News Column

COVIDIEN PLC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 1, 2014

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. 36 -------------------------------------------------------------------------------- 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. 37

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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 38 -------------------------------------------------------------------------------- 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. 39

-------------------------------------------------------------------------------- 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. 40 -------------------------------------------------------------------------------- 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 Respiratory and Patient Care 976 958 2 (1 ) 3 1,929 1,915 1 (1 ) 2 United States 1,277 1,257 2 - 2 2,584 2,526 2 - 2 Non-U.S. Developed Markets(2) 938 921 2 (2 ) 4 1,872 1,862 1 (3 ) 4 Emerging Markets(3) 383 352 9 (5 ) 14 781 709 10 (4 ) 14 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."



(2) Non-U.S. Developed Markets includes Western Europe, Japan, Canada, Australia

and New Zealand. During the second quarter of both fiscal 2014 and 2013,

sales to Japan represented 9% of total net sales. Sales to Japan represented

9% and 10% of total net sales in the first six months of fiscal 2014 and

2013, respectively.

(3) Emerging Markets includes Eastern Europe, Middle East, Africa, Asia

(excluding Japan) and Latin America.

Net sales in the United States increased $20 million, or 2%, during the second quarter of fiscal 2014, compared with the second quarter of fiscal 2013. The increase in sales during the second quarter of fiscal 2014 was primarily a result of increased sales of Respiratory and Patient Care and Surgical Solutions. The increase in sales for Respiratory and Patient Care was mainly due to increased sales of our SharpSafetyTM products, primarily a result of favorable pricing and a shortage of product in the market, and increased sales of incontinence products resulting from the launch of a new product in the second half of fiscal 2013. The increase in sales for Surgical Solutions primarily resulted from the acquisition of Given Imaging during the second quarter of fiscal 2014, partially offset by the impact of the divestiture of our biosurgery sealant product line. Net sales in the United States increased $58 million, or 2%, during the first six months of fiscal 2014, compared with the first six months of fiscal 2013 due to increased sales of Surgical Solutions and Respiratory and Patient Care. Increased sales of Surgical Solutions primarily resulted from increased sales of vessel sealing products and the impact of the acquisition of Given Imaging, partially offset by the impact of the divestiture of our biosurgery sealant product line. The increase in sales for Respiratory and Patient Care was primarily due to increased sales of capnography, enteral feeding and incontinence products, partially offset by declines in monitors, ventilators and medical surgical products. Net sales in Non-U.S. Developed Markets increased $17 million, or 2%, during the second quarter of fiscal 2014, compared with the second quarter of fiscal 2013 and increased $10 million, or 1%, during the first six months of fiscal 2014, compared with the first six months of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $20 million and $69 million in the second quarter and first six months of fiscal 2014, respectively. Excluding the impact of currency exchange, the increases in sales for both the second quarter and first six months of fiscal 2014 primarily related to increased sales of Surgical Solutions, namely stapling and vessel sealing products in Western Europe and Japan and, to a lesser extent, increased sales of sensors within Respiratory and Patient Care in Japan. 41 -------------------------------------------------------------------------------- Net sales in Emerging Markets increased $31 million, or 9%, during the second quarter of fiscal 2014, compared with the second quarter of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $20 million in the second quarter of fiscal 2014. The increase in sales for the second quarter of fiscal 2014 was primarily attributable to Surgical Solutions and Respiratory and Patient Care. The Surgical Solutions sales growth primarily resulted from an increase in sales of stapling and vessel sealing products in Eastern Europe and Asia and, to a lesser extent, increased sales of sutures across all regions. The sales growth in Respiratory and Patient Care was primarily a result of increased sales of sensors across all regions, as well as increased sales of ventilators, in Latin America. Net sales in Emerging Markets increased $72 million, or 10%, during the first six months of fiscal 2014, compared with the first six months of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $28 million in the first six months of fiscal 2014. This increase was due to growth among all product groups. The Surgical Solutions sales growth primarily resulted from an increase in sales of stapling and vessel sealing products in Eastern Europe and Asia and, to a lesser extent, increased sales of sutures across all regions. The sales growth in Respiratory and Patient Care was primarily a result of increased sales of sensors across all regions. Finally, the increase in sales of Vascular Therapies primarily related to increased sales of neurovascular stents and coils in Asia, partially offset by a decrease in sales of these products in Eastern Europe. Operating Expenses A summary of certain operating expenses were as follows: Quarter Ended Six Months Ended March 28, 2014 March 29, 2013 March 28, 2014 March 29, 2013 % of Net % of Net % of Net % of Net



