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COV > SEC Filings for COV > Form 10-Q on 30-Jul-2014All Recent SEC Filings

Show all filings for COVIDIEN PLC

Form 10-Q for COVIDIEN PLC


30-Jul-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.
Following the completion of the separation of our Pharmaceuticals business into a separate, stand alone publicly traded company, Mallinckrodt plc (the 2013 separation), we realigned our operating segments, effective October 1, 2013, 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. Recent Development
On June 15, 2014, Covidien and Medtronic, Inc. announced that they have entered into a definitive agreement under which Medtronic has agreed to acquire Covidien in a cash-and-stock transaction. Under the agreement, each outstanding ordinary share of Covidien will be converted into the right to receive $35.19 in cash and 0.956 of an ordinary share of Medtronic plc (a newly formed Irish company) (New Medtronic). Cash will be paid in lieu of any fractional share amounts. The consummation of the transaction is subject to certain conditions, including the effectiveness of the registration statement filed in connection with the transaction and approvals by Medtronic and Covidien shareholders. In addition, the proposed transaction requires regulatory clearances in the United States, the European Union, China and certain other countries. The transaction is expected to close in the fourth calendar quarter of 2014 or early calendar 2015. If the transaction agreement is terminated under certain circumstances, Covidien may be obligated to reimburse certain expenses of Medtronic, in an amount up to approximately $429 million.
Legal and Environmental Charges
We are currently involved in litigation in various state and federal courts against manufacturers of pelvic mesh products alleging personal injuries resulting from the implantation of those products. Two of our subsidiaries have supplied pelvic mesh products to one of the manufacturers named in the litigation and we are indemnifying that manufacturer on certain claims. During the quarter ended June 27, 2014, we received additional information regarding the nature of the claims and potential exposure based on access to medical records, settlements by other manufacturers and discussions with plaintiff attorneys, including discussions regarding potential future cases. Accordingly, we recorded a $181 million legal charge to increase our estimated indemnification obligation related to this matter, which is included in selling, general and administrative expenses for both the quarter and nine months ended June 27, 2014. Note 17 to our condensed consolidated financial statements provides additional information regarding this products liability matter. 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 in selling, general and administrative expenses in the consolidated statements of income for the nine months ended June 27, 2014. Note 17 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, which are included in our results of operations for the nine months ended June 27, 2014:
(Dollars in Millions)

Impairment of completed technology                      $ 28
Other pre-tax charges(1)                                   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 revenue 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 for the nine months ended June 27, 2014. 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 nine months ended June 27, 2014, our medical device tax was $16 million and $47 million, respectively. During the quarter and nine months ended June 28, 2013, our medical device tax was $12 million and $30 million, respectively.
Acquisitions
During the first nine 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 (New Wave)-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, comprised of upfront cash payments totaling $94 million; 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 revenue 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 $227 million in cash and recorded a pre-tax gain of $107 million during the nine months ended June 27, 2014. These amounts include a $4 million adjustment recorded during the quarter ended June 27, 2014 related to a milestone payment we were required to make under a license arrangement entered into during fiscal 2009. In addition to the cash received at the time of sale, 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 June 27, 2014, we had incurred $112 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 $260 million on an annualized basis once the program is completed. As of June 27, 2014, we had incurred $179 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 6 to our condensed consolidated financial statements.


