Covidien : Reports Third-Quarter Fiscal 2014 Results

Covidien plc (NYSE: COV) today announced financial results for the third quarter of fiscal 2014. Third-quarter net sales of $2.69 billion increased 4%, both on a reported and on an operational basis, from the $2.58 billion in the third quarter a year ago.

“We delivered solid performance in the third quarter, returning to double-digit EPS growth,” said José E. Almeida, chairman, president and CEO, Covidien. “This performance reflects significant increases in Advanced Surgical, aided by global market share gains in vessel sealing and stapling. Substantial growth in both our gastrointestinal and interventional lung offerings, as well as productivity improvements, also contributed to this positive result.”

Covidien continued to execute on its strategy of innovation, customer-focused portfolio management, emerging markets growth and driving operational leverage. Recent highlights include:

• Launching the EverFlex™ Self-expanding Peripheral Stent with Entrust™ Delivery System in Australia and New Zealand and the next-generation Trellis™ Peripheral Infusion System for treatment of deep vein thrombosis in the U.S., Europe and Canada
• Introducing both the Pipeline™ Flex Embolization Device and Nellcor™ Respiration Rate System in Europe
• Receiving U.S. Food and Drug Administration approval of the Apollo™ Onyx™ Delivery Micro Catheter with Detachable Tip and the Emprint™ Ablation System with Thermosphere Technology
• Opening a Covidien Center of Innovation in Turkey, the company’s fourth medical training and research center in an emerging market

Third-quarter 2014 gross margin of 58.9% declined 0.6 percentage points from 59.5% in the prior-year period. On an adjusted basis, excluding the specified items shown on the attached tables containing non-GAAP reconciliations, third-quarter 2014 gross margin of 59.4% was about level with a year ago.

Selling, general and administrative (SG&A) expenses for the third quarter of 2014 were above those of the prior-year quarter, largely due to a legal charge recorded during the current quarter related to an increase in the company’s estimated indemnification obligation for certain pelvic mesh products liability cases. On an adjusted basis, SG&A as a percent of sales decreased approximately 130 basis points primarily due to productivity improvements, partially offset by increased expenses resulting from acquisitions and spending on growth initiatives. Research and development (R&D) expenses in the third quarter of 2014 increased 6% and represented 5.1% of sales, versus 5.0% of sales a year ago.

In the third quarter of 2014, the company reported operating income of $366 million, versus $542 million in the same period the year before. Third-quarter 2014 adjusted operating income, excluding the specified items on the attached table, was $609 million, compared with $554 million in the previous year. Third-quarter 2014 adjusted operating income, excluding the specified items, represented 22.7% of sales, versus 21.5% of sales a year ago.

The third-quarter 2014 effective tax rate was 0.6%, versus an effective tax rate of 26.9% in the third quarter of 2013. The significant decrease in the effective tax rate primarily resulted from a favorable audit settlement reached with certain non-U.S. tax authorities. Excluding the specified items on the attached table, the third-quarter 2014 adjusted tax rate was 16.7%, versus 15.8% in the third quarter a year earlier. During the third quarter of 2014, the company made a net payment of approximately $340 million related to pre-separation tax matters under the Tyco tax sharing agreement for the anticipated settlement of the 2005 through 2007 audit cycle, which otherwise remains open and subject to further examination by the Internal Revenue Service.

Diluted GAAP earnings per share from continuing operations were $0.67 in the third quarter of 2014, versus $0.85 per share in the comparable quarter last year. Third-quarter 2014 adjusted diluted earnings per share from continuing operations, excluding the specified items on the attached table, were $1.04, versus $0.91 a year ago, an increase of 14%.

For the first nine months of fiscal 2014, net sales of $7.93 billion were 3% above the $7.68 billion in the first nine months of the previous year. Operational sales growth was 5%, as foreign exchange rate movement lowered the nine-month sales growth rate by two percentage points.

The company reported operating income of $1.48 billion in the first nine months of fiscal 2014, compared with $1.66 billion in the prior year nine-month period. Nine-month 2014 adjusted operating income, excluding the specified items on the attached table, was $1.77 billion, versus $1.73 billion in the first nine months of the prior year. Nine-month 2014 adjusted operating income, excluding the specified items, represented 22.3% of sales, versus 22.5% a year ago.

The effective tax rate was 19.5% for the first nine months of fiscal 2014, versus an effective tax rate of 22.1% in the same period of 2013. Excluding the specified items on the attached table, the adjusted tax rate for the first nine months of 2014 was 17.0%, versus 16.5% in the first nine months of 2013.

For the first nine months of fiscal 2014, diluted GAAP earnings per share from continuing operations were $2.51, versus $2.61 in the year-ago period. Excluding the specified items on the attached table, adjusted diluted earnings per share from continuing operations were $3.00, versus $2.81 in the comparable period last year.