(Dollars in Millions) $ Amount Sales $ Amount Sales

$ Amount Sales $ Amount Sales Cost of goods sold $ 1,080 41.6 % $ 1,002 39.6 % $ 2,156 41.2 % $ 2,032 39.9 % Selling, general and administrative expenses 896 34.5 830 32.8 1,746 33.3 1,652 32.4 Research and development expenses 135 5.2 122 4.8 260 5.0 233 4.6 Cost of goods sold-Cost of goods sold was 41.6% and 39.6% of net sales in the second quarter of fiscal 2014 and 2013, respectively, and 41.2% and 39.9% of net sales in the first six months of fiscal 2014 and 2013, respectively. The increases in cost of goods sold as a percent of net sales during both current year periods primarily resulted from unfavorable currency exchange fluctuations, pricing pressure, and higher freight and warehousing costs. These increases were partially offset by increased sales volume and a more favorable product mix. Selling, general and administrative expenses-Selling, general and administrative expenses in the second quarter of fiscal 2014 increased $66 million, or 8.0%, to $896 million, compared with $830 million in the second quarter of fiscal 2013. This increase was driven primarily by a $65 million environmental charge associated with a site located in Orrington, Maine and, to a lesser extent, sales force expansion. As part of our strategy, we continue to focus on growing our sales and marketing presence in Emerging Markets. These increases in selling, general and administrative expenses were partially offset by the impact of cost savings initiatives. As a percentage of our net sales, selling, general and administrative expenses were 34.5% for the second quarter of fiscal 2014, compared with 32.8% for the second quarter of fiscal 2013. Selling, general and administrative expenses increased $94 million, or 5.7%, to $1.746 billion in the first six months of fiscal 2014, compared with $1.652 billion in the first six months of fiscal 2013. This increase was largely attributable to the $65 million environmental charge discussed above; sales force expansion, primarily in Emerging Markets; charges incurred in connection with the discontinuance of our renal denervation program; and the medical device tax, which became effective for us in the second quarter of fiscal 2013. These increases in selling, general and administrative expenses were partially offset by cost savings initiatives and the reversal of contingent consideration liabilities associated with the fiscal 2012 acquisition of Maya Medical. As a percentage of our net sales, selling, general and administrative expenses were 33.3% for the first six months of fiscal 2014, compared with 32.4% for the first six months of fiscal 2013. Research and development expenses-Research and development expenses increased $13 million, or 10.7%, to $135 million in the second quarter of fiscal 2014, compared with $122 million in the second quarter of fiscal 2013 and increased $27 million, or 11.6% to $260 million in the first six months of fiscal 2014, compared to $233 million in the first six months of fiscal 2013. These increases primarily resulted from additional spending on drug coated balloon treatment for peripheral arterial disease. Additional spending resulting from acquisitions also contributed to the increase during the second quarter of fiscal 2014. As a percentage of our net sales, research and development expenses were 5.2% and 5.0% for the second quarter and first six months of fiscal 2014, respectively, compared with 4.8% and 4.6% for the second quarter and first six months of fiscal 2013, respectively. 42 -------------------------------------------------------------------------------- Restructuring and related charges, net-During the second quarter of fiscal 2014, we recorded net restructuring and related charges of $17 million, of which charges of $1 million related to accelerated depreciation and were included in cost of goods sold. The remaining $16 million primarily related to severance and employee benefit costs incurred as a result of acquisitions and, to a lesser extent, costs incurred under our 2013 program related to reorganizing our European operations. During the first six months of fiscal 2014, we recorded net restructuring and related charges of $76 million, of which charges of $3 million related to accelerated depreciation and were included in cost of goods sold. The remaining $73 million primarily related to severance and employee benefit costs incurred under our 2013 program related to reorganizing our European operations and, to a lesser extent, costs incurred as a result of