Covidien plc. (COV)

COV 
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Covidien plc (COV)

September 08, 2011 2:00 pm ET

Executives

Bryan C. Hanson - Group President of Surgical and Energy Devices

Matt K. Harbaugh - Interim President of Pharmaceuticals Segment and Chief Financial Officer of Pharmaceuticals Segment

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

Michael Tarnoff -

Brian D. King - Former Senior Vice President of Corporate Operations

Peter L. Wehrly - Group President of Respiratory & Monitoring Solutions and Vascular Therapies Businesses

Coleman N. Lannum - Vice President of Investor Relations

James C. Clemmer - Senior Vice President and President of Medical Supplies

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

Analysts

Adam T. Feinstein - Barclays Capital, Research Division

Matthew J. Dodds - Citigroup Inc, Research Division

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

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

Daniel Sollof - Barclays Capital, Research Division

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

Michael Matson - Mizuho Securities USA Inc., Research Division

Frederick A. Wise - Leerink Swann LLC, Research Division

Robert A. Hopkins - BofA Merrill Lynch, Research Division

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

Kristen M. Stewart - Deutsche Bank AG, Research Division

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

Unknown Analyst -

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

David R. Lewis - Morgan Stanley, Research Division

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

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

Presentation

Operator

Ladies and gentlemen, please welcome, Vice President of Investor Relations, Cole Lannum.

Coleman N. Lannum

Thank you very much, and good afternoon, everyone. It's nice to see everyone here, not only the people that are joining us live but also the roughly 500 plus people that have already dialed in and are joining the webcast.

For the folks here in the Plaza, I hope you took the opportunity to see our product displays outside a few moments ago. We told every single year that that's the most popular piece of the Investor Days that we do. It's a chance for everyone to meet intimately with the senior management team in a way that you don't often get to do from a depth standpoint, so we hope you got some use out of that. Now while most of the senior management team that you saw out there will not be formally presenting today, you will see a number of them later on whenever they get up on stage and we go to our first Q&A session, you'll have a chance to ask them then what's going on.

Before we get started, I need to go through a few logistics. First of all, you may have noticed that the wireless reception in this room is relatively spotty. I know better than to stand up here and to tell you to actually turn off your BlackBerrys and phones because I know that's just not going to happen. But what I would ask you to please, as a courtesy to everyone else here, please do at least put them on silent or vibrate so that we can get through the day without too many interruptions.

Today's full agenda is in your books. This past year's obviously been a very tumultuous one for the markets, for the healthcare industry, for overall healthcare investing as we know. And for both the equity and the credit markets, we've seen a lot of things going on. One of the things that we're going to try to do today is give you a little bit of perspective from the Covidien standpoint. Talk a little bit about what we see, some of our strategies, some of the things that have gone on, some of the end markets out there and also how we expect to address some of these issues compared to other companies in the hospital supply and medical device world. Hopefully, by the end of the day, you'll have a better understanding of exactly where we stand from that standpoint.

Now as I believe you are aware, Rich Meelia resigned as our CEO earlier this year and Joe Almeida took over. You probably know Joe very well from his years as the Head of our Medical Devices segment. But today, he's going to share some of that strategy and some of what he sees -- what's going in the markets out there.

After Joe's remarks, we're going to ask some of the senior management team to come up on stage and we'll do the very first part of the Q&A session. You'll have an opportunity to get deeply into the different businesses and to pick their brains on what they're seeing from a market standpoint. That will probably go until a few minutes before 4:00. At that point, we'll have a break. We'll return back here a few minutes after 4:00 when Chuck Dockendorff, our CFO, will come up and give our 2012 guidance for the first time.

I would note to you that as in past years, just out of respect for the people that can't be here with us live and those who can't be on the webcast, we will not be discussing any of our particular guidance numbers until after 4:00, until after the market is closed. So please keep that in mind whenever we go through the first Q&A session.

