Form 10-Q
Table of Contents

 

 

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 24, 2011

or

 

¨ 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  ¨

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  ¨

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   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of ordinary shares outstanding as of July 22, 2011 was 493,441,175.

 

 

 


Table of Contents

COVIDIEN PLC

INDEX TO FORM 10-Q

 

         Page  

Part I.

  Financial Information   

Item 1.

  Financial Statements      2   
 

Consolidated Statements of Income for the Quarters and Nine Months Ended June 24, 2011 and  June 25, 2010

     2   
 

Consolidated Balance Sheets as of June 24, 2011 and September 24, 2010

     3   
 

Consolidated Statements of Cash Flows for the Nine Months Ended June 24, 2011 and
June 25, 2010

     4   
  Notes to Consolidated Financial Statements      5   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      29   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      43   

Item 4.

  Controls and Procedures      43   

Part II.

  Other Information   

Item 1.

  Legal Proceedings      45   

Item 1A.

  Risk Factors      45   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      45   

Item 3.

  Defaults Upon Senior Securities      45   

Item 5.

  Other Information      45   

Item 6.

  Exhibits      45   
Signatures      46   

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

COVIDIEN PLC

CONSOLIDATED STATEMENTS OF INCOME

Quarters and Nine Months Ended June 24, 2011 and June 25, 2010

(in millions, except per share data)

 

     Quarters Ended     Nine Months Ended  
     June 24,
2011
    June 25,
2010
    June 24,
2011
    June 25,
2010
 

Net sales

   $ 2,926      $ 2,564      $ 8,496      $ 7,759   

Cost of goods sold

     1,255        1,138        3,658        3,421   
                                

Gross profit

     1,671        1,426        4,838        4,338   

Selling, general and administrative expenses

     886        753        2,600        2,341   

Research and development expenses

     138        109        387        321   

Restructuring charges, net

     32        25        83        56   

Shareholder settlement income

     —          —          (11     —     
                                

Operating income

     615        539        1,779        1,620   

Interest expense

     (51     (54     (153     (140

Interest income

     6        6        17        17   

Other (expense) income, net

     (12     21        —          49   
                                

Income from continuing operations before income taxes

     558        512        1,643        1,546   

Income tax expense

     26        160        220        371   
                                

Income from continuing operations

     532        352        1,423        1,175   

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

     3        12        (6     14   
                                

Net income

   $ 535      $ 364      $ 1,417      $ 1,189   
                                

Basic earnings per share:

        

Income from continuing operations

   $ 1.08      $ 0.70      $ 2.88      $ 2.35   

Income (loss) from discontinued operations

     0.01        0.02        (0.01     0.03   

Net income

     1.08        0.73        2.86        2.38   

Diluted earnings per share:

        

Income from continuing operations

   $ 1.06      $ 0.70      $ 2.85      $ 2.33   

Income (loss) from discontinued operations

     0.01        0.02        (0.01     0.03   

Net income

     1.07        0.72        2.84        2.36   

Weighted-average number of shares outstanding:

        

Basic

     495        501        495        500   

Diluted

     500        504        499        505   

Cash dividends declared per ordinary share

   $ —        $ —        $ 0.40      $ 0.36   

See Notes to Consolidated Financial Statements.

 

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Table of Contents

COVIDIEN PLC

CONSOLIDATED BALANCE SHEETS

At June 24, 2011 and September 24, 2010

(in millions, except share data)

 

     June 24,
2011
    September 24,
2010
 

Assets

    

Current Assets:

    

Cash and cash equivalents

   $ 1,755      $ 1,565   

Accounts receivable trade, less allowance for doubtful accounts of $44 and $73

     1,880        1,708   

Inventories

     1,528        1,381   

Prepaid expenses and other current assets

     838        841   

Due from former parent and affiliate

     149        245   
                

Total current assets

     6,150        5,740   

Property, plant and equipment, net

     2,685        2,608   

Goodwill

     7,700        7,675   

Intangible assets, net

     2,823        2,949   

Due from former parent and affiliate

     609        479   

Other assets

     766        936   
                

Total Assets

   $ 20,733      $ 20,387   
                

Liabilities and Shareholders’ Equity

    

Current Liabilities:

    

Current maturities of long-term debt

   $ 96      $ 255   

Accounts payable

     603        586   

Accrued and other current liabilities

     1,381        1,630   

Income taxes payable

     288        547   

Guaranteed contingent tax liabilities

     162        108   
                

Total current liabilities

     2,530        3,126   

Long-term debt

     4,070        4,451   

Income taxes payable

     1,622        1,565   

Guaranteed contingent tax liabilities

     554        608   

Other liabilities

     1,714        1,663   
                

Total Liabilities

     10,490        11,413   

Commitments and contingencies (note 14)

    

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; 513,123,846 and 507,245,024 issued

     103        101   

Ordinary shares held in treasury at cost; 20,120,145 and 12,164,018

     (859     (484

Additional paid-in capital

     6,812        6,563   

Retained earnings

     3,663        2,444   

Accumulated other comprehensive income

     524        350   
                

Total Shareholders’ Equity

     10,243        8,974   
                

Total Liabilities and Shareholders’ Equity

   $ 20,733      $ 20,387   
                

See Notes to Consolidated Financial Statements.

 

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COVIDIEN PLC

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended June 24, 2011 and June 25, 2010

(in millions)

 

     Nine Months Ended  
     June 24,
2011
    June 25,
2010
 

Cash Flows From Operating Activities:

    

Net income

   $ 1,417      $ 1,189   

Loss (income) from discontinued operations, net of income taxes

     6        (14
                

Income from continuing operations

     1,423        1,175   

Adjustments to reconcile net cash provided by continuing operating activities:

    

Depreciation and amortization

     440        349   

Share-based compensation

     79        68   

Deferred income taxes

     36        65   

Provision for losses on accounts receivable and inventory

     54        63   

Change in receivable from former parent and affiliate related to Tax Sharing Agreement

     (7     (48

Other non-cash items

     16        25   

Changes in assets and liabilities, net of the effects of acquisitions and divestitures:

    

Accounts receivable, net

     (84     (54

Inventories

     (175     (91

Accounts payable

     9        37   

Income taxes

     (60     162   

Accrued and other liabilities

     (90     (110

Other

     (32     (166
                

Net cash provided by continuing operating activities

     1,609        1,475   
                

Cash Flows From Investing Activities:

    

Capital expenditures

     (303     (273

Sale of investments

     14        7   

Acquisition-related payments, net of cash acquired

     (13     (189

Acquisition of licenses and technology

     (4     (70

Interest in class action settlement fund

     —          (33

Divestitures

     —          18   

Other

     (9     6   
                

Net cash used in continuing investing activities

     (315     (534
                

Cash Flows From Financing Activities:

    

Net repayment of commercial paper

     (307     (1

Repayment of debt

     (254     (87

Dividends paid

     (297     (270

Repurchase of shares

     (378     (78

Proceeds from exercise of share options

     164        105   

Payment of contingent consideration

     (71     —     

Other

     13        (4
                

Net cash used in continuing financing activities

     (1,130     (335
                

Discontinued Operations:

    

Net cash provided by discontinued operating activities

     —          43   

Net cash used in discontinued investing activities

     —          (9
                

Net cash provided by discontinued operations

     —          34   
                

Effect of currency rate changes on cash

     26        16   
                

Net increase in cash and cash equivalents

     190        656   

Cash and cash equivalents at beginning of period

     1,565        1,467   
                

Cash and cash equivalents at end of period

   $ 1,755      $ 2,123   
                

See Notes to Consolidated Financial Statements.

 

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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 24, 2010.

2. Discontinued Operations

Specialty Chemicals business—During fiscal 2010, the Company sold its Specialty Chemicals business, which was included in discontinued operations. The Company recorded a $4 million pre-tax charge in discontinued operations for pension settlements related to employees of this business in the first nine months of fiscal 2011.

Plastics, Adhesives, Ludlow Coated Products and A&E Products businesses—During the third quarter of fiscal 2011 and 2010, the Company recorded tax benefits of $3 million and $4 million, respectively. In addition, during the first nine months of fiscal 2011 and 2010, the Company recorded tax provisions of $4 million and $11 million, respectively. These amounts resulted from adjustments to certain income tax liabilities associated with the Plastics, Adhesives, Ludlow Coated Products and A&E Products businesses that were sold in fiscal 2006 prior to the Company’s separation from Tyco International Ltd.

Net sales, income from operations and loss on disposition of discontinued operations are as follows:

 

     Quarters Ended      Nine Months Ended  

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
     June 24,
2011
    June 25,
2010
 

Net sales

   $ —         $ 109       $ —        $ 325   
                                  

Income from operations, net of income tax provision of $—, $7,
$— and $24

   $ —         $ 12       $ —        $ 29   

Gain (loss) on disposition, net of income tax (benefit) provision
of $(3), $(4), $2 and $11

     3         —           (6     (15
                                  

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

   $ 3       $ 12       $ (6   $ 14   
                                  

3. Restructuring Charges, Net

During the third quarter of 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 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.

 

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Table of Contents

COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

In fiscal 2007 and 2009, the Company launched restructuring programs, also designed to improve the Company’s cost structure. The Company expects to incur total charges of approximately $200 million under the 2009 program, which are recorded as the specific actions required to execute on these initiatives are identified and approved. As of June 24, 2011, the Company had incurred $158 million of net restructuring charges under the 2009 program since its inception and expects to incur most of the remaining charges by the end of 2011. The 2007 program is substantially completed. These programs exclude restructuring actions associated with acquisitions.