acquisitions. During the second quarter and first six months of fiscal 2013, we recorded net restructuring and related charges of $55 million and $63 million, respectively, of which charges of $1 million in both periods related to accelerated depreciation and were included in cost of goods sold. The remaining $54 million and $62 million for the second quarter and first six months of fiscal 2013, respectively, primarily related to severance and employee benefit costs incurred under our 2011 program. Segment Operating Income Refer to note 2 for a summary of financial results by segment. The following is a summary of significant factors impacting segment financial results. Medical Devices-Operating income for the second quarter of fiscal 2014 decreased $9 million to $618 million, compared with $627 million in the second quarter of fiscal 2013. Operating margin was 28.1% for the second quarter of fiscal 2014, compared with 29.3% for the second quarter of fiscal 2013. The decrease in operating income and margin primarily resulted from pricing pressure and investments in sales force expansion in Emerging Markets. These decreases were partially offset by the favorable sales performance of the segment, as discussed under "Net Sales," and cost savings initiatives. Operating income for the first six months of fiscal 2014 increased $7 million to $1.268 billion, compared with $1.261 billion in the first six months of fiscal 2013. Operating margin was 28.5% for the first six months of fiscal 2014, compared with 29.2% for the first six months of fiscal 2013. The increase in operating income was primarily attributable to increased gross profit on the favorable sales performance for the segment, which is discussed under "Net Sales," and the positive impact of cost savings initiatives. These increases to operating income were partially offset by increases in selling and marketing expenses resulting from sales force expansion, primarily in Emerging Markets, and increased research and development spending, primarily related to drug coated balloon treatment for peripheral arterial disease. The increases in operating expenses, as well as pricing pressure, resulted in a decrease in operating margin for the segment. U.S. Medical Supplies-Operating income for the second quarter of fiscal 2014 decreased $3 million to $39 million, compared with $42 million in the second quarter of fiscal 2013. Operating margin was 9.8% for the second quarter of fiscal 2014, compared with 10.9% for the second quarter of fiscal 2013. The decreases in operating income and margin primarily resulted from increased manufacturing costs, including freight and warehousing, partially offset by the favorable sales performance for the overall segment discussed under "Net Sales." Operating income for the first six months of fiscal 2014 decreased $15 million to $78 million, compared with $93 million in the first six months of fiscal 2013. Operating margin was 9.9% for the first six months of fiscal 2014, compared with 12.0% for the first six months of fiscal 2013. The decreases in operating income and margin primarily resulted from increased manufacturing costs, including freight and warehousing, and the medical device tax, which was not effective for us until the second quarter of fiscal 2013. These decreases were partially offset by the favorable sales performance for the overall segment discussed under "Net Sales." Corporate-Corporate expenses were $97 million and $98 million for the second quarter of fiscal 2014 and 2013, respectively, and $187 million and $179 million for the first six months of fiscal 2014 and 2013, respectively. The increase in corporate expenses during the first six months of fiscal 2014 was primarily due to increased costs associated with employee compensation programs and legal fees. 43 -------------------------------------------------------------------------------- Non-Operating Items Interest Expense and Interest Income-During the second quarter of fiscal 2014 and 2013, interest expense was $54 million and $51 million, respectively. Interest expense was $107 million and $102 million for the first six months of fiscal 2014 and 2013, respectively. Subsequent to the end of the quarter, we entered into interest rate swaps on $500 million principal amount of our 3.20% senior notes due 2022 and $500 million principal amount of our 2.95% senior notes due 2023. Based on interest rates as of the end of the second quarter of fiscal 2014, we expect our interest expense to decrease approximately $20 million annually over