COV-2012.6.30-10Q

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 June 29, 2012
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 July 30, 2012 was 480,096,760.


Table of Contents


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 3.
Item 5.
Item 6.

Table of Contents


PART I. FINANCIAL INFORMATION
 
Item 1.
Financial Statements

COVIDIEN PLC
CONSOLIDATED STATEMENTS OF INCOME
Quarters and Nine Months Ended June 29, 2012 and June 24, 2011
(in millions, except per share data)
 
Quarter Ended
 
Nine Months Ended
 
June 29,
2012
 
June 24,
2011
 
June 29,
2012
 
June 24,
2011
Net sales
$
3,007

 
$
2,926

 
$
8,851

 
$
8,496

Cost of goods sold
1,268

 
1,255

 
3,705

 
3,658

Gross profit
1,739

 
1,671

 
5,146

 
4,838

Selling, general and administrative expenses
936

 
886

 
2,757

 
2,600

Research and development expenses
159

 
138

 
470

 
387

Restructuring charges, net
27

 
32

 
57

 
83

Shareholder settlement income
—

 
—

 
—

 
(11
)
Operating income
617

 
615

 
1,862

 
1,779

Interest expense
(53
)
 
(51
)
 
(155
)
 
(153
)
Interest income
1

 
6

 
13

 
17

Other income (expense), net
12

 
(12
)
 
18

 
—

Income from continuing operations before income taxes
577

 
558

 
1,738

 
1,643

Income tax expense
124

 
26

 
300

 
220

Income from continuing operations
453

 
532

 
1,438

 
1,423

Income (loss) from discontinued operations, net of income taxes
—

 
3

 
6

 
(6
)
Net income
$
453

 
$
535

 
$
1,444


$
1,417

 
 
 
 
 
 
 
 
Basic earnings per share:
 
 
 
 
 
 
 
Income from continuing operations
$
0.94

 
$
1.08

 
$
2.98

 
$
2.88

Income (loss) from discontinued operations
—

 
0.01

 
0.01

 
(0.01
)
Net income
0.94

 
1.08

 
3.00

 
2.86

Diluted earnings per share:
 
 
 
 
 
 
 
Income from continuing operations
$
0.93

 
$
1.06

 
$
2.95

 
$
2.85

Income (loss) from discontinued operations
—

 
0.01

 
0.01

 
(0.01
)
Net income
0.93

 
1.07

 
2.97

 
2.84

Weighted-average number of shares outstanding:
 
 
 
 
 
 
 
Basic
481

 
495

 
482

 
495

Diluted
486

 
500

 
487

 
499

Cash dividends declared per ordinary share
$
—

 
$
—

 
$
0.45

 
$
0.40


See Notes to Consolidated Financial Statements.

2
Table of Contents



COVIDIEN PLC
CONSOLIDATED BALANCE SHEETS
At June 29, 2012 and September 30, 2011
(in millions, except share data)
 
June 29,
2012
 
September 30,
2011
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
1,935

 
$
1,503

Accounts receivable trade, less allowance for doubtful accounts of $42 and $39
1,662

 
1,744

Inventories
1,723

 
1,513

Prepaid expenses and other current assets
938

 
1,013

Total current assets
6,258

 
5,773

Property, plant and equipment, net
2,806

 
2,705

Goodwill
8,486

 
7,683

Intangible assets, net
3,080

 
2,764

Due from former parent and affiliate
595

 
583

Other assets
889

 
866

Total Assets
$
22,114

 
$
20,374

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
Current Liabilities:
 
 
 
Current maturities of long-term debt
$
511

 
$
11

Accounts payable
596

 
576

Accrued and other current liabilities
1,408

 
1,611

Income taxes payable
51

 
97

Guaranteed contingent tax liabilities
30

 
105

Total current liabilities
2,596

 
2,400

Long-term debt
4,574

 
4,197

Income taxes payable
1,675

 
1,629

Guaranteed contingent tax liabilities
583

 
555

Other liabilities
1,974

 
1,776

Total Liabilities
11,402

 
10,557

Commitments and contingencies (note 15)

 

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; 518,421,995 and 513,786,482 issued
104

 
103

Ordinary shares held in treasury at cost; 39,164,281 and 31,828,437
(1,821
)
 
(1,436
)
Additional paid-in capital
7,063

 
6,844

Retained earnings
5,135

 
3,908

Accumulated other comprehensive income
231

 
398

Total Shareholders’ Equity
10,712

 
9,817

Total Liabilities and Shareholders’ Equity
$
22,114

 
$
20,374


See Notes to Consolidated Financial Statements.

3
Table of Contents



COVIDIEN PLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended June 29, 2012 and June 24, 2011
(in millions) 
 
Nine Months Ended
 
June 29,
2012
 
June 24,
2011
Cash Flows From Operating Activities:
 
 
 
Net income
$
1,444

 
$
1,417

(Income) loss from discontinued operations, net of income taxes
(6
)
 
6

Income from continuing operations
1,438

 
1,423

Adjustments to reconcile net cash provided by continuing operating activities:
 
 
 
Depreciation and amortization
463

 
440

Share-based compensation
65

 
79

Deferred income taxes
(69
)
 
36

Provision for losses on accounts receivable and inventory
31

 
54

Other non-cash items
13

 
16

Changes in assets and liabilities, net of the effects of acquisitions:
 
 
 
Accounts receivable, net
35

 
(84
)
Inventories
(208
)
 
(175
)
Accounts payable
13

 
9

Income taxes
131

 
(60
)
Accrued and other liabilities
(235
)
 
(90
)
Other
(40
)
 
(39
)
Net cash provided by operating activities
1,637

 
1,609

Cash Flows From Investing Activities:
 
 
 
Capital expenditures
(378
)
 
(303
)
Acquisition-related payments, net of cash acquired
(1,063
)
 
(13
)
Acquisition of licenses and technology
(26
)
 
(4
)
Sale of investments
7

 
14

Other
(2
)
 
(9
)
Net cash used in investing activities
(1,462
)
 
(315
)
Cash Flows From Financing Activities:
 
 
 
Net issuance (repayment) of commercial paper
136

 
(307
)
Issuance of debt
1,240

 
—

Repayment of debt
(552
)
 
(254
)
Dividends paid
(326
)
 
(297
)
Repurchase of shares
(385
)
 
(378
)
Proceeds from exercise of share options
143

 
164

Payment of contingent consideration
—

 
(71
)
Other
14

 
13

Net cash provided by (used in) financing activities
270

 
(1,130
)
Effect of currency rate changes on cash
(13
)
 
26

Net increase in cash and cash equivalents
432

 
190

Cash and cash equivalents at beginning of period
1,503

 
1,565

Cash and cash equivalents at end of period
$
1,935

 
$
1,755

See Notes to Consolidated Financial Statements.

4
Table of Contents



COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation

Basis of Presentation—The accompanying financial statements reflect the consolidated operations of Covidien plc and its subsidiaries (Covidien or the Company). The unaudited consolidated financial statements have been prepared in United States dollars, in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of the consolidated financial statements in conformity with GAAP requires management to make use of estimates and assumptions that affect the reported amount 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 consolidated financial statements contain all normal recurring adjustments necessary for a fair presentation of the interim results reported. The year-end balance sheet data were derived from audited consolidated financial statements, but do not include all of the annual disclosures required by GAAP; accordingly, these financial statements 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 30, 2011.

Recently Adopted Accounting Pronouncements—In May 2011, the Financial Accounting Standards Board (FASB) updated the accounting guidance related to fair value measurements. This amendment results in convergence of fair value measurement and disclosure requirements between U.S. GAAP and International Financial Reporting Standards (IFRS). The Company adopted this amendment in the second quarter of fiscal 2012. The required disclosures regarding fair value measurements are presented in note 13.

2. Acquisitions and License Agreement

Oridion Systems Ltd.—On June 26, 2012, the Company's Medical Devices segment acquired Oridion Systems Ltd. (Oridion), a developer of patient monitoring systems, for $327 million in cash, net of cash acquired of $10 million. The acquisition of Oridion complements the Company's existing product portfolio of pulse oximeters and monitoring products.

superDimension, Ltd.—On May 15, 2012, the Company's Medical Devices segment acquired superDimension, Ltd., a developer of minimally invasive interventional pulmonology devices, for total consideration of $286 million. The total consideration was comprised of an upfront cash payment of $243 million, net of cash acquired of $8 million, debt assumed of $21 million, which was subsequently repaid, and the fair value of contingent consideration of $22 million. Note 13 provides additional information regarding the contingent consideration. The acquisition of superDimension will allow the Company to deliver more comprehensive solutions in the evaluation and treatment of lung disease.

Newport Medical Instruments, Inc.—On May 1, 2012, the Company's Medical Devices segment acquired Newport Medical Instruments, Inc. (Newport Medical), a designer and manufacturer of ventilators, for total consideration of $101 million. The total consideration was comprised of $92 million in cash, net of cash acquired of $2 million, and $9 million of debt assumed, which was subsequently repaid. The acquisition of Newport Medical complements the Company's existing portfolio of acute care and home care ventilation solutions and broadens the Company's ventilation platforms.

Maya Medical—On April 20, 2012, the Company's Medical Devices segment acquired Maya Medical, a developer of a treatment for hypertension, for total consideration of $106 million. The total consideration was comprised of an upfront cash payment of $49 million, debt assumed of $10 million, which was subsequently repaid, and the fair value of contingent consideration of $47 million. Note 13 provides additional information regarding the contingent consideration. The acquisition of Maya Medical expands the Company's ability to treat vascular diseases by allowing it to enter the hypertension market.

BÂRRX Medical, Inc.—On January 5, 2012, the Company's Medical Devices segment acquired all of the outstanding equity of BÂRRX Medical, Inc. (BÂRRX), a developer of bipolar radiofrequency ablation devices used in the treatment of Barrett's esophagus syndrome, for total consideration of $393 million. The total purchase consideration was comprised of an upfront cash payment of $322 million, net of cash acquired of $16 million, and the fair value of contingent consideration of $71 million. Note 13 provides additional information regarding the contingent consideration. The acquisition of BÂRRX expands the Company's ability to treat gastrointestinal diseases.

    

5
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Fair Value Allocation of Assets Acquired and Liabilities Assumed—The following amounts represent the fair value of the identifiable assets acquired and liabilities assumed:
(Dollars in millions) 
Oridion  
 
superDimension  
 
BÂRRX
 
All Other  
 
Total  
Deferred tax assets (current)
$
—

 
$
24

 
$
27

 
$
6

 
$
57

Other current assets(1)
63

 
18

 
27

 
33

 
141

Intangible assets
142

 
84

 
139

 
95

 
460

Goodwill (non-tax deductible)
178

 
238

 
266

 
149

 
831

Other assets
7

 
3

 
2

 
8

 
20

Total assets acquired
390

 
367

 
461

 
291

 
1,509

Contingent consideration (current)
—

 
—

 
46

 
20

 
66

Other current liabilities
13

 
48

 
6

 
25

 
92

Contingent consideration (non-current)
—

 
22

 
25

 
40

 
87

Deferred tax liabilities (non-current)
38

 
18

 
46

 
23

 
125

Other liabilities
2

 
28

 
—

 
10

 
40

Total liabilities assumed
53

 
116

 
123

 
118

 
410

Net assets acquired
$
337

 
$
251

 
$
338

 
$
173

 
$
1,099

 
(1) 
Amounts include $12 million, $5 million, $6 million and $11 million of accounts receivable for Oridion, superDimension, BÂRRX 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.


6
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Intangible assets acquired consist of the following:
(Dollars in Millions) 
Amount  
 
Weighted-Average Amortization Period  
Oridion
 
 
 
Completed technology
$
67

 
15 years
Customer relationships
75

 
11 years
 
$
142

 
13 years
superDimension
 
 
 
Completed technology
$
47

 
11 years
Customer relationships
26

 
12 years
In-process research and development
9

 
Non-Amortizable
Trademarks
2

 
6 years
 
$
84

 
11 years
BÂRRX
 
 
 
Completed technology
$
85

 
15 years
Customer relationships
54

 
11 years
 
$
139

 
13 years
All Other
 
 
 
Completed technology
$
85

 
14 years
Customer relationships
7

 
7 years
In-process research and development
3

 
Non-Amortizable
 
$
95

 
13 years
Total
 
 
 
Completed technology
$
284

 
14 years
Customer relationships
162

 
11 years
In-process research and development
12

 
Non-Amortizable
Trademarks
2

 
5 years
 
$
460

 
13 years

The benefits of adding a key capnography monitoring technology that monitors the adequacy of ventilation to the Company's Oximetry and Monitoring product portfolio contributed to an acquisition price in excess of the fair value of net assets acquired for Oridion, which resulted in the establishment of goodwill. Similarly, the benefits of adding the i·Logic™ System, which facilitates the evaluation of lung lesions, to the Company's endomechanical device product portfolio contributed to an acquisition price in excess of the fair value of net assets acquired for superDimension, which resulted in the establishment of goodwill. Finally, the benefits of adding a clinically proven radiofrequency ablation device to the Company's surgical energy device product portfolio contributed to an acquisition price in excess of the fair value of net assets acquired for BÂRRX, which resulted in the establishment of goodwill. As high growth companies, each of these acquisitions commanded a purchase price premium. The synergies expected to result from combining infrastructures and leveraging operational expenses also contributed to the establishment of goodwill for each of these acquisitions.

As of June 29, 2012, the Company had not yet finalized its valuation for the acquisitions discussed above, primarily with regard to certain deferred tax assets and deferred tax liabilities, the impact of which is not expected to have a material effect on the Company's financial condition.


7
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Financial Results—The amount of net sales and earnings included in the Company's results for the quarter and nine months ended June 29, 2012 for each of the acquisitions discussed above were as follows:
 
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29, 2012
 
June 29, 2012
Net Sales
 
 
 
Oridion
$
—

 
$
—

superDimension
4

 
4

BÂRRX
10

 
18

All other
9

 
10


$
23

 
$
32

 
 
 
 
Operating Loss(1)
 
 
 
Oridion
$
(5
)
 
$
(5
)
superDimension
(11
)
 
(11
)
BÂRRX
(8
)
 
(16
)
All other
(9
)
 
(10
)
 
$
(33
)
 
$
(42
)
 
(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.

Transaction Costs—The amount of transaction costs included in selling, general and administrative expenses for the quarter and nine months ended June 29, 2012 for each of the acquisitions discussed above were as follows:
 
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29, 2012
 
June 29, 2012
Oridion
$
4

 
$
4

superDimension
7

 
7

BÂRRX
4

 
5

All other
1

 
2

Total transaction costs
$
16

 
$
18

 
In addition to the above transaction costs, the Company recorded charges to cost of goods sold related to inventory that had been written up to fair value upon acquisition of $3 million and $5 million for the quarter and nine months ended June 29, 2012, respectively.

