10-Q 1 cov2014032814_10-q.htm 10-Q COV2014.03.28.14_10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 _________________________________
FORM 10-Q
 _________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 28, 2014
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
001-33259
(Commission File Number)
 _________________________________
COVIDIEN PUBLIC LIMITED COMPANY
(Exact name of registrant as specified in its charter)
 _________________________________
Ireland
 
98-0624794
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
20 On Hatch, Lower Hatch Street
Dublin 2, Ireland
Telephone: +353 1 438-1700
(Address, including zip code, and telephone number,
including area code, of registrant’s principal executive offices)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
 
Large accelerated filer
 
x
  
Accelerated filer
 
o
 
 
 
 
Non-accelerated filer
 
o
  
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
The number of ordinary shares outstanding as of April 29, 2014 was 450,875,930.





COVIDIEN PLC
INDEX TO FORM 10-Q
 
 
 
Page
 
 
 
Part I.
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
Part II.
 
Item 1.
Item 1A.
Item 2.
Item 6.




PART I. FINANCIAL INFORMATION
 
Item 1.
Financial Statements

COVIDIEN PLC
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Quarters and Six Months Ended March 28, 2014 and March 29, 2013
(in millions, except per share data)
 
Quarter Ended
 
Six Months Ended
 
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Net sales
$
2,598

 
$
2,530

 
$
5,237

 
$
5,097

Cost of goods sold
1,080

 
1,002

 
2,156

 
2,032

Gross profit
1,518

 
1,528

 
3,081

 
3,065

Selling, general and administrative expenses
896

 
830

 
1,746

 
1,652

Research and development expenses
135

 
122

 
260

 
233

Restructuring charges, net
16

 
54

 
73

 
62

Gain on divestiture, net
(111
)
 

 
(111
)
 

Operating income
582

 
522

 
1,113

 
1,118

Interest expense
(54
)
 
(51
)
 
(107
)
 
(102
)
Interest income
6

 
2

 
8

 
5

Other income, net
67

 
17

 
100

 
18

Income from continuing operations before income taxes
601

 
490

 
1,114

 
1,039

Income tax expense
160

 
110

 
275

 
203

Income from continuing operations
441

 
380

 
839

 
836

Income from discontinued operations, net of income taxes

 
59

 

 
96

Net income
$
441

 
$
439

 
$
839

 
$
932

Basic earnings per share:
 
 
 
 
 
 
 
Income from continuing operations
$
0.98

 
$
0.80

 
$
1.86

 
$
1.77

Income from discontinued operations

 
0.13

 

 
0.20

Net income
0.98

 
0.93

 
1.86

 
1.97

Diluted earnings per share:
 
 
 
 
 
 
 
Income from continuing operations
$
0.97

 
$
0.80

 
$
1.84

 
$
1.75

Income from discontinued operations

 
0.12

 

 
0.20

Net income
0.97

 
0.92

 
1.84

 
1.96

Weighted-average number of shares outstanding:
 
 
 
 
 
 
 
Basic
451

 
471

 
451

 
472

Diluted
454

 
476

 
455

 
476

Cash dividends declared per ordinary share
$
0.64

 
$
0.26

 
$
0.64

 
$
0.52


See Notes to Condensed Consolidated Financial Statements.

2



COVIDIEN PLC
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Quarters and Six Months Ended March 28, 2014 and March 29, 2013
(in millions)

 
Quarter Ended
 
Six Months Ended
 
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Net Income
$
441

 
$
439

 
$
839

 
$
932

Income from discontinued operations, net of income taxes

 
(59
)
 

 
(96
)
Income from continuing operations
441

 
380

 
839

 
836

Currency translation adjustments
(4
)
 
(71
)
 
(20
)
 
(68
)
Unrecognized (loss) gain on derivatives
(1
)
 
(1
)
 
1

 
3

Unrecognized gain on benefit plans

 
4

 
2

 
5

Other comprehensive loss from continuing operations, net of income taxes
(5
)
 
(68
)
 
(17
)
 
(60
)
Comprehensive income from continuing operations, net of income taxes
436

 
312

 
822

 
776

Comprehensive income from discontinued operations, net of income taxes

 
40

 

 
87

Comprehensive income
$
436

 
$
352

 
$
822

 
$
863


See Notes to Condensed Consolidated Financial Statements.

3



COVIDIEN PLC
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
At March 28, 2014 and September 27, 2013
(in millions, except share data)
 
March 28,
2014
 
September 27,
2013
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
1,178

 
$
1,868

Accounts receivable trade, less allowance for doubtful accounts of $40 and $38
1,552

 
1,526

Inventories
1,419

 
1,352

Due from former parent and affiliate
355

 
293

Prepaid expenses and other current assets (including $71 and $75 due from Mallinckrodt)
875

 
828

Total current assets
5,379

 
5,867

Property, plant and equipment, net
2,033

 
2,012

Goodwill
8,752

 
8,172

Intangible assets, net
3,223

 
2,687

Due from former parent and affiliate
375

 
375

Other assets
745

 
805

Total Assets
$
20,507

 
$
19,918

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
Current Liabilities:
 
 
 
Current maturities of long-term debt
$
6

 
$
11

Accounts payable
511

 
501

Accrued and other current liabilities (including $60 and $55 due to Mallinckrodt)
1,472

 
1,586

Income taxes payable
654

 
541

Total current liabilities
2,643

 
2,639

Long-term debt
5,015

 
5,018

Income taxes payable
1,153

 
1,147

Guaranteed contingent tax liabilities
550

 
571

Other liabilities
1,524

 
1,301

Total Liabilities
10,885

 
10,676

Commitments and contingencies (note 15)

 

Redeemable noncontrolling interest (note 16)
60

 

Shareholders’ Equity:
 
 
 
Preference shares, $0.20 par value, 125,000,000 authorized; none issued

 

Ordinary shares, $0.20 par value, 1,000,000,000 authorized; 452,624,594 and 489,032,186 issued
90

 
97

Ordinary shares held in treasury at cost; 1,990,693 and 36,258,061
(136
)
 
(2,210
)
Additional paid-in capital
7,728

 
7,549

Retained earnings
1,605

 
3,514

Accumulated other comprehensive income
275

 
292

Total Shareholders’ Equity
9,562

 
9,242

Total Liabilities, Redeemable Noncontrolling Interest and Shareholders’ Equity
$
20,507

 
$
19,918

See Notes to Condensed Consolidated Financial Statements.

4



COVIDIEN PLC
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)
Six Months Ended March 28, 2014
(in millions)
 
Ordinary Shares
 
Treasury Shares
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Total
Shareholders’
Equity
Number
 
Par
Value
 
Number
 
Amount
 
Balance at September 27, 2013
489

 
$
97

 
(36
)
 
$
(2,210
)
 
$
7,549

 
$
3,514

 
$
292

 
$
9,242

Net income

 

 

 

 

 
839

 

 
839

Other comprehensive loss, net of income taxes

 

 

 

 

 

 
(17
)
 
(17
)
Dividends declared

 

 

 

 

 
(289
)
 

 
(289
)
Repurchase of shares

 

 
(6
)
 
(393
)
 

 

 

 
(393
)
Retirement of treasury shares
(40
)
 
(8
)
 
40

 
2,467

 

 
(2,459
)
 

 

Share options exercised
3

 
1

 

 

 
127

 

 

 
128

Vesting of restricted shares
1

 

 

 

 

 

 

 

Equity-based compensation

 

 

 

 
52

 

 

 
52

Balance at March 28, 2014
453

 
$
90

 
(2
)
 
$
(136
)
 
$
7,728

 
$
1,605

 
$
275

 
$
9,562


See Notes to Condensed Consolidated Financial Statements.