the remaining life of the debt as a result of entering into these swap contracts. During the second quarter of fiscal 2014 and 2013, interest income was $6 million and $2 million, respectively. Interest income was $8 million and $5 million for the first six months of fiscal 2014 and 2013, respectively. The increases in interest income for both the quarter and first six months of fiscal 2014, compared to the same prior year periods resulted from the favorable impact of interest on previously collected receivables. Other Income, Net-During the second quarter and first six months of fiscal 2014, we recorded other income, net of $67 million and $100 million, respectively. These amounts included income resulting from increases to our receivable from Tyco International Ltd. and TE Connectivity Ltd. of $62 million and $94 million during the quarter and six months ended March 28, 2014, respectively. This income primarily reflects 58% of the interest and other income taxes payable amounts recorded that are subject to the Tyco tax sharing agreement. The $94 million for the first six months of fiscal 2014 also included $25 million of income for our portion of Tyco International's settlement of contract claims under a 2002 tax agreement with CIT Group Inc., a former subsidiary of Tyco International. During the second quarter and first six months of fiscal 2013, we recorded other income, net of $17 million and $18 million, respectively. The amounts for both fiscal 2013 periods include a $9 million gain on investments and a $4 million gain resulting from the demutualization of an insurance carrier. In addition, other income, net for the second quarter and first six months of fiscal 2013 include income of $4 million and $5 million, respectively, and corresponding increases to our receivable from Tyco International and TE Connectivity. These amounts reflect 58% of the interest and other income taxes payable amounts recorded that are subject to the Tyco tax sharing agreement. Income Tax Expense-Income tax expense was $160 million and $110 million on income from continuing operations before income taxes of $601 million and $490 million for the second quarter of fiscal 2014 and 2013, respectively. This resulted in effective tax rates of 26.6% and 22.4% for the second quarter of fiscal 2014 and 2013, respectively. The increase in our effective tax rate for the second quarter of fiscal 2014, compared with the comparative prior year period, primarily resulted from charges recorded in connection with the potential settlement of certain tax matters within the 2005 through 2007 audit cycle. This increase was somewhat offset by taxable gains generated in the second quarter of fiscal 2013 in connection with the restructuring of legal entities in advance of the separation of our Pharmaceuticals business. Income tax expense was $275 million and $203 million on income from continuing operations before income taxes of $1.114 billion and $1.039 billion for the first six months of fiscal 2014 and 2013, respectively. This resulted in effective tax rates of 24.7% and 19.5% for the first six months of fiscal 2014 and 2013, respectively. The increase in our effective tax rate for the first six months of fiscal 2014, compared with the comparative prior year period, primarily resulted from the potential settlement of certain tax matters within the 2005 through 2009 audit cycles and the tax charge associated with the exit of our OneShot™ renal denervation program. This increase was somewhat offset by taxable gains generated in the first six months of fiscal 2013 in connection with the restructuring of legal entities in advance of the separation of our Pharmaceuticals business. Discontinued Operations-During fiscal 2013, we completed the separation of our Pharmaceuticals business into a separate, stand alone publicly traded company, Mallinckrodt plc (the 2013 separation). The historical results of operations of our former Pharmaceuticals business have been presented as discontinued operations in the prior year condensed consolidated statements of income and comprehensive income. Discontinued operations include the results of Mallinckrodt's business except for certain corporate overhead costs and other allocations, which remain in continuing operations. Discontinued operations also include costs we incurred to separate Mallinckrodt. The prior year statement of cash flows has not been adjusted to reflect the effect of the 2013 separation. 44 --------------------------------------------------------------------------------