Restructuring charges, net, including associated asset impairments and actions associated with acquisitions, by segment are as follows:

 

     Quarters Ended      Nine
Months Ended
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
     June 24,
2011
     June 25,
2010
 

Medical Devices

   $ 19       $ 6       $ 79       $ 19   

Pharmaceuticals

     —           5         —           7   

Medical Supplies

     10         13         —           31   

Corporate

     3         1         4         (1
                                   

Total restructuring charges, net

   $ 32       $ 25       $ 83       $ 56   
                                   

Restructuring charges, net are comprised of the following:

 

     Quarters Ended      Nine
Months Ended
 

(Dollars in Millions)

   June 24,
2011
    June 25,
2010
     June 24,
2011
    June 25,
2010
 

Acquisition-related restructuring actions

   $ 4      $ 2       $ 26      $ 8   

2011 program

     15        —           15        —     

2009 program

     13        23         43        46   

2007 program

     —          —           (1     2   
                                 

Total restructuring charges, net

     32        25         83        56   

Less: non-cash charges

     (2     —           (4     (1
                                 

Total charges expected to be settled in cash

   $ 30      $ 25       $ 79      $ 55   
                                 

The following table summarizes cash activity for restructuring reserves related to acquisitions for the nine months ended June 24, 2011:

 

(Dollars in Millions)

   Employee
Severance
and
Benefits
    Other(1)     Total  

Balance at September 24, 2010

   $ 9      $ 2      $ 11   

Charges

     9        19        28   

Changes in estimate

     (1     (1     (2

Cash payments

     (5     (17     (22
                        

Balance at June 24, 2011

   $ 12      $ 3      $ 15   
                        

 

(1) 

Substantially all of these amounts relate to the cancellation of distributor and supplier agreements.

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table summarizes cash activity for restructuring reserves related to the 2011, 2009 and 2007 programs, substantially all of which relates to employee severance and benefits, for the nine months ended June 24, 2011:

 

(Dollars in Millions)

   2011 Program      2009 Program     2007 Program     Total  

Balance at September 24, 2010

   $ —         $ 55      $ 11      $ 66   

Charges

     13         57        —          70   

Changes in estimate

     —           (16     (1     (17

Cash payments

     —           (34     (4     (38

Currency translation

     —           —          1        1   
                                 

Balance at June 24, 2011

   $ 13       $ 62      $ 7      $ 82   
                                 

During the first nine months of fiscal 2011, the Company reversed $16 million of restructuring reserves under the 2009 program, $10 million of which resulted from the determination that one of the restructuring actions within the Medical Supplies segment was no longer cost effective.

Restructuring reserves are reported on the Company’s consolidated balance sheets as follows:

 

(Dollars in Millions)

   June 24,
2011
     September 24,
2010
 

Accrued and other current liabilities

   $ 54       $ 62   

Other liabilities

     43         15   
                 

Restructuring reserves

   $ 97       $ 77   
                 

4. Other (Expense) Income, Net

 

     Quarters Ended     Nine Months Ended  

(Dollars in Millions)

   June 24,
2011
    June 25,
2010
    June 24,
2011
    June 25,
2010
 

(Loss) income under Tax Sharing Agreement (note 13)

   $ (13   $ 22      $ 7      $ 48   

Income (loss) on investments, net

     1        (1     (7     1   
                                

Other (expense) income, net

   $ (12   $ 21      $ —        $ 49   
                                

(Loss) income under Tax Sharing Agreement represents the decrease or increase to the receivable from Tyco International and TE Connectivity Ltd. (formerly Tyco Electronics Ltd.). These amounts reflect 58% of the interest and other income tax payable amounts released and/or recorded during each period that will be subject to the Tax Sharing Agreement.

5. Earnings Per Share

The weighted-average ordinary shares used in the computations of basic and diluted earnings per share were as follows:

 

     Quarters Ended      Nine Months Ended  

(in Millions)

   June 24,
2011
     June 25,
2010
     June 24,
2011
     June 25,
2010
 

Basic shares

     495         501         495         500   

Effect of share options and restricted shares

     5         3         4         5   
                                   

Diluted shares

     500         504         499         505   
                                   

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

For the quarter and nine months ended June 24, 2011, approximately 2 million and 7 million, respectively, of options and restricted share awards were not included in the computation of diluted earnings per share, 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 25, 2010 approximately 10 million and 8 million, respectively, of options and restricted share awards were not included in the computation of diluted earnings per share, 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:

 

     Quarters Ended     Nine Months Ended  

(Dollars in Millions)

   June 24,
2011
    June 25,
2010
    June 24,
2011
    June 25,
2010
 

Net income

   $ 535      $ 364      $ 1,417      $ 1,189   

Currency translation

     53        (150     174        (364

Unrealized gain on derivatives, net of income taxes

     1        2        5        2   

Change related to benefit plans, net of income taxes

     (1     (1     (5     1   
                                

Total comprehensive income

   $ 588      $ 215      $ 1,591      $ 828   
                                

7. Inventories

Inventories were comprised of the following at the end of each period:

 

(Dollars in Millions)

   June 24,
2011
     September 24,
2010
 

Purchased materials and manufactured parts

   $ 328       $ 283   

Work in process

     339         315   

Finished goods

     861         783   
                 

Inventories

   $ 1,528       $ 1,381   
                 

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 24, 2010

   $ 6,778       $ 508       $ 389       $ 7,675   

Currency translation and other

     25         —           —           25   
                                   

Goodwill at June 24, 2011

   $ 6,803       $ 508       $ 389       $ 7,700   
                                   

 

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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 24, 2011      September 24, 2010  

(Dollars in Millions)

   Gross
Carrying
Amount
     Accumulated
Amortization
     Gross
Carrying
Amount
     Accumulated
Amortization
 

Amortizable:

           

Completed technology

   $ 2,199       $ 734       $ 2,129       $ 620   

Customer relationships

     804         98         801         64   

Other

     331         128         323         110   
                                   

Total

   $ 3,334       $ 960       $ 3,253       $ 794   
                                   

Non-Amortizable:

           

Trademarks

   $ 359          $ 356      

In-process research and development

     90            134      
                       

Total

   $ 449          $ 490      
                       

Intangible asset amortization expense for the quarters ended June 24, 2011 and June 25, 2010 was $51 million and $29 million, respectively. Intangible asset amortization expense for the nine months ended June 24, 2011 and June 25, 2010 was $150 million and $83 million, respectively.

9. Retirement Plans

The net periodic benefit cost for the Company’s defined benefit pension plans was as follows:

 

     Quarters Ended     Nine Months Ended  

(Dollars in Millions)

   June 24,
2011
    June 25,
2010
    June 24,
2011
    June 25,
2010
 

Service cost

   $ 5      $ 5      $ 16      $ 15   

Interest cost

     11        12        33        36   

Expected return on plan assets

     (10     (10     (32     (31

Amortization of net actuarial loss

     6        6        18        17   

Amortization of prior service cost

     —          —          —          1   

Settlements and curtailments

     1        5        9        5   
                                

Net periodic benefit cost

   $ 13      $ 18      $ 44      $ 43   
                                

The net periodic benefit cost for postretirement benefit plans for the quarters and nine months ended June 24, 2011 and June 25, 2010 was not material.

10. Guarantees

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 13.

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

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 24, 2011 and September 24, 2010. 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 $82 million. In addition, the Company was required to pay $30 million into an escrow account as collateral, which is included in other assets on the consolidated balance sheet.

The Company has recorded liabilities for known indemnifications included as part of environmental liabilities, which are discussed in note 14. 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.

11. Derivative Instruments

The Company is exposed to certain risks relating to its business operations. Risks that relate to interest rate exposure, foreign exchange exposure and certain commodity price exposures are managed by using derivative instruments. The Company uses interest rate swaps to manage interest rate exposure. Foreign currency option and forward contracts are used to economically manage the foreign exchange exposures of operations outside the United States. Swap contracts on commodities are periodically entered into to manage the price risk associated with forecasted purchases of commodities used in the Company’s manufacturing processes.

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

Fair Value Hedges—The Company manages interest rate exposure through the use of interest rate swap transactions with financial institutions acting as principal counterparties to convert a portion of fixed-rate debt to variable-rate debt. These transactions are designated as fair value hedges. During the first nine months of fiscal 2011, the Company entered into interest rate swaps on $300 million principal amount of its 6.0% senior notes due 2017. Under these contracts, the Company receives fixed amounts of interest applicable to the underlying notes and pays a floating amount based upon the three month U.S. Dollar London interbank offered rate. The fair

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

value of the interest rate swaps as of June 24, 2011 was $11 million. The location and amount of gain (loss) on the hedged fixed-rate debt attributable to changes in the market interest rates and the offsetting gain (loss) on the related interest rate swaps were as follows:

 

     Gain (loss) on swaps      Gain (loss) on borrowings  

(Dollars in Millions)

   Quarter Ended
June 24, 2011
     Nine Months Ended
June  24, 2011
     Quarter Ended
June 24, 2011
    Nine Months Ended
June  24, 2011
 

Income statement location

          

Interest expense

   $ 13       $ 11      $ (13   $ (11 )

Cash Flow Hedges—During fiscal 2007, Covidien International Finance S.A. (CIFSA), a wholly-owned subsidiary of the Company, 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 reclassified to interest expense over the terms of the notes. As of June 24, 2011 and September 24, 2010, the amount of this loss that remained in accumulated other comprehensive income was $46 million and $49 million, respectively.