5


COVIDIEN PLC
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended March 28, 2014 and March 29, 2013
(in millions) 
 
Six Months Ended
 
March 28,
2014
 
March 29,
2013
Cash Flows From Operating Activities:
 
 
 
Net income
$
839

 
$
932

Adjustments to reconcile net cash provided by operating activities:
 
 
 
Depreciation and amortization
272

 
329

Gain on divestiture, net
(111
)
 

Impairment of intangible assets
29

 
10

Equity-based compensation
52

 
53

Deferred income taxes
(20
)
 
72

Provision for losses on accounts receivable and inventory
24

 
39

Other non-cash items
(10
)
 
(24
)
Changes in assets and liabilities, net of the effects of acquisitions:
 
 
 
Accounts receivable, net
2

 
(171
)
Inventories
(39
)
 
(92
)
Accounts payable

 
(2
)
Income taxes
150

 
(29
)
Accrued and other liabilities
(100
)
 
(233
)
Other
(96
)
 
(77
)
Net cash provided by operating activities
992

 
807

Cash Flows From Investing Activities:
 
 
 
Capital expenditures
(153
)
 
(241
)
Acquisitions, net of cash acquired
(1,217
)
 
(238
)
Divestiture
231

 

Sale of investments
57

 
13

Other
(7
)
 
(5
)
Net cash used in investing activities
(1,089
)
 
(471
)
Cash Flows From Financing Activities:
 
 
 
Net issuance of commercial paper

 
40

Dividends paid
(289
)
 
(246
)
Repurchase of shares
(393
)
 
(459
)
Proceeds from exercise of share options
111

 
175

Payment of contingent consideration
(15
)
 
(17
)
Other
9

 
20

Net cash used in financing activities
(577
)
 
(487
)
Effect of currency rate changes on cash
(16
)
 
(32
)
Net decrease in cash and cash equivalents
(690
)
 
(183
)
Cash and cash equivalents at beginning of period
1,868

 
1,866

Cash and cash equivalents at end of period
$
1,178

 
$
1,683

See Notes to Condensed Consolidated Financial Statements.

6


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1. Basis of Presentation
Basis of Presentation—The accompanying financial statements reflect the consolidated operations of Covidien plc, a company incorporated in Ireland, and its subsidiaries (Covidien or the Company). The unaudited condensed consolidated financial statements have been prepared in U.S. dollars, in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make use of estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Actual results may differ from those estimates. In management’s opinion, the unaudited condensed consolidated financial statements contain all normal recurring adjustments necessary for a fair presentation of the interim results reported. The year-end balance sheet data was derived from audited consolidated financial statements. These financial statements do not include all of the annual disclosures required by U.S. GAAP; accordingly, they should be read in conjunction with the Company’s audited consolidated financial statements in its Annual Report on Form 10-K for the fiscal year ended September 27, 2013.
2. Segment and Geographic Data
During fiscal 2013, the Company completed the separation of its Pharmaceuticals business into a separate, stand alone publicly traded company, Mallinckrodt plc (the 2013 separation). As discussed in note 4, the historical results of operations of the Company’s former Pharmaceuticals business have been presented as discontinued operations. Accordingly, the segment data below has been recast to exclude the Company’s former Pharmaceuticals segment and to reallocate certain allocations previously included within this segment.
Following the 2013 separation, the Company realigned its operating segments, effective October 1, 2013, such that the Medical Supplies business in Western Europe is now managed by the Medical Devices segment. Integrating these businesses allows Covidien to better utilize internal resources and achieve cost synergies. In addition, certain costs that were previously included in corporate expense, primarily information technology and certain shared service costs, are now reflected in the Company’s reportable segments, consistent with the way in which management measures and evaluates segment performance. Following this realignment, the Company’s reportable segments are as follows:
Medical Devices includes worldwide sales of the following products: advanced and general surgical solutions; peripheral vascular and neurovascular therapies; patient monitoring products; and airway and ventilation products. It also includes sales of the following products outside the United States: nursing care; medical surgical; SharpSafetyTM and original equipment manufacturer (OEM).
U.S. Medical Supplies includes sales of the following products in the United States: nursing care; medical surgical; SharpSafetyTM and OEM.
The Company has aggregated the following four operating segments into the Medical Devices reportable segment based upon their similar operational and economic characteristics:
Western Europe;
Developed Markets—Canada, Japan, Australia and New Zealand;
Emerging Markets—Eastern Europe, Middle East, Africa, Asia (excluding Japan) and Latin America; and
U.S. Medical Devices.
Management measures and evaluates the Company’s operating segments based on segment net sales and operating income. Management excludes corporate expenses from segment operating income. In addition, certain amounts that management considers to be non-recurring or non-operational are excluded from segment operating income because management evaluates the operating results of the segments excluding such items. These items include net (charges) income associated with acquisitions; net gain on divestiture; net restructuring and related charges; impairments and other charges associated with certain product discontinuances; and certain environmental charges. Although these amounts are excluded from segment operating income, as applicable, they are included in the reconciliations that follow.

7


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Selected information by business segment is presented below:
 
Quarter Ended
 
Six Months Ended
(Dollars in Millions)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Net sales(1) :
 
 
 
 
 
 
 
Medical Devices
$
2,199

 
$
2,143

 
$
4,450

 
$
4,325

U.S. Medical Supplies
399

 
387

 
787

 
772

Consolidated net sales
$
2,598

 
$
2,530

 
$
5,237

 
$
5,097

Segment operating income:
 
 
 
 
 
 
 
Medical Devices
$
618

 
$
627

 
$
1,268

 
$
1,261

U.S. Medical Supplies
39

 
42

 
78

 
93

Segment operating income
657

 
669

 
1,346

 
1,354

Unallocated amounts:
 
 
 
 
 
 
 
Corporate expenses
(97
)
 
(98
)
 
(187
)
 
(179
)
Net (charges) income associated with acquisitions(2)
(7
)
 
6

 
(7
)
 
6

Gain on divestiture, net (note 4)
111

 

 
111

 

Restructuring and related charges, net (note 5)
(17
)
 
(55
)
 
(76
)
 
(63
)
Renal denervation charges, net(3)

 

 
(9
)
 

Environmental charge (note 15)
(65
)
 

 
(65
)
 

Interest expense, net
(48
)
 
(49
)
 
(99
)
 
(97
)
Other income, net
67

 
17

 
100

 
18

Income from continuing operations before income taxes
$
601

 
$
490

 
$
1,114

 
$
1,039

  
(1) 
Amounts represent sales to external customers. Intersegment sales are insignificant.
(2) 
Current period amounts relate to acquisition-related transaction costs and the sale of acquired inventory that had been written up to fair value upon acquisition. Prior period amounts relate to an adjustment to contingent consideration.
(3) 
Represents charges incurred in connection with the Company’s decision to exit its OneShotTM renal denervation program totaling $35 million, the majority of which relates to the write-off of intangible assets, which is discussed in note 10. These charges were 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 discussed in note 12.

Net sales by groups of products within the Company’s segments are as follows:
 
Quarter Ended
 
Six Months Ended
(Dollars in Millions)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Advanced Surgical
$
835

 
$
774

 
$
1,688

 
$
1,564

General Surgical
378

 
392

 
786

 
796

Surgical Solutions
1,213

 
1,166

 
2,474

 
2,360

Peripheral Vascular
298

 
295

 
613

 
605

Neurovascular
111

 
111

 
221

 
217

Vascular Therapies
409

 
406

 
834

 
822

Patient Monitoring
258

 
250

 
508

 
491

Airway & Ventilation
190

 
191

 
372

 
387

Nursing Care
258

 
254

 
517

 
508

Patient Care
270

 
263

 
532

 
529

Respiratory and Patient Care
976

 
958

 
1,929

 
1,915

Total Covidien
$
2,598

 
$
2,530

 
$
5,237

 
$
5,097


8


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Net sales by geographic area are as follows:
 
Quarter Ended
 
Six Months Ended
(Dollars in Millions)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Net sales(1):
 
 
 
 
 
 
 