Net sales and income from Mallinckrodt's operations and adjustments to the loss recorded on prior dispositions were as follows:

Quarter Ended March 29, Six Months Ended (Dollars in Millions) 2013 March 29, 2013 Net sales $ 573 $ 1,062 Income from operations, net of tax expense of $14 and $38(1) $ 61 $ 98 Loss on dispositions, net of tax benefit of $- and $- (2 ) (2 ) Income from discontinued operations, net of income taxes $ 59 $ 96 (1) Includes pre-tax charges incurred in connection with the activities taken to complete the 2013 separation and to build out Mallinckrodt's corporate infrastructure totaling $36 million and $55 million for the quarter and six months ended March 29, 2013, respectively. Management's Use of Non-GAAP Measures Operational growth, a non-GAAP financial measure, measures the change in sales between 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 financial measures in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), 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 U.S. GAAP. Free cash flow, a non-GAAP measure, represents the cash that we have available to pursue opportunities that we believe enhance shareholder value. Management uses this non-GAAP financial measure, in addition to U.S. 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 U.S. GAAP. 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 continue to invest in growth opportunities and fund operations for the foreseeable future. A summary of our cash flows from operating, investing and financing activities is provided in the following table: Six Months Ended March 28, March 29, (Dollars in Millions) 2014 2013 Net cash provided by (used in): Operating activities $ 992$ 807 Investing activities (1,089 ) (471 ) Financing activities (577 )



(487 ) Effect of currency exchange rate changes on cash and cash equivalents

(16 ) (32 ) Net decrease in cash and cash equivalents $ (690 )



$ (183 )

Operating Activities Net cash provided by operating activities of $992 million for the first six months of fiscal 2014 was primarily attributable to net income, as adjusted for depreciation, amortization and net gain on divestiture, partially offset by a working capital outflow of $83 million. A decrease in accrued and other liabilities of $100 million, largely driven by the annual payout of cash bonuses for performance in the prior fiscal year, partially offset by an increase in environmental reserves, contributed to the working capital outflow. A $96 million decrease in other working capital, primarily resulting from a $62 million increase in our receivable from Tyco International and TE Connectivity, also contributed to the outflow. These working capital outflows were partially offset by an increase in income taxes payable of $150 million. The increase in accounts receivable resulting from 45 -------------------------------------------------------------------------------- increased sales was offset by collections of $115 million from the Spanish government in February 2014, which related to invoices issued prior to June 2013. Net cash provided by operating activities of $807 million for the first six months of fiscal 2013 was primarily attributable to net income, as adjusted for depreciation and amortization, partially offset by a working capital outflow of $604 million. The working capital outflow was primarily attributable to a decrease in accrued and other liabilities of $233 million, an increase in accounts receivable of $171 million and an increase in inventory of $92 million. The decrease in accrued and other liabilities was largely driven by the annual payout of cash bonuses for performance in the prior fiscal year and the $50 million voluntary contribution we made to our pension plans during the first six months of fiscal 2013. Investing Activities Net cash used in investing activities was $1.089 billion and $471 million for the first six months of fiscal 2014 and 2013, respectively. Acquisitions and Divestiture-During the first six months of fiscal 2014, we paid cash of $1.217 billion to acquire seven businesses, of which $925 million was for the acquisition of Given Imaging. In addition, during the first six months of fiscal 2014, we received cash of $231 million for the sale of our biosurgery sealant product line. During the first six months of fiscal 2013, we paid cash of $238 million for acquisitions, $100 million of which was for the acquisition of CV Ingenuity; $88 million of which was for the acquisition of CNS Therapeutics, Inc., which was acquired by our former Pharmaceuticals segment; and $50 million of which was for the acquisition of Nfocus Neuromedical, Inc.Capital Spending-Capital expenditures were $153 million and $241 million for the first six months of fiscal 2014 and 2013, respectively. This decrease was primarily due to the 2013 separation. For the full year fiscal 2014, we expect capital expenditures to be in the range of $375 million to $400 million, which we expect to fund using cash generated from operations. Financing Activities Net cash used in financing activities was $577 million and $487 million for the first six months of fiscal 2014 and 2013, respectively. Debt Issuances-During the first six months of fiscal 2013, we received net proceeds of $40 million from the issuance of commercial paper. Dividend Payments-Dividend payments were $289 million during the first six months of fiscal 2014, compared with $246 million during the first six months of fiscal 2013. Share Repurchases and Option Exercises-We repurchased approximately 5.6 million shares for $378 million during the first six months of fiscal 2014 and approximately 7.5 million shares for $450 million during the first six months of fiscal 2013 under our share buyback program. We also repurchased 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. We spent $15 million and $9 million to acquire shares in connection with these equity-based awards during the first six months of fiscal 2014 and 2013, respectively. Share repurchases were somewhat offset by proceeds from option exercises of $111 million and $175 million during the first six months of fiscal 2014 and 2013, respectively. Free Cash Flow We returned 69% and 87% of our operating cash flow to shareholders during the first six months of fiscal 2014 and 2013, respectively, through a combination of both dividend payments and share repurchases. Free cash flow returned to shareholders was 81% and 125% for the first six months of fiscal 2014 and 2013, respectively. Free cash flow was $839 million for the first six months of fiscal 2014, compared with $566 million for the first six months of fiscal 2013. The $273 million increase in free cash flow primarily resulted from a decrease in capital expenditures of $88 million and a decrease in income taxes paid, net of refunds of approximately $90 million. In addition, we made a $50 million voluntary contribution to our pension plans during the prior period. In the next 12 months, we expect to make a net payment of approximately $320 million related to pre-separation tax matters under the Tyco tax sharing agreement for the anticipated settlement of the 2005 through 2007 audit cycles discussed under "Commitments and Contingencies-Income Taxes." Free cash flow 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." Reconciliations between net cash provided by operating activities (the most comparable U.S. GAAP measure) and free cash 46 --------------------------------------------------------------------------------