Foreign Exchange Exposure

Derivatives not Designated as Hedging Instruments—The Company’s operations outside the United States are significant. As a result, the Company has foreign exchange exposure on the translation of the financial statements and on transactions denominated in foreign currencies. The Company’s policy is to use various forward and option contracts to economically manage foreign currency exposures on accounts and notes receivable, accounts payable, intercompany loans and forecasted transactions that are denominated in certain foreign currencies, principally the euro and yen, as well as approximately 20 other currencies. The Company generally manages its exposure for forecasted transactions for the upcoming 12 months. All forward and option contracts are recorded on the balance sheet at fair value. At June 24, 2011, the Company had foreign currency forward and option contracts outstanding with a notional amount of $839 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 net (loss) gain on foreign exchange forward and option contracts not designated as hedging instruments and related hedged items are included in the following income statement captions in the amounts shown:

 

     Quarters Ended      Nine Months Ended  

(Dollars in Millions)

   June 24,
2011
    June 25,
2010
     June 24,
2011
    June 25,
2010
 

Cost of goods sold

   $ (6   $ 7       $ (16   $ 22   

Selling, general and administrative expenses

     (7     8         (12     (1
                                 
   $ (13   $ 15       $ (28   $ 21   
                                 

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Fair Value of Derivative Instruments

The following table summarizes the classification and fair values of derivative instruments reported in the consolidated balance sheets:

 

        June 24, 2011     September 24, 2010  

(Dollars in Millions)

 

Balance sheet location

  Fair value  of
Derivative
Assets
    Fair value of
Derivative
Liabilities
    Fair value  of
Derivative
Assets
    Fair value of
Derivative
Liabilities
 

Derivative instruments designated as hedges:

         

Interest rate swaps

  Other assets   $ 11      $ —       $ —       $ —    

Derivative instruments not designated as hedges:

         

Foreign exchange contracts

  Prepaid and other current assets     12        —         16        4   

Foreign exchange contracts

  Accrued and other current liabilities     1        25        —         20   
                                 

Total derivative instruments not designated as hedges

      13        25        16        24   
                                 

Total derivative instruments

    $ 24      $ 25      $ 16      $ 24   
                                 

12. Financial Instruments and Fair Value Measurements

The following table provides a summary of the significant assets and liabilities that are measured at fair value on a recurring basis at June 24, 2011:

 

(Dollars in Millions)

   June 24,
2011
     Basis of Fair Value Measurement  
      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

   $ 13       $ —         $ 13       $ —     

Interest rate swaps

     11         —           11         —     

Debt and equity securities held in rabbi trust

     35         26         9         —     
                                   

Total assets at fair value

   $ 59       $ 26       $ 33       $ —     
                                   

Liabilities

           

Foreign currency contracts

   $ 25       $ —         $ 25       $ —     

Deferred compensation liabilities

     96         —           96         —     
                                   

Total liabilities at fair value

   $ 121       $ —         $ 121       $ —     
                                   

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table provides a summary of the significant assets and liabilities that are measured at fair value on a recurring basis at September 24, 2010:

 

(Dollars in Millions)

   September 24,
2010
     Basis of Fair Value Measurement  
      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

   $ 16       $ —         $ 16       $ —     

Debt and equity securities held in rabbi trust

     33         25         8         —     
                                   

Total assets at fair value

   $ 49       $ 25       $ 24       $ —     
                                   

Liabilities

           

Foreign currency contracts

   $ 24       $ —         $ 24       $ —     

Deferred compensation liabilities

     78         —           78         —     

Contingent payments

     71         —           —           71   
                                   

Total liabilities at fair value

   $ 173       $ —         $ 102       $ 71   
                                   

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 consist primarily 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.

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Contingent payments—In connection with the acquisition of ev3, the Company assumed an agreement to pay milestone-based contingent payments of up to $75 million upon the U.S. Food and Drug Administration pre-market approval of the Pipeline® Embolization Device. The fair value of the contingent payments was measured based on the probability-weighted present value of the consideration expected to be transferred. The changes in the fair value shown in the following reconciliation are included in selling, general and administrative expenses:

 

(Dollars in Millions)

   Quarter
Ended
June 24, 2011
    Nine  Months
Ended

June 24, 2011
 

Balance at beginning of period

   $ 75      $ 71   

Change in fair value

     —          4   

Settlement

     (75     (75
                

Fair value at June 24, 2011

   $ —        $ —     
                

Fair Value of Financial Instruments

The Company’s financial instruments consist primarily of cash and cash equivalents, accounts receivable, investments, amounts due from former parent and affiliate, accounts payable, debt and derivative financial instruments. The fair value of cash and cash equivalents, accounts receivable, investments and accounts payable approximated their carrying values at June 24, 2011 and September 24, 2010. The fair value of the Company’s unsecured senior notes was approximately $4.445 billion and $4.627 billion at June 24, 2011 and September 24, 2010, respectively. The carrying value of the senior notes was $3.994 billion and $4.243 billion at June 24, 2011 and September 24, 2010, respectively. It is not practicable to estimate the fair value of the 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 consist primarily 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 an A/A2 long-term debt rating. 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. The Company continually evaluates all government receivables, particularly in Greece, Spain, Italy, Portugal and other parts of Western Europe for potential collection risks associated with the availability of government funding and reimbursement practices.

The most significant payment delays the Company has experienced relate to accounts receivable associated with the national healthcare system in Greece. However, during the first nine months of fiscal 2011, the

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Company received $98 million in non-interest bearing government bonds from the Greek government to satisfy debts it had incurred from 2007 to 2009. The Company sold substantially all of these bonds for proceeds of $71 million during the nine months ended June 24, 2011. As a result of these transactions, the Company recorded a $4 million gain, net of the reserves that had previously been established on the related receivables.

13. 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 in 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

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 24, 2011, the Company is the primary obligor to the taxing authorities for $1.936 billion of contingent tax liabilities that are recorded on the consolidated balance sheet, of which $1.426 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 24, 2010, the Company was the primary obligor to the taxing authorities for $1.986 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 $758 million and $724 million at June 24, 2011 and September 24, 2010, respectively. This receivable, which reflects 58% of the contingent tax liabilities that are subject to the Tax Sharing Agreement, is classified as due from former parent and affiliate on the consolidated balance sheets. Adjustments to this receivable are recorded in other (expense) income, net.

Guaranteed Tax Liabilities—The Company has certain guarantee commitments and indemnifications with Tyco International and TE Connectivity, primarily related to certain contingent tax liabilities. A current and non-current liability totaling $716 million relating to these guarantees was included on the Company’s consolidated balance sheet at both June 24, 2011 and September 24, 2010.

14. 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.

Antitrust Litigation

The Company was involved in an antitrust case with Natchitoches Parish Hospital Service District in which Natchitoches Parish Hospital alleged anticompetitive conduct by the Company in violation of federal antitrust laws. During the first nine months of fiscal 2010, the Company paid $32.5 million to resolve all claims in this case. Accordingly, the Company recorded a $32.5 million legal charge in selling, general and administrative expenses during the nine months ended June 25, 2010.

Products Liability Litigation

Mallinckrodt Inc., a subsidiary of the Company, is one of four manufacturers of gadolinium-based contrast agents involved in litigation alleging that administration of these agents causes development of a recently identified disease, nephrogenic systemic fibrosis, in a small number of patients with advanced renal impairment. The litigation includes a federal multi-district litigation in the United States District Court for the Northern

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

District of Ohio and cases in various state courts. Generally, complaints allege design and manufacturing defects, failure to warn, breach of warranty, fraud and violations of various state consumer protection laws. The Company believes that it has meritorious defenses to these complaints and will vigorously defend against them. When appropriate, the Company settles cases. As of June 24, 2011, there were 35 cases pending in which the plaintiff has either documented or specifically alleged use of the Company’s Optimark™ product. 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 cases, the Company believes that the final resolution 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.

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 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 24, 2011, there were approximately 11,500 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 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 24, 2011, the Company concluded that it was probable that it would incur remedial costs in the range of $183 million to $307 million. As of June 24, 2011, the Company concluded that the best estimate within this range was $190 million, of which $21 million was included in accrued and other current liabilities and $169 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.

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 24, 2011, the Company estimates that the cost to comply with these proposed remediation alternatives at this site ranges from $98 million to $165 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. As of June 24, 2011 and September 24, 2010, the Company’s AROs were $83 million and $79 million, respectively. The increase in the AROs during the first nine months of fiscal 2011 resulted from interest accretion and foreign currency translation. 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 13, 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

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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.

Compliance Matters

Tyco International has received and responded to various allegations that certain improper payments were made in recent years 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 Company’s and its subsidiaries income tax returns are periodically examined by various tax authorities. The U.S. Internal Revenue Service (IRS) has commenced its examination of 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 taxes payable. With respect to these potential income tax liabilities from all of these years, Covidien believes that the amounts recorded in its financial statements as current or non-current 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 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 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. Tyco International and the IRS have entered into settlements related to certain outstanding tax matters arising in this audit cycle, which otherwise remains open and subject to examination and resolution of other matters. In addition, the IRS has commenced its examination of certain of Tyco International’s U.S. federal income tax returns for the years 2005 through 2007.