United States
$
1,277

 
$
1,257

 
$
2,584

 
$
2,526

Non-U.S. Developed Markets(2)
938

 
921

 
1,872

 
1,862

Emerging Markets
383

 
352

 
781

 
709

 
$
2,598

 
$
2,530

 
$
5,237

 
$
5,097

          
(1) 
Sales to external customers are reflected in the regions based on the reporting entity that records the transaction.
(2) 
During the second quarter of both fiscal 2014 and 2013, sales to Japan represented 9% of total net sales. Sales to Japan represented 9% and 10% of total net sales in the first six months of fiscal 2014 and 2013, respectively.
3. Acquisitions
New Wave Surgical Corporation—In March 2014, the Company acquired all of the outstanding equity of New Wave Surgical Corporation (New Wave), a manufacturer of an endoscopic visualization system, for total consideration of $114 million ($113 million, net of cash acquired). This consideration was comprised of cash of $111 million ($110 million, net of cash acquired) and debt assumed of $3 million, which was subsequently repaid. The transaction expands the Company’s product offerings to include an endoscopic visualization system for use during laparoscopic procedures.
Given Imaging Ltd.—In February 2014, the Company acquired all of the outstanding equity of Given Imaging Ltd., a developer of gastrointestinal medical devices, for cash of $1.033 billion ($925 million, net of cash acquired). The acquisition of Given Imaging provides the Company with additional scale and scope to serve the global gastrointestinal market and supports Covidien’s strategy to comprehensively address key global specialties and procedures.
WEM Equipamentos Electrônicos Ltda.—In January 2014, the Company acquired all of the outstanding equity of WEM Equipamentos Electrônicos Ltda. (WEM), a manufacturer of electrosurgical generators, disposables and accessories in Brazil, for cash of $54 million. The transaction provides the Company with lower cost manufacturing and supports its strategy of providing more affordable healthcare solutions in new markets.
Changzhou Kangdi Medical Stapler Co., Ltd.—In January 2014, the Company acquired 65% of the outstanding shares of Changzhou Kangdi Medical Stapler Co., Ltd. (Kangdi), a manufacturer of open stapler products in China, for cash of $39 million ($36 million, net of cash acquired). The transaction provides the Company with lower cost manufacturing and supports its strategy of providing more affordable healthcare solutions in new markets. Covidien has the option to purchase the remaining shares of Kangdi, and the noncontrolling shareholders have the option to sell their shares to Covidien, in fiscal 2019, or earlier if certain revenue targets are achieved. The price Covidien would have to pay for the remaining shares of Kangdi is between $60 million and $96 million, the final determination of which will be based on the achievement of certain revenue targets. Since the noncontrolling interest shareholders can require Covidien to purchase the remaining shares of Kangdi, their 35% equity interest has been classified as a redeemable noncontrolling interest. Note 16 provides additional information regarding this redeemable noncontrolling interest.
In addition, during the first six months of fiscal 2014, the Company acquired three other businesses for total consideration of $128 million ($126 million, net of cash acquired). The total consideration was comprised of upfront cash payments totaling $94 million ($92 million, net of cash acquired); debt assumed of $1 million, which was subsequently repaid; and the fair value of contingent consideration of $33 million. The contingent consideration, which could total a maximum of $192 million, consists of milestone payments related to the achievement of sales targets.

9


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Fair Value Allocation of Assets Acquired and Liabilities Assumed—The following amounts represent the preliminary determination of the fair value of the identifiable assets acquired and liabilities assumed for Given Imaging and all other acquisitions completed during the first six months of fiscal 2014:
(Dollars in Millions) 
Given Imaging
 
All Other
 
Total  
Cash
$
108

 
$
6

 
$
114

Inventories
44

 
11

 
55

Short-term investments
48

 

 
48

Other current assets(1)
26

 
15

 
41

Intangible assets
598

 
153

 
751

Goodwill ($29 of which is tax deductible)
393

 
249

 
642

Other assets
13

 
8

 
21

Total assets acquired
1,230

 
442

 
1,672

Other current liabilities
42

 
18

 
60

Contingent consideration (non-current)

 
33

 
33

Deferred tax liabilities (non-current)
151

 
32

 
183

Other liabilities
4

 
1

 
5

Redeemable noncontrolling interest

 
60

 
60

Total liabilities assumed
197

 
144

 
341

Net assets acquired
$
1,033

 
$
298

 
$
1,331

 
(1)
Amounts include $27 million and $8 million of accounts receivable for Given Imaging and all other acquisitions, respectively, which are also the gross contractual values. As of each acquisition date, the fair value of accounts receivable approximated carrying value.
Redeemable Noncontrolling Interest—The valuation of the redeemable noncontrolling interest was based upon the minimum amount Covidien would have to pay to purchase the remaining shares of Kangdi and the expected incremental purchase price based on management’s estimate of Kangdi’s future revenues. The minimum payment of $60 million was discounted for the time value of money using a five-year rate considered commensurate with a market participant’s cost of debt, while the incremental expected purchase price was discounted using a rate considered commensurate with a market participant’s risk of achieving the future revenue forecasts. The weighted-average discount rate was 6%.
Goodwill—The benefits of adding minimally invasive gastrointestinal diagnostic products to the Company’s Advanced Surgical product portfolio contributed to an acquisition price in excess of the fair value of net assets acquired for Given Imaging, which resulted in the establishment of goodwill. In addition, the synergies expected to result from combining infrastructures and leveraging operational expenses also contributed to the establishment of goodwill for this acquisition.
The benefits of adding an endoscopic visualization system, which maintains optimal visualization during laparoscopic procedures, to the Company’s General Surgical product portfolio contributed to an acquisition price in excess of the fair value of net assets acquired for New Wave, which resulted in the establishment of goodwill. Finally, the benefits of lower cost manufacturing, complementary sales channels and the addition of more brands to the Company’s Advanced and General Surgical product portfolios contributed to acquisition prices in excess of the fair value of net assets acquired for Kangdi and WEM, which resulted in the establishment of goodwill.
As of March 28, 2014, the Company had not yet finalized its valuation of certain non-current assets and related deferred tax liabilities for Given Imaging. In addition, due to the limited time since the acquisition date, as of March 28, 2014, the Company had not yet finalized its valuation for one of the other acquisitions completed during the six months ended March 28, 2014. The impact of the finalization of these valuations is not expected to have a material effect on the Company’s financial condition.


10


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Intangible assets acquired consist of the following:
(Dollars in Millions) 
Amount  
 
Weighted-Average Amortization Period
Given Imaging
 
 
 
Completed technology
$
135

 
12 years
Customer relationships
442

 
20 years
Trademarks
3

 
4 years
In-process research and development
18

 
Non-Amortizable
 
$
598

 
18 years
All Other
 
 
 
Completed technology
$
111

 
15 years
Customer relationships
42

 
15 years
 
$
153

 
15 years
Total
 
 
 
Completed technology
$
246

 
13 years
Customer relationships
484

 
20 years
Trademarks
3

 
4 years
In-process research and development
18

 
Non-Amortizable
 
$
751

 
17 years
Financial Results—The amount of net sales and operating loss included in the Company’s results for the quarter and six months ended March 28, 2014 for Given Imaging and all other acquisitions completed during the first six months of fiscal 2014 were as follows:
(Dollars in Millions)
Quarter Ended March 28, 2014
 
Six Months Ended March 28, 2014
Net sales
 
 
 
Given Imaging
$
18

 
$
18

All other
3

 
3

 
$
21

 
$
21

 
 
 
 
Operating loss(1)
 
 
 
Given Imaging
$
(13
)
 
$
(13
)
All other
(5
)
 
(6
)
 
$
(18
)
 
$
(19
)
 
(1)
Amounts include restructuring charges, charges to cost of goods sold related to the sale of acquired inventory that had been written up to fair value upon acquisition and transaction costs.
Acquisition-Related Costs—The amount of acquisition-related costs incurred associated with fiscal 2014 acquisitions were $7 million for both the quarter and six months ended March 28, 2014. In addition, in both the quarter and six months ended March 28, 2014, the Company recorded $9 million of integration costs, which were included in restructuring charges, net.
Unaudited Pro Forma Financial Information—The following unaudited pro forma financial information summarizes the results of operations for the periods indicated as if the acquisitions of Given Imaging and all other acquisitions had been completed as of the beginning of fiscal 2013. The pro forma financial information is based on the historical financial information for Covidien, Given Imaging and all other acquisitions and reflects the following pro forma adjustments:
Elimination of historical amortization expense and depreciation expense for each of the acquired companies and additional amortization and depreciation expense related to the fair value of intangible assets and property, plant and equipment acquired;

11


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

A decrease in interest income for cash used to fund the acquisitions and repay debt assumed;
Elimination of historical interest expense associated with debt assumed that was immediately repaid;
Elimination of direct acquisition transaction costs, restructuring charges and charges included in cost of goods sold related to the sale of acquired inventory that had been written up to fair value upon acquisition in fiscal 2014 and inclusion of such items in fiscal 2013;
Tax impact of all of the above adjustments; and
Elimination of the historical income tax expense for each of the acquired companies and inclusion of income tax expense on the historical results of each of the acquired companies using the respective jurisdictional tax rates.
 