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 Oridion, superDimension, Newport Medical, Maya Medical and BÂRRX had been completed as of the beginning of fiscal 2011. The pro forma financial information is based on the historical financial information for Covidien, Oridion, superDimension, Newport Medical, Maya Medical and BÂRRX 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;
•
Adjustments to interest income for cash used to fund the acquisitions;
•
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;
•
Elimination of the Company's gain on sale of its 2% non-controlling interest in superDimension;

8
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

•
Tax impact of all of the above adjustments;
•
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
 
Nine Months Ended
(Dollars in Millions, Except per Share Data)
June 29, 2012
 
June 24, 2011
 
June 29, 2012
 
June 24, 2011
Net sales
$
3,028

 
$
2,970

 
$
8,956

 
$
8,621

Income from continuing operations
449

 
526

 
1,422

 
1,403

Net income
449

 
529

 
1,428

 
1,397

Basic earnings per share:
 
 
 
 
 

 
 

Income from continuing operations
$
0.93

 
$
1.06

 
$
2.95

 
$
2.84

Net income
0.93

 
1.07

 
2.96

 
2.82

Diluted earnings per share:
 
 
 
 
 

 
 

Income from continuing operations
$
0.92

 
$
1.05

 
$
2.92

 
$
2.81

Net income
0.92

 
1.06

 
2.94

 
2.80


MindFrame, Inc.—On July 2, 2012, the Company's Medical Devices segment acquired MindFrame, Inc., a designer and manufacturer of devices designed to optimize rapid perfusion and clot removal in the treatment of patients suffering from ischemic stroke, for approximately $75 million in cash. The acquisition of MindFrame broadens the Company's product offerings for the treatment of acute ischemic stroke.

Licensing Agreement—On January 17, 2012, the Company's Medical Devices segment entered into an exclusive licensing agreement which grants Covidien product rights for two medical device patent and product candidates that are designed to remove peripheral artery blockages. This licensing arrangement included an upfront cash payment of $12 million, which was included in research and development expenses. In addition, during the first nine months of fiscal 2012, the Company made a regulatory-related milestone payment of $5 million, which was capitalized as an intangible asset. Covidien may also be required to make additional payments of up to $60 million if certain regulatory and sales milestones are achieved.

3. Restructuring Charges, Net

In fiscal 2011, the Company launched a restructuring program, designed to improve the Company’s cost structure. This program includes actions across all three segments as well as corporate. The Company expects to incur charges of approximately $275 million under this program as the specific actions to execute on these initiatives are identified and approved, most of which are expected to be incurred by the end of fiscal 2014. This program excludes restructuring actions associated with acquisitions.

In fiscal 2009 and 2007, the Company launched a $200 million and a $150 million restructuring program, respectively, both of which were also designed to improve the Company’s cost structure. The Company recorded charges as the specific actions required to execute on these initiatives were identified and approved. The 2009 and 2007 programs were both substantially completed during fiscal 2011.

9
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Net restructuring and related charges, including actions associated with acquisitions, by segment are as follows:
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
June 29,
2012
 
June 24,
2011
Medical Devices
$
19

 
$
19

 
$
43

 
$
79

Pharmaceuticals
7

 
—

 
18

 
—

Medical Supplies
1

 
10

 
3

 
—

Corporate
2

 
3

 
4

 
4

Restructuring and related charges, net
29

 
32

 
68

 
83

Less: accelerated depreciation
(2
)
 
—

 
(11
)
 
—

Restructuring charges, net
$
27

 
$
32

 
$
57

 
$
83


During the nine months ended June 24, 2011, the Company reversed $10 million of restructuring reserves under the 2009 program, due to the determination that one of the restructuring actions within the Medical Supplies segment was no longer cost effective.

Net restructuring and related charges are comprised of the following:
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
June 29,
2012
 
June 24,
2011
Acquisition-related restructuring actions(1)
$
8

 
$
4

 
$
16

 
$
26

2011 program
21

 
15

 
47

 
15

2009 and 2007 programs
—

 
13

 
5

 
42

Restructuring and related charges, net
29

 
32

 
68

 
83

Less: non-cash charges, including accelerated depreciation
(4
)
 
(2
)
 
(14
)
 
(4
)
Total charges expected to be settled in cash
$
25

 
$
30

 
$
54

 
$
79

 
(1) For the quarter and nine months ended June 29, 2012, approximately $4 million of restructuring charges related to fiscal 2012 acquisitions. All other charges related to fiscal 2010 acquisitions.

The following table summarizes cash activity for restructuring reserves related to acquisitions for the nine months ended June 29, 2012:
(Dollars in Millions)
Employee Severance and Benefits
 
Other
 
Total
Balance at September 30, 2011
$
10

 
$
2

 
$
12

Charges
8

 
8

 
16

Changes in estimate
(1
)
 
—

 
(1
)
Cash payments
(6
)
 
(2
)
 
(8
)
Balance at June 29, 2012
$
11

 
$
8

 
$
19



10
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The following table summarizes cash activity for restructuring reserves related to the 2011 and prior programs for the nine months ended June 29, 2012, substantially all of which relates to employee severance and benefits:
(Dollars in Millions)
2011 Program
 
2009 and 2007
Programs
 
Total
Balance at September 30, 2011
$
45

 
$
52

 
$
97

Charges
40

 
2

 
42

Changes in estimate
(1
)
 
(2
)
 
(3
)
Cash payments
(28
)
 
(16
)
 
(44
)
Currency translation
(2
)
 
—

 
(2
)
Balance at June 29, 2012
$
54

 
$
36

 
$
90


Net restructuring and related charges, including associated asset impairments, incurred cumulative to date related to the 2011 program is as follows:
(Dollars in Millions)
2011 Program
Medical Devices
$
61

Pharmaceuticals
26

Corporate
11

Total
$
98


Restructuring reserves are reported on the Company’s consolidated balance sheets as follows:
(Dollars in Millions)
June 29,
2012
 
September 30,
2011
Accrued and other current liabilities
$
68

 
$
66

Other liabilities
41

 
43

Restructuring reserves
$
109

 
$
109

 

4. Other Income (Expense), Net

Other income (expense), net was comprised of the following:
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
June 29,
2012
 
June 24,
2011
Income (loss) under Tax Sharing Agreement (note 14)
$
16

 
$
(13
)
 
$
23

 
$
7

Loss on early retirement of debt (note 9)
(9
)
 
—

 
(9
)
 
—

Gain (loss) on investments, net
5

 
1

 
4

 
(7
)
Other income (expense), net
$
12

 
$
(12
)
 
$
18

 
$
—


Income (loss) under Tax Sharing Agreement represents the increase or decrease to the receivable from Tyco International Ltd. and TE Connectivity Ltd. These amounts reflect 58% of the interest and other income taxes payable amounts recorded and/or released during each period that are subject to the Tax Sharing Agreement.



11
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

5. Earnings Per Share

The weighted-average ordinary shares used in the computations of basic and diluted earnings per share were as follows:
 
Quarter Ended
 
Nine Months Ended
(in Millions)
June 29,
2012
 
June 24,
2011
 
June 29,
2012
 
June 24,
2011
Basic shares
481
 
495
 
482
 
495
Effect of share options and restricted shares
5
 
5
 
5
 
4
Diluted shares
486
 
500
 
487
 
499

The computation of diluted earnings per share for the quarter and nine months ended June 29, 2012, excludes less than 1 million and approximately 4 million shares, respectively, of options and restricted share awards because either the effect would have been anti-dilutive or the performance criteria related to the awards had not yet been met. For the quarter and nine months ended June 24, 2011, the computation of diluted earnings per share excludes approximately 2 million and 7 million shares, respectively, of options and restricted share awards because either the effect would have been anti-dilutive or the performance criteria related to the awards had not yet been met.

6. Comprehensive Income

Comprehensive income was comprised of the following:
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
June 29,
2012
 
June 24,
2011
Net income
$
453

 
$
535

 
$
1,444

 
$
1,417

Currency translation
(134
)
 
53

 
(172
)
 
174

Unrealized gain on derivatives, net of income taxes
3

 
1

 
4

 
5

Change related to benefit plans, net of income taxes
—

 
(1
)
 
1

 
(5
)
Total comprehensive income
$
322

 
$
588

 
$
1,277

 
$
1,591


7. Inventories

Inventories were comprised of the following at the end of each period:
(Dollars in Millions)
June 29,
2012
 
September 30,
2011
Purchased materials and manufactured parts
$
365

 
$
316

Work in process
369

 
310

Finished goods
989

 
887

Inventories
$
1,723

 
$
1,513


8. Goodwill and Intangible Assets

The changes in the carrying amount of goodwill were as follows:
(Dollars in Millions)
Medical Devices
 
Pharmaceuticals
 
Medical Supplies
 
Total
Goodwill at September 30, 2011
$
6,786

 
$
508

 
$
389

 
$
7,683

Acquisitions
831

 
—

 
—

 
831

Currency translation
(28
)
 
—

 
—

 
(28
)
Goodwill at June 29, 2012
$
7,589

 
$
508

 
$
389

 
$
8,486



12
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The gross carrying amount and accumulated amortization of intangible assets at the end of each period were as follows:
 
June 29, 2012
 
September 30, 2011
(Dollars in Millions)
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Gross
Carrying
Amount
 
Accumulated
Amortization
Amortizable:
 
 
 
 
 
 
 
Completed technology
$
2,516

 
$
860

 
$
2,208

 
$
761

Customer relationships
959

 
139

 
801

 
108

Licenses
219

 
84

 
216

 
74

Trademarks
68

 
33

 
68

 
31

Other
55

 
26

 
45

 
26

Total
$
3,817

 
$
1,142

 
$
3,338

 
$
1,000

Non-Amortizable:
 
 
 
 
 
 
 
Trademarks
$
353

 
 
 
$
357

 
 
In-process research and development
52

 
 
 
69

 
 
Total
$
405

 
 
 
$
426

 
 

Intangible asset amortization expense for the quarter ended June 29, 2012 and June 24, 2011 was $57 million and $51 million, respectively. Intangible asset amortization for the nine months ended June 29, 2012 and June 24, 2011 was $162 million and $150 million, respectively. Annual amortization expense is expected to be as follows:
(Dollars in Millions)
 
Fiscal 2012
$
239

Fiscal 2013
244
Fiscal 2014
242
Fiscal 2015
241
Fiscal 2016
236


9. Debt

On May 22, 2012, Covidien International Finance S.A. (CIFSA), a wholly-owned subsidiary of the Company, issued $600 million aggregate principal amount of 1.35% senior notes due May 2015 and $650 million aggregate principal amount of 3.20% senior notes due June 2022. The notes are fully and unconditionally guaranteed by both Covidien plc and Covidien Ltd. The net proceeds of $1.24 billion were used to fund the redemption of its $500 million 5.45% senior notes due October 2012 and for general corporate purposes. In connection with the redemption of the senior notes, the Company recorded a $9 million loss on early retirement of debt in other income (expense), net during both the quarter and nine months ended June 29, 2012.



13
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

10. Retirement Plans

The net periodic benefit cost for the Company’s defined benefit pension plans was as follows:
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
June 29,
2012
 
June 24,
2011
Service cost
$
6

 
$
5

 
$
16

 
$
16

Interest cost
10

 
11

 
31

 
33

Expected return on plan assets
(11
)
 
(10
)
 
(32
)
 
(32
)
Amortization of net actuarial loss
7

 
6

 
19

 
18

Settlements and curtailments
—

 
1

 
—

 
9

Net periodic benefit cost
$
12

 
$
13

 
$
34

 
$
44


The net periodic benefit cost for postretirement benefit plans for the quarter and nine months ended June 29, 2012 and June 24, 2011 was not material.

11. Guarantees

In disposing of assets or businesses, the Company often provides representations, warranties and indemnities to cover various risks 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 and legal fees related to periods prior to disposition. Except as discussed below, the Company generally 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.

In connection with the sale of the Specialty Chemicals business, the Company provided the purchaser with an indemnification for various risks, including environmental, health, safety, tax and other matters, some of which have an indefinite term. However, the most significant portion of this indemnification relates to environmental, health and safety matters, which has a term of 17 years. A liability of $22 million relating to this indemnification was included on the Company’s consolidated balance sheet at both June 29, 2012 and September 30, 2011. The value of the environmental, health and safety guarantee was measured based on the probability-weighted present value of the costs expected to be incurred to address environmental claims proposed under the indemnity. The maximum future payments the Company could be required to make under the indemnification provided to the purchaser is $79 million. In addition, the Company was required to pay $30 million into an escrow account as collateral, of which $26 million remained in other assets on the consolidated balance sheet at June 29, 2012.

The Company has recorded liabilities for known indemnifications 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.

Pursuant to the Separation and Distribution Agreement and Tax Sharing Agreement, the Company entered into certain guarantee commitments and indemnifications with Tyco International and TE Connectivity, which are discussed in note 14.

12. 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.


14
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The Company recognizes all derivative instruments as either assets or liabilities at fair value on the 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.

Interest Rate Exposure

Cash Flow Hedges—During fiscal 2007, CIFSA entered into a series of 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 in fiscal 2007 and fiscal 2008 prior to the issuance of the notes in accordance with their terms. The rate locks were considered to be highly effective, accordingly, the loss that resulted upon termination of the rate locks was recorded in accumulated other comprehensive income and is being amortized to interest expense over the terms of the notes. As of June 29, 2012 and September 30, 2011, the amount of this loss that remained in accumulated other comprehensive income was $40 million and $45 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 over 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 consolidated balance sheet at fair value. At June 29, 2012, the Company had foreign currency forward and option contracts outstanding with a notional amount of $837 million. These contracts do not meet the necessary criteria to qualify for hedge accounting. Accordingly, all associated changes in fair value are recognized in earnings.

The location and amount of the net gain (loss) on foreign exchange forward and option contracts not designated as hedging instruments and related hedged items were as follows:
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
June 29,
2012
 
June 24,
2011
Cost of goods sold
$
3

 
$
(6
)
 
$
9

 
$
(16
)
Selling, general and administrative expenses
4

 
(7
)
 
(3
)
 
(12
)
Total
$
7

 
$
(13
)
 
$
6

 
$
(28
)

Fair Value of Derivative Instruments

The fair value of foreign exchange forward and option contracts not designated as hedging instruments are included in the following consolidated balance sheet captions in the amounts shown:
(Dollars in Millions)
June 29,
2012
 
September 30,
2011
Derivative Assets:
 
 
 
Prepaid expenses and other current assets
$
32

 
$
40

Accrued and other current liabilities
2

 
1

 
$
34


$
41

Derivative Liabilities:
 
 
 
Prepaid expenses and other current assets
$
5

 
$
5

Accrued and other current liabilities
12

 
24

 
$
17

 
$
29



15
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

13. 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. Fair value is a market-based measurement that should be determined using assumptions that market participants would use in pricing an asset or liability. The fair value guidance establishes a three-level hierarchy, which maximizes the use of observable inputs and minimizes the use of unobservable inputs used in measuring fair value. The levels within the hierarchy are as follows:

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

Level 3—significant unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions

The following tables provide a summary of the significant assets and liabilities that are measured at fair value on a recurring basis at June 29, 2012 and September 30, 2011:
 
 
 
Basis of Fair Value Measurement
(Dollars in Millions)
June 29,
2012
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
Assets:
 
 
 
 
 
 
 
Foreign currency contracts
$
34

 
$
—

 
$
34

 
$
—

Debt and equity securities held in rabbi trust
34

 
18

 
16

 
—

Total assets at fair value
$
68

 
$
18

 
$
50

 
$
—

Liabilities:
 
 
 
 
 
 
 
Foreign currency contracts
$
17

 
$
—

 
$
17

 
$
—

Deferred compensation liabilities
94

 
—

 
94

 
—

Contingent consideration
158

 
—

 
—

 
158

Total liabilities at fair value
$
269

 
$
—

 
$
111

 
$
158


 
 
 
Basis of Fair Value Measurement
(Dollars in Millions)
September 30,
2011
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
Assets:
 
 
 
 
 
 
 
Foreign currency contracts
$
41

 
$
—

 
$
41

 
$
—

Debt and equity securities held in rabbi trust
33

 
15

 
18

 
—

Total assets at fair value
$
74

 
$
15

 
$
59

 
$
—

Liabilities:
 
 
 
 
 
 
 
Foreign currency contracts
$
29

 
$
—

 
$
29

 
$
—

Deferred compensation liabilities
93

 
—

 
93

 
—

Total liabilities at fair value
$
122

 
$
—

 
$
122

 
$
—



16
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Foreign currency contracts—The fair values of foreign currency 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 materially differ from the amounts that could be realized upon settlement or maturity, or that the changes in fair value will have a material effect on its results of operations, financial condition or cash flows.