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

In connection with the settlements of the 1997 through 2000 and 2001 through 2004 U.S. audit cycles and other non-U.S. audits, the Company estimates that it will be required to make a payment of approximately $314 million, net of refunds, within the next 12 months, which is included in current income taxes payable on the consolidated balance sheet. Pursuant to the Tax Sharing Agreement, Covidien will receive net payments totaling approximately $149 million from Tyco International and TE Connectivity, which is classified as the current portion of due from former parent and affiliate on the consolidated balance sheet. Covidien will also be required to reimburse Tyco International and TE Connectivity $162 million for its portion of their settlements. This amount is classified as the current portion of guaranteed contingent tax liabilities on the consolidated balance sheet.

The resolution of issues arising from the 1997 through 2000, 2001 through 2004 and 2005 through 2007 U.S. audit cycles and other non-U.S. audits, as well as other settlements or statute of limitations expirations, could result in a significant change in the Company’s unrecognized tax benefits. The Company estimates that within the next 12 months, its gross uncertain tax positions, exclusive of interest, could decrease by as much as $412 million, as a result of such settlements or statute expirations. At September 24, 2010, the Company’s estimate of the decrease in the amount of gross uncertain tax positions, exclusive of interest, as a result of settlements or statute expirations in the upcoming 12 months was $745 million. The decrease in this amount was primarily due to changes in the estimated timing of the Company’s expected settlements. These estimates of changes to unrecognized tax benefits may not be representative of actual outcomes. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible change related to the Company’s unrecognized tax benefits.

15. Segment Data

Selected information by business segment is as follows:

 

     Quarters Ended     Nine Months Ended  

(Dollars in Millions)

   June 24,
2011
    June 25,
2010
    June 24,
2011
    June 25,
2010
 

Net sales(1) :

        

Medical Devices

   $ 1,985      $ 1,630      $ 5,739      $ 4,942   

Pharmaceuticals

     500        507        1,460        1,526   

Medical Supplies

     441        427        1,297        1,291   
                                
   $ 2,926      $ 2,564      $ 8,496      $ 7,759   
                                

Operating income:

        

Medical Devices

   $ 613      $ 512      $ 1,777      $ 1,549   

Pharmaceuticals

     80        83        237        268   

Medical Supplies

     59        70        181        208   
                                

Operating income of reportable segments

     752        665        2,195        2,025   

Unallocated amounts:

        

Corporate expenses

     (105     (96     (312     (311

Restructuring charges, net

     (32     (25     (83     (56

Acquisition-related charges(2)

     —          (5     (32     (5

Shareholder settlement income and legal charge

     —          —          11        (33
                                

Consolidated operating income

   $ 615      $ 539      $ 1,779      $ 1,620   
                                

 

(1) 

Amounts represent sales to external customers. Intersegment sales are not significant.

(2) 

Amount for the nine months ended June 24, 2011 represents charges included in cost of goods sold related to the sale of acquired inventory that had been written up to fair value upon acquisition.

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

16. 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 and the borrower under the revolving credit facility, all of which are fully and unconditionally guaranteed by both Covidien plc and Covidien Ltd., the owners of CIFSA. 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 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   
                                               

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENT OF INCOME

Quarter Ended June 25, 2010

(dollars in millions)

 

    Covidien plc     Covidien Ltd.     CIFSA     Other
Subsidiaries
    Consolidating
Adjustments
    Total  

Net sales

  $ —        $ —        $ —        $ 2,564      $ —        $ 2,564   

Cost of goods sold

    —          —          —          1,138        —          1,138   
                                               

Gross profit

    —          —          —          1,426        —          1,426   

Selling, general and administrative expenses

    3        —          —          750        —          753   

Research and development expenses

    —          —          —          109        —          109   

Restructuring charges

    —          —          —          25        —          25   
                                               

Operating (loss) income

    (3     —          —          542        —          539   

Interest expense

    —          —          (54     —          —          (54

Interest income

    —          —          —          6        —          6   

Other income, net

    —          —          —          21        —          21   

Equity in net income of subsidiaries

    390        391        428        —          (1,209     —     

Intercompany interest and fees

    (23     (1     17        7        —          —     
                                               

Income from continuing operations before income taxes

    364        390        391        576        (1,209     512   

Income tax expense

    —          —          —          160        —          160   
                                               

Income from continuing operations

    364        390        391        416        (1,209     352   

Income from discontinued operations, net of income taxes

    —          —          —          12        —          12   
                                               

Net income

  $ 364      $ 390      $ 391      $ 428      $ (1,209   $ 364   
                                               

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENT OF 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   
                                               

 

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Table of Contents

COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENT OF INCOME

Nine Months Ended June 25, 2010

(dollars in millions)

 

     Covidien plc     Covidien Ltd.     CIFSA     Other
Subsidiaries
     Consolidating
Adjustments
    Total  

Net sales

   $ —        $ —        $ —        $ 7,759       $ —        $ 7,759   

Cost of goods sold

     —          —          —          3,421         —          3,421   
                                                 

Gross profit

     —          —          —          4,338         —          4,338   

Selling, general and administrative expenses

     10        —          1        2,330         —          2,341   

Research and development expenses

     —          —          —          321         —          321   

Restructuring charges

     —          —          —          56         —          56   
                                                 

Operating (loss) income

     (10     —          (1     1,631         —          1,620   

Interest expense

     —          —          (140     —           —          (140

Interest income

     —          —          —          17         —          17   

Other income, net

     —          —          —          49         —          49   

Equity in net income of subsidiaries

     1,269        1,272        1,364        —           (3,905     —     

Intercompany interest and fees

     (70     (3     49        24         —          —     
                                                 

Income from continuing operations before income taxes

     1,189        1,269        1,272        1,721         (3,905     1,546   

Income tax expense

     —          —          —          371         —          371   
                                                 

Income from continuing operations

     1,189        1,269        1,272        1,350         (3,905     1,175   

Income from discontinued operations, net of income taxes

     —          —          —          14         —          14   
                                                 

Net income

   $ 1,189      $ 1,269      $ 1,272      $ 1,364       $ (3,905   $ 1,189   
                                                 

 

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Table of Contents

COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING BALANCE SHEET

At June 24, 2011

(dollars in millions)

 

    Covidien plc     Covidien Ltd.     CIFSA     Other
Subsidiaries
    Consolidating
Adjustments
    Total  

Assets

           

Current Assets:

           

Cash and cash equivalents

  $ 2      $ —        $ 261      $ 1,492      $ —        $ 1,755   

Accounts receivable trade, net

    —          —          —          1,880        —          1,880   

Inventories

    —          —          —          1,528        —          1,528   

Intercompany receivable

    51        28        —          21        (100     —     

Prepaid expenses and other current assets

    1        —          2        835        —          838   

Due from former parent and affiliate

    —          —          —          149        —          149   
                                               

Total current assets

    54        28        263        5,905        (100     6,150   

Property, plant and equipment, net

    1        —          —          2,684        —          2,685   

Goodwill

    —          —          —          7,700        —          7,700   

Intangible assets, net

    —          —          —          2,823        —          2,823   

Due from former parent and affiliate

    —          —          —          609        —          609   

Investment in subsidiaries

    11,531        12,148        10,891        —          (34,570     —     

Intercompany loans receivable

    —          93        10,833        5,742        (16,668     —     

Other assets

    —          —          32        734        —          766   
                                               

Total Assets

  $ 11,586      $ 12,269      $ 22,019      $ 26,197      $ (51,338   $ 20,733   
                                               

Liabilities and Shareholders’ Equity

           

Current Liabilities:

           

Current maturities of long-term debt

  $ —        $ —        $ 90     $ 6      $ —        $ 96   

Accounts payable

    —          —          —          603        —          603   

Intercompany payable

    21        —          —          79        (100     —     

Accrued and other current liabilities

    —          —          35        1,346        —          1,381   

Income taxes payable

    —          —          —          288        —          288   

Guaranteed contingent tax liabilities

    —          —          —          162        —          162   
                                               

Total current liabilities

    21        —          125        2,484        (100     2,530   

Long-term debt

    —          —          4,005        65        —          4,070   

Income taxes payable

    —          —          —          1,622        —          1,622   

Guaranteed contingent tax liabilities

    —          —          —          554        —          554   

Intercompany loans payable

    1,322        738        5,741        8,867        (16,668     —     

Other liabilities

    —          —          —          1,714        —          1,714   
                                               

Total Liabilities

    1,343        738        9,871        15,306        (16,768     10,490   

Shareholders’ Equity

    10,243        11,531        12,148        10,891        (34,570     10,243   
                                               

Total Liabilities and Shareholders’ Equity

  $ 11,586      $ 12,269      $ 22,019      $ 26,197      $ (51,338   $ 20,733   
                                               

 

25


Table of Contents

COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING BALANCE SHEET

At September 24, 2010

(dollars in millions)

 

    Covidien plc     Covidien Ltd.     CIFSA     Other
Subsidiaries
    Consolidating
Adjustments
    Total  

Assets

           

Current Assets:

           