Now after Chuck gives his guidance comments, we'll open up for another broad Q&A session. That will go until about 5:00 or so or until we run out of questions. At which time, there will be a reception in the foyer.

Last year, we tried something new. It ended up being pretty successful, so we're going to do it again today. For those of you listening on the webcast as well as for those of you here, you can either anonymously send in your -- any questions to the website that's on the screen. Or for those of you on the webcast, just type in your questions. We'll try to get to as many of those questions as we can, both here live and for those of you in the virtual audience.

I think it's important for a second to talk a little bit about some of the fine print. And before I hand the podium over to Joe, I want to talk about a little bit of the forward-looking statements. During the presentations, we will make some forward-looking statements, and it is possible that actual results could differ materially from current expectations and differ materially from the statements that we make today. We are under no obligation to update any of these statements even if they change dramatically over time. I would ask that you please refer to the cautionary statements contained in our SEC filings for more detailed explanation of the inherent limitations of such forward-looking statements.

We'll also be talking about some non-GAAP financial measures today, particularly, but not limited to, Chuck's commentary later on this afternoon. You can find a reconciliation of our non-GAAP to GAAP measures at our website, covidien.com.

With those preliminaries out of the way, I'd like to now introduce you to our President and CEO, Joe Almeida. Joe?

José E. Almeida

Thank you, Cole, and welcome to our 2011 Investor Conference Day. This is my first conference as the CEO and President of Covidien. And for the last couple of months, I've been thinking, what are the things that I want really to tell you today? What are the things that are important to me as a CEO of the company and to Covidien that I'd like you to take away with you today? And there's about 3 major objectives. One is, I want to go back quickly and review some of the achievements that we had in the last 4 years. And why is that important? Because going forward, I want you to understand the credibility that we have built with our investors in terms of delivering what we promised.

Second is, we're going to talk about the market. The market has been changing. There's some good things and there's some tough things. And after we talk about the market is how Covidien will react and how Covidien will grow and win in this market that is ever-changing?

So if we just look at the performance that we had in the last 4 years, we had a CAGR in our sales from 2007 to '10 of about 7%. We just released our earnings in July and we spoke about our 9-month performance. And that, you can see provided some substantial growth versus the same period of 2010. When we look at our earnings per share, 11% growth with some good momentum in 2011.

Our growth outside the U.S. and the U.S. has been different. We grew 5% in U.S. and about 9% outside the U.S. It is 9% is the blend of Europe, Japan, Canada, Australia and emerging markets. And I have to tell you, the emerging markets growth has exceeded our expectations in this near 20%.

When we were here about 4 years ago, I remember clearly and most of you were with us, we spoke about taking money from our profitability and re-invest in research and development. We went from about 2.9% to 4.6%. And the result of that is 75 new products we're able to launch since 2007. They are responsible in great part for the great performance in sales. We're not there yet. However, we're looking forward to more productive and more effective R&D spending even going forward.

We increased our gross margins and basically, there are couple of things that we've done well. One is the mix of products into our gross margin. Medical Devices are higher margins growing faster than the rest of our business. Second, we are relentless about our operational excellence programs and we've been delivering strong cost reductions for a long time. And the result, you can see, is about over 500 basis points of improvement.

And I've been asked many times during the last couple of years, when are you going to top off your gross margin? How much more headroom do you have there? As we continue to grow, our gross margin -- our Medical Device business is faster than the other business and we're going to show you how. You should expect our gross margin to continue to improve.

We're aggressively managing our portfolio. We look at some of our businesses that did not make sense to be part of Covidien. We divest the business that were distractions to us and made sense to be with somebody else. But we acquired some really good businesses. We have done acquisitions that provided the technology to Covidien, which is the case of Power Medical. And you're going to see that you probably saw in the demonstration before our meeting that, that is a great product they're going to continue to enhance the ability to deliver economical value to our customers.

We acquired Aspect Medic and Somanetics that amplified adjacencies in our monitoring businesses. And finally, Ev3, which was a great acquisition, bringing the neurovascular and the peripheral vascular business to Covidien. So the job done here was well done.