flow are as follows: Six Months Ended March 28, March 29, (Dollars in Millions) 2014 2013 Net cash provided by operating activities $ 992$ 807 Capital expenditures (153 ) (241 ) Free cash flow $ 839$ 566 Capitalization



Shareholders' equity was $9.562 billion at March 28, 2014, compared with $9.242 billion at September 27, 2013. The increase in shareholders' equity was primarily due to net income of $839 million, partially offset by share repurchases of $393 million and dividends declared of $289 million. The following table contains several key measures to gauge our financial condition and liquidity at the end of each period:

March 28, September 27, (Dollars in Millions) 2014 2013 Cash and cash equivalents $ 1,178$ 1,868 Current maturities of long-term debt 6 11 Long-term debt 5,015 5,018 Total debt 5,021 5,029 Shareholders' equity 9,562 9,242 Debt-to-total capital ratio 34 % 35 % As of March 28, 2014, our cash and cash equivalents were held principally in subsidiaries which are located throughout the world. Under current laws, substantially all of these amounts can be repatriated to our Luxembourg subsidiary, Covidien International Finance S.A., which is the obligor of substantially all of our debt, and to our Irish parent company; however, the repatriation of these amounts could subject us to additional tax costs. We provide for tax liabilities in our financial statements with respect to amounts that we expect to repatriate; however, no tax liabilities are recorded for amounts that we consider to be permanently reinvested outside of Ireland. Our current plans do not demonstrate a need to repatriate earnings that are designated as permanently reinvested in order to fund our operations, including investing and financing activities. We have a $1.50 billion five-year unsecured senior revolving credit facility, which expires in August 2016. In addition, we may increase this facility by up to $500 million to a maximum of $2.00 billion provided certain borrowing conditions are met. We are required to maintain an available unused balance under our $1.50 billion revolving credit facility sufficient to support amounts outstanding under our commercial paper program. We had no commercial paper outstanding at March 28, 2014 and September 27, 2013. In addition, no amount was outstanding under our credit facility at the end of either period. 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 On January 16, 2014, the board of directors declared a quarterly cash dividend of $0.32 per share, which was paid during the second quarter of fiscal 2014. Dividend payments totaled $289 million for the first six months of fiscal 2014. On March 19, 2014, the board of directors declared a quarterly cash dividend of $0.32 per share to shareholders of record at the close of business on April 7, 2014. The dividend is payable on May 5, 2014. Commitments and Contingencies Legal Proceedings We are subject to various legal proceedings and claims, including patent infringement claims, products liability matters, environmental matters, employment disputes, contractual disputes and other commercial disputes, as described in our Annual Report on Form 10-K for the fiscal year ended September 27, 2013. 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 47 -------------------------------------------------------------------------------- upon our experience, current information and applicable law, we do not expect that these proceedings will have a material adverse effect on our financial condition. However, one or more of the proceedings could have a material adverse effect on our results of operations or cash flows for a future period. Further information regarding our legal proceedings is provided in note 15 to our condensed consolidated financial statements and in Part II, Item 1 of this Quarterly Report. Guarantees In connection with our 2007 separation from Tyco International and TE Connectivity, we entered into guarantee commitments and indemnifications with Tyco International and TE Connectivity related to certain contingent tax liabilities. Current and non-current liabilities totaling $589 million relating to these guarantees were included on our condensed consolidated balance sheet at March 28, 2014, a substantial portion of which is classified as non-current. In connection with the 2013 separation, Mallinckrodt assumed the tax liabilities