Cash and cash equivalents

  $ 1      $ —        $ 399      $ 1,165      $ —        $ 1,565   

Accounts receivable trade, net

    —          —          —          1,708        —          1,708   

Inventories

    —          —          —          1,381        —          1,381   

Intercompany receivable

    32        200        —          16        (248     —     

Prepaid expenses and other current assets

    4        —          —          837        —          841   

Due from former parent and affiliate

    —          —          —          245        —          245   
                                               

Total current assets

    37        200        399        5,352        (248     5,740   

Property, plant and equipment, net

    1        —          —          2,607        —          2,608   

Goodwill

    —          —          —          7,675        —          7,675   

Intangible assets, net

    —          —          —          2,949        —          2,949   

Due from former parent and affiliate

    —          —          —          479        —          479   

Investment in subsidiaries

    9,886        10,300        9,856        —          (30,042     —     

Intercompany loans receivable

    —          94        9,926        5,174        (15,194     —     

Other assets

    —          —          23        913        —          936   
                                               

Total Assets

  $ 9,924      $ 10,594      $ 20,204      $ 25,149      $ (45,484   $ 20,387   
                                               

Liabilities and Shareholders’ Equity

           

Current Liabilities:

           

Current maturities of long-term debt

  $ —        $ —        $ 250      $ 5      $ —        $ 255   

Accounts payable

    —          —          1        585        —          586   

Intercompany payable

    15        —          —          233        (248     —     

Accrued and other current liabilities

    100        —          88        1,442        —          1,630   

Income taxes payable

    —          —          —          547        —          547   

Guaranteed contingent tax liabilities

    —          —          —          108        —          108   
                                               

Total current liabilities

    115        —          339        2,920        (248     3,126   

Long-term debt

    —          —          4,391        60        —          4,451   

Income taxes payable

    —          —          —          1,565        —          1,565   

Guaranteed contingent tax liabilities

    —          —          —          608        —          608   

Intercompany loans payable

    835        708        5,174        8,477        (15,194     —     

Other liabilities

    —          —          —          1,663        —          1,663   
                                               

Total Liabilities

    950        708        9,904        15,293        (15,442     11,413   

Shareholders’ Equity

    8,974        9,886        10,300        9,856        (30,042     8,974   
                                               

Total Liabilities and Shareholders’ Equity

  $ 9,924      $ 10,594      $ 20,204      $ 25,149      $ (45,484   $ 20,387   
                                               

 

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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 continuing operating activities

  $ (23   $ 169      $ 270      $ 1,193      $ —        $ 1,609   
                                               

Cash Flows From Investing Activities:

           

Capital expenditures

    —          —          —          (303     —          (303

Sale of investments

    —          —          —          14        —          14   

Acquisition-related payments

    —          —          —          (13     —          (13

Acquisition of licenses and technology

    —          —          —          (4     —          (4

Net increase in intercompany loans

    —          —          (341     —          341        —     

Increase in investment in subsidiary

    —          (199     —          —          199        —     

Other

    —          —          —          (9     —          (9
                                               

Net cash used in continuing 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 from parent

    —          —          —          199        (199     —     

Other

    48        —          —          (35     —          13   
                                               

Net cash provided by (used in) continuing 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   
                                               

 

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COVIDIEN PLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

Nine Months Ended June 25, 2010

(dollars in millions)

 

    Covidien plc     Covidien Ltd.     CIFSA     Other
Subsidiaries
    Consolidating
Adjustments
    Total  

Cash Flows From Operating Activities:

           

Net cash (used in) provided by continuing operating activities

  $ (8   $ (39   $ (119   $ 1,641      $ —        $ 1,475   
                                               

Cash Flows From Investing Activities:

           

Capital expenditures

    (1     —          —          (272     —          (273

Sale of investments

    —          —          —          7        —          7   

Acquisition-related payments, net of cash acquired

    —          —          —          (189     —          (189

Acquisition of licenses and technology

    —          —          —          (70     —          (70

Interest in class action settlement fund

    —          —          —          (33     —          (33

Divestitures

    —          —          —          18        —          18   

Net increase in intercompany loans

    —          —          (7,115     —          7,115        —     

Other

    —          —          —          6        —          6   
                                               

Net cash used in continuing investing activities

    (1     —          (7,115     (533     7,115        (534
                                               

Cash Flows From Financing Activities:

           

Net repayment of commercial paper

    —          —          (1     —          —          (1

Repayment of debt

    —          —          —          (87     —          (87

Dividends paid

    (270     —          —          —          —          (270

Repurchase of shares

    (78     —          —          —          —          (78

Proceeds from exercise of share options

    105        —          —          —          —          105   

Net intercompany loan borrowings

    251        39        —          6,825        (7,115     —     

Intercompany dividend received (paid)

    —          —          7,353        (7,353     —          —     

Other

    —          —          (11     7        —          (4
                                               

Net cash provided by (used in) continuing financing activities

    8        39        7,341        (608     (7,115     (335
                                               

Discontinued Operations:

           

Net cash provided by discontinued operating activities

    —          —          —          43        —          43   

Net cash used in discontinued investing activities

    —          —          —          (9     —          (9
                                               

Net cash provided by discontinued operations

    —          —          —          34        —          34   
                                               

Effect of currency rate changes on cash

    —          —          —          16        —          16   
                                               

Net (decrease) increase in cash and cash equivalents

    (1     —          107        550        —          656   

Cash and cash equivalents at beginning of period

    1        —          135        1,331        —          1,467   
                                               

Cash and cash equivalents at end of period

  $ —        $ —        $ 242      $ 1,881      $ —        $ 2,123   
                                               

 

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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 24, 2010 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, soft tissue repair products, energy devices, oximetry and monitoring products, airway and ventilation products, products used in vascular therapies 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.

Healthcare Reform

In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act were enacted in the United States, which includes provisions that would impose a 2.3% excise tax on the sale of certain of our medical device and supply products in the United States starting in 2013. In addition, the new legislation 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, we do not expect this annual assessment to have a significant impact on Covidien. The medical devices tax, however, may have a significant impact on our results of operations. We are still evaluating the potential impact that this tax may have on our overall business. This new legislation increases our cost of doing business. If this cost is not offset by increased demand for our products, cost reductions or price increases, we could experience lower margins and profitability and our business and results of operations could be materially and adversely affected. 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 impact our financial results in future periods.

Restructuring Initiatives

During the third quarter of 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.

In fiscal 2009, 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 $200 million under this program, which are recorded as the specific actions required to execute on these

 

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initiatives are identified and approved. The anticipated expenditures primarily relate to employee severance and benefits. As of June 24, 2011, we had incurred $158 million of net restructuring charges under the 2009 program since its inception and expect to incur most of the remaining charges by the end of 2011. This program excludes restructuring actions associated with acquisitions. In addition to continuing to incur charges under the 2009 program, we also expect to incur additional charges as restructuring actions stemming from our recent acquisitions are implemented.

Results of Operations

Quarters and Nine Months Ended June 24, 2011 and June 25, 2010

The following table presents results of operations, including percentage of net sales:

 

    Quarters Ended     Nine Months Ended  

(Dollars in Millions)

  June 24, 2011     June 25, 2010     June 24, 2011     June 25, 2010  

Net sales

  $ 2,926        100.0   $ 2,564        100.0   $ 8,496        100.0   $ 7,759        100.0

Cost of goods sold

    1,255        42.9        1,138        44.4        3,658        43.1        3,421        44.1   
                                       

Gross profit

    1,671        57.1        1,426        55.6        4,838        56.9        4,338        55.9   

Selling, general and administrative expenses

    886        30.3        753        29.4        2,600        30.6        2,341        30.2   

Research and development expenses

    138        4.7        109        4.3        387        4.6        321        4.1   

Restructuring charges, net

    32        1.1        25        1.0        83        1.0        56        0.7   

Shareholder settlement income

    —          —          —          —          (11     (0.1     —          —     
                                       

Operating income

    615        21.0        539        21.0        1,779        20.9        1,620        20.9   

Interest expense

    (51     (1.7     (54     (2.1     (153     (1.8     (140     (1.8

Interest income

    6        0.2        6        0.2        17        0.2        17        0.2   

Other (expense) income, net

    (12     (0.4 )     21        0.8        —          —          49        0.6   
                                       

Income from continuing operations before income taxes

    558        19.1        512        20.0        1,643        19.3        1,546        19.9   

Income tax expense

    26        0.9        160        6.2        220        2.6        371        4.8   
                                       

Income from continuing operations

    532        18.2        352        13.7        1,423        16.7        1,175        15.1   

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

    3        0.1        12        0.5        (6     (0.1     14        0.2   
                                       

Net income

  $ 535        18.3      $ 364        14.2      $ 1,417        16.7      $ 1,189        15.3   
                                       

Net sales—Our net sales in the third quarter of fiscal 2011 increased $362 million, or 14%, to $2.926 billion, compared with $2.564 billion in the third quarter of fiscal 2010. Our net sales in the first nine months of fiscal 2011 increased $737 million, or 9%, to $8.496 billion, compared with $7.759 billion in the first nine months of fiscal 2010. Favorable currency exchange rate fluctuations resulted in increases in net sales of $132 million and $156 million for the third quarter and first nine months of fiscal 2011, respectively. The remaining increase in net sales for both periods were driven by sales growth within our Medical Devices segment, largely attributable to the acquisition of ev3 Inc., partially offset by decreased sales within our Pharmaceuticals segment, primarily resulting from the divestiture of our nuclear pharmacies within the United States during the third quarter of fiscal 2010.