Debt and equity securities held in rabbi trust—Debt securities held in the rabbi trust primarily consist of U.S. government and agency securities and corporate bonds. Where quoted prices are available in an active market, the investments are classified as level 1. When quoted market prices for a security are not available in an active market, they are classified as level 2. Equity securities held in the rabbi trust primarily consist of U.S. common stocks, which are valued using quoted market prices reported on nationally recognized securities exchanges.

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 record keeping 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—During the third quarter of fiscal 2012, the Company recorded contingent consideration of $47 million upon the acquisition of Maya Medical. This contingent consideration, which could total a maximum of $170 million, consists of $70 million in milestone payments related to the commercialization of a radiofrequency energy-based renal denervation device (RF Device) and $100 million in milestone payments related to a device that delivers a chemical agent to cause renal denervation (Drug Device), both of which are for the treatment of hypertension.
The milestone payments related to the RF Device consist of $20 million for the first commercial sale of the product outside of the United States and $20 million for the successful completion of a post-market clinical trial. The Company recorded contingent consideration of $20 million and $17 million related to the first commercial sale and successful completion of the post-market clinical trial within the required timeframes, respectively. In addition, the Company may be obligated to pay up to a maximum of $30 million based on the achievement of sales targets. The Company has recorded contingent consideration of $8 million related to these sales targets.
The milestone payments related to the Drug Device consist of $25 million for the successful completion of a pre-clinical trial study, $25 million for the successful completion of a clinical trial and $10 million for the first commercial sale of the product outside of the United States. The Company applied probability rates of 5% or less to each of these milestones and accordingly, the value of this contingent consideration is insignificant. In addition, the Company may be obligated to pay up to a maximum of $40 million based on the achievement of sales targets. The Company has assigned no value to this contingent consideration.
During the third quarter of fiscal 2012, the Company recorded contingent consideration of $22 million upon the acquisition of superDimension. This contingent consideration, which could total a maximum of $50 million, is based on the achievement of sales targets.

During the nine months ended June 29, 2012, the Company recorded contingent consideration of $71 million upon the acquisition of BÂRRX and an additional $4 million upon the achievement of health insurance coverage targets for procedures utilizing BÂRRX devices.

In addition, during the nine months ended June 29, 2012, the Company recorded contingent consideration of $13 million upon the acquisition of another business. This contingent consideration, which could total $20 million, is based on the achievement of sales targets.
 
The fair values of contingent consideration are based on significant unobservable inputs, including management estimates and assumptions, and were 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. These liabilities will be re-measured each reporting period and changes in the fair values will be included in the consolidated statements of income. Following is a reconciliation of changes in the fair value of contingent consideration for both the quarter and nine months ended June 29, 2012:

17
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29, 2012
 
June 29, 2012
Balance at beginning of period
$
85

 
$
—

Fair value of acquired liabilities
69

 
153

Changes in fair value
4

 
5

Fair value at June 29, 2012
$
158

 
$
158


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 restricted cash is equivalent to its carrying value of $52 million and $60 million as of June 29, 2012 and September 30, 2011, respectively (level 1). The Company’s life insurance contracts are carried at cash surrender value (level 3). The fair value of these contracts approximates the carrying value of $87 million and $88 million at June 29, 2012 and September 30, 2011, respectively. 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 $5.764 billion and $4.781 billion at June 29, 2012 and September 30, 2011, respectively. It is not practicable to estimate the fair value of the Company’s guaranteed contingent tax liability and the related amounts due to or 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 Moody’s and Standard & Poor’s long-term debt rating of A/A2. 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.

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, which are subject to payment delays. Payment is dependent upon the financial stability and creditworthiness of those countries’ national economies. 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. If the financial condition of customers or the countries’ healthcare systems continue 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 are as follows:
(Dollars in Millions)
June 29,
2012
 
September 30,
2011
Accounts receivable, net in Spain, Italy and Portugal
$
410

 
$
563

Percentage of total accounts receivable, net
25
%
 
32
%

Net sales to customers in Spain, Italy and Portugal totaled $168 million and $201 million during the quarters ended June 29, 2012 and June 24, 2011, respectively. Net sales to customers in Spain, Italy and Portugal totaled $504 million and $556 million during the nine months ended June 29, 2012 and June 24, 2011, respectively. At the end of June 2012, the Company collected $248 million from the Spanish government, which related to 2011 and prior invoices.



18
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

14. Transactions with Former Parent and Affiliate

Separation and Distribution Agreement—On June 29, 2007, the Company entered into a Separation and Distribution Agreement with Tyco International and TE Connectivity. Under this agreement, subject to certain exceptions contained in the Tax Sharing Agreement, Covidien, Tyco International and TE Connectivity assumed 42%, 27% and 31%, respectively, of certain of Tyco International’s contingent and other corporate liabilities, primarily consolidated securities litigation and any actions with respect to the separation brought by any third party. These contingent and other corporate liabilities do not include liabilities that specifically relate to one of the three separated companies, which were allocated solely to the relevant company.

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. 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 separation. All costs and expenses associated with the management of these tax liabilities are being shared equally among the parties. The Company is responsible for all of its own taxes that are not shared pursuant to the Tax Sharing Agreement.

All the tax liabilities of Tyco International that were associated with the Company’s business became Covidien’s tax liabilities following the separation. Although Covidien shares certain of these tax liabilities with Tyco International and TE Connectivity pursuant to the Tax Sharing Agreement, Covidien is primarily liable for all of these liabilities. Accordingly, 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.

If any party to the Tax Sharing Agreement were to default in its obligation to another party to pay its share of the distribution taxes that arise as a result of no party’s fault, each non-defaulting party would be required to pay, equally with any other non-defaulting party, the amounts in default. In addition, if another party to the Tax Sharing Agreement that is responsible for all or a portion of an income tax liability were to default in its payment of such liability to a taxing authority, the Company could be legally liable under applicable tax law for such liabilities and be required to make additional tax payments. Accordingly, under certain circumstances, the Company may be obligated to pay amounts in excess of the Company’s agreed upon share of its, Tyco International’s and TE Connectivity’s tax liabilities.
 
The Company has used available information to develop its best estimates for certain assets and liabilities related to periods prior to separation, including amounts subject to or impacted by the provisions of the Tax Sharing Agreement. Although the Company believes its estimates are adequate, the outcome of any potential litigation is uncertain and could result in a significant increase to its liability for taxes arising prior to June 29, 2007. The actual amounts that Covidien may be required to ultimately accrue or pay under the Tax Sharing Agreement could vary depending upon the outcome of the unresolved tax matters, which may not occur for several years, especially if certain matters are litigated. Final determination of the balances will be made in subsequent periods, primarily related to certain pre-separation tax liabilities and tax years open for examination. These balances will also be impacted by the filing of final or amended income tax returns in certain jurisdictions where those returns include a combination of Tyco International, Covidien and/or TE Connectivity legal entities for periods prior to the separation.

At June 29, 2012, the Company is the primary obligor to the taxing authorities for $1.707 billion of contingent tax liabilities that are recorded on the consolidated balance sheet, of which $1.124 billion relates to periods prior to the separation and which is shared with Tyco International and TE Connectivity pursuant to the Tax Sharing Agreement. At September 30, 2011, the Company was the primary obligor to the taxing authorities for $1.631 billion of contingent tax liabilities that were recorded on the consolidated balance sheet.

Income Tax Receivables—The Company has a current and non-current receivable from Tyco International and TE Connectivity totaling $602 million and $587 million at June 29, 2012 and September 30, 2011, respectively. These receivables, which reflect 58% of the contingent tax liabilities that are subject to the Tax Sharing Agreement, are classified as due from former parent and affiliate on the consolidated balance sheets. Adjustments to these receivables are recorded in other income. During the first nine months of fiscal 2012, the Company received a net reimbursement payment totaling $11 million from Tyco International and TE Connectivity.
 

19
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Guaranteed Contingent Tax Liabilities—The Company has certain guarantee commitments and indemnifications with Tyco International and TE Connectivity, primarily related to certain contingent tax liabilities. Current and non-current liabilities totaling $613 million and $660 million related to these guarantees were included on the Company’s consolidated balance sheets at June 29, 2012 and September 30, 2011, respectively. During the first nine months of fiscal 2012, the Company made payments totaling $45 million to Tyco International and TE Connectivity, which represents the 42% reimbursement required pursuant to the Tax Sharing Agreement for applicable tax and interest payments made by Tyco International and TE Connectivity.

15. Commitments and Contingencies

The Company is subject to various legal proceedings and claims, including patent infringement claims, product liability matters, environmental matters, employment disputes, disputes on agreements 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.

Products Liability Litigation—The Company currently is involved in litigation in various state and federal courts against manufacturers of transvaginal pelvic mesh products alleging personal injuries resulting from the implantation of those products. Two subsidiaries of the Company have supplied pelvic mesh product 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. 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 June 29, 2012, there were approximately 520 cases pending believed to involve products manufactured by Company subsidiaries. During fiscal 2011, the Company recorded a charge of $46 million for all known pending and estimated future claims, net of anticipated insurance recoveries. During the first nine months of fiscal 2012, the Company continued to receive claims and used the claims data to update its estimate of future claims. Accordingly, the Company recorded an additional charge of $47 million, which is included in selling, general and administrative expenses. The liability and insurance receivable are included in other liabilities and other assets, respectively, on the consolidated balance sheets. The Company believes that it has adequate amounts recorded relating to these matters based on current information. 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 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.

Asbestos Matters—Mallinckrodt Inc. is named as a defendant in personal injury lawsuits based on alleged exposure to asbestos-containing materials. A majority of the cases involve product liability claims, based principally on allegations of past distribution of products incorporating asbestos. A very limited number of the cases allege premises liability, based on claims that individuals were exposed to asbestos while on Mallinckrodt’s property. Each case typically names dozens of corporate defendants in addition to Mallinckrodt. The complaints generally seek monetary damages for personal injury or bodily injury resulting from alleged exposure to products containing asbestos.

The Company’s involvement in asbestos cases has been limited because Mallinckrodt did not mine or produce asbestos. Furthermore, in the Company’s experience, a large percentage of these claims have never been substantiated and have been dismissed by the courts. The Company has not suffered an adverse verdict in a trial court proceeding related to asbestos claims, and intends to continue to vigorously defend these lawsuits. When appropriate, the Company settles claims; however, amounts paid to settle and defend all asbestos claims have been immaterial. As of June 29, 2012, there were approximately 11,800 asbestos liability cases pending against Mallinckrodt.

The Company estimates pending asbestos claims and claims that were incurred but not reported, as well as related insurance recoveries. The Company’s estimate of its liability for pending and future claims is based on claims experience over the past five years and covers claims either currently filed or expected to be filed over the next seven years. The Company believes that it has adequate amounts recorded related to these matters. While it is not possible at this time to determine with certainty the ultimate outcome of these asbestos-related proceedings, the Company believes that the final outcome of all known

20
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COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

and anticipated future claims, after taking into account amounts already accrued and insurance coverage, will not 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 June 29, 2012, the Company concluded that it was probable that it would incur remedial costs in the range of $168 million to $285 million. As of June 29, 2012, the Company concluded that the best estimate within this range was $168 million, of which $19 million was included in accrued and other current liabilities and $149 million was included in other liabilities on the 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.

Mallinckrodt LLC, a subsidiary of the Company, is a successor to a company which owned and operated a chemical manufacturing facility in Orrington, Maine from 1967 until 1982. Mallinckrodt 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, Mallinckrodt 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 (now known as Mallinckrodt US LLC) and United States Surgical Corporation in December 2008. The compliance order included a directive to remove a significant volume of soils at the site. On December 19, 2008, Mallinckrodt 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, Mallinckrodt appealed the final order issued by the Maine Board in Maine Superior Court. On appeal Mallinckrodt 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 Mallinckrodt remove one of the two landfills and recap the remaining three landfills. Mallinckrodt also appealed certain administrative requirements of the final order. The Company has assessed the status of this matter and has concluded that it is more likely than not that the Maine Board’s final order will be either invalidated, reversed or modified, and, further, intends to vigorously pursue all available means to achieve such result.

As of June 29, 2012, the Company estimates that the cost to comply with these proposed remediation alternatives at this site ranges from $92 million to $166 million. These amounts are included in the range of aggregate environmental remediation costs described above. However, there are still significant uncertainties in the outcome of the pending litigation, and the Company continues to disagree with the level of remediation outlined in the Maine Board’s final order.

The Company has also recorded asset retirement obligations (AROs) for the estimated future costs primarily associated with legal obligations to decommission two facilities within the Pharmaceuticals segment. At both June 29, 2012 and September 30, 2011, the Company’s AROs were $53 million. 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.

Other Matters—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.

Tyco International Legal Proceedings—As discussed in note 14, pursuant to the Separation and Distribution Agreement, the Company assumed a portion of Tyco International’s contingent and other corporate liabilities, including potential liabilities related to certain of Tyco International’s outstanding litigation matters. As of June 24, 2011, there were no remaining securities lawsuits outstanding. Accordingly, during the first nine months of fiscal 2011, the Company recorded income of $11 million related to the reversal of its portion of the remaining reserves that had previously been established.


21
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COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Compliance Matters—Prior to the separation from Tyco International, Tyco International received and responded to various allegations that certain improper payments were made by Tyco International subsidiaries, including subsidiaries which are now part of the Company. During 2005, Tyco International reported to the U.S. Department of Justice (DOJ) and the U.S. Securities and Exchange Commission (SEC) the investigative steps and remedial measures that it had taken in response to the allegations. Tyco International also informed the DOJ and the SEC that it retained outside counsel to perform a company-wide baseline review of its policies, controls and practices with respect to compliance with the Foreign Corrupt Practices Act (FCPA), that it would continue to make periodic progress reports to these agencies and that it would present its factual findings upon conclusion of the baseline review. The Company has continued to communicate with the DOJ and SEC to provide updates on the baseline review and follow-up investigations, including, as appropriate, briefings concerning additional instances of potential improper conduct identified by the Company in the course of its ongoing compliance activities. To date, the baseline review and other compliance reviews have revealed that some past business practices may not comply with Covidien and FCPA requirements. The Company believes that it has adequate amounts recorded related to these matters, the amount of which is not significant.

