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COV > SEC Filings for COV > Form 10-Q on 1-May-2014All Recent SEC Filings

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Form 10-Q for COVIDIEN PLC


1-May-2014

Quarterly Report


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 condensed 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 27, 2013 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.
As discussed under "Non-Operating Items-Discontinued Operations," the historical results of operations of our former Pharmaceuticals business have been presented as discontinued operations. Accordingly, our segment data has been recast to exclude our former Pharmaceuticals segment and to reallocate certain allocations previously included within this segment.
Effective October 1, 2013, we realigned our operating segments such that our Medical Supplies business in Western Europe is now managed by our Medical Devices segment. Integrating these businesses allows us to better utilize internal resources and achieve cost synergies. In addition, certain costs that were previously included in corporate expense, primarily information technology and certain shared service costs, are now reflected in our reportable segments, consistent with the way in which management measures and evaluates segment performance. Following this realignment, our reportable segments are as follows:
• Medical Devices includes worldwide sales of the following products:
advanced and general surgical solutions; peripheral vascular and neurovascular therapies; patient monitoring products; and airway and ventilation products. It also includes sales of the following products outside the United States: nursing care; medical surgical; SharpSafetyTM and original equipment manufacturer (OEM).

• U.S. Medical Supplies includes sales of the following products in the United States: nursing care; medical surgical; SharpSafetyTM and OEM.

We are also reporting our geographic sales primarily based on customer location rather than the location of the selling entity. We have restated prior period segment and geographic information to conform to the current year presentation. Environmental Charge
We are involved in various stages of investigation and cleanup related to environmental remediation matters at a number of sites. The most significant of these liabilities pertains to a site in Orrington, Maine. Following a court decision affirming a compliance order issued by the Maine Board of Environmental Protection, we recorded a $65 million charge for the estimated incremental costs of implementing the compliance order. This charge is included within selling, general and administrative expenses in the consolidated statements of income for both the quarter and six months ended March 28, 2014. Note 15 to our condensed consolidated financial statements provides additional information regarding this environmental matter.

Exit of Renal Denervation Program
In connection with management's regular review of strategic programs and growth potential for our product portfolio, management decided to exit our OneShot™ renal denervation program associated with the fiscal 2012 acquisition of Maya Medical. This decision was primarily driven by slower than expected development of the renal denervation market.


The following table summarizes the financial impact the decision to exit our renal denervation program had on our results of operations for the first quarter of fiscal 2014:
(Dollars in Millions)

Impairment of completed technology                      $ 28
Other pre-tax charges                                      7
Reversal of contingent consideration                     (26 )
   Total pre-tax charges                                   9
Income tax benefit on pre-tax charges                    (11 )
Income tax expense on contingent consideration reversal    2
Write-off of prepaid tax asset                            22
   Net income tax expense                                 13
Total charges, net of income tax expense                $ 22

(1) Other pre-tax charges primarily relate to the write-down of inventory and contract cancellation. During the first quarter of fiscal 2014, we determined that the post-market clinical trial associated with the radiofrequency energy-based renal denervation device (RF Device) to treat hypertension would not be successfully completed within the required timeframe. Accordingly, we reversed the $20 million contingent consideration liability associated with the achievement of this milestone. In addition, as a result of our decision to exit our renal denervation program, we reversed $6 million of contingent consideration liabilities that were primarily associated with the achievement of sales targets for the RF Device. During the second quarter of fiscal 2014, we recorded additional charges associated with exiting our renal denervation program, the amount of which was insignificant and primarily related to employee severance and benefits costs included in restructuring and related charges, net in the consolidated statement of income. Healthcare Reform
In March 2010, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act, was enacted into law in the United States. This legislation imposes a 2.3% excise tax on the sale in the United States of certain medical devices by a manufacturer, producer or importer of such devices starting after December 31, 2012. We estimate that the medical device tax will be between $60 and $65 million in fiscal 2014. During the quarter and six months ended March 28, 2014, our medical device tax was $15 million and $31 million, respectively. During both the quarter and six months ended March 29, 2013, our medical device tax was $18 million. Acquisitions
During the first six months of fiscal 2014, we acquired:
• Given Imaging Ltd.-a developer of gastrointestinal medical devices, for cash of $1.033 billion ($925 million, net of cash acquired);

• New Wave Surgical Corporation-a manufacturer of an endoscopic visualization system for use during laparoscopic procedures, for total consideration of $114 million ($113 million, net of cash acquired), comprised of cash of $111 million ($110 million, net of cash acquired) and debt assumed of $3 million, which was subsequently repaid;

• WEM Equipamentos Electrônicos Ltda.-a manufacturer of electrosurgical generators, disposables and accessories in Brazil, for cash of $54 million;