Quarter Ended
 
Six Months Ended
(Dollars in Millions, Except per Share Data)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Net sales
$
2,629

 
$
2,580

 
$
5,331

 
$
5,206

Income from continuing operations
445

 
372

 
840

 
812

Net income
445

 
431

 
840

 
908

Basic earnings per share:
 
 
 
 
 
 
 
Income from continuing operations
$
0.99

 
$
0.79

 
$
1.86

 
$
1.72

Net income
0.99

 
0.92

 
1.86

 
1.92

Diluted earnings per share:
 
 
 
 
 
 
 
Income from continuing operations
$
0.98

 
$
0.78

 
$
1.84

 
$
1.70

Net income
0.98

 
0.91

 
1.84

 
1.91

The unaudited pro forma financial information above is not indicative of the results that would have actually been obtained if the acquisitions had occurred as of the beginning of fiscal 2013, or that may be obtained in the future. No effect has been given to cost reductions or operating synergies relating to the integration of these companies.
4. Discontinued Operations and Divestiture
Discontinued Operations
The historical results of operations of Covidien’s former Pharmaceuticals business have been presented as discontinued operations in the prior year condensed consolidated statements of income and comprehensive income. Discontinued operations include the results of Mallinckrodt’s business except for certain corporate overhead costs and other allocations, which remain in continuing operations. Discontinued operations also include costs incurred by Covidien to separate Mallinckrodt. The prior year statement of cash flows has not been adjusted to reflect the effect of the 2013 separation.
Net sales and income from Mallinckrodt’s operations and adjustments to the loss recorded on prior dispositions were as follows: 
(Dollars in Millions)
Quarter Ended March 29, 2013
 
Six Months Ended March 29, 2013
Net sales
$
573

 
$
1,062

Income from operations, net of tax expense of $14 and $38(1)
$
61

 
$
98

Loss on dispositions, net of tax benefit of $— and $—
(2
)
 
(2
)
Income from discontinued operations, net of income taxes
$
59

 
$
96

 
(1) Includes pre-tax charges incurred in connection with the activities taken to complete the 2013 separation and to build out Mallinckrodt’s corporate infrastructure totaling $36 million and $55 million for the quarter and six months ended March 29, 2013, respectively.

12


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Divestiture
On January 15, 2014, the Company sold its biosurgery sealant product line within the Medical Devices segment because it was not aligned with its long-term strategic objectives. In connection with this transaction, the Company received $231 million in cash and recorded a pre-tax gain of $111 million. In addition, the Company may receive up to $30 million, contingent upon the achievement of certain performance measures.
5. Restructuring and Related Charges, Net
In fiscal 2013, the Company launched a restructuring program designed to improve the Company’s cost structure. This program includes actions across the Company’s segments and corporate. Such actions include, among other things, reducing corporate expenses, expanding the use of shared services in low-cost locations, outsourcing services where appropriate, streamlining the Company’s organizational structure, consolidating manufacturing locations, consolidating and optimizing distribution centers and expanding low-cost country sourcing. The Company expects to incur aggregate charges between $350 million and $450 million associated with these actions. These charges, which are recorded as the specific actions required to execute on these initiatives are identified and approved, are expected to be incurred through fiscal 2018. This program excludes restructuring actions associated with acquisitions.
In fiscal 2011, the Company launched a $275 million restructuring program designed to improve the Company’s cost structure. This program includes actions across the Company’s segments and corporate and excludes restructuring actions associated with acquisitions. Charges totaling approximately $50 million recorded under this program by the Company’s former Pharmaceuticals segment have been reclassified to discontinued operations. Accordingly, aggregate charges of approximately $225 million are expected to relate to the Company’s continuing operations. These charges, which are recorded as the specific actions required to execute on these initiatives are identified and approved, are expected to be incurred by the end of fiscal 2015.

13


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Net restructuring and related charges recognized in continuing operations, including actions associated with acquisitions, by segment were as follows:
 
Quarter Ended
 
Six Months Ended
(Dollars in Millions)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Medical Devices
$
15

 
$
53

 
$
71

 
$
58

U.S. Medical Supplies
1

 
2

 
2

 
5

Corporate
1

 

 
3

 

Restructuring and related charges, net
17

 
55

 
76

 
63

Less: accelerated depreciation
(1
)
 
(1
)
 
(3
)
 
(1
)
Restructuring charges, net
$
16

 
$
54

 
$
73

 
$
62

Net restructuring and related charges recognized in continuing operations were comprised of the following:
 
Quarter Ended
 
Six Months Ended
(Dollars in Millions)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Acquisition-related restructuring actions
$
8

 
$
6

 
$
11

 
$
8

2013 program
6

 

 
63

 

2011 and prior programs
3

 
49

 
2

 
55

Restructuring and related charges, net
17

 
55

 
76

 
63

Less: non-cash charges, including accelerated depreciation
(6
)
 
(1
)
 
(8
)
 
(4
)
Total charges expected to be settled in cash
$
11

 
$
54

 
$
68

 
$
59

The following table summarizes cash activity for restructuring reserves related to acquisitions for the six months ended March 28, 2014:
(Dollars in Millions)
Employee Severance and Benefits
 
Other
 
Total
Balance at September 27, 2013
$
6

 
$
6

 
$
12

Charges
10

 
3

 
13

Changes in estimate
(2
)
 

 
(2
)
Cash payments
(3
)
 
(2
)
 
(5
)
Balance at March 28, 2014
$
11

 
$
7

 
$
18

The following table summarizes cash activity for restructuring reserves related to the 2013 and 2011 and prior programs for the six months ended March 28, 2014, substantially all of which relates to employee severance and benefits:
(Dollars in Millions)
2013 Program
 
2011 and Prior
Programs
 
Total
Balance at September 27, 2013
$
22

 
$
88

 
$
110

Charges
67

 
6

 
73

Changes in estimate
(4
)
 
(12
)
 
(16
)
Cash payments
(29
)
 
(43
)
 
(72
)
Currency translation

 
1

 
1

Balance at March 28, 2014
$
56

 
$
40

 
$
96


14


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Net restructuring and related charges, including associated asset impairments, incurred cumulative to date under the 2013 and 2011 programs as of March 28, 2014 were as follows:
(Dollars in Millions)
2013 Program
 
2011 Program
Medical Devices
$
72

 
$
158

U.S. Medical Supplies
4

 
3

Corporate
11

 
11

Total
$
87

 
$
172

Restructuring reserves were reported on the Company’s condensed consolidated balance sheets as follows:
(Dollars in Millions)
March 28,
2014
 
September 27,
2013
Accrued and other current liabilities
$
100

 
$
109

Other liabilities
14

 
13

Restructuring reserves
$
114

 
$
122

6. Retirement Plans
The net periodic benefit cost for the Company’s defined benefit pension plans was as follows:
 
Quarter Ended
 
Six Months Ended
(Dollars in Millions)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Service cost
$
4

 
$
3

 
$
8

 
$
7

Interest cost
5

 
4

 
10

 
8

Expected return on plan assets
(5
)
 
(4
)
 
(10
)
 
(9
)
Amortization of net actuarial loss
2

 
3

 
4

 
6

Net periodic benefit cost included in continuing operations
6

 
6

 
12

 
12

Net periodic benefit cost included in discontinued operations

 
2

 

 
4

Net periodic benefit cost
$
6

 
$
8

 
$
12

 
$
16

The net periodic benefit cost for postretirement benefit plans for the quarters and six months ended March 28, 2014 and March 29, 2013 was insignificant.
7. Other Income, Net
Other income, net was comprised of the following:
 
Quarter Ended
 
Six Months Ended
(Dollars in Millions)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Income under Tyco tax sharing agreement (note 13)
$
62

 
$
4

 
$
94

 
$
5

Gain on investments, net
5

 
9

 
6

 
9

Gain on demutualization of insurance carrier

 
4

 

 
4

Other income, net
$
67

 
$
17

 
$
100

 
$
18

Income under Tyco tax sharing agreement represents an increase to the receivable from Tyco International Ltd. and TE Connectivity Ltd. and primarily reflects 58% of the interest and other income taxes payable amounts recorded during each period that are subject to the Tyco tax sharing agreement. Income under the Tyco tax sharing agreement for the six months ended March 28, 2014 also includes $25 million of income for Covidien’s portion of Tyco International’s settlement of contract claims under a 2002 tax agreement with CIT Group Inc., a former subsidiary of Tyco International.