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. 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 Tax Sharing Agreement. Tyco International has the right to administer, control and settle all U.S. income tax audits for periods prior to the 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 the current and non-current income taxes payable. With respect to these potential income tax liabilities from all of these years, Covidien believes that the amounts recorded in its consolidated financial statements as current or non-current income taxes payable 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 Covidien believes that some of these adjustments relating to certain Tyco International subsidiaries are likely to be resolved within the next 12 months. With respect to other adjustments, Tyco International has indicated that settlement is unlikely. In the event that Tyco International is unable to resolve these issues in the IRS administrative process, Tyco International will likely contest certain adjustments related to disallowed deductions through litigation. While Covidien believes that the amounts recorded as non-current taxes payable or guaranteed contingent tax liabilities related to these adjustments are adequate, the timing and outcome of such litigation is highly uncertain and could have a significant effect on the consolidated financial statements.

The IRS continues to audit certain of Tyco International’s U.S. federal income tax returns for the years 2001 through 2004 and 2005 through 2007 audit cycles. Tyco International and the IRS have entered into settlements related to certain outstanding tax matters arising in the 2001 through 2004 U.S. audit cycle, which otherwise remains open and subject to examination and resolution of other matters.

The resolution of tax matters arising from the 1997 through 2007 U.S. audits, non-U.S. audits and other settlements or statute of limitations expirations, could result in a significant change in the Company’s unrecognized tax benefits. However, the Company does not expect that the total amount of unrecognized tax benefits will significantly change over the next 12 months.


22
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

16. Segment Data

The Company’s three reportable segments are as follows:
•
Medical Devices includes the development, manufacture and sale of endomechanical instruments, energy devices, soft tissue repair products, vascular products, oximetry and monitoring products, airway and ventilation products and other medical products.
•
Pharmaceuticals includes the development, manufacture and distribution of specialty pharmaceuticals, active pharmaceutical ingredients, contrast products and radiopharmaceuticals.
•
Medical Supplies includes the development, manufacture and sale of nursing care products, medical surgical products, SharpSafety products and original equipment manufacturer products (OEM).

The Company has aggregated the following five operating segments into the Medical Devices reportable segment based upon their similar operational and economic characteristics: General Surgery in the United States and Europe, Vascular in the United States and Europe, Respiratory & Monitoring Solutions in the United States and Europe, Developed Markets (Canada, Japan, Australia and New Zealand) and Emerging Markets (Latin America, Asia, Eastern Europe, the Middle East and Africa).

Selected information by business segment is as follows:
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
June 29,
2012
 
June 24,
2011
Net sales(1) :
 
 
 
 
 
 
 
Medical Devices
$
2,063

 
$
1,985

 
$
6,051

 
$
5,739

Pharmaceuticals
501

 
500

 
1,499

 
1,460

Medical Supplies
443

 
441

 
1,301

 
1,297

 
$
3,007

 
$
2,926

 
$
8,851

 
$
8,496

Operating income:
 
 
 
 
 
 
 
Medical Devices
$
640

 
$
613

 
$
1,902

 
$
1,777

Pharmaceuticals
88

 
80

 
263

 
237

Medical Supplies
52

 
59

 
154

 
181

Operating income of reportable segments
780

 
752

 
2,319

 
2,195

Unallocated amounts:
 
 
 
 
 
 
 
Corporate expenses
(104
)
 
(105
)
 
(286
)
 
(312
)
Legal charges (note 15)
—

 
—

 
(47
)
 
—

Restructuring and related charges, net (note 3)
(29
)
 
(32
)
 
(68
)
 
(83
)
Separation costs(2)
(11
)
 
—

 
(21
)
 
—

Charges associated with acquisitions and licensing arrangement(3)
(19
)
 
—

 
(35
)
 
(32
)
Shareholder settlement income
—

 
—

 
—

 
11

Consolidated operating income
$
617

 
$
615

 
$
1,862

 
$
1,779

  
(1) 
Amounts represent sales to external customers. Intersegment sales are not significant.
(2) 
Amounts represent costs incurred related to the separation of the Company’s Pharmaceuticals segment, which are included in selling, general and administrative expenses.
(3) 
Note 2 provides information regarding current period amounts. Prior year amount represent charges included in cost of goods sold related to the sale of acquired inventory that had been written up to fair value upon acquisition.


23
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

17. Covidien International Finance S.A.

CIFSA, a Luxembourg company, is a holding company that owns, directly or indirectly, substantially all of the operating subsidiaries of Covidien plc. CIFSA is the issuer of the Company’s senior notes and commercial paper, both of which are fully and unconditionally guaranteed by Covidien plc and Covidien Ltd., the owners of CIFSA. In addition, CIFSA is the borrower under the revolving credit facility, which is fully and unconditionally guaranteed by Covidien plc. The following information provides the composition of the Company’s income, assets, liabilities, equity and cash flows by relevant group within the Company: Covidien plc and Covidien Ltd. as the guarantors, CIFSA as issuer of the debt and the operating companies that represent assets of CIFSA. There are no other subsidiary guarantees. Condensed consolidating financial information for Covidien plc, Covidien Ltd. and CIFSA, on a stand-alone basis, is presented using the equity method of accounting for subsidiaries.


CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
Quarter Ended June 29, 2012
(dollars in millions)
 
 
Covidien plc
 
Covidien Ltd.
 
CIFSA
 
Other
Subsidiaries
 
Consolidating
Adjustments
 
Total
Net sales
$
—

 
$
—

 
$
—

 
$
3,007

 
$
—

 
$
3,007

Cost of goods sold
—

 
—

 
—

 
1,268

 
—

 
1,268

Gross profit
—

 
—

 
—

 
1,739

 
—

 
1,739

Selling, general and administrative expenses
26

 
—

 
1

 
909

 
—

 
936

Research and development expenses
—

 
—

 
—

 
159

 
—

 
159

Restructuring charges, net
—

 
—

 
—

 
27

 
—

 
27

Operating (loss) income
(26
)
 
—

 
(1
)
 
644

 
—

 
617

Interest expense
—

 
—

 
(53
)
 
—

 
—

 
(53
)
Interest income
—

 
—

 
—

 
1

 
—

 
1

Other (expense) income, net
—

 
—

 
(9
)
 
21

 
—

 
12

Equity in net income of subsidiaries
474

 
476

 
375

 
—

 
(1,325
)
 
—

Intercompany interest and fees
4

 
(2
)
 
164

 
(166
)
 
—

 
—

Income before income taxes
452

 
474

 
476

 
500

 
(1,325
)
 
577

Income tax (benefit) expense
(1
)
 
—

 
—

 
125

 
—

 
124

Net income
453

 
474

 
476

 
375

 
(1,325
)
 
453

Currency translation
—

 
—

 
—

 
(134
)
 
—

 
(134
)
Unrealized gain on derivatives, net of income taxes
—

 
—

 
2

 
1

 
—

 
3

Total comprehensive income
$
453

 
$
474

 
$
478

 
$
242

 
$
(1,325
)
 
$
322


24
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
Quarter Ended June 24, 2011
(dollars in millions)
 
 
Covidien plc
 
Covidien Ltd.
 
CIFSA
 
Other
Subsidiaries
 
Consolidating
Adjustments
 
Total
Net sales
$
—

 
$
—

 
$
—

 
$
2,926

 
$
—

 
$
2,926

Cost of goods sold
—

 
—

 
—

 
1,255

 
—

 
1,255

Gross profit
—

 
—

 
—

 
1,671

 
—

 
1,671

Selling, general and administrative expenses
4

 
—

 
1

 
881

 
—

 
886

Research and development expenses
—

 
—

 
—

 
138

 
—

 
138

Restructuring charges, net
—

 
—

 
—

 
32

 
—

 
32

Operating (loss) income
(4
)
 
—

 
(1
)
 
620

 
—

 
615

Interest expense
—

 
—

 
(50
)
 
(1
)
 
—

 
(51
)
Interest income
—

 
—

 
—

 
6

 
—

 
6

Other expense, net
—

 
—

 
—

 
(12
)
 
—

 
(12
)
Equity in net income of subsidiaries
519

 
521

 
413

 
—

 
(1,453
)
 
—

Intercompany interest and fees
18

 
(2
)
 
159

 
(175
)
 
—

 
—

Income from continuing operations before income taxes
533

 
519

 
521

 
438

 
(1,453
)
 
558

Income tax (benefit) expense
(2
)
 
—

 
—

 
28

 
—

 
26

Income from continuing operations
535

 
519

 
521

 
410

 
(1,453
)
 
532

Income from discontinued operations, net of income taxes
—

 
—

 
—

 
3

 
—

 
3

Net income
535

 
519

 
521

 
413

 
(1,453
)
 
535

Currency translation
—

 
—

 
—

 
53

 
—

 
53

Unrealized gain on derivatives, net of income taxes
—

 
—

 
1

 
—

 
—

 
1

Change related to benefit plans, net of income taxes
—

 
—

 
—

 
(1
)
 
—

 
(1
)
Total comprehensive income
$
535

 
$
519

 
$
522

 
$
465

 
$
(1,453
)
 
$
588


25
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
Nine Months Ended June 29, 2012
(dollars in millions)
 
 
Covidien plc
 
Covidien Ltd.
 
CIFSA
 
Other
Subsidiaries
 
Consolidating
Adjustments
 
Total
Net sales
$
—

 
$
—

 
$
—

 
$
8,851

 
$
—

 
$
8,851

Cost of goods sold
—

 
—

 
—

 
3,705

 
—

 
3,705

Gross profit
—

 
—

 
—

 
5,146

 
—

 
5,146

Selling, general and administrative expenses
74

 
—

 
2

 
2,681

 
—

 
2,757

Research and development expenses
—

 
—

 
—

 
470

 
—

 
470

Restructuring charges, net
—

 
—

 
—

 
57

 
—

 
57

Operating (loss) income
(74
)
 
—

 
(2
)
 
1,938

 
—

 
1,862

Interest expense
—

 
—

 
(156
)
 
1

 
—

 
(155
)
Interest income
—

 
—

 
—

 
13

 
—

 
13

Other (expense) income, net
—

 
—

 
(9
)
 
27

 
—

 
18

Equity in net income of subsidiaries
1,572

 
1,577

 
1,255

 
—

 
(4,404
)
 
—

Intercompany interest and fees
(59
)
 
(5
)
 
489

 
(425
)
 
—

 
—

Income from continuing operations before income taxes
1,439

 
1,572

 
1,577

 
1,554

 
(4,404
)
 
1,738

Income tax (benefit) expense
(5
)
 
—

 
—

 
305

 
—

 
300

Income from continuing operations
1,444

 
1,572

 
1,577

 
1,249

 
(4,404
)
 
1,438

Income from discontinued operations, net of income taxes
—

 
—

 
—

 
6

 
—

—

6

Net income
1,444

 
1,572

 
1,577

 
1,255

 
(4,404
)
 
1,444

Currency translation
—

 
—

 
—

 
(172
)
 
—

 
(172
)
Unrealized gain on derivatives, net of income taxes
—

 
—

 
4

 
—

 
—

 
4

Change related to benefit plans, net of income taxes
—

 
—

 
—

 
1

 
—

 
1

Total comprehensive income
$
1,444

 
$
1,572

 
$
1,581

 
$
1,084

 
$
(4,404
)
 
$
1,277


26
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
Nine Months Ended June 24, 2011
(dollars in millions)
 
 
Covidien plc
 
Covidien Ltd.
 
CIFSA
 
Other
Subsidiaries
 
Consolidating
Adjustments
 
Total
Net sales
$
—

 
$
—

 
$
—

 
$
8,496

 
$
—

 
$
8,496

Cost of goods sold
—

 
—

 
—

 
3,658

 
—

 
3,658

Gross profit
—

 
—

 
—

 
4,838

 
—

 
4,838

Selling, general and administrative expenses
11

 
—

 
2

 
2,587

 
—

 
2,600

Research and development expenses
—

 
—

 
—

 
387

 
—

 
387

Restructuring charges, net
—

 
—

 
—

 
83

 
—

 
83

Shareholder settlement income
—

 
—

 
—

 
(11
)
 
—

 
(11
)
Operating (loss) income
(11
)
 
—

 
(2
)
 
1,792

 
—

 
1,779

Interest expense
—

 
—

 
(154
)
 
1

 
—

 
(153
)
Interest income
—

 
—

 
—

 
17

 
—

 
17

Equity in net income of subsidiaries
1,460

 
1,464

 
1,145

 
—

 
(4,069
)
 
—

Intercompany interest and fees
(43
)
 
(4
)
 
475

 
(428
)
 
—

 
—

Income from continuing operations before income taxes
1,406

 
1,460

 
1,464

 
1,382

 
(4,069
)
 
1,643

Income tax (benefit) expense
(11
)
 
—

 
—

 
231

 
—

 
220

Income from continuing operations
1,417

 
1,460

 
1,464

 
1,151

 
(4,069
)
 
1,423

Loss from discontinued operations, net of income taxes
—

 
—

 
—

 
(6
)
 
—

 
(6
)
Net income
1,417

 
1,460

 
1,464

 
1,145

 
(4,069
)
 
1,417

Currency translation
—

 
—

 
—

 
174

 
—

 
174

Unrealized gain on derivatives, net of income taxes
—

 
—

 
3

 
2

 
—

 
5

Change related to benefit plans, net of income taxes
—

 
—

 
—

 
(5
)
 
—

 
(5
)
Total comprehensive income
$
1,417

 
$
1,460

 
$
1,467

 
$
1,316

 
$
(4,069
)
 
$
1,591


27
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 CONDENSED CONSOLIDATING BALANCE SHEET
At June 29, 2012
(dollars in millions)
 
 
Covidien plc
 
Covidien Ltd.
 