Results of Operations
Quarters and Nine Months Ended June 27, 2014 and June 28, 2013
Net sales
Net sales by reportable segment were as follows:
                               Quarter Ended                                                                                Nine Months Ended
                          June 27,       June 28,                                                                        June 27,         June 28,
(Dollars in Millions)       2014           2013       Percent change     Currency impact    Operational growth (1)         2014             2013       Percent change     Currency impact    Operational growth (1)
Medical Devices         $    2,302     $    2,189           5  %               - %                    5  %            $    6,752        $    6,514           4 %               (1 )%                   5 %
U.S. Medical Supplies          386            389          (1 )                -                     (1 )                  1,173             1,161           1                  -                      1
Total Covidien          $    2,688     $    2,578           4                  -                      4               $    7,925        $    7,675           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 third quarter of fiscal 2014 increased $110 million, or 4%, to $2.688 billion, compared with $2.578 billion in the third quarter of fiscal 2013. Net sales for the first nine months of fiscal 2014 increased $250 million, or 3%, to $7.925 billion, compared with $7.675 billion in the first nine months of fiscal 2013. The increases in net sales for both periods were driven by increased sales volume and product mix, as well as the impact of the acquisitions, particularly the acquisition of Given Imaging. These increases in net sales were partially offset by the impact of pricing pressure and the divestiture of our biosurgery sealant product line. In addition, the increase in net sales for the nine month period was partially offset by the unfavorable impact of currency exchange fluctuations of $97 million. The primary exchange rate movement that negatively impacted our consolidated net sales growth for the first nine months of fiscal 2014 was the U.S. dollar compared to the Japanese yen, partially offset by the favorable exchange rate movement of the Euro. The increases in net sales for our Medical Devices segment in both the third quarter and first nine months of fiscal 2014 was driven by sales growth for vessel sealing and stapling products and the impact of the Given Imaging acquisition. During the third quarter of fiscal 2014, the decrease in sales for our U.S. Medical Supplies segment primarily resulted from a decline in sales of enteral feeding products. This decrease was partially offset by sales of SharpSafetyTM products, largely resulting from a competitive shortage of pre-filled syringes and more favorable pricing. During the first nine months of fiscal 2014, the increase in sales for our U.S. Medical Supplies segment was primarily driven by increased sales of SharpSafetyTM and incontinence products. Net sales by major product line were as follows:

                                      Quarter Ended                                                                                Nine Months Ended
                                 June 27,       June 28,                                                                        June 27,         June 28,
(Dollars in Millions)              2014           2013       Percent change     Currency impact    Operational growth (1)         2014             2013       Percent change     Currency impact    Operational growth (1)
Advanced Surgical              $      914     $      810          13  %               - %                   13  %            $    2,602        $    2,374          10  %              (1 )%                  11  %
General Surgical                      391            403          (3 )                -                     (3 )                  1,177             1,199          (2 )               (1 )                   (1 )
Surgical Solutions                  1,305          1,213           8                  1                      7                    3,779             3,573           6                 (1 )                    7

Peripheral Vascular                   304            305           -                  -                      -                      917               910           1                 (2 )                    3
Neurovascular                         113            112           1                  -                      1                      334               329           2                  -                      2
Vascular Therapies                    417            417           -                  -                      -                    1,251             1,239           1                 (1 )                    2

Patient Monitoring                    251            237           6                  -                      6                      759               728           4                 (1 )                    5
Airway & Ventilation                  198            193           3                  -                      3                      570               580          (2 )               (2 )                    -
Nursing Care                          249            254          (2 )                -                     (2 )                    766               762           1                 (1 )                    2
Patient Care                          268            264           2                  -                      2                      800               793           1                 (1 )                    2
Respiratory and Patient Care          966            948           2                  -                      2                    2,895             2,863           1                 (1 )                    2
Total Covidien                 $    2,688     $    2,578           4                  -                      4               $    7,925        $    7,675           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 products.