• 65% of Changzhou Kangdi Medical Stapler Co., Ltd. (Kangdi)-a manufacturer of open stapler products in China, for cash of $39 million ($36 million, net of cash acquired). In addition, we have the option to purchase the remaining shares of Kangdi, and the noncontrolling shareholders have the option to sell their shares to us, in fiscal 2019, or earlier if certain revenue targets are achieved. The price we would have to pay for the remaining shares of Kangdi is between $60 million and $96 million;

• Three other businesses for total consideration of $128 million ($126 million, net of cash acquired), comprised of upfront cash payments totaling $94 million ($92 million, net of cash acquired); debt assumed of $1 million, which was subsequently repaid; and the fair value of contingent consideration of $33 million. The contingent consideration, which could total a maximum of $192 million, consists of milestone payments related to the achievement of sales targets.


Divestiture
In January 2014, we sold our biosurgery sealant product line within our Medical Devices segment because it was not aligned with our long-term strategic objectives. In connection with this transaction, we received $231 million in cash and recorded a pre-tax gain of $111 million. In addition, we may receive up to $30 million, contingent upon the achievement of certain performance measures. This product line generated approximately $65 million of sales in fiscal 2013. Restructuring Initiatives
In fiscal 2013, we launched a restructuring program designed to improve our cost structure. This program includes actions across our segments and corporate. Such actions include, among other things, reducing corporate expenses, expanding the use of shared services in low-cost locations, outsourcing services where appropriate, streamlining our organizational structure, consolidating manufacturing locations, consolidating and optimizing distribution centers and expanding low-cost country sourcing. We expect to incur aggregate charges between $350 million and $450 million associated with these actions, of which approximately $100 million is estimated to be non-cash charges associated with facility closures. The remaining amount is expected to relate primarily to severance and termination costs, which we plan to fund using cash generated from operations. These charges, which are recorded as the specific actions required to execute on these initiatives are identified and approved, are expected to be incurred through fiscal 2018. Management is targeting savings from this program of $250 million to $300 million on an annualized basis once the program is completed. As of March 28, 2014, we had incurred $87 million of net restructuring and related charges under this program since its inception. This program excludes restructuring actions associated with acquisitions. In fiscal 2011, we launched a $275 million restructuring program designed to improve our cost structure. This program includes actions across our segments and corporate and excludes restructuring actions associated with acquisitions. Charges totaling approximately $50 million recorded under this program by our former Pharmaceuticals segment have been reclassified to discontinued operations. Accordingly, aggregate charges of approximately $225 million are expected to relate to our continuing operations. These charges, which are recorded as the specific actions required to execute on these initiatives are identified and approved, are expected to be incurred by the end of fiscal 2015. Savings from this program are estimated to be approximately $205 million on an annualized basis once the program is completed. As of March 28, 2014, we had incurred $172 million of net restructuring and related charges under this program since its inception. Additional information regarding restructuring and related charges is provided in "Results of Operations-Restructuring and related charges, net" and note 5 to our condensed consolidated financial statements. Results of Operations
Quarters and Six Months Ended March 28, 2014 and March 29, 2013 Net sales
Net sales by reportable segment were as follows:

                                Quarter Ended                                                                                 Six Months Ended
                          March 28,       March 29,                                                                       March 28,       March 29,
(Dollars in Millions)       2014            2013        Percent change     Currency impact    Operational growth (1)        2014            2013        Percent change     Currency impact    Operational growth (1)
Medical Devices         $     2,199     $     2,143           3 %               (1 )%                   4 %             $     4,450     $     4,325           3 %               (2 )%                   5 %
U.S. Medical Supplies           399             387           3 %                -  %                   3 %                     787             772           2 %                -  %                   2 %
Total Covidien          $     2,598     $     2,530           3 %               (1 )%                   4 %             $     5,237     $     5,097           3 %               (2 )%                   5 %

(1) Operational growth is a non-GAAP financial measure, which should be considered supplemental to, and not a substitute for, our reported financial results prepared in accordance with U.S. GAAP. See "Management's Use of Non-GAAP Measures."

Net sales in the second quarter of fiscal 2014 increased $68 million, or 3%, to $2.598 billion, compared with $2.530 billion in the second quarter of fiscal 2013. Net sales for the first six months of fiscal 2014 increased $140 million, or 3%, to $5.237 billion, compared with $5.097 billion in the first six months of fiscal 2013. The increases in net sales for both periods were driven by increased sales volume and product mix, partially offset by the unfavorable impact of currency exchange fluctuations of $40 million and $97 million in the second quarter and first six months of fiscal 2014, respectively, and the impact of pricing pressure. The primary exchange rate movement that negatively impacted our consolidated net sales growth for both the second quarter and first six months of fiscal 2014 was the U.S. dollar compared to the Japanese yen. The increases in net sales for our Medical Devices segment in both the second quarter and first six months of fiscal 2014 was primarily a result of increased sales of our Surgical Solutions product group, specifically Advanced Surgical products. During the second


quarter of fiscal 2014, the increase in sales for our U.S. Medical Supplies segment primarily resulted from increased sales of our U.S. Patient Care products, specifically SharpSafetyTM products. During the first six months of fiscal 2014, the increase in sales for our U.S. Medical Supplies segment primarily resulted from increased sales of U.S. Nursing Care products, primarily enteral feeding and incontinence products. Net sales by major product line were as follows:

                                       Quarter Ended                                                                                 Six Months Ended
                                 March 28,       March 29,                                                                       March 28,       March 29,
(Dollars in Millions)              2014            2013        Percent change     Currency impact    Operational growth (1)        2014            2013        Percent change     Currency impact    Operational growth (1)
Advanced Surgical              $       835     $       774           8  %              (1 )%                   9  %            $     1,688     $     1,564           8  %              (2 )%                  10  %
General Surgical                       378             392          (4 )               (2 )                   (2 )                     786             796          (1 )               (2 )                    1
Surgical Solutions                   1,213           1,166           4                 (2 )                    6                     2,474           2,360           5                 (2 )                    7
Peripheral Vascular                    298             295           1                 (2 )                    3                       613             605           1                 (3 )                    4
Neurovascular                          111             111           -                  -                      -                       221             217           2                  -                      2
Vascular Therapies                     409             406           1                 (1 )                    2                       834             822           1                 (3 )                    4
Patient Monitoring                     258             250           3                 (1 )                    4                       508             491           3                 (2 )                    5
Airway & Ventilation                   190             191          (1 )               (3 )                    2                       372             387          (4 )               (3 )                   (1 )
Nursing Care                           258             254           2                 (1 )                    3                       517             508           2                 (2 )                    4
Patient Care                           270             263           3                 (1 )                    4                       532             529           1                  -                      1
Respiratory and Patient Care           976             958           2                 (1 )                    3                     1,929           1,915           1                 (1 )                    2
Total Covidien                 $     2,598     $     2,530           3                 (1 )                    4               $     5,237     $     5,097           3                 (2 )                    5

(1) Operational growth is a non-GAAP financial measure, which should be considered supplemental to, and not a substitute for, our reported financial results prepared in accordance with U.S. GAAP. See "Management's Use of Non-GAAP Measures."

Surgical Solutions-Surgical Solutions is comprised of the following:
• Advanced Surgical, which primarily includes sales of stapling, vessel sealing, fixation (hernia mechanical devices), mesh, hardware and ablation products, and interventional lung and gastrointestinal solutions.

• General Surgical, which primarily includes sales of surgical instruments, sutures, and electrosurgery and biosurgery products.

Sales of our Surgical Solutions product group increased $47 million, or 4%, to $1.213 billion in the second quarter of fiscal 2014, compared with $1.166 billion in the second quarter of fiscal 2013 and increased $114 million, or 5%, to $2.474 billion in the first six months of fiscal 2014, compared with $2.360 billion in the first six months of fiscal 2013. Unfavorable currency exchange decreased net sales by $20 million and $47 million in the second quarter and first six months of fiscal 2014, respectively. Excluding the impact of currency exchange, the sales increases for both the second quarter and first six months of fiscal 2014 were primarily attributable to stapling and vessel sealing products within Advanced Surgical. Sales growth of stapling products was primarily driven by sales of Tri-Staple™ reloads outside the United States, while sales growth for vessel sealing products was largely driven by product launches in prior years, including LigaSure™ Blunt Tip, LigaSure Impact™ and Sonicision™. In addition, Advanced Surgical benefited from the acquisition of Given Imaging in February 2014, which resulted in $18 million of sales in both the second quarter and first six months of fiscal 2014. Within General Surgical, sales decreased during the second quarter as increased sales of sutures were more than offset by the sale of our biosurgery sealant product line in January 2014. However, sales of General Surgical products increased during the first six months of fiscal 2014, as the impact of the biosurgery sealant divestiture was more than offset by increased sales of sutures and electrosurgery products. Vascular Therapies-Vascular Therapies is comprised of the following:
• Peripheral Vascular, which includes sales of compression, dialysis, venous insufficiency products, peripheral stents and directional artherectomy products, as well as other products to support procedures.

•         Neurovascular, which includes sales of coils, neurovascular stents and
          flow diversion products, as well as access and delivery products to
          support procedures.