CIFSA
 
Other
Subsidiaries
 
Consolidating
Adjustments
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
—

 
$
—

 
$
351

 
$
1,584

 
$
—

 
$
1,935

Accounts receivable trade, net
—

 
—

 
—

 
1,662

 
—

 
1,662

Inventories
—

 
—

 
—

 
1,723

 
—

 
1,723

Intercompany receivable
23

 
51

 
—

 
19

 
(93
)
 
—

Prepaid expenses and other current assets
1

 
—

 
1

 
936

 
—

 
938

Total current assets
24

 
51

 
352

 
5,924

 
(93
)
 
6,258

Property, plant and equipment, net
2

 
—

 
—

 
2,804

 
—

 
2,806

Goodwill
—

 
—

 
—

 
8,486

 
—

 
8,486

Intangible assets, net
—

 
—

 
—

 
3,080

 
—

 
3,080

Due from former parent and affiliate
—

 
—

 
—

 
595

 
—

 
595

Investment in subsidiaries
13,278

 
13,901

 
11,356

 
—

 
(38,535
)
 
—

Intercompany loans receivable
—

 
93

 
12,110

 
4,898

 
(17,101
)
 
—

Other assets
—

 
—

 
27

 
862

 
—

 
889

Total Assets
$
13,304

 
$
14,045

 
$
23,845

 
$
26,649

 
$
(55,729
)
 
$
22,114

Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
 
 
 

Current Liabilities:
 
 
 
 
 
 
 
 
 
 

Current maturities of long-term debt
$
—

 
$
—

 
$
503

 
$
8

 
$
—

 
$
511

Accounts payable
3

 
—

 
—

 
593

 
—

 
596

Intercompany payable
19

 
—

 
—

 
74

 
(93
)
 
—

Accrued and other current liabilities
1

 
—

 
32

 
1,375

 
—

 
1,408

Income taxes payable
—

 
—

 
—

 
51

 
—

 
51

Guaranteed contingent tax liabilities
—

 
—

 
—

 
30

 
—

 
30

Total current liabilities
23

 
—

 
535

 
2,131

 
(93
)
 
2,596

Long-term debt
—

 
—

 
4,511

 
63

 
—

 
4,574

Income taxes payable
—

 
—

 
—

 
1,675

 
—

 
1,675

Guaranteed contingent tax liabilities
—

 
—

 
—

 
583

 
—

 
583

Intercompany loans payable
2,569

 
767

 
4,898

 
8,867

 
(17,101
)
 
—

Other liabilities
—

 
—

 
—

 
1,974

 
—

 
1,974

Total Liabilities
2,592

 
767

 
9,944

 
15,293

 
(17,194
)
 
11,402

Shareholders’ Equity
10,712

 
13,278

 
13,901

 
11,356

 
(38,535
)
 
10,712

Total Liabilities and Shareholders’ Equity
$
13,304

 
$
14,045

 
$
23,845

 
$
26,649

 
$
(55,729
)
 
$
22,114


28
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


CONDENSED CONSOLIDATING BALANCE SHEET
At September 30, 2011
(dollars in millions)
 
 
Covidien plc
 
Covidien Ltd.
 
CIFSA
 
Other
Subsidiaries
 
Consolidating
Adjustments
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
—

 
$
—

 
$
169

 
$
1,334

 
$
—

 
$
1,503

Accounts receivable trade, net
—

 
—

 
—

 
1,744

 
—

 
1,744

Inventories
—

 
—

 
—

 
1,513

 
—

 
1,513

Intercompany receivable
23

 
—

 
—

 
153

 
(176
)
 
—

Prepaid expenses and other current assets
3

 
—

 
29

 
981

 
—

 
1,013

Total current assets
26

 
—

 
198

 
5,725

 
(176
)
 
5,773

Property, plant and equipment, net
2

 
—

 
—

 
2,703

 
—

 
2,705

Goodwill
—

 
—

 
—

 
7,683

 
—

 
7,683

Intangible assets, net
—

 
—

 
—

 
2,764

 
—

 
2,764

Due from former parent and affiliate
—

 
—

 
—

 
583

 
—

 
583

Investment in subsidiaries
11,860

 
12,478

 
11,340

 
—

 
(35,678
)
 
—

Intercompany loans receivable
—

 
94

 
11,294

 
6,160

 
(17,548
)
 
—

Other assets
—

 
—

 
22

 
844

 
—

 
866

Total Assets
$
11,888

 
$
12,572

 
$
22,854

 
$
26,462

 
$
(53,402
)
 
$
20,374

Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
 
 
 

Current Liabilities:
 
 
 
 
 
 
 
 
 
 

Current maturities of long-term debt
$
—

 
$
—

 
$
3

 
$
8

 
$
—

 
$
11

Accounts payable
—

 
—

 
—

 
576

 
—

 
576

Intercompany payable
24

 
129

 
—

 
23

 
(176
)
 
—

Accrued and other current liabilities
109

 
—

 
83

 
1,419

 
—

 
1,611

Income taxes payable
—

 
—

 
—

 
97

 
—

 
97

Guaranteed contingent tax liabilities
—

 
—

 
—

 
105

 
—

 
105

Total current liabilities
133

 
129

 
86

 
2,228

 
(176
)
 
2,400

Long-term debt
—

 
—

 
4,129

 
68

 
—

 
4,197

Income taxes payable
—

 
—

 
—

 
1,629

 
—

 
1,629

Guaranteed contingent tax liabilities
—

 
—

 
—

 
555

 
—

 
555

Intercompany loans payable
1,937

 
583

 
6,161

 
8,867

 
(17,548
)
 
—

Other liabilities
1

 
—

 
—

 
1,775

 
—

 
1,776

Total Liabilities
2,071

 
712

 
10,376

 
15,122

 
(17,724
)
 
10,557

Shareholders’ Equity
9,817

 
11,860

 
12,478

 
11,340

 
(35,678
)
 
9,817

Total Liabilities and Shareholders’ Equity
$
11,888

 
$
12,572

 
$
22,854

 
$
26,462

 
$
(53,402
)
 
$
20,374


29
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Nine Months Ended June 29, 2012
(dollars in millions)
 
 
Covidien plc
 
Covidien Ltd.
 
CIFSA
 
Other
Subsidiaries
 
Consolidating
Adjustments
 
Total
Cash Flows From Operating Activities:
 
 
 
 
 
 
 
 
 
 
 
Net cash (used in) provided by operating activities
$
(89
)
 
$
(184
)
 
$
312

 
$
1,598

 
$
—

 
$
1,637

Cash Flows From Investing Activities:
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures
—

 
—

 
—

 
(378
)
 
—

 
(378
)
Acquisition-related payments, net of cash acquired
—

 
—

 
—

 
(1,063
)
 
—

 
(1,063
)
Acquisition of licenses and technology
—

 
—

 
—

 
(26
)
 
—

 
(26
)
Sale of investments
—

 
—

 
—

 
7

 
—

 
7

Net increase in intercompany loans
—

 
—

 
(2,078
)
 
—

 
2,078

 
—

Increase in investment in subsidiary
—

 
—

 
(625
)
 
—

 
625

 
—

Other
—

 
—

 
—

 
(2
)
 
—

 
(2
)
Net cash used in investing activities
—

 
—

 
(2,703
)
 
(1,462
)
 
2,703

 
(1,462
)
Cash Flows From Financing Activities:
 
 
 
 
 
 
 
 
 
 
 
Net issuance of commercial paper
—

 
—

 
136

 
—

 
—

 
136

Issuance of debt
—

 
—

 
1,240

 
—

 
—

 
1,240

Repayment of debt
—

 
—

 
(508
)
 
(44
)
 
—

 
(552
)
Dividends paid
(326
)
 
—

 
—

 
—

 
—

 
(326
)
Repurchase of shares
(385
)
 
—

 
—

 
—

 
—

 
(385
)
Proceeds from exercise of share options
143

 
—

 
—

 
—

 
—

 
143

Net intercompany loan borrowings
632

 
184

 
—

 
1,262

 
(2,078
)
 
—

Intercompany dividend received (paid)
—

 
—

 
1,705

 
(1,705
)
 
—

 
—

Capital contribution
—

 
—

 
—

 
625

 
(625
)
 
—

Other
25

 
—

 
—

 
(11
)
 
—

 
14

Net cash provided by (used in) financing activities
89

 
184

 
2,573

 
127

 
(2,703
)
 
270

Effect of currency rate changes on cash
—

 
—

 
—

 
(13
)
 
—

 
(13
)
Net increase in cash and cash equivalents
—

 
—

 
182

 
250

 
—

 
432

Cash and cash equivalents at beginning of period
—

 
—

 
169

 
1,334

 
—

 
1,503

Cash and cash equivalents at end of period
$
—

 
$
—

 
$
351

 
$
1,584

 
$
—

 
$
1,935


30
Table of Contents
COVIDIEN PLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Nine Months Ended June 24, 2011
(dollars in millions)
 
 
Covidien plc
 
Covidien Ltd.
 
CIFSA
 
Other
Subsidiaries
 
Consolidating
Adjustments
 
Total
Cash Flows From Operating Activities:
 
 
 
 
 
 
 
 
 
 
 
Net cash (used in) provided by operating activities
$
(23
)
 
$
169

 
$
270

 
$
1,193

 
$
—

 
$
1,609

Cash Flows From Investing Activities:
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures
—

 
—

 
—

 
(303
)
 
—

 
(303
)
Acquisition-related payments
—

 
—

 
—

 
(13
)
 
—

 
(13
)
Acquisition of licenses and technology
—

 
—

 
—

 
(4
)
 
—

 
(4
)
Sale of investments
—

 
—

 
—

 
14

 
—

 
14

Net increase in intercompany loans
—

 
—

 
(341
)
 
—

 
341

 
—

Increase in investment in subsidiary
—

 
(199
)
 
—

 
—

 
199

 
—

Other
—

 
—

 
—

 
(9
)
 
—

 
(9
)
Net cash used in investing activities
—

 
(199
)
 
(341
)
 
(315
)
 
540

 
(315
)
Cash Flows From Financing Activities:
 
 
 
 
 
 
 
 
 
 
 
Net repayment of commercial paper
—

 
—

 
(307
)
 
—

 
—

 
(307
)
Repayment of debt
—

 
—

 
(250
)
 
(4
)
 
—

 
(254
)
Dividends paid
(297
)
 
—

 
—

 
—

 
—

 
(297
)
Repurchase of shares
(378
)
 
—

 
—

 
—

 
—

 
(378
)
Proceeds from exercise of share options
164

 
—

 
—

 
—

 
—

 
164

Payment of contingent consideration
—

 
—

 
—

 
(71
)
 
—

 
(71
)
Net intercompany loan borrowings
487

 
30

 
—

 
(176
)
 
(341
)
 
—

Intercompany dividend received (paid)
—

 
—

 
490

 
(490
)
 
—

 
—

Capital contribution
—

 
—

 
—

 
199

 
(199
)
 
—

Other
48

 
—

 
—

 
(35
)
 
—

 
13

Net cash provided by (used in) financing activities
24

 
30

 
(67
)
 
(577
)
 
(540
)
 
(1,130
)
Effect of currency rate changes on cash
—

 
—

 
—

 
26

 
—

 
26

Net increase (decrease) in cash and cash equivalents
1

 
—

 
(138
)
 
327

 
—

 
190

Cash and cash equivalents at beginning of period
1

 
—

 
399

 
1,165

 
—

 
1,565

Cash and cash equivalents at end of period
$
2

 
$
—

 
$
261

 
$
1,492

 
$
—

 
$
1,755


31
Table of Contents


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the accompanying notes included in this Quarterly Report. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs and involve risks, uncertainties and assumptions. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those discussed under the headings “Risk Factors” and “Forward-Looking Statements” in both our Annual Report on Form 10-K for the fiscal year ended September 30, 2011 and in this Quarterly Report.

Overview

We develop, manufacture and sell healthcare products for use in clinical and home settings. Our mission is to create and deliver innovative healthcare solutions, developed in ethical collaboration with medical professionals, which enhance the quality of life for patients and improve outcomes for our customers and our shareholders. We manage and operate our business through the following three segments:
•
Medical Devices includes the development, manufacture and sale of endomechanical instruments, energy devices, soft tissue repair products, vascular products, oximetry and monitoring products, airway and ventilation products, and other medical products.
•
Pharmaceuticals includes the development, manufacture and distribution of specialty pharmaceuticals, active pharmaceutical ingredients, contrast products and radiopharmaceuticals.
•
Medical Supplies includes the development, manufacture and sale of nursing care products, medical surgical products, SharpSafety products and original equipment manufacturer (OEM) products.

Separation

In December 2011, we announced a plan to spin off our pharmaceuticals business into a stand-alone public company. We anticipate that the transaction will be in the form of a distribution that will be tax-free to U.S. shareholders of a new publicly traded stock in the new pharmaceuticals company. Completion of the transaction is expected to be subject to certain conditions, including, among others, receipt of regulatory approvals, assurance as to the tax-free status of the spin-off of the pharmaceuticals business to our U.S. shareholders, the effectiveness of a Form 10 registration statement to be filed with the U.S. Securities and Exchange Commission and final approval by our Board of Directors. We currently expect to complete the transaction in June 2013; however, there can be no assurance regarding the ultimate timing of the proposed transaction or that the transaction will be completed.

Healthcare Reform

In March 2010, the Patient Protection and Affordable Care Act was enacted in the United States. This legislation includes a provision that imposes a 2.3% excise tax on the sale of certain medical devices by a manufacturer, producer or importer of such devices in the United States starting after December 31, 2012. The legislation also includes a $28 billion fee on the branded pharmaceutical industry over nine years starting in 2011 and a $2.8 billion annual fee on branded pharmaceuticals thereafter. The amount of branded pharmaceutical fee payable by each company is based upon market share. Since our branded pharmaceutical sales currently represent a small portion of the total market, this annual assessment has not had a significant impact on Covidien. The medical devices tax, however, may have a significant impact on our results of operations, the potential impact of which is still being evaluated. U.S. net sales of potentially taxable medical devices represented approximately 30% to 40% of our total net sales in fiscal 2011 and, therefore, this tax burden may have a material, negative impact on our results of operations and our cash flows. In addition to the excise tax and annual fee described above, the new legislation contains numerous other provisions, many of which pertain to health insurance plans, which could adversely impact our financial results in future periods.

Acquisitions

In June 2012, we acquired Oridion Systems Ltd. (Oridion), a developer of patient monitoring systems, for $327 million in cash, net of cash acquired of $10 million. The acquisition of Oridion complements our existing product portfolio of pulse oximeters and monitoring products.


32
Table of Contents


In May 2012, we acquired superDimension, Ltd., a developer of minimally invasive interventional pulmonology devices, for total consideration of $286 million. The total consideration was comprised of an upfront cash payment of $243 million, net of cash acquired of $8 million, debt assumed of $21 million, which was subsequently repaid, and the fair value of contingent consideration of $22 million. The contingent consideration, which could total $50 million, consists of milestone payments related to the achievement of sales targets. The acquisition of superDimension allows us to deliver more comprehensive solutions in the evaluation and treatment of lung disease.

In May 2012, we acquired Newport Medical Instruments, Inc. (Newport Medical), a designer and manufacturer of ventilators, for total consideration of $101 million. The total consideration was comprised of $92 million in cash, net of cash acquired of $2 million, and $9 million of debt assumed, which was subsequently repaid. The acquisition of Newport Medical complements our existing portfolio of acute care and home care ventilation solutions and broadens our ventilation platforms.

In April 2012, we acquired Maya Medical, a developer of a treatment for hypertension, for total consideration of $106 million. The total consideration was comprised of an upfront cash payment of $49 million, debt assumed of $10 million, which was subsequently repaid, and the fair value of contingent consideration of $47 million. The contingent consideration, which could total a maximum of $170 million, consists of $70 million in milestone payments related to the commercialization of a radiofrequency energy-based renal denervation device and $100 million in milestone payments related to a device that delivers a chemical agent to cause renal denervation. The acquisition of Maya Medical expands our ability to treat vascular diseases by allowing us to enter the hypertension market.