PRODUCT LINE SALES RESULTS

Surgical Solutions sales of $1.31 billion in the third quarter were 8% higher than the $1.21 billion in the comparable quarter of last year. Operational sales growth was 7%, as foreign exchange rate movement increased the quarterly sales growth rate by one percentage point. Operationally, third-quarter sales in Advanced Surgical were significantly above those of the prior year, driven largely by the acquisition of Given Imaging. In addition, the company’s BÂRRX gastrointestinal business grew more than 20% during the quarter, as did the company’s interventional lung business. Once again, vessel sealing and synthetic mesh both achieved double-digit quarterly sales gains. In General Surgical, operational sales were somewhat below those of a year ago, primarily as a result of the sale of the Confluent biosurgery product line in January 2014, partially offset by the impact of the New Wave Surgical acquisition.

For the first nine months of fiscal 2014, Surgical Solutions sales increased 6% to $3.78 billion from $3.57 billion in the comparable period a year ago. Operational sales growth was 7%, as foreign exchange rate movement reduced the sales growth rate by one percentage point.

Vascular Therapies sales of $417 million in the third quarter were level with last year’s third-quarter sales on both a reported and operational basis. Sales in Peripheral Vascular were about the same as a year ago, with increases in sales of chronic venous insufficiency and procedural support products offset by decreases in sales of compression and dialysis products and the impact of the company’s exit from the renal denervation market. Neurovascular sales were also virtually unchanged from a year ago, as sales growth of flow diversion products were offset by lower sales of access delivery products.

For the first nine months of fiscal 2014, Vascular Therapies sales increased 1% to $1.25 billion from $1.24 billion in the prior-year period. Operational sales growth was 2%, as foreign exchange rate movement reduced the sales growth rate by one percentage point.

Respiratory and Patient Care third-quarter sales of $966 million were 2% higher, on both a reported and operational basis, compared with last year’s third-quarter sales of $948 million. Patient Monitoring sales were 6% above those of a year ago, primarily resulting from increased sales of capnography products, which continued to grow above 30%. Airway & Ventilation sales grew modestly during the quarter due to increased sales of ventilators. Patient Care sales were slightly above those of a year ago, led by higher sales of SharpSafety™ products primarily resulting from the continued impact of favorable pricing and a competitive shortage of pre-filled syringes. Nursing Care sales were marginally below those in the prior year quarter, mainly due to lower sales of enteral feeding products.

For the first nine months of fiscal 2014, Respiratory and Patient Care sales increased 1% to $2.90 billion from $2.86 billion in the comparable period a year ago. Operational sales growth was 2%, as foreign exchange rate movement reduced the sales growth rate by one percentage point.

ABOUT COVIDIEN

Covidien is a global health care leader that understands the challenges faced by providers and their patients and works to address them with innovative medical technology solutions and patient care products. Inspired by patients and caregivers, Covidien’s team of dedicated professionals is privileged to help save and improve lives around the world. With more than 38,000 employees, Covidien operates in 150-plus countries and had 2013 revenue of $10.2 billion. To learn more about our business visit www.covidien.com or connect with us on Twitter.

CONFERENCE CALL AND WEBCAST

The company will hold a conference call for investors today, beginning at 8:30 a.m. ET. This call can be accessed three ways:

• At Covidien’s website: http://investor.covidien.com
• By telephone: For both “listen-only” participants and those participants who wish to take part in the question-and-answer portion of the call, the telephone dial-in number in the U.S. is 877-546-5021. For participants outside the U.S., the dial-in number is 857-244-7553. The access code for all callers is 44793724.
• Through an audio replay: A replay of the conference call will be available through 5:00 p.m. on August 5, 2014. The dial-in number for U.S. participants is 888-286-8010. For participants outside the U.S., the replay dial-in number is 617-801-6888. The replay access code for all callers is 61713038.

NON-GAAP FINANCIAL MEASURES

This press release contains financial measures, including operational growth, adjusted gross margin, adjusted operating income, adjusted earnings per share and adjusted operating margin, which are considered “non-GAAP” financial measures under applicable U.S. Securities and Exchange Commission (SEC) rules and regulations.

These non-GAAP financial measures should be considered supplemental to and not a substitute for financial information prepared in accordance with generally accepted accounting principles (GAAP). The company’s definition of these non-GAAP measures may differ from similarly titled measures used by others.