that are attributable to its subsidiaries. We have indemnified Mallinckrodt to the extent that such tax liabilities arising from periods prior to fiscal 2013 exceed $200 million, net of certain tax benefits realized. In addition, in connection with the 2013 separation, we entered into certain other guarantee commitments and indemnifications with Mallinckrodt. The values attributable to the tax indemnification and other guarantees were insignificant. In disposing of assets or businesses, we often provide representations, warranties and indemnities to cover various risks and liabilities, including unknown damage to the assets, environmental risks involved in the sale of real estate, liability to investigate and remediate environmental contamination at waste disposal sites and manufacturing facilities, and unidentified tax liabilities related to periods prior to disposition. We 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. We have recorded liabilities for known indemnification obligations included as part of environmental liabilities. 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. Off-Balance Sheet Arrangements As of March 28, 2014, we had various outstanding letters of credit and guarantee and surety bonds totaling $193 million, none of which were individually significant. Income Taxes At March 28, 2014, we are the primary obligor to the taxing authorities for $1.807 billion of tax liabilities that are recorded on our condensed consolidated balance sheet, of which $1.477 billion relates to periods prior to our 2007 separation from Tyco International and is shared with Tyco International and TE Connectivity pursuant to the Tyco tax sharing agreement. However, the actual amounts that we may be required to ultimately accrue or pay under the Tyco tax sharing agreement could vary depending upon the outcome of the unresolved tax matters, some of which may not be resolved for several years. The Internal Revenue Service (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 has resolved all but one of the matters associated with the proposed tax adjustments. With respect to the outstanding issue that remains in dispute, on June 20, 2013, we were advised by Tyco International that it had received Notices of Deficiency from the IRS asserting that several of Tyco International's former U.S. subsidiaries owe additional taxes of $914 million plus penalties of $154 million based on audits of the 1997 through 2000 tax years of Tyco International and its subsidiaries as they existed at that time. These amounts exclude interest and do not reflect the impact on subsequent periods if the IRS position is ultimately proved correct. The IRS has asserted in the Notices of Deficiency that substantially all of Tyco International's intercompany debt originating during the years 1997 through 2000 should not be treated as debt for U.S. federal income tax purposes, and has disallowed interest deductions related to the intercompany debt and certain tax attribute adjustments recognized on Tyco International's U.S. income tax returns totaling approximately $3.0 billion. We strongly disagree with the IRS's proposed adjustments. On July 22, 2013, Tyco International filed a petition with the U.S. Tax Court contesting the IRS assessment. We believe there are meritorious defenses for the tax filings in question, that the IRS positions with regard to these matters are inconsistent with the applicable tax laws and existing Treasury regulations, and that the previously reported taxes for the years in question are appropriate. No payments with respect to these matters or any additional matters that may be raised by the U.S. Tax Court would be required until the dispute is definitively resolved, which could take several years. While we believe that the amounts recorded as non-current income taxes payable and guaranteed contingent tax liabilities related to these adjustments are adequate, the 48 -------------------------------------------------------------------------------- timing and outcome of such litigation is highly uncertain and could have a material adverse effect on our condensed consolidated financial statements. In particular, if the IRS is successful in asserting its claim, it would likely assert that approximately $6.6 billion of interest deductions with respect to Tyco International's intercompany debt in subsequent time periods