Covidien PLC Earnings Call Nuggets: Sustaining Growth and Gross Margins

Covidien PLC (NYSE:COV) recently reported its first quarter earnings and discussed the following topics in its earnings conference call.

Sustaining Growth

David Roman – Goldman Sachs & Co.: I was hoping you could go into a little bit more detail on what’s really changed since the last call and I guess really the context why I am asking is that obviously a very, very strong quarter but then a pretty decent raise in the guidance for the balance of the year. I understand the conservative piece there but maybe you could talk through Joe or Chuck the device piece of it and what gives you confidence one quarter in the year that what you’ve seen so far can be sustained over the balance of fiscal 13?

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Jose E. Almeida – Chairman, President and CEO: We don’t plan our growth on a quarter-by-quarter basis. So this is a crescendo that is resulting from significant investments in some key franchise of the Company. We have been very (hard) investment in emerging markets and what we see now is not only taking advantage of local growth but also having an infrastructure to take market share in some key franchises, primarily Surgical which is Endomechanical and soft issue. Then we also have invested significantly in our neurovascular franchise which continues to do well and grow above market. So, what we have spoken to the street in the past, the slightly gain in procedures in the U.S. were not enough just to get Covidien to be where it is today. It was our relentless pursuit of investing in technology, in Energy, in Endomechanical, in Vascular, in emerging markets that really got us here. We feel very confident about what we’ve done so far and we think we still have a great deal of technology in our R&D pipeline that will give us good runway ahead of us.

Charles J. Dockendorff – EVP and CFO: Dave, this is Chuck. I would also add. I think the (bigger it get to), we see some big opportunities in emerging markets. We had very good growth there in the first quarter. I think it was a little over 19% which is above where we finished all of last year. So, as we continue to make investments over there, we just see nice penetration into those markets and we expect that to continue through the balance of the year and that’s why we’ve kind of recommitted some more additional funding to emerging markets in the balance of the year. We’ve seen those investments pay off. They continue to. We just think there’s some more opportunity over in those marketplaces.

David Roman – Goldman Sachs & Co.: Maybe for my follow-up, Joe, you brought up the Japan opportunity in your prepared remarks and obviously, that’s going to take some time to ramp up and train physicians et cetera. But can you maybe help us think through what the long-term opportunity is there? Maybe any perspective on the size of the surgery market or current penetration rates, as we think about the multi-year opportunities that provides?

Jose E. Almeida – Chairman, President and CEO: David, this was a great news for the industry in general, but mainly for Covidien in terms of our leadership and in terms of market share when it comes to endoscopic instrumentation. The current penetration rates in Japan are low, probably one of the lowest in the developed world, I would say sub-10%. So, you can see there is significant opportunity and there is incentive from the government. We have internal program at Covidien that we’ve been working for the last six months to really take advantage of this opportunity. We have the sales force, we have the products Tri-Staple is quite important in this venture. Energy products will be very important in getting us there. Also we have a very good training site just outside Tokyo. So, we feel very bullish about the opportunity in Japan, so there is great upside there for the industry in general.

Gross Margins

David Lewis – Morgan Stanley: Maybe a question for Chuck, and a quick follow-up for maybe Joe and Chuck. I guess, Chuck just thinking about gross margins in the quarter were obviously stronger sequentially and what we thought we were going to see here in the first quarter. If you think about FX trends throughout the balance of the year, and in addition to what looks like pretty significant positive mix that you’re getting and your better price mix you discussed in the quarter, do you still see gross margins improving across the quarters throughout the balance of the year?

Charles J. Dockendorff – EVP and CFO: I think our gross margins do go up and down in the quarter, and a lot of that has to do with the mix of our business and how strengthen comes in from one quarter to the other. I think while we are down versus the prior year 130 basis points and a big driver of that was that foreign exchange. We are up from Q4. So if you look historically at our quarters we do tend to trend up and down on that piece a bit. But I think going forward with the trends you are going to see continue we still expect to see continued favorable product mix. The rate of that again not to be – but would depend on the mix of the products within the quarter. Pricing is a little at the lower end of our – where we have been in the past. We are anticipating that pricing pressures will continue, how fast those come, how we can mitigate those, it’s kind of difficult to predict. But we have been more in the range of 50 to 100 basis points. So we talked about and certainly in the first quarter we saw better improvement there. FX year-over-year, the first quarter is the worst, when we do a year-over-year comparison and it should just continue at the current rate as to what it is this quarter going forward. So those are our components of gross margin. I would expect it to stay at this rate going forward through the balance of the year.

David Lewis – Morgan Stanley: Then maybe for Joe or for Chuck, I wonder if, maybe you could share with us your sort of management philosophy heading into the spin here in the middle part of the year? I guess the main message from Covidien the last several quarters has been significant reinvestment to drive growth and you are once again today reinvesting to continue to drive that growth this year. So as you head into the spin, how do you approach that? Obviously there is going to be some G&A step up dilution. Is your strategy to continue to invest in the business, the G&A dilution is what is or do you back off on some of that relative reinvestment and offset some of that delusion?

Charles J. Dockendorff – EVP and CFO: David we will – the reason we are successful today is our relentless portfolio management in how we select investments and place our bets. I don’t see Covidien change our philosophy at all. We will deal with what Covidien’s numbers will be going forward later in the year once we have the Form 10 out there. But what I want to make very clear that we have a philosophy to double down in areas we think there are great opportunities and we are going to continue to do that. If you look at life cycle curve of our products, we continue to make bets in early-stage businesses but also we are not neglecting at all business that are getting to maturity like Energy and Endomechanical and some other vascular products. But that does not negate the fact that Covidien is relentless in pursuing cost reductions and a great deal of investments that we’ve been doing have been saving money in G&A through shared services and cost reductions by closing down plants and moving plants and getting efficiencies and reinvesting there in sales and marketing and research and development. So that DNA is not going away, but I’ll reserve more specifics about what the plan is going to like towards between May timeframe when we speak to you guys about that.

A Closer Look: Covidien PLC Earnings Cheat Sheet>>