We used our strong cash flow to finance areas that we're not very good at. In 2007, when we stood in front of you guys and just spoke -- and Rich has spoke and I spoke, we said we have some deficiencies in our sales and marketing. We don't have people where we should have, so we used this investment to add sales reps in the right places. And that has paid off, as you can see, in our surgical business, energy business, the growth of above market. We also had a very limited ability to do business development and licensing. We went ahead and hired some really good people under Amy Wendell. They are able to do a great job with the acquisitions and the divestures that you just saw.

Most importantly, and this is for the future, the investment medical affairs and healthcare economics. This is paramount for the future. As things are changing, that capability acquired by Covidien and led by Dr. Michael Tarnoff is absolutely a necessity going forward. And above all, one of the greatest opportunities for Covidien is emerging markets, and we're investing heavily there.

We also used our capital prudently. We have maintained a strong balance sheet; we continue to target a credit rating; we employed free cash flow to growth initiatives; but when we don't have the right acquisitions, we say we're going to return the money to the shareholders. We have not hold money or hold cash in our balance sheet. As we announced in July, we, on a trailing basis, have returned over 50% of our free cash flow to our shareholders.

But no, Covidien needs to evolve. And how do we accelerate growth in the current market environment? So what are the tailwinds? And what are the things can make me so excited about this business? Growth access to care remains a political and social goal worldwide. If you go to Brazil, you go to China, to India, what you see is a tremendous essential in the middle class. And what does the middle class want? They want wellness. Medical technology is a great space to be in, in those markets. Ongoing demographic trends support demand growth. Why? Global population is aging. The fundamentals are there. And lastly, we made the right investments in healthcare economics and medical affairs. So we have the infrastructure to look forward to a space that becomes more demanding in the clinical needs of our customers, as well as the economical needs of our customers.

But what are the things that keep me up at night? The condition of economy impact on provider economics is changing. The unemployment rate in the U.S. is over 9%. The consumption of healthcare is middle-class driven. So it is important to understand that the lack of improvement that we've seen in the last few quarters is somehow driven by unemployment, which is mostly driven by unemployment of middle class.

The dynamics and impact of adoption in pricing of new technology is also a factor. The surgeon, the physician is not the decision makers solely anymore. They have a voice. The economical buyer has a stronger voice in many cases. Things are changing in some of our markets. Blue Cross Blue Shield [Blue Cross and Blue Shield] recently, if I'm not mistaken, in Illinois now owns 3,400 physicians and 350,000 patients. So if you think about the ACOs, everybody's dibbling. Everybody's trying to figure out what that really means.

Things will be different in the future. The way the care is delivered is different. Today, it would be different in the future. The market growth rates have somehow shrunk a little bit since 2009. And the regulatory environment is concerning, not only FDA, and the approval processes becoming more complex, more complicated, more unpredictable, but also you see behaviors there similar to that in China and Brazil and other economies that are also growing. So the ability to be the best in the way we behave and file our PMAs, our 510(k)s and approval in foreign countries is important to Covidien.

So how is this whole thing going to impact our business and how are we going to win in this new market? We have some real good strengths that play well in these conditions. We are competing in very attractive and growing markets still. Our end markets have not changed. So let me walk you through some of the growth rates of the market in our Medical Device businesses. We're #1 and #2 in most of these businesses. The Energy business is 7% to 9%. That growth is staying by the mix of lower-end, more commoditized energy products on the 3% to 4% growth, all the way to a 14%, 15% of vessel sealing. Very attractive Covidien large market growth there. Great product for us. So very excited about the Energy business. Endomechanical is still a very attractive business for Covidien. And Vascular, this is also another branded rate for Vascular, which has neurovascular growing market about mid-teens. Peripheral Vascular at the lower end of the growth spectrum is the Compression business. So this is the -- the Medical Device business is a good portfolio, 4% to 6% growth. And we are growing at or above market in most categories.

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