15


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

8. Earnings per Share
The weighted-average ordinary shares used in the computations of basic and diluted earnings per share were as follows:
 
Quarter Ended
 
Six Months Ended
(in Millions)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Basic shares
451
 
471
 
451
 
472
Effect of share options and restricted shares
3
 
5
 
4
 
4
Diluted shares
454
 
476
 
455
 
476
The computation of diluted earnings per share for both the quarters ended March 28, 2014 and March 29, 2013 exclude less than 1 million of options and restricted share units because either the effect would have been anti-dilutive or the performance criteria related to the units had not yet been met. For both the six months ended March 28, 2014 and March 29, 2013, the computation of diluted earnings per share excludes approximately 2 million of options and restricted share units because either the effect would have been anti-dilutive or the performance criteria related to the units had not yet been met.
9. Inventories
At the end of each period, inventories were comprised of the following:
(Dollars in Millions)
March 28,
2014
 
September 27,
2013
Purchased materials and manufactured parts
$
320

 
$
289

Work in process
170

 
169

Finished goods
929

 
894

Inventories
$
1,419

 
$
1,352

10. Goodwill and Intangible Assets
The changes in the carrying amounts of goodwill for the six months ended March 28, 2014 were as follows:
(Dollars in Millions)
Medical Devices
 
Medical Supplies
 
U.S. Medical Supplies
 
Total
Goodwill at September 27, 2013
$
7,783

 
$
389

 
$

 
$
8,172

Segment realignment (note 2)
26

 
(389
)
 
363

 

Acquisitions (note 3)
642

 

 

 
642

Divestiture (note 4)
(66
)
 

 

 
(66
)
Currency translation
4

 

 

 
4

Goodwill at March 28, 2014
$
8,389

 
$

 
$
363

 
$
8,752



16


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The gross carrying amount and accumulated amortization of intangible assets at the end of each period were as follows:
 
March 28, 2014
 
September 27, 2013
(Dollars in Millions)
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Gross
Carrying
Amount
 
Accumulated
Amortization
Amortizable:
 
 
 
 
 
 
 
Completed technology
$
2,293

 
$
869

 
$
2,229

 
$
890

Customer relationships
1,442

 
244

 
959

 
213

Other
144

 
88

 
161

 
86

Total
$
3,879

 
$
1,201

 
$
3,349

 
$
1,189

Non-Amortizable:
 
 
 
 
 
 
 
Trademarks
$
323

 
 
 
$
322

 
 
In-process research and development
222

 
 
 
205

 
 
Total
$
545

 
 
 
$
527

 
 
In connection with management’s regular review of strategic programs and growth potential for the Company’s product portfolio, management decided to exit the Company’s OneShot™ renal denervation program associated with the fiscal 2012 acquisition of Maya Medical. This decision was primarily driven by slower than expected development of the renal denervation market. As a result of this decision, during the first six months of fiscal 2014, the Company recorded pre-tax intangible asset impairment charges of $28 million to write off the completed technology associated with this project.
Intangible asset amortization expense from continuing operations was $56 million for both the quarters ended March 28, 2014 and March 29, 2013. Intangible asset amortization expense from continuing operations was $109 million and $111 million for the six months ended March 28, 2014 and March 29, 2013, respectively. Amortization expense associated with the intangible assets included on the Company’s balance sheet as of March 28, 2014 is expected to be as follows:
(Dollars in Millions)
 
Fiscal 2014
$
236

Fiscal 2015
252

Fiscal 2016
247

Fiscal 2017
244

Fiscal 2018
240

11. Derivative Instruments
The Company is exposed to certain risks relating to its business operations. Risks that relate to interest rate exposure, foreign exchange exposure and certain commodity price exposures are managed by using derivative instruments. The Company uses interest rate swaps to manage interest rate exposure. Foreign currency option and forward contracts are used to economically manage the foreign exchange exposures of operations outside the United States. Swap contracts on commodities are periodically entered into to manage the price risk associated with forecasted purchases of commodities used in the Company’s manufacturing processes.
The Company recognizes all derivative instruments as either assets or liabilities at fair value on the condensed consolidated balance sheet. Changes in a derivative financial instrument’s fair value are recognized in earnings unless specific hedge criteria are met. The Company has designated certain interest rate lock contracts and certain commodity swap contracts as cash flow hedges. The Company has not designated the foreign currency forward and option contracts as hedging instruments.

17


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Interest Rate Exposure
Fair Value Hedges—During fiscal 2011, Covidien International Finance S.A. (CIFSA) entered into interest rate swaps to convert its senior notes due in 2017 from fixed rate debt to variable rate debt. These swaps were subsequently terminated during the fourth quarter of fiscal 2011. Since the interest rate swaps were designated as hedging instruments of outstanding debt, the $23 million gain is being amortized to interest expense over the remaining life of the related debt.
Cash Flow Hedges—During both fiscal 2013 and 2007, CIFSA entered into forward interest rate lock contracts to hedge the risk of variability in the market interest rates prior to the issuance of fixed rate senior notes. The rate locks were designated as cash flow hedges at inception and were terminated prior to the issuance of the notes in accordance with their terms. The rate locks were considered to be highly effective; accordingly, the gains and losses that resulted upon termination of the rate locks were recorded in accumulated other comprehensive income and are being amortized to interest expense over the terms of the notes. The amounts reclassified to earnings during the quarters and six months ended March 28, 2014 and March 29, 2013 were insignificant, as is the amount expected to be reclassified to earnings during the next 12 months. At March 28, 2014 and September 27, 2013, the amount of loss that remained in accumulated other comprehensive income was $33 million and $34 million, respectively.
Foreign Exchange Exposure
Derivatives not Designated as Hedging Instruments—The Company’s operations outside the United States are significant. As a result, the Company has foreign exchange exposure on the translation of the financial statements and on transactions denominated in foreign currencies. The Company’s policy is to use various forward and option contracts to economically manage foreign currency exposures on accounts and notes receivable, accounts payable, intercompany loans and forecasted transactions that are denominated in certain foreign currencies, principally the euro and yen, as well as approximately 20 other currencies. The Company generally manages its exposure for forecasted transactions for the upcoming 12 months. All forward and option contracts are recorded on the condensed consolidated balance sheet at fair value. At March 28, 2014, the Company had foreign currency forward and option contracts outstanding with a notional amount of $1.444 billion. These contracts do not meet the necessary criteria to qualify for hedge accounting; accordingly, changes in fair value are recognized in earnings.

Net losses and gains from foreign currency transaction exposures and the impact of related derivatives not designated as hedging instruments included in continuing operations were as follows:
 
Quarter Ended
 
Six Months Ended
(Dollars in Millions)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Cost of goods sold:
 
 
 
 
 
 
 
Loss on foreign currency transaction exposures
$
(21
)
 
$
(13
)
 
$
(50
)
 
$
(29
)
(Loss) gain on foreign currency hedge contracts
(6
)
 
24

 

 
30

Net foreign currency (loss) gain
$
(27
)
 
$
11

 
$
(50
)
 
$
1

 
 
 
 
 
 
 
 
Selling, general and administrative expenses:
 
 
 
 
 
 
 
Loss on foreign currency transaction exposures
$
(11
)
 
$
(21
)
 
$
(24
)
 
$
(7
)
Gain on foreign currency hedge contracts
10

 
20

 
28

 
9

Net foreign currency (loss) gain
$
(1
)
 
$
(1
)
 
$
4

 
$
2

 
 
 
 
 
 
 
 
Total:
 
 
 
 
 
 
 
Loss on foreign currency transaction exposures
$
(32
)
 
$
(34
)
 
$
(74
)
 
$
(36
)
Gain on foreign currency hedge contracts
4

 
44

 
28

 
39

Net foreign currency (loss) gain
$
(28
)
 
$
10

 
$
(46
)
 
$
3


18


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Fair Value of Derivative Instruments
The fair value of foreign exchange forward and option contracts not designated as hedging instruments were included in the following condensed consolidated balance sheet accounts in the amounts shown:
(Dollars in Millions)
March 28,
2014
 
September 27,
2013
Derivative Assets:
 
 
 
Prepaid expenses and other current assets
$
10

 
$
7

Accrued and other current liabilities
8

 
10

 
$
18

 
$
17

Derivative Liabilities:
 
 
 
Prepaid expenses and other current assets
$
2

 
$
1

Accrued and other current liabilities
22

 
38

 
$
24

 
$
39

The Company’s derivatives that are subject to master netting agreements, allowing for the right of offset by the counterparty, are presented on a net basis on the condensed consolidated balance sheets. The following table provides information on all of the Company’s derivative positions on a gross basis, as well as on a net basis when subject to master netting agreements, at the end of each period:
 
March 28, 2014
 
September 27, 2013
(Dollars in Millions)
Asset
 
Liability
 
Asset
 
Liability
Gross amounts recognized
$
18

 
$
24

 
$
17

 
$
39

Gross amounts offset in the condensed consolidated
balance sheets
(10
)
 
(10
)
 
(11
)
 
(11
)
Net amounts presented in the condensed consolidated
balance sheets
$
8

 
$
14

 
$
6

 
$
28

12. Financial Instruments and Fair Value Measurements
Fair value is defined as the exit price that would be received from the sale of an asset or paid to transfer a liability, using assumptions that market participants would use in pricing an asset or liability. The fair value guidance establishes the following three-level hierarchy used for measuring fair value:
Level 1—observable inputs such as quoted prices in active markets for identical assets or liabilities;
Level 2—significant other observable inputs that are observable either directly or indirectly; and
Level 3—significant unobservable inputs for which there is little or no market data, which requires the Company to develop its own assumptions.