In January 2012, we acquired all of the outstanding equity of BÂRRX Medical, Inc. (BÂRRX), a developer of bipolar radiofrequency ablation devices used in the treatment of Barrett's esophagus syndrome, for total consideration of $393 million. The total purchase consideration was comprised of an upfront cash payment of $322 million, net of cash acquired of $16 million, and the fair value of contingent consideration of $71 million. During the quarter ended June 29, 2012, the Company recorded an additional $4 million of contingent consideration upon the achievement of health insurance coverage targets for procedures utilizing BÂRRX devices. The acquisition of BÂRRX expands our ability to treat gastrointestinal diseases.

In July 2012, we acquired MindFrame, Inc., a designer and manufacturer of devices designed to optimize rapid perfusion and clot removal in the treatment of patients suffering from ischemic stroke, for approximately $75 million in cash. The acquisition of MindFrame broadens our product offerings for the treatment of acute ischemic stroke.

Licensing Agreement

In January 2012, our Medical Devices segment entered into an exclusive licensing agreement which grants us product rights for two medical device patent and product candidates that are designed to remove peripheral artery blockages. This licensing arrangement included an upfront cash payment of $12 million, which was included in research and development expenses. In addition, during the first nine months of fiscal 2012, we made a regulatory-related milestone payment of $5 million, which was capitalized as an intangible asset. We may also be required to make additional payments of up to $60 million if certain regulatory and sales milestones are achieved.

Restructuring Initiatives

In fiscal 2011, we launched a restructuring program, designed to improve our cost structure. This program includes actions across all three segments as well as corporate. We expect to incur total charges of approximately $275 million as the specific actions required to execute on these initiatives are identified and approved, most of which are expected to be incurred by the end of fiscal 2014. Savings from this program are estimated to be $175 million to $225 million on an annualized basis once the program is completed. As of June 29, 2012, we had incurred $98 million of net restructuring charges under the 2011 program since its inception.


33
Table of Contents


Results of Operations

Quarter and Nine Months Ended June 29, 2012 and June 24, 2011

The following table presents results of operations, including percentage of net sales:
 
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29, 2012
 
June 24, 2011
 
June 29, 2012
 
June 24, 2011
Net sales
$
3,007

 
100.0
 %
 
$
2,926

 
100.0
 %
 
$
8,851

 
100.0
 %
 
$
8,496

 
100.0
 %
Cost of goods sold
1,268

 
42.2

 
1,255

 
42.9

 
3,705

 
41.9

 
3,658

 
43.1

Gross profit
1,739

 
57.8

 
1,671

 
57.1

 
5,146

 
58.1

 
4,838

 
56.9

Selling, general and administrative expenses
936

 
31.1

 
886

 
30.3

 
2,757

 
31.1

 
2,600

 
30.6

Research and development expenses
159

 
5.3

 
138

 
4.7

 
470

 
5.3

 
387

 
4.6

Restructuring charges, net
27

 
0.9

 
32

 
1.1

 
57

 
0.6

 
83

 
1.0

Shareholder settlement income
—

 
—

 
—

 
—

 
—

 
—

 
(11
)
 
(0.1
)
Operating income
617

 
20.5

 
615

 
21.0

 
1,862

 
21.0

 
1,779

 
20.9

Interest expense
(53
)
 
(1.8
)
 
(51
)
 
(1.7
)
 
(155
)
 
(1.8
)
 
(153
)
 
(1.8
)
Interest income
1

 
—

 
6

 
0.2

 
13

 
0.1

 
17

 
0.2

Other income (expense), net
12

 
0.4

 
(12
)
 
(0.4
)
 
18

 
0.2

 
—

 
—

Income from continuing operations before income taxes
577

 
19.2

 
558

 
19.1

 
1,738

 
19.6

 
1,643

 
19.3

Income tax expense
124

 
4.1

 
26

 
0.9

 
300

 
3.4

 
220

 
2.6

Income from continuing operations
453

 
15.1

 
532

 
18.2

 
1,438

 
16.2

 
1,423

 
16.7

Income (loss) from discontinued operations, net of income taxes
—

 
—

 
3

 
0.1

 
6

 
0.1

 
(6
)
 
(0.1
)
Net income
$
453

 
15.1

 
$
535

 
18.3

 
$
1,444

 
16.3

 
$
1,417

 
16.7


Net sales—Our net sales in the third quarter of fiscal 2012 increased $81 million, or 2.8%, to $3.007 billion, compared with $2.926 billion in the third quarter of fiscal 2012. Our net sales for the first nine months of fiscal 2012 increased $355 million, or 4.2%, to $8.851 billion, compared to $8.496 billion in the first nine months of fiscal 2011. The increases in net sales for both periods were driven by sales growth within our Medical Devices segment, partially offset by unfavorable currency exchange rate fluctuations of $89 million and $105 million for the third quarter and first nine months of fiscal 2012, respectively.

Net sales generated by our businesses in the United States were $1.680 billion and $1.580 billion for the third quarter of fiscal 2012 and 2011, respectively, and $4.904 billion and $4.653 billion for the first nine months of fiscal 2012 and 2011, respectively. Our non-U.S. businesses generated net sales of $1.327 billion and $1.346 billion for the third quarter of fiscal 2012 and 2011, respectively, and $3.947 billion and $3.843 billion for the first nine months of fiscal 2012 and 2011, respectively. Our business outside the United States accounted for approximately 44% and 46% of our net sales for the third quarter of fiscal 2012 and 2011, respectively, and 45% for both the first nine months of fiscal 2012 and 2011.


34
Table of Contents


Net sales by geographic area are shown in the following table:
 
 
Quarter Ended
 
Percentage
Change
 
Currency
Impact
 
Operational Growth(2)
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
U.S.
$
1,680

 
$
1,580

 
6
 %
 
—
 %
 
6
%
Other Americas
186

 
191

 
(3
)
 
(9
)
 
6

Europe
660

 
721

 
(8
)
 
(10
)
 
2

Asia-Pacific
481

 
434

 
11

 
—

 
11

Net Sales(1)
$
3,007

 
$
2,926

 
3

 
(3
)
 
6

 
 
Nine Months Ended
 
Percentage
Change
 
Currency
Impact
 
Operational Growth(2)
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
U.S.
$
4,904

 
$
4,653

 
5
 %
 
—
 %
 
5
%
Other Americas
535

 
537

 
—

 
(5
)
 
5

Europe
2,003

 
2,048

 
(2
)
 
(5
)
 
3

Asia-Pacific
1,409

 
1,258

 
12

 
3

 
9

Net Sales(1)
$
8,851

 
$
8,496

 
4

 
(1
)
 
5

 
(1) 
Sales to external customers are reflected in the regions based on the reporting entity that records the transaction. U.S. sales include sales of neurovascular and peripheral products exported to customers outside the United States and invoiced in multiple currencies of approximately $80 million and $77 million for the third quarter of fiscal 2012 and 2011, respectively and $234 million and $209 million for the first nine months of fiscal 2012 and 2011, respectively. Accordingly, these U.S. sales are subject to the effects of changes in foreign currency exchange rates.
(2) 
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. We have provided this non-GAAP financial measure because we believe it provides meaningful information regarding our results on a consistent and comparable basis for the periods presented. Management uses this non-GAAP financial measure, in addition to GAAP financial measures, to evaluate our operating results. It is also one of the performance metrics that determines management incentive compensation. This non-GAAP financial measure should be considered supplemental to and not a substitute for our reported financial results prepared in accordance with GAAP.

Cost of goods sold—Cost of goods sold was 42.2% and 41.9% of net sales in the third quarter and first nine months of fiscal 2012, respectively, compared to 42.9% and 43.1% of net sales in the third quarter and first nine months of fiscal 2011, respectively. The decreases in cost of goods sold as a percent of net sales for both fiscal 2012 periods were primarily attributable to favorable mix of businesses and manufacturing cost reductions.

Selling, general and administrative expenses—Selling, general and administrative expenses in the third quarter of fiscal 2012 increased $50 million, or 5.6%, to $936 million, compared with the third quarter of fiscal 2011, and increased $157 million, or 6.0%, to $2.757 billion, compared with the first nine months of fiscal 2011. The increases in selling, general and administrative expenses for both fiscal 2012 periods were primarily due to increased selling and marketing expenses resulting from sales force expansion, primarily in the emerging markets. Separation and transaction costs totaling $27 million and $39 million for the third quarter and first nine months of fiscal 2012, respectively, also contributed to the increase in selling, general and administrative expenses for both current year periods. In addition, legal charges of $47 million recorded during the first nine months of fiscal 2012 related to indemnification obligations for certain claims pertaining to all known pending and estimated future pelvic mesh product liability cases contributed to the increase in selling, general and administrative expenses during the first nine months of fiscal 2012. We expect selling, general and administrative expenses to continue to increase as a result of our recent acquisitions, planned sales and marketing investments to drive our future growth, and the medical device excise tax, which becomes effective in January 2013.

Research and development expenses—Research and development expenses increased $21 million, or 15.2%, to $159 million in the third quarter of fiscal 2012, compared with the third quarter of fiscal 2011, and increased $83 million, or 21.4%, to $470 million in the first nine months of fiscal 2012, compared to the first nine months of fiscal 2011. The increases in research and development expenses for both periods primarily resulted from increased spending within our Medical Devices segment to support our growth initiatives. In addition, the first nine months of fiscal 2012 includes a $12 million upfront

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payment made in connection with a license agreement entered into by our Medical Devices segment. As a percentage of our net sales, research and development expenses was 5.3% for both the third quarter and first nine months of fiscal 2012, compared to 4.7% and 4.6% for the third quarter and first nine months of fiscal 2011, respectively.

Restructuring charges, net—During the third quarter and first nine months of fiscal 2012, we recorded net restructuring and related charges of $29 million and $68 million, respectively, of which charges of $2 million and $11 million, respectively, related to accelerated depreciation and were included in cost of goods sold. The remaining amounts of $27 million and $57 million for the third quarter and first nine months of fiscal 2012, respectively, primarily related to severance and employee benefit costs incurred under our 2011 program.
We recorded net restructuring charges of $32 million and $83 million during the third quarter and first nine months of fiscal 2011, respectively. The charges recorded during the first nine months of fiscal 2011 primarily related to severance and employee benefit costs incurred under our 2009 and 2011 programs and the cancellation of distributor and supplier agreements associated with acquisitions by our Medical Devices segment. In addition, during the first nine months of fiscal 2011, we reversed $16 million of restructuring reserves under our 2009 program, $10 million of which resulted from the determination that one of the restructuring actions within our Medical Supplies segment was no longer cost effective. Additional information regarding our restructuring charges is provided in note 3 to our consolidated financial statements.

Shareholder settlement income—During fiscal 2011, the remaining securities lawsuits were resolved. Accordingly, during the first nine months of fiscal 2011, we recorded income of $11 million related to the reversal of our portion of the remaining reserves that had previously been established.
Operating income—In the third quarter of fiscal 2012, operating income increased $2 million to $617 million, compared with operating income of $615 million in the third quarter of fiscal 2011. The increase in operating income for the third quarter of fiscal 2012 compared with the same prior year period was primarily due to the gross profit resulting from increased sales volume within our Medical Devices segment. This increase to operating income was partially offset by increased selling and marketing expenses resulting from sales force expansion, $30 million of separation and transaction costs incurred during the current quarter and a $21 million increase in research and development expenses.
In the first nine months of fiscal 2012, operating income increased $83 million to $1.862 billion, compared with operating income of $1.779 billion in the first nine months of fiscal 2011. The increase in operating income for the first nine months of fiscal 2012 compared with the same prior year period was primarily due to the gross profit resulting from increased sales volume within our Medical Devices segment. The increase in operating income was partially offset by an $83 million increase in research and development expenses, $47 million of legal charges recorded during the first nine months of fiscal 2012 related to indemnification obligations for certain claims pertaining to all known pending and estimated future pelvic mesh product liability cases and $21 million of separation costs related to the spin-off of our Pharmaceuticals segment.

Analysis of Operating Results by Segment
Net sales by segment are shown in the following table:
 
Quarter Ended
 
Percentage
Change
 
Currency
Impact
 
Operational
Growth
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
Medical Devices
$
2,063

 
$
1,985

 
4
%
 
(4
)%
 
8
%
Pharmaceuticals
501

 
500

 
—

 
(2
)
 
2

Medical Supplies
443

 
441

 
—

 
(2
)
 
2

 
$
3,007

 
$
2,926

 
3

 
(3
)
 
6

 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
Percentage
Change
 
Currency
Impact
 
Operational
Growth
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
Medical Devices
$
6,051

 
$
5,739

 
5
%
 
(2
)%
 
7
%
Pharmaceuticals
1,499

 
1,460

 
3

 
(1
)
 
4

Medical Supplies
1,301

 
1,297

 
—

 
(1
)
 
1

 
$
8,851

 
$
8,496

 
4

 
(1
)
 
5


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Operating income by segment and as a percentage of segment net sales is shown in the following table:
 
 
Quarter Ended
 
Nine Months Ended
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
June 29,
2012
 
June 24,
2011
Medical Devices
$
640

 
31.0
%
 
$
613

 
30.9
%
 
$
1,902

 
31.4
%
 
$
1,777

 
31.0
%
Pharmaceuticals
88

 
17.6

 
80

 
16.0

 
263

 
17.5

 
237

 
16.2

Medical Supplies
52

 
11.7

 
59

 
13.4

 
154

 
11.8

 
181

 
14.0

Operating income of reportable segments
780

 
25.9

 
752

 
25.7

 
2,319

 
26.2

 
2,195

 
25.8

Unallocated amounts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate expenses
(104
)
 
 
 
(105
)
 
 
 
(286
)
 
 
 
(312
)
 
 
Legal charges
—

 
 
 
—

 
 
 
(47
)
 
 
 
—

 
 
Restructuring and related charges, net
(29
)
 
 
 
(32
)
 
 
 
(68
)
 
 
 
(83
)
 
 
Separation costs(1)
(11
)
 
 
 
—

 
 
 
(21
)
 
 
 
—

 
 
Charges associated with acquisitions and licensing arrangement(2) 
(19
)
 
 
 
—

 
 
 
(35
)
 
 
 
(32
)
 
 
Shareholder settlement income
—

 
 
 
—

 
 
 
—

 
 
 
11

 
 
Consolidated operating income
$
617

 
 
 
$
615

 
 
 
$
1,862

 
 
 
$
1,779

 
 
 
(1) 
Amounts represent costs incurred related to the separation of our Pharmaceuticals segment, which are included in selling, general and administrative expenses.
(2) 
Note 2 to our consolidated financial statements provides information regarding current period amounts. Prior year amount represent charges included in cost of goods sold related to the sale of acquired inventory that had been written up to fair value upon acquisition.