Net sales generated by our businesses in the United States were $1.580 billion and $1.413 billion for the third quarter of fiscal 2011 and 2010, respectively, and $4.653 billion and $4.222 billion for the first nine months of fiscal 2011 and 2010, respectively. Our non-U.S. businesses generated net sales of $1.346 billion and $1.151 billion for the third quarter of fiscal 2011 and 2010, respectively, and $3.843 billion and $3.537 billion for the

 

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first nine months of fiscal 2011 and 2010, respectively. Our business outside the United States accounted for approximately 46% and 45% of our net sales for the third quarter of fiscal 2011 and 2010, respectively, and 45% and 46% for the first nine months of fiscal 2011 and 2010, respectively. Japan represented approximately 8% of our net sales for both the third quarter and first nine months of fiscal 2011. Our results of operations for these periods were not adversely impacted by the natural disasters that occurred during the second quarter of fiscal 2011 in Japan.

Net sales by geographic area are shown in the following tables:

 

     Quarters Ended      Percentage
Change
    Currency
Impact
    Operational
Growth (1)
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
        

U.S. 

   $ 1,580       $ 1,413         12     —       12

Other Americas

     191         160         19        7        12   

Europe

     721         637         13        12        1   

Asia-Pacific

     434         354         23        13        10   
                        
   $ 2,926       $ 2,564         14        5        9   
                        

 

     Nine Months Ended      Percentage
Change
    Currency
Impact
    Operational
Growth (1)
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
        

U.S. 

   $ 4,653       $ 4,222         10     —       10

Other Americas

     537         483         11        5        6   

Europe

     2,048         2,007         2        2        —     

Asia-Pacific

     1,258         1,047         20        9        11   
                        
   $ 8,496       $ 7,759         9        2        7   
                        

 

(1) 

Operational growth, a non-GAAP financial measure, measures the change in sales between current and prior year periods using a constant currency, the exchange rate in effect during the applicable prior year period. 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 42.9% and 43.1% of net sales in the third quarter and first nine months of fiscal 2011, respectively, compared with 44.4% and 44.1% of net sales in the third quarter and first nine months of fiscal 2010, respectively. The decrease in cost of goods sold as a percent of net sales for the first nine months of fiscal 2011 compared to the comparative prior year period was primarily attributable to a more favorable mix of businesses resulting primarily from acquisitions and divestitures in the prior year, as well as manufacturing cost reductions. The decrease for the first nine months of fiscal 2011 was partially offset by $32 million of charges in cost of goods sold related to the sale of acquired inventory that had been written up to fair value upon the acquisition of ev3 and increased raw material prices.

Selling, general and administrative expenses—Selling, general and administrative expenses in the third quarter of fiscal 2011 increased $133 million, or 18%, to $886 million, compared with $753 million in the third quarter of fiscal 2010. Selling, general and administrative expenses in the first nine months of fiscal 2011 increased $259 million, or 11%, to $2.600 billion, compared with $2.341 billion in the first nine months of fiscal 2010. The increases in selling, general and administrative expenses for both fiscal 2011 periods were largely due to increased costs, primarily selling and marketing, resulting from recent acquisitions within our Medical Devices segment.

 

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Research and development expenses—Research and development expenses increased $29 million, or 27%, to $138 million in the third quarter of fiscal 2011, compared with the third quarter of fiscal 2010, and increased $66 million, or 21%, to $387 million in the first nine months of fiscal 2011, compared with the same prior year period. These increases resulted from additional spending within our Medical Devices segment, primarily resulting from recent acquisitions and, to a lesser extent, increased spending within our Pharmaceuticals segment. As a percentage of our net sales, research and development expenses was 4.7% and 4.6% for the third quarter and first nine months of fiscal 2011, respectively, compared with 4.3% and 4.1% for the third quarter and first nine months of fiscal 2010, respectively.

Restructuring charges, net—During the third quarter and first nine months of fiscal 2011, we recorded net restructuring charges of $32 million and $83 million, 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 recent 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. During the third quarter and first nine months of fiscal 2010, we recorded restructuring charges of $25 million and $56 million, respectively, primarily related to severance costs across all segments.

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 2011, operating income increased $76 million to $615 million, compared with operating income of $539 million in the third quarter of fiscal 2010. The increase in operating income for the third quarter of fiscal 2011 compared to the third quarter of fiscal 2010 was primarily due to increased sales volume within our Medical Devices segment, largely attributable to the acquisition of ev3. The current year period also benefitted from the absence of a $19 million charge related to the write-down of accounts receivable associated with the national healthcare system in Greece. These increases to operating income were partially offset by increased costs resulting from acquisitions.

In the first nine months of fiscal 2011, operating income increased $159 million to $1.779 billion, compared with operating income of $1.620 billion in the first nine months of fiscal 2010. The increase in operating income for the first nine months of fiscal 2011 compared to the comparative prior year period was primarily due to increased sales volume within our Medical Devices segment, largely attributable to the acquisition of ev3. The current year period also benefitted from the absence of a $33 million legal charge incurred in the prior year to settle an antitrust case. These increases in operating income were partially offset by increased costs resulting from acquisitions and $27 million of incremental net restructuring charges.

Analysis of Operating Results by Segment

Net sales by segment are shown in the following tables:

 

     Quarters Ended      Percentage
Change
    Currency
Impact
    Operational
Growth
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
        

Medical Devices

   $ 1,985       $ 1,630         22     7     15

Pharmaceuticals

     500         507         (1     3       (4

Medical Supplies

     441         427         3        1       2   
                        
   $ 2,926       $ 2,564         14        5        9   
                        

 

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     Nine Months Ended      Percentage
Change
    Currency
Impact
    Operational
Growth
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
        

Medical Devices

   $ 5,739       $ 4,942         16     3     13

Pharmaceuticals

     1,460         1,526         (4     1        (5

Medical Supplies

     1,297         1,291         —          —          —     
                        
   $ 8,496       $ 7,759         9        2        7   
                        

Operating income by segment and as a percentage of segment net sales is shown in the following table:

 

     Quarters Ended     Nine Months Ended  

(Dollars in Millions)

   June 24,
2011
    June 25,
2010
    June 24,
2011
    June 25,
2010
 

Medical Devices

   $ 613        30.9   $ 512        31.4   $ 1,777        31.0   $ 1,549        31.3

Pharmaceuticals

     80        16.0        83        16.4        237        16.2        268        17.6   

Medical Supplies

     59        13.4        70        16.4        181        14.0        208        16.1   
                                        

Operating income of reportable segments

     752        25.7        665        25.9        2,195        25.8        2,025        26.1   

Unallocated amounts:

                

Corporate expenses

     (105       (96       (312       (311  

Restructuring charges, net

     (32       (25       (83       (56  

Acquisition-related charges(1)

     —            (5       (32       (5  

Shareholder settlement income and legal charge

     —            —            11          (33  
                                        

Consolidated operating income

   $ 615        $ 539        $ 1,779        $ 1,620     
                                        

 

(1) 

Amounts for the quarter and nine months ended June 24, 2011 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 2011 and 2010 were as follows:

 

     Quarters Ended      Percentage
Change
    Currency
Impact
    Operational
Growth
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
        

Endomechanical Instruments

   $ 593       $ 533         11     7     4

Soft Tissue Repair Products

     229         209         10        7        3   

Energy Devices

     301         252         19        6        13   

Oximetry & Monitoring Products

     211         189         12        5        7   

Airway & Ventilation Products

     183         178         3        7        (4

Vascular Products

     368         175         110        6        104   

Other Products

     100         94         6        8        (2
                        
   $ 1,985       $ 1,630         22        7        15   
                        

U.S. 

   $ 874       $ 685         28     —       28

Non-U.S. 

     1,111         945         18        12        6   
                        
   $ 1,985       $ 1,630         22        7        15   
                        

Net sales for the third quarter of fiscal 2011 increased $355 million, or 22%, to $1.985 billion, compared with $1.630 billion for the third quarter of fiscal 2010. Favorable currency exchange fluctuations positively impacted net

 

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sales for the segment by $110 million. 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 the acquisition of ev3, which resulted in an additional $171 million in net sales for the segment. The increase in Energy Devices sales resulted primarily from higher sales volume of vessel sealing products in the United States and Europe. Finally, the increase in sales of Endomechanical Instruments primarily resulted from higher sales volume of stapling devices in the United States.

Operating income for the third quarter of fiscal 2011 increased $101 million to $613 million, compared with $512 million for the third quarter of fiscal 2010. Our operating margin was 30.9% for the third quarter of fiscal 2011, compared with 31.4% for the third quarter of fiscal 2010. The increase in our operating income was primarily attributable to increased gross profit on the favorable sales performance for the overall segment discussed above, as well as the absence of a $19 million charge related to the write-down of accounts receivable associated with the national healthcare system in Greece. These increases to operating income were partially offset by increased costs related to acquisitions, particularly selling, general and administrative expenses.

Net sales for Medical Devices by groups of products and by geography for the first nine months of fiscal 2011 and 2010 were as follows:

 

     Nine Months Ended      Percentage
Change
    Currency
Impact
    Operational
Growth
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
        

Endomechanical Instruments

   $ 1,718       $ 1,604         7     3     4

Soft Tissue Repair Products

     670         641         5        3        2   

Energy Devices

     854         733         17        3        14   

Oximetry & Monitoring Products

     627         563         11        1        10   

Airway & Ventilation Products

     554         585         (5     3        (8

Vascular Products

     1,033         521         98        3        95   

Other Products

     283         295         (4     6        (10
                        
   $ 5,739       $ 4,942         16        3        13   
                        

U.S. 