19


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following tables provide a summary of the significant assets and liabilities that are measured at fair value on a recurring basis at March 28, 2014 and September 27, 2013:
 
 
 
Basis of Fair Value Measurement
(Dollars in Millions)
March 28,
2014
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Foreign currency hedge contracts
$
18

 
$

 
$
18

 
$

Liabilities:
 
 
 
 
 
 
 
Foreign currency hedge contracts
$
24

 
$

 
$
24

 
$

Deferred compensation liabilities
125

 

 
125

 

Contingent consideration
116

 

 

 
116

Total liabilities at fair value
$
265

 
$

 
$
149

 
$
116

 
 
 
Basis of Fair Value Measurement
(Dollars in Millions)
September 27,
2013
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Foreign currency hedge contracts
$
17

 
$

 
$
17

 
$

Liabilities:
 
 
 
 
 
 
 
Foreign currency hedge contracts
$
39

 
$

 
$
39

 
$

Deferred compensation liabilities
114

 

 
114

 

Contingent consideration
127

 

 

 
127

Total liabilities at fair value
$
280

 
$

 
$
153

 
$
127

Foreign currency hedge contracts—The fair values of foreign currency hedge contracts were measured using significant other observable inputs and valued by reference to over-the-counter quoted market prices for similar instruments. The Company does not believe that the fair values of these derivative instruments differ significantly from the amounts that could be realized upon settlement or maturity, or that the changes in fair value will have a significant effect on its results of operations, financial condition or cash flows.
Deferred compensation liabilities—The Company maintains a non-qualified deferred compensation plan in the United States, which permits eligible employees to defer a portion of their compensation. A recordkeeping account is set up for each participant and the participant chooses from a variety of funds for the deemed investment of their accounts. The measurement funds generally correspond to the funds offered in the Company’s U.S. tax-qualified retirement plan and the account balance fluctuates with the investment returns on those funds.
Contingent consideration—The fair values of contingent consideration are based on significant unobservable inputs, including management estimates and assumptions, and are measured based on the probability-weighted present value of the payments expected to be made. Accordingly, the fair values of contingent consideration have been classified as level 3 within the fair value hierarchy.

20


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The recurring Level 3 fair value measurements of contingent consideration liabilities include the following significant unobservable inputs:
(Dollars in Millions)
 
Fair Value at March 28, 2014
 
Valuation Technique
 
Unobservable Input
 
Range
 
 
 
 
 
 
Discount rate
 
0% - 23%
Revenue-based payments
 
$
66

 
Discounted cash flow
 
Probability of payment
 
73% - 100%
 
 
 
 
 
 
Projected year of payment
 
2014 - 2024
 
 
 
 
 
 
Discount rate
 
1.4% - 2.5%
Regulatory-based payments
 
$
50

 
Discounted cash flow
 
Probability of payment
 
87% - 93%
 
 
 
 
 
 
Projected year of payment
 
2017 - 2020
As of March 28, 2014, the maximum potential contingent consideration that the Company could be required to pay is $382 million. The fair value of contingent consideration associated with acquisitions was $116 million and $127 million at March 28, 2014 and September 27, 2013, respectively. As of March 28, 2014, $16 million was included in accrued and other current liabilities and $100 million was included in other liabilities on the condensed consolidated balance sheet.
Following are reconciliations of change in the fair value of contingent consideration:
 
Quarter Ended
 
Six Months Ended
(Dollars in Millions)
March 28,
2014
 
March 29,
2013
 
March 28,
2014
 
March 29,
2013
Balance at beginning of period
$
112

 
$
95

 
$
127

 
$
108

Acquisition date fair value of contingent consideration
22

 
138

 
33

 
138

Change in fair value included in selling, general and administrative expenses
(3
)
 
(7
)
 
(29
)
 
(6
)
Payments
(15
)
 
(3
)
 
(15
)
 
(17
)
Balance at end of period
$
116

 
$
223

 
$
116

 
$
223

During the first six months of fiscal 2014, the Company determined that the post-market clinical trial associated with the radiofrequency energy-based renal denervation device (RF Device) to treat hypertension, resulting from the fiscal 2012 acquisition of Maya Medical, would not be successfully completed within the required timeframe. Accordingly, the Company reversed the $20 million contingent consideration liability associated with the achievement of this milestone. In addition, as a result of the Company’s decision to exit the renal denervation program, the Company reversed $6 million of contingent consideration liabilities that were primarily associated with the achievement of sales targets for the RF Device. Accordingly, during the first six months of fiscal 2014, the Company recorded income totaling $26 million related to a reduction in the fair value of contingent consideration liabilities associated with the acquisition of Maya Medical.
Financial Instruments Not Measured at Fair Value
The fair value of cash and cash equivalents approximate carrying value since cash equivalents consist of liquid investments with a maturity of three months or less (level 1). The fair value of long-term debt, including both current and non-current maturities, is based upon quoted prices in active markets for similar instruments (level 2) and was approximately $5.453 billion and $5.433 billion at March 28, 2014 and September 27, 2013, respectively. It is not practicable to estimate the fair value of the Company’s guaranteed contingent tax liabilities and the related amount due from former parent and affiliate.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk primarily consist of cash and cash equivalents, derivative financial instruments and accounts receivable. The Company invests its excess cash in deposits or money market funds and diversifies the concentration of cash among different financial institutions that have at least an A- credit rating. Counterparties to the Company’s derivative financial instruments are limited to major financial institutions with at least a Standard & Poor’s and Moody’s long-term debt rating of A-/A3. While the Company does not require collateral or other security to be furnished by the counterparties to its derivative financial instruments, it minimizes exposure to credit risk by dealing with a diversified group of major financial institutions and actively monitoring outstanding positions.

21


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Concentrations of credit risk with respect to trade accounts receivable are generally limited due to the Company’s large number of customers and their diversity across many geographic areas. A portion of the Company’s trade accounts receivable outside the United States, however, include sales to government-owned or supported healthcare systems in several countries that are subject to payment delays. Payment is dependent upon the financial stability of those countries’ national economies and the creditworthiness of those countries’ national governments. Deteriorating credit and economic conditions in parts of Western Europe, particularly in Spain, Italy and Portugal, may continue to increase the average length of time it takes the Company to collect its accounts receivable in certain regions within these countries. The Company routinely evaluates all government receivables for potential collection risks associated with the availability of government funding and reimbursement practices. While the Company has not incurred significant losses on government receivables, if the financial condition of customers or the countries’ healthcare systems continues to deteriorate such that their ability to make payments is uncertain, charges may be required in future periods.
The Company’s aggregate accounts receivable, net of the allowance for doubtful accounts, in Spain, Italy and Portugal and as a percent of the Company’s total accounts receivable at the end of each period were as follows:
(Dollars in Millions)
March 28,
2014
 
