Covidien's second-quarter medical devices sales up 11%

Covidien plc (NYSE: COV) today reported results for the second quarter of fiscal 2010 (January - March 2010).

“Our top-line performance, however, did not meet our expectations, particularly in the Pharmaceuticals and Medical Supplies segments. In our largest business segment, Medical Devices, another solid quarter was led by strong growth for Energy and Vascular.”

This release will discuss the Company's performance on a GAAP basis and an adjusted financial results basis. The reconciliation of the adjusted financial results to the GAAP results is shown in the attached Non-GAAP Reconciliations and Sales Analysis tables. The adjusted financial results exclude $258 million in sales of oxycodone hydrochloride extended-release tablets (Oxy ER) in the second-quarter of 2009, as well as the other items specified in the tables.

GAAP RESULTS

Net sales of $2.7 billion were down 5% from the $2.8 billion reported a year ago, with favorable foreign exchange of $98 million increasing the quarterly sales growth rate by approximately 3 percentage points. The sales decline was primarily due to the 2009 sales of Oxy ER.

Second-quarter 2010 gross margin of 55.7% rose 0.4 percentage points from the prior-year period. Selling, general and administrative expenses for the second quarter of fiscal 2010 were significantly higher than those of a year ago. The 2010 expenses included planned increases in selling and marketing, unfavorable foreign exchange and expenses related to recent acquisitions. Research and Development (R&D) expense in the second quarter climbed 16% from that of the prior year and represented 4.4% of net sales.

In the second quarter of 2010, the Company reported operating income of $561 million, versus $548 million in the same period the year before. The 2009 operating income was adversely impacted by a $183 million charge for shareholder settlements. The second-quarter 2010 effective tax rate was 21.5%, versus 64.1% in the second quarter of 2009, which included certain one-time charges. Diluted GAAP earnings per share from continuing operations were $0.85 in the second quarter of 2010, versus $0.37 per share in the comparable quarter last year.

For the first six months of fiscal 2010, net sales of $5.41 billion were 1% above the $5.36 billion in the prior year, with favorable foreign exchange increasing the sales growth rate by approximately 4 percentage points.

The Company reported operating income of $1.11 billion in the first six months of fiscal 2010, versus $1.09 billion in the comparable period a year ago. For the first six months of 2010, the effective tax rate was 21.3% and diluted GAAP earnings per share from continuing operations were $1.66, versus $1.12 a year ago.

ADJUSTED FINANCIAL RESULTS

Second-quarter 2010 adjusted net sales increased 5%, while operational growth (net sales growth, excluding the effect of foreign exchange) was 1%, driven primarily by higher volume and new products.

Gross margin was up 4.7 percentage points to 55.7% versus the 2009 adjusted gross margin of 51.0%. The second-quarter 2010 improvement reflected positive mix in the Medical Devices segment, benefits from our restructuring program and favorable foreign exchange.

Second-quarter 2010 adjusted operating income was up 15% to $587 million, compared with $509 million in the previous year. Second-quarter 2010 adjusted operating income represented 22.1% of sales, versus 20.0% a year ago. The second-quarter 2010 adjusted tax rate was 20.4% versus 23.7% a year ago.

Second-quarter adjusted diluted earnings per share were $0.88, versus $0.72 a year ago, a 22% increase.

For the first six months of fiscal 2010, net sales of $5.41 billion were 8% above the $5.01 billion in the prior year, with favorable foreign exchange increasing the sales growth rate by approximately 4 percentage points.

Six-month 2010 adjusted operating income was $1.18 billion, versus $998 million in the previous year, an increase of 18%. Six-month 2010 adjusted operating income represented 21.8% of sales, versus 19.9% a year ago. The adjusted tax rate for the first six months was 21.5%, versus 26.1% in the first six months of 2009.

For the first six months of 2010, adjusted diluted earnings per share from continuing operations were $1.73, versus $1.37 a year ago, a 26% increase.

"We delivered significantly improved gross and operating margins, on an adjusted basis, while continuing to make the investments that will propel our future growth. We are pleased with this upward trend in margin improvement," said Richard J. Meelia, Chairman, President and CEO. "Our top-line performance, however, did not meet our expectations, particularly in the Pharmaceuticals and Medical Supplies segments. In our largest business segment, Medical Devices, another solid quarter was led by strong growth for Energy and Vascular.