Medical Devices

Net sales for Medical Devices by groups of products and by geography for the third quarter of fiscal 2012 and 2011 are as follows:
 
Quarter Ended
 
Percentage
Change
 
Currency
Impact
 
Operational
Growth
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
Endomechanical Instruments
$
600

 
$
593

 
1
 %
 
(5
)%
 
6
 %
Energy Devices
330

 
301

 
10

 
(3
)
 
13

Soft Tissue Repair Products
226

 
229

 
(1
)
 
(5
)
 
4

Vascular Products
418

 
368

 
14

 
(1
)
 
15

Oximetry & Monitoring Products
210

 
211

 
—

 
(2
)
 
2

Airway & Ventilation Products
184

 
183

 
1

 
(3
)
 
4

Other Products
95

 
100

 
(5
)
 
(4
)
 
(1
)
 
$
2,063

 
$
1,985

 
4

 
(4
)
 
8

U.S.
$
952

 
$
874

 
9
 %
 
—
 %
 
9
 %
Non-U.S.
1,111

 
1,111

 
—

 
(6
)
 
6

 
$
2,063

 
$
1,985

 
4

 
(4
)
 
8


Net sales for the third quarter of fiscal 2012 increased $78 million, or 4%, to $2.063 billion, compared with $1.985 billion for the third quarter of fiscal 2011. Unfavorable currency exchange fluctuations lowered net sales by $72 million during the third quarter of fiscal 2012, while acquisitions resulted in an additional $23 million in net sales during the current quarter. The remaining increase in net sales for the segment was driven by increased sales of Vascular Products and Energy Devices. The increase in sales for Vascular Products was primarily due to increased sales of neurovascular products, namely our Pipeline™ Embolization and Solitaire™ FR Revascularization devices. Sales of peripheral vascular products also contributed to the increase, although to a lesser extent, aided by a competitor recall. The increase in Energy Devices sales primarily resulted from higher sales volume of vessel sealing products, most notably in the United States.

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Operating income for the third quarter of fiscal 2012 increased $27 million to $640 million, compared with $613 million for the third quarter of fiscal 2011. Our operating margin was 31.0% for the third quarter of fiscal 2012, compared with 30.9% for the third quarter of fiscal 2011. The increase in our operating income was primarily attributable to increased gross profit on the favorable sales performance for the overall segment discussed above. This increase to operating income was partially offset by an increase in selling and marketing expenses primarily resulting from sales force expansion in the emerging markets and an increase in research and development expenses to support our growth initiatives.

Net sales for Medical Devices by groups of products and by geography for the first nine months of fiscal 2012 and 2011 are as follows:
 
Nine Months Ended
 
Percentage
Change
 
Currency
Impact
 
Operational
Growth
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
Endomechanical Instruments
$
1,758

 
$
1,718

 
2
 %
 
(2
)%
 
4
 %
Energy Devices
969

 
854

 
13

 
(2
)
 
15

Soft Tissue Repair Products
666

 
670

 
(1
)
 
(3
)
 
2

Vascular Products
1,195

 
1,033

 
16

 
—

 
16

Oximetry & Monitoring Products
637

 
627

 
2

 
(1
)
 
3

Airway & Ventilation Products
550

 
554

 
(1
)
 
(2
)
 
1

Other Products
276

 
283

 
(2
)
 
—

 
(2
)
 
$
6,051

 
$
5,739

 
5

 
(2
)
 
7

U.S.
$
2,751

 
$
2,562

 
7
 %
 
—
 %
 
7
 %
Non-U.S.
3,300

 
3,177

 
4

 
(2
)
 
6

 
$
6,051

 
$
5,739

 
5

 
(2
)
 
7


Net sales for the first nine months of fiscal 2012 increased $312 million, or 5%, to $6.051 billion, compared with $5.739 billion for the first nine months of fiscal 2011. Unfavorable currency exchange fluctuations lowered net sales by $78 million during the first nine months of fiscal 2012, while acquisitions resulted in an additional $32 million in net sales during the current period. The remaining increase in net sales for the segment was driven by increased sales of Vascular Products, Energy Devices and Endomechanical Instruments. The increase in sales for Vascular Products was primarily due to increased sales of neurovascular products and, to a lesser extent, peripheral vascular and chronic venous insufficiency products. The increase in Energy Devices sales primarily resulted from higher sales volume of vessel sealing products, most notably in the United States. Finally, the increase in sales of Endomechanical Instruments primarily resulted from higher sales volume of stapling devices, partially offset by a decrease in sales of laparoscopy instruments.

Operating income for the first nine months of fiscal 2012 increased $125 million to $1.902 billion, compared with $1.777 billion for the first nine months of fiscal 2011. Our operating margin was 31.4% for the first nine months of fiscal 2012, compared with 31.0% for the first nine months of fiscal 2011. The increase in our operating income was primarily attributable to increased gross profit on the favorable sales performance for the overall segment discussed above. This increase to operating income was partially offset by an increase in selling and marketing expenses primarily resulting from sales force expansion in the emerging markets and an increase in research and development expenses to support our growth initiatives.



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Pharmaceuticals

Net sales for Pharmaceuticals by groups of products and by geography for the third quarter of fiscal 2012 and 2011 are as follows:
 
Quarter Ended
 
Percentage
Change
 
Currency
Impact
 
Operational
Growth
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
Specialty Pharmaceuticals
$
145

 
$
120

 
21
 %
 
—
 %
 
21
 %
Active Pharmaceutical Ingredients
110

 
107

 
3

 
—

 
3

Contrast Products
129

 
157

 
(18
)
 
(5
)
 
(13
)
Radiopharmaceuticals
117

 
116

 
1

 
(3
)
 
4

 
$
501

 
$
500

 
—

 
(2
)
 
2

U.S.
$
335

 
$
322

 
4
 %
 
—
 %
 
4
 %
Non-U.S.
166

 
178

 
(7
)
 
(7
)
 
—

 
$
501

 
$
500

 
—

 
(2
)
 
2


Net sales of $501 million for the third quarter of fiscal 2012 were relatively level with net sales for the third quarter of fiscal 2011. This increase was primarily driven by increased sales of our branded EXALGO® and PENNSAID® products within Specialty Pharmaceuticals. These increases were offset by decreased sales of Contrast Products primarily resulting from lower sales of Optiray™ contrast agent and the continued impact of the loss of a customer contract.

Operating income for the third quarter of fiscal 2012 increased $8 million to $88 million, compared with $80 million for the third quarter of fiscal 2011. Our operating margin was 17.6% for the third quarter of fiscal 2012, compared with 16.0% for the third quarter of fiscal 2011. The increase in operating income and margin was primarily due to favorable product mix resulting from increased sales of our higher margin branded products. This increase to operating income was partially offset by an increase in general and administrative expenses, primarily resulting from a contract settlement.

Net sales for Pharmaceuticals by groups of products and by geography for the first nine months of fiscal 2012 and 2011 are as follows:
 
Nine Months Ended
 
Percentage
Change
 
Currency
Impact
 
Operational
Growth
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
Specialty Pharmaceuticals
$
421

 
$
357

 
18
 %
 
—
 %
 
18
 %
Active Pharmaceutical Ingredients
326

 
312

 
4

 
(1
)
 
5

Contrast Products
409

 
454

 
(10
)
 
(3
)
 
(7
)
Radiopharmaceuticals
343

 
337

 
2

 
(2
)
 
4

 
$
1,499

 
$
1,460

 
3

 
(1
)
 
4

U.S.
$
1,002

 
$
956

 
5
 %
 
—
 %
 
5
 %
Non-U.S.
497

 
504

 
(1
)
 
(3
)
 
2

 
$
1,499

 
$
1,460

 
3

 
(1
)
 
4


Net sales for the first nine months of fiscal 2012 increased $39 million to $1.499 billion, compared with $1.460 billion for the first nine months of fiscal 2011. This increase was primarily driven by increased sales of our EXALGO® and PENNSAID® branded products within Specialty Pharmaceuticals. These increases were partially offset by decreased sales of Contrast Products primarily resulting from lower sales of Optiray™ contrast agent and the continued impact of the loss of a customer contract.

Operating income for the first nine months of fiscal 2012 increased $26 million to $263 million, compared with $237 million for the first nine months of fiscal 2011. Our operating margin was 17.5% for the first nine months of fiscal 2012, compared with 16.2% for the first nine months of fiscal 2011. The increase in operating income and margin was primarily due to favorable product mix resulting from increased sales of our higher margin branded products. This increase to operating income was partially offset by increases in general and administrative expenses, primarily resulting from higher environmental costs, benefit costs and bad debt expense.

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Table of Contents




Medical Supplies

Net sales for Medical Supplies by groups of products and by geography for the third quarter of fiscal 2012 and 2011 are as follows:
 
Quarter Ended
 
Percentage
Change
 
Currency
Impact
 
Operational
Growth
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
Nursing Care Products
$
205

 
$
199

 
3
 %
 
(1
)%
 
4
 %
Medical Surgical Products
111

 
110

 
1

 
(3
)
 
4

SharpSafety Products
72

 
77

 
(6
)
 
1

 
(7
)
Original Equipment Manufacturer (OEM) Products
55

 
55

 
—

 
(1
)
 
1

 
$
443

 
$
441

 
—

 
(2
)
 
2

U.S.
$
393

 
$
384

 
2
 %
 
—
 %
 
2
 %
Non-U.S.
50

 
57

 
(12
)
 
(10
)
 
(2
)
 
$
443

 
$
441

 
—

 
(2
)
 
2


Net sales of $443 million for the third quarter of fiscal 2012 were relatively level with net sales for the third quarter of fiscal 2011. Increased sales of incontinence products within Nursing Care Products and increased sales of electrodes within Medical Surgical Products were mostly offset by decreased sales of SharpSafety Products.

Operating income for the third quarter of fiscal 2012 decreased $7 million to $52 million, compared with $59 million for the third quarter of fiscal 2011. Our operating margin was 11.7% for the third quarter of fiscal 2012, compared with 13.4% for the third quarter of fiscal 2011. The decrease in operating income and margin primarily resulted from pricing pressure and, to a lesser extent, increased general and administrative costs, largely driven by increased employee benefit costs.

Net sales for Medical Supplies by groups of products and by geography for the first nine months of fiscal 2012 and 2011 are as follows:
 
Nine Months Ended
 
Percentage
Change
 
Currency
Impact
 
Operational
Growth
(Dollars in Millions)
June 29,
2012
 
June 24,
2011
 
Nursing Care Products
$
599

 
$
589

 
2
 %
 
—
 %
 
2
 %
Medical Surgical Products
332

 
323

 
3

 
(1
)
 
4

SharpSafety Products
214

 
226

 
(5
)
 
—

 
(5
)
Original Equipment Manufacturer (OEM) Products
156

 
159

 
(2
)
 
(1
)
 
(1
)
 
$
1,301

 
$
1,297

 
—

 
(1
)
 
1

U.S.
$
1,151

 
$
1,135

 
1
 %
 
—
 %
 
1
 %
Non-U.S.
150

 
162

 
(7
)
 
(5
)
 
(2
)
 
$
1,301

 
$
1,297

 
—

 
(1
)
 
1


Net sales of $1.301 billion for the first nine months of fiscal 2012 were relatively level with net sales for the first nine months of fiscal 2011. Increased sales of incontinence products within Nursing Care and higher sales of electrodes within Medical Surgical Products were mostly offset by decreased sales of SharpSafety Products and, to a much lesser extent, OEM Products.

Operating income for the first nine months of fiscal 2012 decreased $27 million to $154 million, compared with $181 million for the first nine months of fiscal 2011. Our operating margin was 11.8% for the first nine months of fiscal 2012, compared with 14.0% for the first nine months of fiscal 2011. The decrease in operating income and margin primarily resulted from pricing pressure and, to a much lesser extent, increased freight costs.

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Corporate

Corporate expenses were $104 million and $105 million for the third quarter of fiscal 2012 and 2011, respectively, and $286 million and $312 million for the first nine months of fiscal 2012 and 2011, respectively. The decrease in corporate expense for the first nine months of fiscal 2012, compared to the same prior year period was primarily due to lower legal and environmental expenses. The timing of stock-based compensation expense recognition, and an overall decrease in annual stock-based compensation expense, also contributed to the decrease in corporate expenses for the first nine months of fiscal 2012, compared to the same prior year period.

Non-Operating Items

Interest Expense and Interest Income

During the third quarter of fiscal 2012 and 2011, interest expense was $53 million and $51 million, respectively. Interest income was $1 million and $6 million for the third quarter of fiscal 2012 and 2011, respectively. During the first nine months of fiscal 2012 and 2011, interest expense was $155 million and $153 million, respectively. Interest income was $13 million and $17 million for the first nine months of fiscal 2012 and 2011, respectively.

Other Income (Expense), net
During the third quarter and first nine months of fiscal 2012, we recorded other income, net of $12 million and $18 million, respectively. Other income, net for the third quarter and first nine months of fiscal 2012 includes income of $16 million and $23 million, respectively, and corresponding increases to our receivable from Tyco International Ltd. and TE Connectivity Ltd. These amounts reflect 58% of the interest and other income taxes payable amounts recorded that are subject to the Tax Sharing Agreement. Other income, net for both the third quarter and first nine months of fiscal 2012 also include a $9 million loss on early retirement of debt, which is discussed in Liquidity and Capital Resources—Capitalization, partially offset by a gain on investments.

During the third quarter of fiscal 2011, we recorded other expense, net of $12 million, which includes expense of $13 million and a corresponding decrease to our receivable from Tyco International and TE Connectivity. During the first nine months of fiscal 2011, we recorded other income of $7 million and a corresponding increase to our receivable from Tyco International and TE Connectivity. These amounts reflect 58% of interest and other income taxes payable recorded and/or released during each period that will be subject to the Tax Sharing Agreement. The $7 million of income recorded during the first nine months of fiscal 2011 was offset by a $7 million net loss on investments.

Income Tax Expense

Income tax expense was $124 million and $26 million on income from continuing operations before income taxes of $577 million and $558 million for the third quarter of fiscal 2012 and 2011, respectively. This resulted in effective tax rates of 21.5% and 4.7% for the third quarter of fiscal 2012 and 2011, respectively. Income tax expense was $300 million and $220 million on income from continuing operations before income taxes of $1.738 billion and $1.643 billion for the first nine months of fiscal 2012 and 2011, respectively. This resulted in effective tax rates of 17.3% and 13.4% for the first nine months of fiscal 2012 and 2011, respectively. The increases in the effective tax rates for the third quarter and first nine months of fiscal 2012, compared to the comparative prior year periods primarily resulted from a favorable settlement reached with certain non-U.S. taxing authorities in the prior year periods, compared to an unfavorable settlement reached with certain non-U.S. taxing authorities in the current year periods. The release of certain U.S. and non-U.S. uncertain tax positions due to statute expirations, which occurred in the prior year periods, also contributed to the increase in the effective tax rates in the current year. In addition, the expiration of the U.S. research and development credit as of December 31, 2011 and the retroactive re-enactment of the 2010 credit during the first quarter of fiscal 2011, contributed to the increase in the current year effective tax rates. These increases were partially offset by the implementation of tax planning strategies, including the release of a valuation allowance.



41
Table of Contents


Liquidity and Capital Resources

Our ability to fund our capital needs will be affected by our ongoing ability to generate cash from operations and access to the capital markets. We believe, however, that our cash balances and other sources of liquidity, primarily our committed credit facility, will be sufficient to allow us to fund operations for the foreseeable future and continue to invest in growth opportunities.

