the dynamics in Washington having not changed much it will be a very difficult task. Not impossible but very difficult. But at our association and I praise our association for doing this, is we continue to work very hard all the way to the repeal of the tax.

Operator

And that concludes the question-and-answer portion for today. I would now like to turn the call back to Cole Lannum for any closing remarks.

Coleman N. Lannum

Great. Thank you very much, Deana. Starting at noon Eastern Time today, a replay of the call will be available. Additionally, the replay will be available on our corporate website, covidien.com, a few hours from now. For members of the media who have listened to the call and have additional questions, please contact Eric Kraus, our Head of Corporate Communications. I know there were several of you still in line, we were not able to get to you because of the opening of the market. So for you and for anyone else having more detailed questions involving, of course, nonmaterial information, Todd and I will be available to take your call throughout the day. Thanks, and have a great day.

Operator

Thank you again, ladies and gentlemen, for your participation. This concludes today's conference call. You may now disconnect. Have a great day.

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