The non-GAAP financial measures used in this press release adjust for specified items that can be highly variable or difficult to predict. The company generally uses these non-GAAP financial measures to facilitate management’s financial and operational decision-making, including evaluation of Covidien’s historical operating results, comparison to competitors’ operating results and determination of management incentive compensation. These non-GAAP financial measures reflect an additional way of viewing aspects of the company’s operations that, when viewed with GAAP results and the reconciliations to corresponding GAAP financial measures, may provide a more complete understanding of factors and trends affecting Covidien’s business.

Because non-GAAP financial measures exclude the effect of items that will increase or decrease the company’s reported results of operations, management strongly encourages investors to review the company’s consolidated financial statements and publicly filed reports in their entirety. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP financial measures are included in the tables accompanying this release.

COVIDIEN CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Statements contained in this communication that refer to Covidien’s estimated or anticipated future results or other non-historical facts are forward-looking statements that reflect Covidien’s current perspective of existing trends and information as of the date of this communication. Forward-looking statements generally will be accompanied by words such as “anticipate,” “believe,” “plan,” “could,” “should,” “estimate,” “expect,” “forecast,” “outlook,” “guidance,” “intend,” “may,” “might,” “will,” “possible,” “potential,” “predict,” “project,” or other similar words, phrases or expressions. It is important to note that Covidien’s goals and expectations are not predictions of actual performance. Actual results may differ materially from Covidien’s current expectations depending upon a number of factors affecting Covidien’s business. These factors include, among others, competitive factors and market conditions in the industry in which Covidien operates; Covidien’s ability to obtain regulatory approval and customer acceptance of new products, and continued customer acceptance of its existing products; and the other risks identified in Covidien’s periodic filings including its Annual Report on Form 10-K for the fiscal year ended September 27, 2013, and from time to time in Covidien’s other investor communications. We caution you that the foregoing list of important factors is not exclusive. In addition, in light of these risks and uncertainties, the matters referred to in Covidien’s forward-looking statements may not occur. Covidien undertakes no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as may be required by law.

NO PROFIT FORECAST / ASSET VALUATIONS

No statement in this communication is intended to constitute a profit forecast for any period, nor should any statements be interpreted to mean that earnings or earnings per share will necessarily be greater or lesser than those for the relevant preceding financial periods for Medtronic or Covidien or New Medtronic as appropriate. No statement in this communication constitutes an asset valuation.

⁽¹⁾ Adjustments are tax effected at the applicable local statutory tax rates.
⁽²⁾ Includes charges of $12 million related to the sale of acquired inventory that had been written up to fair value upon the acquisition of businesses, which are included in cost of goods sold. Also includes $8 million of income related to an adjustment to contingent consideration, partially offset by $1 million of acquisition-related transaction costs, both of which are included in selling, general and administrative expenses.
⁽³⁾ Includes restructuring charges of $43 million, which are included in restructuring charges, net, and restructuring-related accelerated depreciation expense of $2 million, which is included in cost of goods sold.
⁽⁴⁾ Represents a legal charge resulting from an increase to our estimated indemnification obligation for certain pelvic mesh products liability cases, which is included in selling, general and administrative expenses.
⁽⁵⁾ Represents transaction costs resulting from our definitive agreement to be acquired by Medtronic Inc., which are included in selling, general and administrative expenses.
⁽⁶⁾ Represents an adjustment to the gain on the sale of our Confluent biosurgery product line.
⁽⁷⁾ Represents the non-interest portion of the impact of our tax sharing agreement with Tyco International Ltd. and TE Connectivity Ltd., which is included in other (expense) income, net.
⁽⁸⁾ Relates primarily to a favorable audit settlement reached with certain non-U.S. taxing authorities.
⁽⁹⁾ Includes restructuring charges of $9 million, which are included in restructuring charges, net, and restructuring-related accelerated depreciation expense of $1 million, which is included in cost of goods sold.
⁽¹⁰⁾ Includes $2 million of adjustments to contingent consideration, which are included in selling, general and administrative expenses, and $10 million of income related to a gain associated with our acquisition of CV Ingenuity, which is included in other (expense) income, net.
⁽¹¹⁾ Relates to adjustments to income tax liabilities subject to the tax sharing agreement with Tyco International and TE Connectivity.

⁽¹⁾ Operational growth, a non-GAAP financial measure, measures the change in sales between current and prior year periods using a constant currency, the exchange rate in effect during the applicable prior year period. See description of non-GAAP financial measures contained in this release.
⁽²⁾ Non-U.S. Developed Markets includes Western Europe, Japan, Canada, Australia and New Zealand.
⁽³⁾ Emerging Markets includes Eastern Europe, Middle East, Africa, Asia (excluding Japan) and Latin America.

⁽¹⁾ Operational growth, a non-GAAP financial measure, measures the change in sales between current and prior year periods using a constant currency, the exchange rate in effect during the applicable prior year period. See description of non-GAAP financial measures contained in this release.