   $ 2,562       $ 2,035         26     —       26

Non-U.S. 

     3,177         2,907         9        5        4   
                        
   $ 5,739       $ 4,942         16        3        13   
                        

Net sales for the first nine months of fiscal 2011 increased $797 million, or 16%, to $5.739 billion, compared with $4.942 billion for the first nine months of fiscal 2010. Favorable currency exchange rate fluctuations positively impacted net sales for the segment by $139 million. The remaining increase in net sales for the segment was driven by increased sales of Vascular Products, Energy Devices, Endomechanical Instruments and Oximetry & Monitoring Products. The increase in Vascular Products sales was primarily due to the acquisition of ev3, which resulted in an additional $462 million in net sales for the segment. The increase in net sales for Energy Devices and Endomechanical Instruments resulted primarily from higher sales volume of vessel sealing products and stapling devices, respectively, largely attributable to sales of new products. Finally, the increase in sales for Oximetry & Monitoring Products was primarily driven by higher sales volume of sensors resulting from the prior year acquisition of Somanetics Corporation. These increases in net sales were somewhat offset by a decrease in sales of Airway & Ventilation Products resulting from strong sales in the prior year due to the H1N1 pandemic.

Operating income for the first nine months of fiscal 2011 increased $228 million to $1.777 billion, compared with $1.549 billion for the first nine months of fiscal 2010. Our operating margin was 31.0% for the first nine months of fiscal 2011, compared with 31.3% for the first nine months of fiscal 2010. The increase in our operating income was primarily attributable to increased gross profit on the favorable sales performance for the overall segment discussed above, partially offset by increased costs related to acquisitions, particularly selling, general and administrative expenses.

 

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Pharmaceuticals

Net sales for Pharmaceuticals by groups of products and by geography for the third quarter of fiscal 2011 and 2010 were as follows:

 

     Quarters Ended      Percentage
Change
    Currency
Impact
    Operational
Growth
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
        

Specialty Pharmaceuticals

   $ 120       $ 127         (6 )%      —       (6 )% 

Active Pharmaceutical Ingredients

     107         103         4        3        1   

Contrast Products

     157         150         5        5        —     

Radiopharmaceuticals

     116         127         (9     3        (12
                        
   $ 500       $ 507         (1     3        (4
                        

U.S. 

   $ 322       $ 352         (9 )%      —       (9 )% 

Non-U.S. 

     178         155         15        10        5   
                        
   $ 500       $ 507         (1     3        (4
                        

Net sales for the third quarter of fiscal 2011 decreased $7 million to $500 million, compared with $507 million for the third quarter of fiscal 2010. This decrease was driven by a decline in Radiopharmaceuticals net sales resulting from the divestiture of our nuclear pharmacies within the United States during the third quarter of fiscal 2010 and a decline in sales of our branded products, which stemmed primarily from the inventory stocking for PENNSAID® and EXALGO® launched in the third quarter of fiscal 2010. These decreases were partially offset by increased sales of generic pharmaceuticals, primarily the fentanyl lozenge and patch.

Operating income for the third quarter of fiscal 2011 decreased $3 million to $80 million, compared with $83 million for the third quarter of fiscal 2010. Our operating margin was 16.0% for the third quarter of fiscal 2011, compared with 16.4% for the third quarter of fiscal 2010. The decrease in operating income was primarily due to increased research and development and environmental expenses, partially offset by a decrease in selling and marketing spending.

Net sales for Pharmaceuticals by groups of products and by geography for the first nine months of fiscal 2011 and 2010 were as follows:

 

     Nine Months Ended      Percentage
Change
    Currency
Impact
    Operational
Growth
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
        

Specialty Pharmaceuticals

   $ 357       $ 373         (4 )%      —       (4 )% 

Active Pharmaceutical Ingredients

     312         302         3        1        2   

Contrast Products

     454         437         4        2        2   

Radiopharmaceuticals

     337         414         (19     —          (19
                        
   $ 1,460       $ 1,526         (4     1        (5
                        

U.S. 

   $ 956       $ 1,057         (10 )%      —       (10 )% 

Non-U.S. 

     504         469         7        3        4   
                        
   $ 1,460       $ 1,526         (4     1        (5
                        

Net sales for the first nine months of fiscal 2011 decreased $66 million, or 4%, to $1.460 billion, compared with $1.526 billion for the first nine months of fiscal 2010. This decrease primarily resulted from a decline in Radiopharmaceuticals and, to a much lesser extent, Specialty Pharmaceuticals net sales. The decrease in Radiopharmaceuticals sales resulted from the divestiture of our nuclear pharmacies within the United States

 

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during the third quarter of fiscal 2010. The decrease in Specialty Pharmaceuticals sales was attributable to a decline in sales of our older branded products, primarily resulting from generic competition, partially offset by sales of PENNSAID® and EXALGO®.

Operating income for the first nine months of fiscal 2011 decreased $31 million to $237 million, compared with $268 million for the first nine months of fiscal 2010. Our operating margin was 16.2% for the first nine months of fiscal 2011, compared with 17.6% for the first nine months of fiscal 2010. The decrease in operating income was primarily due to the decrease in gross profit resulting from the overall segment sales decline discussed above. In addition, the decline in operating income and margin resulted from increased research and development expenses and increased selling and marketing expenses to support our recent product launches, partially offset by decreased legal costs.

Medical Supplies

Net sales for Medical Supplies by groups of products and by geography for the third quarter of fiscal 2011 and 2010 were as follows:

 

     Quarters Ended      Percentage
Change
    Currency
Impact
    Operational
Growth
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
        

Nursing Care Products

   $ 199       $ 194         3     2     1

Medical Surgical Products

     110         102         8        4        4   

SharpSafety Products

     77         77         —          (1     1   

Original Equipment Manufacturer (OEM) Products

     55         54         2        1        1   
                        
   $ 441       $ 427         3        1        2   
                        

U.S. 

   $ 384       $ 376         2     —       2

Non-U.S. 

     57         51         12        13        (1
                        
   $ 441       $ 427         3        1        2   
                        

Net sales for the third quarter of fiscal 2011 increased $14 million, or 3%, to $441 million, compared with $427 million for the third quarter of fiscal 2010. The increase in net sales for the segment was driven by increased sales of Medical Surgical Products and, to a lesser extent, Nursing Care Products. The increase in sales of Medical Surgical Products was largely attributable to sales of a new disposable lead wire system, while the sales increase in Nursing Care Products resulted from higher sales of incontinence and enteral feeding products.

Operating income for the third quarter of fiscal 2011 decreased $11 million to $59 million, compared with $70 million for the third quarter of fiscal 2010. Our operating margin was 13.4% for the third quarter of fiscal 2011, compared with 16.4% for the third quarter of fiscal 2010. The decrease in operating income and margin primarily resulted from increased raw material costs, partially offset by the overall segment sales performance discussed above.

 

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Net sales for Medical Supplies by groups of products and by geography for the first nine months of fiscal 2011 and 2010 were as follows:

 

     Nine Months Ended      Percentage
Change
    Currency
Impact
    Operational
Growth
 

(Dollars in Millions)

   June 24,
2011
     June 25,
2010
        

Nursing Care Products

   $ 589       $ 586         1     1     —  

Medical Surgical Products

     323         311         4        1        3   

SharpSafety Products

     226         240         (6     —          (6

Original Equipment Manufacturer (OEM) Products

     159         154         3        —          3   
                        
   $ 1,297       $ 1,291         —          —          —     
                        

U.S. 

   $ 1,135       $ 1,130         —       —       —  

Non-U.S. 

     162         161         1        2        (1
                        
   $ 1,297       $ 1,291         —          —          —     
                        

Net sales for the first nine months of fiscal 2011 increased $6 million to $1.297 billion, compared with $1.291 billion for the first nine months of fiscal 2010. The increase in net sales for the segment was primarily driven by increased sales of Medical Surgical Products largely attributable to sales of a new disposable lead wire system. This increase was partially offset by a decline in sales of SharpSafety Products primarily resulting from stronger sales in the comparative prior year period due to the H1N1 flu pandemic.

Operating income for the first nine months of fiscal 2011 decreased $27 million to $181 million, compared with $208 million for the first nine months of fiscal 2010. Our operating margin was 14.0% for the first nine months of fiscal 2011, compared with 16.1% for the first nine months of fiscal 2010. The decrease in operating income and margin resulted from increased raw material costs.

Corporate

Corporate expense was $105 million for the third quarter of fiscal 2011, compared with $96 million for the third quarter of fiscal 2010 and $312 million for the first nine months of fiscal 2011, compared with $311 million for the comparative prior year period.

Non-Operating Items

Interest Expense and Interest Income

During the third quarters of fiscal 2011 and 2010, interest expense was $51 million and $54 million, respectively, and interest income was $6 million in each period. During the first nine months of fiscal 2011 and 2010, interest expense was $153 million and $140 million, respectively, and interest income was $17 million in each period. The increase in interest expense during the first nine months of fiscal 2011, compared with the comparative prior year periods was due to the issuance of $1.5 billion in senior notes during the fourth quarter of fiscal 2010, partially offset by the repayment of our $250 million 5.2% senior notes upon maturity. These increases were more than offset by the favorable impact of interest rate swaps entered into in 2011, resulting in an overall decrease in interest expense for the third quarter of fiscal 2011 compared to the comparative prior year quarter.