Sales of our Vascular Therapies product group increased $3 million, or 1%, to $409 million in the second quarter of fiscal 2014, compared with $406 million in the second quarter of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $6 million. Excluding the impact of currency exchange, the increase in sales was primarily driven by compression products, and, to a lesser extent, procedural support products within Peripheral Vascular. For the second quarter of fiscal 2014, Neurovascular sales were level with the comparable prior year period, as a decrease in sales of access and delivery products was offset by slight increases in other neurovascular products. Sales of our Vascular Therapies product group increased $12 million, or 1%, to $834 million in the first six months of fiscal 2014, compared with $822 million in the first six months of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $17 million in the first six months of fiscal 2014. Excluding the impact of currency exchange, the increase in sales primarily resulted from increased sales of Peripheral Vascular products, specifically chronic venous insufficiency and procedural support products, and, to a lesser extent, compression products. The increase in sales of Neurovascular products was primarily attributable to sales of coils and other Neurovascular products, partially offset by a decrease in sales of access and delivery products.
During the second quarter of fiscal 2014, we announced a voluntary recall to address an issue with certain lots of our Pipeline™ Embolization Device and Alligator™ Retrieval Device. We believe that we have identified a solution to the problem and are actively working with the U.S. Food and Drug Administration. The recall is expected to have a slight negative effect on our sales and earnings in the second half of fiscal 2014. However, the timing of obtaining regulatory approval to get the products back on the market is uncertain. If this process takes longer than expected, the delay could have a material effect on our results of operations for the fourth quarter of fiscal 2014.
Respiratory and Patient Care-Respiratory and Patient Care is comprised of the following:

•         Patient Monitoring, which includes sales of sensors, monitors and
          temperature management products.


•         Airway & Ventilation, which primarily includes sales of airway,
          ventilator and inhalation therapy products and breathing systems.


•         Nursing Care, which primarily includes sales of incontinence, enteral
          feeding, wound care, urology and suction products.


•         Patient Care, which includes sales of medical surgical products, such
          as operating room supply products and electrodes; OEM products, which
          are various medical supplies manufactured for other medical products
          companies; and SharpSafetyTM products, which includes needles, syringes
          and sharps disposal products.

Sales of our Respiratory and Patient Care product group increased $18 million to $976 million in the second quarter of fiscal 2014, compared with $958 million in the second quarter of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $14 million in the second quarter of fiscal 2014. Excluding the impact of currency exchange, the increase in sales during the second quarter of fiscal 2014 was attributable to increases across all major product lines, particularly Patient Monitoring, Patient Care and Nursing Care products. The increase in Patient Monitoring was principally attributable to increased sales of capnography and advanced parameter sensors. The increase in sales for Patient Care primarily resulted from increased sales of SharpSafetyTM products resulting from favorable pricing and a shortage of product in the market. Finally, the increase in sales for Nursing Care primarily resulted from a new incontinence product that we launched in the second half of fiscal 2013. Sales of our Respiratory and Patient Care product group increased $14 million to $1.929 billion in the first six months of fiscal 2014, compared with $1.915 billion the first six months of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $33 million. The increase in sales of Respiratory and Patient Care products was primarily due Patient Monitoring and Nursing Care products. The increase in Patient Monitoring products primarily resulted from increased sales of capnography products and, to a lesser extent, advanced parameter sensors. The increase in Nursing Care products was mainly due to increased sales of enteral feeding products and, to a lesser extent, incontinence products. These increases were partially offset by an overall decrease in Airway and Ventilation products, primarily resulting from decreased sales of ventilators.


Net sales by geographic area, based primarily on the location of the customer, were as follows:

                                  Quarter Ended                                                                          Six Months Ended
                            March 28,       March 29,                                             Operational        March 28,       March 29,                                             Operational
(Dollars in Millions)         2014            2013        Percent change     Currency impact       growth(1)           2014            2013        Percent change     Currency impact       growth(1)
United States             $       448     $       439           2  %               -  %                2 %         $       927     $       896           3  %               -  %                3 %
Non-U.S. Developed
Markets(2)                        531             518           3                 (1 )                 4                 1,070           1,046           2                 (3 )                 5
Emerging Markets(3)               234             209          12                 (6 )                18                   477             418          14                 (4 )                18
Surgical Solutions              1,213           1,166           4                 (2 )                 6                 2,474           2,360           5                 (2 )                 7
United States                     226             225           -                  -                   -                   463             456           2                  -                   2
Non-U.S. Developed
Markets(2)                        126             123           2                 (3 )                 5                   256             258          (1 )               (5 )                 4
Emerging Markets(3)                57              58          (2 )               (4 )                 2                   115             108           6                 (4 )                10
Vascular Therapies                409             406           1                 (1 )                 2                   834             822           1                 (3 )                 4
United States                     603             593           2                  -                   2                 1,194           1,174           2                  -                   2
Non-U.S. Developed
Markets(2)                        281             280           -                 (3 )                 3                   546             558          (2 )               (4 )                 2
Emerging Markets(3)                92              85           8                 (7 )                15                   189             183           3                 (5 )                 8
. . .
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