Nine Months Ended June 29, 2012 Cash Flow Activity

The net cash provided by operating activities of $1.637 billion was primarily attributable to income from continuing operations, as adjusted for depreciation and amortization, partially offset by a net change in working capital of $304 million, driven largely by a decrease in accrued and other liabilities of $235 million and an increase in inventory of $208 million. The decrease in accrued and other liabilities was largely driven by bonus payments, interest payments and payments made under the Tax Sharing Agreement. In fiscal 2012, we expect to make net indemnification payments totaling approximately $53 million related to pre-separation tax matters under the Tax Sharing Agreement, of which a net payment of $34 million was made during the first nine months of fiscal 2012. In addition, at the end of June 2012, we collected $248 million from the Spanish government, which related to 2011 and prior invoices.

The net cash used in investing activities of $1.462 billion was primarily due to acquisition-related payments of $1.063 billion and capital expenditures of $378 million. For the full year fiscal 2012, we expect capital expenditures to be in the range of $500 to $525 million.

The net cash provided by financing activities of $270 million was primarily the result of net proceeds from the issuance of debt of $1.240 billion and net proceeds from the issuance of commercial paper of $136 million. These amounts were partially offset by the repayment of debt of $552 million, share repurchases of $385 million and dividend payments of $326 million.

Capitalization

Shareholders’ equity was $10.712 billion, or $22.35 per share, at June 29, 2012, compared with $9.817 billion, or $20.37 per share, at September 30, 2011. The increase in shareholders’ equity was primarily due to net income of $1.444 billion, partially offset by the repurchase of shares of $385 million and dividends declared of $217 million.

The following table contains several key measures to gauge our financial condition and liquidity at June 29, 2012:
(Dollars in Millions)
June 29,
2012
 
September 30,
2011
Cash and cash equivalents
$
1,935

 
$
1,503

Current maturities of long-term debt
511

 
11

Long-term debt
4,574

 
4,197

Total debt
5,085

 
4,208

Shareholders’ equity
10,712

 
9,817

Debt-to-total capital ratio
32
%
 
30
%
On May 22, 2012, CIFSA issued $600 million aggregate principal amount of 1.35% senior notes due May 2015 and $650 million aggregate principal amount of 3.20% senior notes due June 2022. The notes are fully and unconditionally guaranteed by both Covidien plc and Covidien Ltd. The net proceeds of approximately $1.24 billion were used to fund the redemption of all of its outstanding 5.45% senior notes due October 2012 and for general corporate purposes.

We are required to maintain an available unused balance under our $1.5 billion revolving credit facility sufficient to support amounts outstanding under our commercial paper program. At June 29, 2012, we had $251 million of commercial paper outstanding and no borrowings outstanding under the credit facility.

Our credit facility agreement contains a covenant limiting our ratio of debt to earnings before interest, income taxes, depreciation and amortization. In addition, the agreement contains other customary covenants, none of which we consider restrictive to our operations. We are currently in compliance with all of our debt covenants.


42
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Dividends

Dividend payments totaled $326 million for the first nine months of fiscal 2012. On July 18, 2012, the Board of Directors declared a quarterly cash dividend of $0.225 per share to shareholders of record at the close of business on July 30, 2012. The dividend is payable on August 16, 2012.

Commitments and Contingencies

Legal Proceedings

We are subject to various legal proceedings and claims, including patent infringement claims, product liability matters, environmental matters, employment disputes, disputes on agreements and other commercial disputes, as described in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011. We believe 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 our experience, current information and applicable law, we do not expect that these proceedings will have a material adverse effect on our financial condition. However, one or more of the proceedings could have a material adverse effect on our results of operations or cash flows for a future period. Further information regarding our legal proceedings is provided in note 15 to our consolidated financial statements and in Part II, Item 1 of this 10-Q.

Income Taxes

Our income tax returns are periodically examined by various tax authorities. The IRS continues to examine our U.S. federal income tax returns for the years 2008 and 2009. Open periods for examination also include certain periods during which we were a subsidiary of Tyco International. The resolution of the matters arising during periods in which we were a Tyco International subsidiary is subject to the conditions set forth in the Tax Sharing Agreement discussed in note 14 to our consolidated financial statements. Tyco International has the right to administer, control and settle all U.S. income tax audits for periods prior to the separation. We have potential liabilities related to these income tax returns and have included our best estimate of potential liabilities for these years within our current and non-current taxes payable. With respect to these potential income tax liabilities from all of these years, we believe that the amounts recorded in our consolidated financial statements as current or non-current taxes payable are adequate.

In accordance with the Tax Sharing Agreement, we share certain contingent liabilities relating to unresolved tax matters of Tyco International for periods prior to the separation, with Covidien assuming 42%, Tyco International 27% and TE Connectivity 31% of the total amount. We are the primary obligor to the taxing authorities for $1.707 billion of contingent tax liabilities that are recorded on the consolidated balance sheet at June 29, 2012, $1.124 billion of which relates to periods prior to the separation and which is shared with Tyco International and TE Connectivity pursuant to the Tax Sharing Agreement. The actual amounts that we may be required to ultimately accrue or pay under the Tax Sharing Agreement could vary depending upon the outcome of the unresolved tax matters, some of which may not be resolved for several years.

In addition, pursuant to the terms of the Tax Sharing Agreement, we have recorded a receivable from Tyco International and TE Connectivity of $602 million as of June 29, 2012, substantially all of which is non-current. This amount primarily reflects 58% of our contingent tax liabilities that are subject to the Tax Sharing Agreement. If Tyco International and TE Connectivity default on their obligations to us under the Tax Sharing Agreement, however, we would be liable for the entire amount of such liabilities. 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 our income tax returns for years after 2000. Tyco International has appealed certain of the tax adjustments proposed by the IRS and we believe that some of these adjustments relating to certain Tyco International subsidiaries are likely to be resolved within the next 12 months. With respect to other adjustments, Tyco International has indicated that settlement is unlikely. In the event that Tyco International is unable to resolve these issues in the IRS administrative process, Tyco International will likely contest certain adjustments related to disallowed deductions through litigation. While we believe that the amounts recorded as non-current taxes payable or guaranteed contingent tax liabilities related to these adjustments are adequate, the timing and outcome of such litigation is highly uncertain and could have a significant effect on our consolidated financial statements.

The IRS continues to audit certain of Tyco International’s U.S. federal income tax returns for the years 2001 through 2004 and the 2005 through 2007 audit cycles. Tyco International and the IRS have entered into settlements related to certain outstanding tax matters arising in these audit cycles, which otherwise remain open and subject to examination and resolution of other matters.


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The resolution of tax matters arising from the 1997 through 2007 U.S. audits, non-U.S. audits, and other settlements or statute of limitations expirations, could result in a significant change in our unrecognized tax benefits. However, we do not expect that the total amount of unrecognized tax benefits will significantly change over the next 12 months.

Guarantees

Pursuant to the Separation and Distribution Agreement and Tax Sharing Agreement, we entered into certain guarantee commitments and indemnifications with Tyco International and TE Connectivity. These guarantee arrangements and indemnifications primarily relate to certain contingent tax liabilities; we assumed and are responsible for 42% of these liabilities. Regarding the guarantees, if any of the companies responsible for all or a portion of such liabilities were to default in its payment of costs related to any such liability, we would be responsible for a portion of the defaulting party or parties’ obligation. These arrangements were valued upon our separation from Tyco International using appraisals and a liability related to these guarantees was recorded on our balance sheet, the offset of which was reflected as a reduction in shareholders’ equity.

Each reporting period, we evaluate the potential loss which we believe is probable as a result of our commitments under the Agreements. To the extent such potential loss exceeds the amount recorded on our balance sheet, an adjustment will be required to increase the recorded liability to the amount of such potential loss. This guarantee is not amortized because no predictable pattern of performance currently exists. As a result, the liability generally will be reduced upon release from our obligations under the Agreements, which may not occur for some years. In addition, as payments are made to indemnified parties, such payments are recorded as reductions to the liability and the impact of such payments is considered in the periodic evaluation of the sufficiency of the liability. Current and non-current liabilities totaling $613 million and $660 million relating to these guarantees were included on our consolidated balance sheet at June 29, 2012 and September 30, 2011, respectively.

In disposing of assets or businesses, we often provide representations, warranties and indemnities to cover various risks, 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 and legal fees related to periods prior to disposition. Except as discussed below, we generally do not have the ability to estimate the potential liability from such indemnities because they relate to unknown conditions. However, we have no reason to believe that these uncertainties would have a material adverse effect on our results of operations, financial condition or cash flows.

In connection with the sale of our Specialty Chemicals business, we provided the purchaser with an indemnification for various risks, including environmental, health, safety, tax and other matters, some of which have an indefinite term. However, the most significant portion of this indemnification relates to environmental, health and safety matters, which has a term of 17 years. A liability of $22 million relating to this indemnification was included on our consolidated balance sheet at both June 29, 2012 and September 30, 2011. The value of the environmental, health and safety guarantee was measured based on the probability-weighted present value of the costs expected to be incurred to address environmental claims proposed under the indemnity. The maximum future payments we could be required to make under the indemnification provided to the purchaser is $79 million. In addition, we were required to pay $30 million into an escrow account as collateral, of which $26 million remained in other assets on the consolidated balance sheet at June 29, 2012.

We have recorded liabilities for known indemnifications included as part of environmental liabilities, which are discussed in note 15 to our consolidated financial statements. In addition, we are liable for product performance; however in the opinion of management, such obligations will not significantly affect our results of operations, financial condition or cash flows.

Contingent Consideration
In connection with certain of our acquisitions completed in fiscal 2012, we may be required to pay future consideration that is contingent upon the achievement of certain revenue, regulatory or commercialization based milestones. As of the respective acquisition dates, we recorded contingent liabilities representing the estimated fair value of the contingent consideration we expected to pay to the former shareholders of the acquired businesses. We remeasure these liabilities each reporting period and record changes in the fair value in our consolidated statements of income. Increases or decreases in the fair value of the contingent consideration liability can result from changes in the timing and amount of revenue estimates or changes in the expected probability and timing of achieving regulatory or commercialization milestones, as well as changes in discount rates. During the third quarter and first nine months of fiscal 2012, we recorded expense of $4 million and $5 million, respectively, representing the increase in the estimated fair value of these obligations.


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Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to use judgment in making estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities.

We believe that our accounting policies for revenue recognition, inventories, property, plant and equipment, intangible assets, business combinations, goodwill, contingencies, pension and postretirement benefits, guarantees and income taxes are based on, among other things, judgments and assumptions made by management that include inherent risks and uncertainties. There have been no significant changes to the above critical accounting policies or in the underlying accounting assumptions and estimates used in such policies from those disclosed in our annual consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011.

Recently Issued Accounting Pronouncements

In June 2011, the FASB issued an amendment to the requirements for presentation of comprehensive income. Under this amendment, we can elect to present items of net income and other comprehensive income in a single continuous statement or in two separate, but consecutive, statements. We are required to comply with this new requirement beginning in the first quarter of fiscal 2013.

In September 2011, the FASB issued an amendment to goodwill impairment testing. This amendment permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. We are required to comply with this amendment beginning in the first quarter of fiscal 2013.



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FORWARD-LOOKING STATEMENTS

We have made forward-looking statements in this report that are based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, potential growth opportunities, potential operating performance improvements, the effects of competition, and the effects of future legislation or regulations. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words “believe,” “expect,” “plan,” “intend,” “anticipate,” “estimate,” “predict,” “potential,” “continue,” “may,” “should” or the negative of these terms or similar expressions.

Forward-looking statements involve risks, uncertainties and assumptions. Actual results may differ materially from those expressed in these forward-looking statements. You should not put undue reliance on any forward-looking statements.

The risk factors discussed in “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011 and in this Quarterly Report could cause our results to differ materially from those expressed in forward-looking statements. There may be other risks and uncertainties that we are unable to predict at this time or that we currently do not expect to have a material adverse effect on our business. We expressly disclaim any obligation to update these forward-looking statements other than as required by law.

Item 3.
Quantitative and Qualitative Disclosures about Market Risk

There have been no significant changes in our exposures to market risk during the first nine months of fiscal 2012. Refer to “Part II. Item 7A. Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011 for further discussion of our exposures to market risk.

Item 4.
Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the specified time periods, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of that date, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended June 29, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II. OTHER INFORMATION

Item 1.
Legal Proceedings

We are subject to various legal proceedings and claims, including patent infringement claims, product liability matters, environmental matters, employment disputes, disputes on agreements and other commercial disputes, as described in our Annual Report on form 10-K for the fiscal year ended September 30, 2011. There were no material developments during the quarter ended June 29, 2012 related to previously described legal proceedings; however, during the quarter ended June 29, 2012, a subsidiary of the Company received a notice letter from the United States Environmental Protection Agency (EPA), which is discussed below.

A subsidiary of the Company, Mallinckrodt Inc. (now known as Mallinckrodt LLC), received from the EPA on April 11, 2012, a notice of a proposed penalty in connection with alleged violations of the Resource Conservation and Recovery Act (RCRA) for “Operating as a Treatment, Storage, or Disposal facility without a RCRA permit for failing to comply with generator requirements pursuant to RCRA §3005” arising from a RCRA inspection conducted at its St. Louis, MO facility. The EPA proposed a civil penalty of $581,951.  The Company disputes the allegations and has provided information to the EPA challenging its proposed penalty. The Company is currently in discussions with EPA to resolve this matter.


Item 1A.
Risk Factors

There have been no significant changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011. Please refer to the “Risks Factors” section in our Annual Report for a discussion of risks to which our business, financial condition, results of operations and cash flows are subject.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities
Period
Total Number
of Shares
Purchased
 
Average
Price
Paid per
Share
 
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
 
Maximum Approximate
Dollar Value of
Shares that May Yet Be
Purchased Under
Publicly Announced
Plans or Programs
03/31/12 - 04/27/12

—

 
$
—

 
—

 
$
1,650,419,804

04/28/12 - 06/01/12

1,798,033

 
$
54.28

 
1,798,033

 
$
1,552,814,257

06/02/12 - 06/29/12

2,492,870

 
$
51.87

 
2,492,870

 
$
1,423,502,185


Item 3.
Defaults Upon Senior Securities

None.

Item 5.
Other Information

None.



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Item 6.
Exhibits

Exhibit
Number
  
Exhibit
 
 
31.1
  
Certification by the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
 
 
31.2
  
Certification by the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
 
 
32.1
  
Certification by the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
 
 
101
  
The following materials from the Covidien plc Quarterly Report on Form 10-Q for the quarterly period ended June 29, 2012 formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Statements of Income, (ii) the Consolidated Balance Sheets, (iii) the Consolidated Statements of Cash Flows and (iv) related notes.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
 
COVIDIEN PUBLIC LIMITED COMPANY
 
 
 
 
By: 
/s/ Richard G. Brown, Jr.
 
 
Richard G. Brown, Jr.
Vice President, Chief Accounting Officer and
Corporate Controller
 
 
 
 
 
/s/ Charles J. Dockendorff
 
 
Charles J. Dockendorff
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)

Date: August 6, 2012

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