Surgical Solutions net sales increased $92 million, or 8%, to $1.305 billion in the third quarter of fiscal 2014, compared with $1.213 billion in the third quarter of fiscal 2013 and increased $206 million, or 6%, to $3.779 billion in the first nine months of fiscal 2014, compared with $3.573 billion in the first nine months of fiscal 2013. Currency exchange had almost no impact on the third quarter, however reduced net sales by $45 million during the first nine months of fiscal 2014. Excluding the impact of currency exchange, Surgical Solutions sales growth for both the third quarter and first nine months of fiscal 2014 primarily resulted from increased sales of vessel sealing and stapling products within Advanced Surgical. The increase in sales of vessel sealing products was largely driven by prior year product launches, including LigaSure™ Blunt Tip and LigaSure Impact™, while the increase for stapling products was primarily driven by our Tri-Staple™ reloads outside the United States. In addition, the acquisition of Given Imaging in February 2014 contributed $50 million and $68 million of net sales in the third quarter and first nine months of fiscal 2014, respectively.
Within General Surgical, the sales decline for both the quarter and first nine months of fiscal 2014 primarily resulted from the sale of our biosurgery sealant product line in January 2014 and lower sales of surgical instruments. These declines were partially offset by the positive impact of the New Wave acquisition and 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.

Vascular Therapies net sales of $417 million in the third quarter of fiscal 2014 were level with the comparable prior year period. Within Peripheral Vascular, increased sales of chronic venous insufficiency and procedural support products were more than offset by decreased sales of renal denervation, dialysis and compression products. The decline in renal denervation sales resulted from our exit of this business in the first quarter of fiscal 2014. The decline in dialysis sales largely resulted from the impact of the recently enacted consumption tax in Japan. Finally, the decrease in compression sales resulted from a rebate adjustment.
Within Neurovascular, decreased sales of access delivery products were offset by sales growth of flow diversion products, despite the voluntary product recall of our Pipeline™ Embolization Device and Alligator™ Retrieval Device announced in April 2014. We were able to achieve this growth through launching our new Pipeline™ Flex Embolization Device in Europe, which allowed us to transfer unaffected inventory from Europe to the U.S. during the third quarter. We have been working to resolve this recall issue and submitted our first filing to the Food and Drug Administration on July 18, 2014. The timing of obtaining regulatory approval to get our products back on the market remains uncertain. While the recall is expected to have a negative effect on our sales and earnings in the fourth quarter of fiscal 2014, such impact could be material if it takes longer than expected to get the products back on the market and we are unable to mitigate the impact.
Vascular Therapies net sales increased $12 million, or 1%, to $1.251 billion in the first nine months of fiscal 2014, compared with $1.239 billion in the first nine months of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $17 million. Excluding the impact of currency exchange, sales growth for Vascular Therapies was primarily driven by increased sales of Peripheral Vascular products, namely chronic venous insufficiency and procedural support products, partially offset by decreased sales of renal denervation products and stents. In addition, Neurovascular sales increased across all product lines, with the exception of access and delivery.
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.

Respiratory and Patient Care net sales increased $18 million to $966 million in the third quarter of fiscal 2014, compared with $948 million in the third quarter of fiscal 2013. This increase in sales was attributable to sales growth in Patient Monitoring and, to a lesser extent, Airway & Ventilation and Patient Care. Sales growth in Patient Monitoring primarily resulted from increased sales of capnography products and pulse oximetry sensors. Airway & Ventilation sales growth was largely due to increased sales of ventilators. Finally, Patient Care sales growth was primarily attributable to increased sales of SharpSafetyTM products, primarily resulting from a competitive shortage of pre-filled syringes and more favorable pricing. These increases in Respiratory and Patient Care sales were partially offset by a decline in sales for enteral feeding products within Nursing Care.
Respiratory and Patient Care net sales increased $32 million to $2.895 billion in the first nine months of fiscal 2014, compared with $2.863 billion the first nine months of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $35 million. Excluding the impact of currency exchange, the increase in sales was primarily driven by Patient Monitoring and, to a lesser extent, Patient Care and Nursing Care. Sales growth in Patient Monitoring primarily resulted from increased sales of capnography products and, to a lesser extent, advanced parameter and pulse oximetry sensors. Patient Care sales growth was primarily due to increased sales of SharpSafetyTM products resulting from more a competitive shortage of pre-filled syringes and more favorable pricing. Finally, sales growth in Nursing Care was largely due to increased sales of enteral feeding and incontinence products.
Net sales by geographic area, based primarily on the location of the customer, were as follows: . . .

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