September 27,
2013
Accounts receivable, net in Spain, Italy and Portugal
$
311

 
$
406

Percentage of total accounts receivable, net
20
%
 
27
%
Net sales to customers in Spain, Italy and Portugal totaled $163 million and $165 million during the quarters ended March 28, 2014 and March 29, 2013, respectively. Net sales to customers in Spain, Italy and Portugal totaled $307 million and $309 million during the six months ended March 28, 2014 and March 29, 2013, respectively. Accounts receivable, net in Spain, Italy and Portugal over 365 days past due were $24 million and $54 million as of March 28, 2014 and September 27, 2013, respectively. In February 2014, the Company collected $115 million from the Spanish government, which related to invoices issued prior to June 2013.
13. Transactions with Former Parent and Affiliate
Tyco Tax Sharing Agreement—On June 29, 2007, the Company entered into a tax sharing agreement, under which the Company shares responsibility for certain of its, Tyco International’s and TE Connectivity’s income tax liabilities for periods prior to the separation from Tyco International in 2007 (the 2007 separation). Covidien, Tyco International and TE Connectivity share 42%, 27% and 31%, respectively, of U.S. income tax liabilities that arise from adjustments made by tax authorities to its, Tyco International’s and TE Connectivity’s U.S. income tax returns, certain income tax liabilities arising from adjustments made by tax authorities to intercompany transactions or similar adjustments, and certain taxes attributable to internal transactions undertaken in anticipation of the 2007 separation. If Tyco International and TE Connectivity default on their obligations to Covidien under the tax sharing agreement, Covidien would be liable for the entire amount of these liabilities. All costs and expenses associated with the management of these tax liabilities are being shared equally among the parties.
At March 28, 2014, the Company is the primary obligor to the taxing authorities for $1.807 billion of tax liabilities that are recorded on the condensed consolidated balance sheet, of which $1.477 billion relates to periods prior to the 2007 separation and is shared with Tyco International and TE Connectivity pursuant to the Tyco tax sharing agreement. At September 27, 2013, the Company was the primary obligor to the taxing authorities for $1.688 billion of tax liabilities that were recorded on the condensed consolidated balance sheet.
Income Tax Receivables—The Company has a current and non-current receivable from Tyco International and TE Connectivity totaling $730 million and $668 million at March 28, 2014 and September 27, 2013, respectively. These receivables primarily reflect 58% of the contingent tax liabilities that are subject to the Tyco tax sharing agreement and are classified as due from former parent and affiliate on the condensed consolidated balance sheets. As discussed in note 7, adjustments to these receivables are recorded in other income, net.
Guaranteed Contingent Tax Liabilities—The Company has certain guarantee commitments and indemnifications with Tyco International and TE Connectivity related to certain contingent tax liabilities. Current and non-current liabilities totaling $589 million and $584 million related to these guarantees were included on the Company’s condensed consolidated balance sheets at March 28, 2014 and September 27, 2013, respectively. The non-current portion of these liabilities are classified as guaranteed contingent tax liabilities on the condensed consolidated balance sheets, while the current portion is included in accrued and other current liabilities.

22


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

14. Guarantees
In connection with the 2013 separation, Mallinckrodt assumed the tax liabilities that are attributable to its subsidiaries. Covidien has indemnified Mallinckrodt to the extent that such tax liabilities arising from periods prior to fiscal 2013 exceed $200 million, net of certain tax benefits realized. In addition, in connection with the 2013 separation, the Company entered into certain other guarantee commitments and indemnifications with Mallinckrodt. The values attributable to the tax indemnification and other guarantees were insignificant. Additionally, in connection with the 2007 separation, the Company entered into certain guarantee commitments and indemnifications with Tyco International and TE Connectivity, which are discussed in note 13.
In disposing of assets or businesses, the Company often provides representations, warranties and indemnities to cover various risks and liabilities, including unknown damage to the assets, environmental risks involved in the sale of real estate, liability to investigate and remediate environmental contamination at waste disposal sites and manufacturing facilities, and unidentified tax liabilities related to periods prior to disposition. The Company does not have the ability to estimate the potential liability from such indemnities because they relate to unknown conditions. However, the Company has no reason to believe that these uncertainties would have a material adverse effect on its results of operations, financial condition or cash flows.
The Company has recorded liabilities for known indemnification obligations included as part of environmental liabilities, which are discussed in note 15. In addition, the Company is liable for product performance; however, in the opinion of management, such obligations will not significantly affect the Company’s results of operations, financial condition or cash flows.
As of March 28, 2014, the Company had various outstanding letters of credit and guarantee and surety bonds totaling $193 million, none of which were individually significant.
15. Commitments and Contingencies
The Company is subject to various legal proceedings and claims, including patent infringement claims, products liability matters, environmental matters, employment disputes, contractual disputes and other commercial disputes. Management believes that these legal proceedings and claims likely will be resolved over an extended period of time. Although it is not feasible to predict the outcome of these proceedings, based upon the Company’s experience, current information and applicable law, management does not expect that these proceedings will have a material adverse effect on the Company’s financial condition. However, one or more of the proceedings could have a material adverse effect on the Company’s results of operations or cash flows for a future period. The most significant of these matters are discussed below.
Legal Proceedings
The Company records a liability when a loss is considered probable and the amount can be reasonably estimated. When the reasonable estimate of a probable loss is a range and a best estimate cannot be made, the minimum amount of the range is accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. As of March 28, 2014 and September 27, 2013, the Company had accruals for products liability and other legal matters totaling $143 million and $147 million, respectively, which includes reserves for certain of the matters discussed below. In addition, the Company had related insurance receivables of $29 million at both March 28, 2014 and September 27, 2013.
Products Liability Litigation—The Company currently is involved in litigation in various state and federal courts against manufacturers of pelvic mesh products alleging personal injuries resulting from the implantation of those products. Two subsidiaries of the Company have supplied pelvic mesh products to one of the manufacturers named in the litigation and the Company is indemnifying that manufacturer on certain claims. The litigation includes a federal multi-district litigation in the United States District Court for the Northern District of West Virginia and cases in various state courts and in Canada. Generally, complaints allege design and manufacturing claims, failure to warn, breach of warranty, fraud, violations of state consumer protection laws and loss of consortium claims. The Company believes that it has meritorious defenses to these claims and is vigorously defending against them. As of March 28, 2014, there were approximately 6,000 cases pending believed to involve products manufactured by Company subsidiaries. Although the number of pending cases increased during the six months ended March 28, 2014, the Company has little to no information regarding the nature of claims and potential damages in these cases and, accordingly, did not record any additional charges for these cases during the first six months of fiscal 2014. Based on current information, the Company believes that it has adequate amounts recorded relating to these matters. While the Company believes that the final disposition of all known claims, after taking into account amounts already accrued and insurance coverage, will not have a material adverse effect on the Company’s results of operations, financial condition or cash

23


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

flows, it is not possible at this time to determine with certainty the ultimate outcome of these matters or the effect of potential future claims.
Patent Litigation—On March 28, 2013, the Company prevailed in a patent infringement suit against Ethicon Endo-Surgery, Inc. (Ethicon), a Johnson & Johnson company, relating to Ethicon’s Harmonic® line of ultrasonic surgical products. The federal court awarded Covidien a $177 million verdict upon ruling that several claims of Covidien’s patents were valid, enforceable and infringed by Ethicon. The amount of the verdict was based on an eight percent royalty rate on infringing sales through March 2012, plus prejudgment interest. Ethicon has appealed the decision; accordingly, the Company has not recorded any income related to this case.
Ethicon Endo-Surgery, Inc., et al. v. Covidien, Inc., et al. is a patent infringement action filed on December 14, 2011 in the United States District Court for the Southern District of Ohio, Western Division. The complaint alleges that the Company’s Sonicision™ product infringes several of Ethicon’s design and utility patents. Ethicon is seeking monetary damages and injunctive relief. The parties have engaged in discovery and pre-trial motion practice. The Company believes that it has meritorious defenses to these claims and is vigorously defending against them. On January 22, 2014, the district court entered summary judgment in the Company’s favor, ruling that the Company does not infringe any of the seven Ethicon patents in dispute and declaring five of Ethicon’s patents invalid. Ethicon has appealed the district court’s decision.
Other Matters—One of the Company’s subsidiaries, ev3 Inc., acquired Appriva Medical, Inc. in 2002. The acquisition agreement relating to ev3’s acquisition of Appriva Medical, Inc. contained four contingent milestone payments totaling $175 million. ev3 determined that the milestones were not achieved by the applicable dates and that none of the milestones were payable. On April 7, 2009, Michael Lesh and Erik Van Der Burg, acting jointly as the Shareholder Representatives for the former shareholders of Appriva Medical, Inc., filed a motion to amend their previously dismissed complaints in Superior Court of the State of Delaware. The amended complaint sought recovery of all of the $175 million milestone payments, as well as punitive damages. The plaintiffs asserted several claims, including breach of contract, fraudulent inducement and violation of California securities law.
On May 1, 2013, the jury returned a verdict finding that ev3 breached the merger agreement and awarded $175 million in damages plus interest to the plaintiffs. Since the jury did not find fraud, the jury did not have the option of awarding punitive damages. The Company estimates that its possible range of loss is $0 to $275 million, which includes approximately $100 million of post judgment interest. On August 29, 2013, the court denied the Company’s motions for judgment as a matter of law and for a new trial. The Company has appealed the verdict to the Delaware Supreme Court. Oral argument for the appeal was held on March 12, 2014. The Delaware Supreme Court subsequently ordered a rehearing before the full court, which has not yet been scheduled. The Company has assessed the status of this matter, has concluded that it is more likely than not that the finding will be overturned, and intends to vigorously pursue all available means to achieve such reversal. Accordingly, no liability has been recorded with respect to any damage award.
The Company is a defendant in a number of other pending legal proceedings incidental to present and former operations, acquisitions and dispositions. The Company does not expect the outcome of these proceedings, either individually or in the aggregate, to have a material adverse effect on its results of operations, financial condition or cash flows.
Environmental Proceedings
The Company is involved in various stages of investigation and cleanup related to environmental remediation matters at a number of sites. The ultimate cost of site cleanup and timing of future cash flows is difficult to predict, given the uncertainties regarding the extent of the required cleanup, the interpretation of applicable laws and regulations and alternative cleanup methods. As of March 28, 2014, the Company concluded that it was probable that it would incur remedial costs of $179 million, of which $9 million was included in accrued and other current liabilities and $170 million was included in other liabilities on the condensed consolidated balance sheet. The most significant of these liabilities pertains to a site in Orrington, Maine, which is discussed below. The Company believes that any potential payment of such estimated amounts will not have a material adverse effect on its results of operations, financial condition or cash flows.
The Company is a successor to a company which owned and operated a chemical manufacturing facility in Orrington, Maine from 1967 until 1982. The Company is responsible for the costs of completing an environmental site investigation required by the United States Environmental Protection Agency (EPA) and the Maine Department of Environmental Protection (MDEP). Based on the site investigation, the Company submitted a Corrective Measures Study plan and identified a preferred alternative which was submitted to the EPA and MDEP for approval in 2004. MDEP disagreed with the proposed alternative and served a compliance order on Mallinckrodt LLC and United States Surgical Corporation in December 2008. The