Other (Expense) Income, net

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 Ltd. and TE Connectivity Ltd. (formerly Tyco Electronics Ltd.). During the first nine months of fiscal 2011, we recorded

 

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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.

During the third quarter and first nine months of fiscal 2010, we recorded other income of $21 million and $49 million, respectively. These amounts include income of $22 million and $48 million and corresponding increases to our receivable from Tyco International and TE Connectivity, for the third quarter and first nine months of fiscal 2010, respectively.

Income Taxes

Income tax expense was $26 million and $160 million on income from continuing operations before income taxes of $558 million and $512 million for the third quarters of fiscal 2011 and 2010, respectively. This resulted in effective tax rates of 4.7% and 31.3% for the third quarters of fiscal 2011 and 2010, respectively. Income tax expense was $220 million and $371 million on income from continuing operations before income taxes of $1.643 billion and $1.546 billion for the first nine months of fiscal 2011 and 2010, respectively. This resulted in effective tax rates of 13.4% and 24.0% for the first nine months of fiscal 2011 and 2010, respectively. The decrease in the effective tax rate for the third quarter and first nine months of fiscal 2011, compared to the comparative prior year periods resulted primarily from a favorable settlement reached with certain non-U.S. taxing authorities and, to a lesser extent, the release of certain U.S. and non-U.S. uncertain tax positions due to statute expirations. In addition, the decrease in the effective tax rate in both current year periods resulted from an increase in earnings in lower tax jurisdictions, the retroactive reenactment of the U.S. research and development tax credit and the implementation of our tax planning strategies.

Discontinued Operations

In fiscal 2010, we sold our Specialty Chemicals business within our Pharmaceuticals segment, which was included in discontinued operations.

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 24, 2011 Cash Flow Activity

The net cash provided by operating activities of $1.609 billion was primarily attributable to income from continuing operations, as adjusted for depreciation and amortization, partially offset by an increase in inventory of $175 million. We estimate that within the next 12 months we will make a net payment of $327 million in connection with the settlements of U.S. tax audits for the years 1997 through 2004 and other non-U.S. audits, of which approximately $220 is expected to occur in fiscal 2011. These amounts include the net payments expected to be made under the Tax Sharing Agreement.

The net cash used in investing activities of $315 million was primarily due to capital expenditures of $303 million.

The net cash used in financing activities of $1.130 billion was primarily the result of the repayment of $307 million under our commercial paper program and the repayment of our $250 million 5.2% senior notes upon maturity. In addition, we paid $378 million to repurchase shares and made dividend payments of $297 million.

 

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Capitalization

Shareholders’ equity was $10.243 billion, or $20.78 per share, at June 24, 2011, compared with $8.974 billion, or $18.13 per share, at September 24, 2010. Net income of $1.417 billion, favorable changes in currency exchange rates of $174 million and proceeds from the exercise of options of $164 million, were partially offset by the repurchase of shares of $378 million and dividends declared of $198 million during the first nine months of fiscal 2011.

At June 24, 2011, total debt was $4.166 billion and cash was $1.755 billion, compared with total debt of $4.706 billion and cash of $1.565 billion at September 24, 2010. The decrease in our total debt primarily resulted from the partial repayment of amounts outstanding under our commercial paper program and the repayment of our $250 million 5.2% senior notes upon maturity. Total debt as a percentage of total capitalization (total debt and shareholders’ equity) was 29% at June 24, 2011, compared with 34% at September 24, 2010.

We are required to maintain an available unused balance under our $1.425 billion revolving credit facility sufficient to support amounts outstanding under our commercial paper program. At June 24, 2011, we had $90 million of commercial paper outstanding and no amount 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.

Dividends

Dividend payments totaled $297 million for the first nine months of fiscal 2011. On July 20, 2011, the Board of Directors declared a quarterly cash dividend of $0.20 per share to shareholders of record at the close of business on August 1, 2011. The dividend is payable on August 19, 2011.

Share Repurchases

During the first nine months of fiscal 2011, we purchased approximately 7.3 million shares for $375 million under our $1.0 billion share repurchase program. Since inception of the share repurchase program, we have purchased approximately 13.8 million shares for $625 million. We also repurchase shares from certain employees in order to satisfy employee tax withholding requirements in connection with the vesting of restricted shares and to settle certain option exercises. During the first nine months of fiscal 2011, we spent $3 million to acquire shares in connection with such share-based awards.

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 24, 2010. 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 14 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 U.S. Internal Revenue Service (IRS) has commenced its examination of our U.S. federal income tax returns for the years 2008 and

 

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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 during which we were a Tyco International subsidiary is subject to the conditions set forth in the Tax Sharing Agreement discussed in note 13 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 $1.936 billion of contingent tax liabilities that are recorded on the consolidated balance sheet at June 24, 2011, $1.426 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 current and long-term receivable from Tyco International and TE Connectivity of $149 million and $609 million, respectively, which are classified as due from former parent and affiliate on our consolidated balance sheet at June 24, 2011. These receivables primarily reflect 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 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. Tyco International and the IRS have entered into settlements related to certain outstanding tax matters arising in this audit cycle, which otherwise remains open and subject to examination and resolution of other matters. In addition, the IRS has commenced its examination of certain of Tyco International’s U.S. federal income tax returns for the years 2005 through 2007.

In connection with the settlements of the 1997 through 2000 and 2001 through 2004 U.S. audit cycles and other non-U.S. audits, we estimate that we will be required to make a payment of approximately $314 million, net of refunds, within the next 12 months, which is included in current income taxes payable on the consolidated balance sheet. Pursuant to the Tax Sharing Agreement, we will receive net payments totaling approximately $149 million from Tyco International and TE Connectivity, which is classified as the current portion of due from former parent and affiliate on the consolidated balance sheet. We will also be required to reimburse Tyco International and TE Connectivity $162 million for our portion of their settlements. This amount is classified as the current portion of guaranteed contingent tax liabilities on the consolidated balance sheet.

 

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The resolution of issues arising from the 1997 through 2000, 2001 through 2004 and 2005 through 2007 U.S. audit cycles and other non-U.S. audits, as well as other settlements or statute of limitations expirations, could result in a significant change in our unrecognized tax benefits. We estimate that within the next 12 months, our gross uncertain tax positions, exclusive of interest could decrease by as much as $412 million, as a result of such settlements or expirations. At September 24, 2010, our estimate of the decrease in the amount of gross uncertain tax positions, exclusive of interest, as a result of settlements or statute expirations in the upcoming 12 months was $745 million. The decrease in this amount was primarily due to changes in the estimated timing of our expected settlements. These estimates of changes to unrecognized tax benefits may not be representative of actual outcomes. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible change related to our unrecognized tax benefits.

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. A current and non-current liability totaling $716 million relating to these guarantees was included on our consolidated balance sheet at both June 24, 2011 and September 24, 2010.

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 as of June 24, 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 $82 million. In addition, we were required to pay $30 million into an escrow account as collateral, which is included in other assets on the consolidated balance sheet.

 

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We have recorded liabilities for known indemnifications included as part of environmental liabilities, which are discussed in note 14 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.

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 24, 2010.

 

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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 24, 2010 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

Foreign Currency Exposures

We use forward currency exchange contracts on accounts and notes receivable, accounts payable, intercompany loan balances and forecasted transactions that are denominated in certain foreign currencies. Based on a sensitivity analysis of our existing forward contracts outstanding at June 24, 2011, a 10% appreciation of the U.S. dollar from the June 24, 2011 market rates would increase the unrealized value of our forward contracts on our balance sheet by $48 million, while a 10% depreciation of the U.S. dollar would decrease the unrealized value of forward contracts on our balance sheet by $59 million. However, such gains or losses on these contracts would ultimately be offset by the gains or losses on the revaluation or settlement of the underlying transactions.

Interest Rate Exposures

We manage interest rate exposure through the use of interest rate swap transactions with financial institutions acting as principal counterparties to convert a portion of fixed-rate debt to variable-rate debt. These transactions are designated as fair value hedges. During the first nine months of fiscal 2011, we entered into interest rate swaps on $300 million principal amount of our 6.0% senior notes due 2017. Under these contracts, we receive fixed amounts of interest applicable to the underlying notes and pay a floating amount based upon the three month U.S. Dollar London interbank offered rate. A 25 basis point increase or decrease in interest rates relative to interest rates as of June 24, 2011 would have an immaterial effect on our annual earnings and on the fair value of our fixed-rate debt and interest rate swaps.

 

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.

 

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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 24, 2011 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 24, 2010. Other than as described below, there were no material developments during the quarter ended June 24, 2011 related to previously described legal proceedings.

On May 2, 2011, the U.S. Attorney’s Office for the District of Massachusetts issued a subpoena to ev3 Inc., one of our subsidiaries, requesting production of documents relating to the following neurovascular products: Onyx®, Axium and Concerto. ev3 will comply as required with the terms of the subpoena.

 

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 24, 2010. 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
 

3/26/11 – 4/22/11

     —         $ —           —         $ 650,011,452   

4/23/11 – 5/27/11

     4,926,500      $ 55.8659        4,926,500      $ 374,788,269   

5/28/11 – 6/24/11

     —         $ —           —         $ 374,788,269   

 

Item 3. Defaults Upon Senior Securities

None.

 

Item 5. Other Information

None.

 

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 24, 2011 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.

 

* Furnished herewith.

 

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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: July 29, 2011

 

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