"Last week, we showcased a number of new products at the SAGES conference and, in the next month, we will launch additional offerings, including two major new Pharmaceutical products, PENNSAID® and EXALGO™. We expect that these and other innovations will fuel our growth in an increasingly competitive marketplace. We also look to complete the next step in the announced reshaping of our portfolio by concluding the sale of our U.S. nuclear pharmacies. We remain confident in our prospects and expect to make additional strategic investments funded by our strong cash flow," Mr. Meelia said.

BUSINESS SEGMENT RESULTS

Medical Devices sales of $1.62 billion in the second quarter were 11% above the $1.46 billion in the comparable quarter of last year. Operational growth was 5%, reflecting new products and increased volume. Operationally, sales in Endomechanical advanced, as both laparoscopic instruments and stapling products registered good growth. The Energy double-digit quarterly sales gain was again due to a sharp rise in sales of vessel sealing products, partially offset by a continued slowdown in capital-related hardware products. In Soft Tissue Repair, sales of mesh and biosurgery products increased, though at a slower rate than in recent quarters. In the Oximetry and Monitoring product line, sales gains were aided by the Aspect acquisition, partially offset by lower than expected flu-related volume. In Airway and Ventilation, the sales advance primarily reflected another quarter of exceptional growth for ventilators outside the United States. The increase was largely offset by lower sales of sleep products following the divestiture of the diagnostics product line. Vascular sales climbed at a strong double-digit pace, due to the addition of VNUS and Bacchus products, partially offset by lower sales of compression products.

For the first six months of fiscal 2010, Medical Devices sales rose 14% to $3.31 billion from $2.90 billion a year ago. Favorable foreign exchange contributed approximately 6 percentage points to the increase.

Pharmaceuticals sales of $619 million in the second quarter were 2% below last year's adjusted sales of $631 million. Operationally, second-quarter 2010 sales were 5% below those of the previous year. Sales in the 2010 second quarter benefited from a double-digit increase in Radiopharmaceuticals, aided by a supply situation that improved from the year before and by higher thallium sales. Operationally, quarterly sales of Contrast Products and Active Pharmaceutical Ingredients declined from those of a year ago. Sales of Specialty Chemicals rose, primarily reflecting higher sales of pharmaceutical and laboratory chemicals. Excluding Oxy ER, sales of Specialty Pharmaceuticals were well below those of the prior year, due to sharply lower generic and branded product sales. The decline in branded products was largely attributable to Restoril, while the generics shortfall was due to increased competitive activity, difficult comparisons with the prior year and distributor order timing.

For the first six months of fiscal 2010, Pharmaceuticals adjusted sales were essentially unchanged from those of a year ago.

On a GAAP basis, sales in the second quarter of fiscal 2010 for the Pharmaceuticals segment were $619 million, 30% below the prior year's $889 million, which included $258 million of Oxy ER. For the first six months of fiscal 2010, Pharmaceuticals sales of $1.24 billion decreased 22% from last year's $1.59 billion, which included $354 million of Oxy ER.

Medical Supplies second-quarter sales of $421 million were 5% below the $445 million reported in the comparable quarter of the previous year. The decrease was largely due to lower sales of Nursing Care, Medical Surgical and SharpSafety products, due in part to a weaker than expected late flu season and distributor inventory destocking. For the first six months of fiscal 2010, sales of Medical Supplies, at $864 million, were 2% below last year's $880 million.

In the second quarter of fiscal 2010, Covidien purchased approximately 500,000 ordinary shares under its previously announced share buyback programs.

FISCAL 2010 OUTLOOK

Covidien has updated its fiscal 2010 sales guidance to reflect the recent strengthening of the U.S. dollar against most currencies, the approval of EXALGO™, the sale of the U.S. nuclear pharmacies, coupled with weakness in certain product lines. The Company now estimates that net sales in fiscal 2010 will be up 5% to 8%, including foreign exchange at current rates and excluding Oxy ER sales from the 2009 base. This compares with prior guidance of a 6% to 9% sales increase in 2010. Net sales are now expected to be up 9% to 12% versus 2009 in the Medical Devices segment. Sales in both the Pharmaceuticals and Medical Supplies segments are now expected to be about even with those of 2009. Including foreign exchange at current rates and excluding the impact of one-time items, there are no changes to our previous 2010 expectations for operating margin (21% to 22%), effective tax rate (21% to 23%) or free cash flow (in excess of $1.5 billion).