24


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

compliance order included a directive to remove a significant volume of soils at the site. On December 19, 2008, the Company filed an appeal with the Maine Board of Environmental Protection (Maine Board) to challenge the terms of the compliance order. A hearing before the Maine Board began on January 25, 2010 and concluded on February 4, 2010. On August 19, 2010, the Maine Board modified the MDEP order and issued a final order requiring removal of two landfills, capping of the remaining three landfills, installation of a groundwater extraction system and long-term monitoring of the site and the three remaining landfills.
On September 17, 2010, the Company appealed the final order issued by the Maine Board in Maine Superior Court. On appeal, the Company has requested that the Superior Court invalidate the Maine Board’s final order in its entirety or, in the alternative, reverse or modify the final order to eliminate the requirements that the Company remove one of the two landfills and recap the remaining three landfills. The Company also appealed certain administrative requirements of the final order. On November 1, 2012, the Superior Court affirmed the Maine Board’s final order. The Company has appealed the Superior Court’s decision to the Maine Supreme Judicial Court. Oral argument for the appeal was held on February 11, 2014. On April 3, 2014, the Maine Supreme Judicial Court affirmed the Maine Board’s compliance order. Following this decision, the Company recorded a $65 million charge for the estimated incremental costs of implementing the compliance order. This charge is included within selling, general and administrative expenses in the consolidated statements of income for both the quarter and six months ended March 28, 2014.
The Company has also been involved in a lawsuit filed in the U.S. District Court for the District of Maine by the Natural Resources Defense Council and the Maine People’s Alliance. Plaintiffs sought an injunction requiring the Company to conduct extensive studies of mercury contamination of the Penobscot River and Bay and options for remediating such contamination, and to perform appropriate remedial activities, if necessary.
On July 29, 2002, following a March 2002 trial, the District Court entered an opinion and order which held that conditions in the Penobscot River and Bay may pose an imminent and substantial endangerment and that the Company was liable for the cost of performing a study of the river and bay. The District Court subsequently appointed an independent study panel to oversee the study and ordered the Company to pay costs associated with the study. The study panel conducted a Phase I study and completed a Phase II study which included several years of field work and data collection. The study panel issued the Phase II Penobscot River Mercury Study Report (Phase II Report) on April 17, 2013. The Phase II Report contains recommendations for a variety of potential remedial options which could be implemented individually or in a variety of combinations. The Phase II Report also includes preliminary cost estimates for the potential remedial options. These cost estimates, which the report describes as “very rough estimates of cost,” range from $25 million to $235 million, depending upon which potential option or combination of potential options are implemented, if any. The Phase II Report indicates that these costs are subject to uncertainties, and that before any remedial option is implemented, further engineering studies and engineering design work will be necessary to determine the feasibility of the proposed remedial options. The Company has reviewed the Phase II Report with its outside legal and technical consultants and believes there are significant problems with the conclusions and recommendations in the report. The Company does not believe remediation is necessary and intends to vigorously defend its position. In addition, no remediation order has been issued. However, the Company has developed a proposal for certain limited studies and a proposal for monitoring some wildlife species, including but not limited to, certain fish and birds. The estimated costs of the proposed studies and monitoring have been accrued, the amounts of which are not significant. Discovery has commenced and the trial is scheduled for June 3, 2014.
Income Taxes
The income tax returns of the Company and its subsidiaries are periodically examined by various tax authorities. The U.S. Internal Revenue Service (IRS) continues to audit the Company’s U.S. federal income tax returns for the years 2008 and 2009. Fieldwork for this audit is expected to conclude in fiscal 2014. Open periods for examination also include certain periods during which the Company was a subsidiary of Tyco International. The resolution of these matters is subject to the conditions set forth in the Tyco tax sharing agreement. Tyco International has the right to administer, control and settle all U.S. income tax audits for periods prior to the 2007 separation. The Company has potential liabilities related to these income tax returns and has included its best estimate of potential liabilities for these years within current and non-current income taxes payable on its condensed consolidated balance sheets. With respect to these potential income tax liabilities, Covidien believes that the amounts recorded on its condensed consolidated balance sheets are adequate.
The IRS has concluded its field examination of certain of Tyco International’s U.S. federal income tax returns for the years 1997 through 2000 and proposed tax adjustments, several of which also affect Covidien’s income tax returns for years after 2000. Tyco International has appealed certain of the tax adjustments proposed by the IRS and has resolved all but one of the matters associated with the proposed tax adjustments. With respect to the outstanding issue that remains in dispute, on June

25


COVIDIEN PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

20, 2013, Tyco International advised the Company that it had received Notices of Deficiency from the IRS asserting that several of Tyco International’s former U.S. subsidiaries owe additional taxes of $914 million plus penalties of $154 million based on audits of the 1997 through 2000 tax years of Tyco International and its subsidiaries as they existed at that time. These amounts exclude interest, and do not reflect the impact on subsequent periods if the IRS position is ultimately proved correct. The IRS has asserted in the Notices of Deficiency that substantially all of Tyco International’s intercompany debt originating during the years 1997 through 2000 should not be treated as debt for U.S. federal income tax purposes, and has disallowed interest deductions related to the intercompany debt and certain tax attribute adjustments recognized on Tyco International’s U.S. income tax returns totaling approximately $3.0 billion. The Company strongly disagrees with the IRS’s proposed adjustments. On July 22, 2013, Tyco International filed a petition with the U.S. Tax Court contesting the IRS assessment. The Company believes there are meritorious defenses for the tax filings in question, that the IRS positions with regard to these matters are inconsistent with the applicable tax laws and existing Treasury regulations, and that the previously reported taxes for the years in question are appropriate.
No payments with respect to these matters or any additional matters that may be raised by the U.S. Tax Court would be required until the dispute is definitively resolved, which could take several years. While Covidien believes that the amounts recorded as non-current income taxes payable and guaranteed contingent tax liabilities related to these adjustments are adequate, the timing and outcome of such litigation is highly uncertain and could have a material adverse effect on the condensed consolidated financial statements. In particular, if the IRS is successful in asserting its claim, it would likely assert that approximately $6.6 billion of interest deductions with respect to Tyco International’s intercompany debt in subsequent time periods should also be disallowed.
Tyco International’s income tax returns for the years 2001 through 2004 remain subject to adjustment by the IRS upon ultimate resolution of the disputed issue involving certain intercompany loans that originated during 1997 through 2000. It is Covidien’s understanding that Tyco International and the IRS expect to reach a written agreement during fiscal 2014 on all undisputed issues for the years 2001 through 2007.
In connection with the anticipated settlement of the 2005 through 2007 audit cycle, the Company estimates that it will be required to make a payment to the IRS in fiscal