⁽¹⁾ Operational growth, a non-GAAP financial measure, measures the change in sales between current and prior year periods using a constant currency, the exchange rate in effect during the applicable prior year period. See description of non-GAAP financial measures contained in this release.

⁽¹⁾ Adjustments are tax effected at the applicable local statutory tax rates.
⁽²⁾ Includes charges of $16 million related to the sale of acquired inventory that had been written up to fair value upon the acquisition of businesses, which are included in cost of goods sold. Also includes $8 million of income related to an adjustment to contingent consideration, partially offset by $4 million of acquisition-related transaction costs, both of which are included in selling, general and administrative expenses.
⁽³⁾ Includes restructuring charges of $116 million, which are included in restructuring charges, net, and restructuring-related accelerated depreciation expense of $5 million, which is included in cost of goods sold.
⁽⁴⁾ Represents charges associated with the exit of our OneShot™ renal denervation program totaling $35 million, of which $32 million is included in selling, general and administrative expenses and primarily relates to the impairment of intangible assets. The remaining $3 million relates to the write-off of inventory and is included in cost of goods sold. These charges are partially offset by income of $26 million resulting from the reversal of contingent consideration associated with the fiscal 2012 acquisition of Maya Medical, which is included in selling, general and administrative expenses. In connection with these transactions, we recognized $24 million of income tax expense, of which $22 million related to the write-off of a prepaid tax asset that had been established in connection with the acquisition of Maya Medical. This income tax expense was partially offset by an $11 million income tax benefit on the pre-tax charges, resulting in a total net tax expense of $13 million.
⁽⁵⁾ Includes a $181 million legal charge resulting from an increase to our estimated indemnification obligation for certain pelvic mesh products liability cases and a $65 million environmental charge for the estimated additional remediation costs for a site located in Orrington, Maine. Both of these charges are included in selling, general and administrative expenses.
⁽⁶⁾ Represents transaction costs resulting from our definitive agreement to be acquired by Medtronic Inc., which are included in selling, general and administrative expenses.
⁽⁷⁾ Represents the net gain recognized in connection with the sale of our Confluent biosurgery product line.
⁽⁸⁾ Represents the non-interest portion of the impact of our tax sharing agreement with Tyco International Ltd. and TE Connectivity Ltd. and, to a lesser extent, our portion of Tyco International’s settlement of contract claims under a 2002 tax agreement with CIT Group Inc., a former subsidiary of Tyco International, both of which are included in other income, net.
⁽⁹⁾ Primarily relates to the potential settlement of certain pre-2007 Tyco separation tax matters subject to our tax sharing agreement with Tyco International and TE Connectivity, partially offset by a favorable audit settlement reached with certain non-U.S. taxing authorities.
⁽¹⁰⁾ Includes restructuring charges of $71 million, which are included in restructuring charges, net and restructuring-related accelerated depreciation expense of $2 million, which is included in cost of goods sold.
⁽¹¹⁾ Includes $4 million of income related to an adjustment to contingent consideration, which is included in selling, general and administrative expenses, and $18 million of income related to a gain associated with our acquisition of CV Ingenuity, which is included in other income, net.
⁽¹²⁾ Represents the non-interest portion of the impact of our tax sharing agreement with Tyco International and TE Connectivity, which is included in other income, net.
⁽¹³⁾ Consists of a $71 million adjustment to income tax liabilities subject to the tax sharing agreement with Tyco International and TE Connectivity, $47 million of tax expense generated in connection with the restructuring of legal entities in advance of the 2013 separation of our Pharmaceuticals business and $2 million of tax expense resulting from an adjustment to prior year deferred income tax assets, partially offset by $7 million related to the fiscal 2012 portion of the retroactive re-enactment of the U.S. research and development tax credit.

⁽¹⁾ Operational growth, a non-GAAP financial measure, measures the change in sales between current and prior year periods using a constant currency, the exchange rate in effect during the applicable prior year period. See description of non-GAAP financial measures contained in this release.
⁽²⁾ Non-U.S. Developed Markets includes Western Europe, Japan, Canada, Australia and New Zealand.
⁽³⁾ Emerging Markets includes Eastern Europe, Middle East, Africa, Asia (excluding Japan) and Latin America.

⁽¹⁾ Operational growth, a non-GAAP financial measure, measures the change in sales between current and prior year periods using a constant currency, the exchange rate in effect during the applicable prior year period. See description of non-GAAP financial measures contained in this release.

⁽¹⁾ Operational growth, a non-GAAP financial measure, measures the change in sales between current and prior year periods using a constant currency, the exchange rate in effect during the applicable prior year period. See description of non-GAAP financial measures contained in this release.