should also be disallowed. Tyco International's income tax returns for the years 2001 through 2004 remain subject to adjustment by the IRS upon ultimate resolution of the disputed issue involving certain intercompany loans that originated during 1997 through 2000. It is our understanding that Tyco International and the IRS expect to reach a written agreement during fiscal 2014 on all undisputed issues for the years 2001 through 2007. In connection with the anticipated settlement of the 2005 through 2007 audit cycle, we estimate that we will be required to make a payment to the IRS in fiscal 2014 of $643 million. This amount is comprised of interest of $202 million, an adjustment for pre-2005 net operating loss utilization of $267 million and $174 million related to undisputed issues in the 2005 through 2007 audit cycle. This amount is included in current income taxes payable on our condensed consolidated balance sheet. However, pursuant to the Tyco tax sharing agreement, we estimate that we will receive reimbursement payments totaling $339 million from Tyco International and TE Connectivity, which are included in current due from former parent and affiliate. We will also be required to reimburse Tyco International and TE Connectivity for our portion of their settlements, which is estimated to be $17 million. The resolution of tax matters arising from the 1997 through 2007 U.S. audits, non-U.S. audits and other settlements or statute of limitations expirations, could result in a significant change in our unrecognized tax benefits. We estimate that within the next 12 months, our uncertain tax positions, excluding interest, could decrease by as much as $341 million. Pursuant to the terms of the Tyco tax sharing agreement, we have recorded a current and non-current receivable from Tyco International and TE Connectivity totaling $730 million as of March 28, 2014. This amount primarily reflects 58% of our contingent tax liabilities that are subject to the Tyco tax sharing agreement. If Tyco International and TE Connectivity default on their obligations to us under the Tyco tax sharing agreement, however, we would be liable for the entire amount of such liabilities. Additional information regarding the Tyco tax sharing agreement is provided in note 13 to our condensed consolidated financial statements. Concentration of Credit Risk Financial instruments that potentially subject us to concentrations of credit risk primarily consist of cash and cash equivalents, derivative financial instruments and accounts receivable. We invest our excess cash in deposits or money market funds and diversify the concentration of cash among different financial institutions that have at least an A- credit rating. Counterparties to our derivative financial instruments are limited to major financial institutions with at least a Standard & Poor's and Moody's long-term debt rating of A-/A3. While we do not require collateral or other security to be furnished by the counterparties to our derivative financial instruments, we minimize 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 our large number of customers and their diversity across many geographic areas. A portion of our trade accounts receivable outside the United States, however, include sales to government-owned or supported healthcare systems in several countries that are subject to payment delays. Payment is dependent upon the financial stability of those countries' national economies and the creditworthiness of those countries' national governments. Deteriorating credit and economic conditions in parts of Western Europe, particularly in Spain, Italy and Portugal, may continue to increase the average length of time it takes us to collect our accounts receivable in certain regions within these countries. We routinely evaluate all government receivables for potential collection risks associated with the availability of government funding and reimbursement practices. While we have not incurred significant losses on government receivables, if the financial condition of customers or the countries' healthcare systems continues to deteriorate such that their ability to make payments is uncertain, charges may be required in future periods. Our aggregate accounts receivable, net of the allowance for doubtful accounts, in Spain, Italy and Portugal and as a percent of our total accounts receivable at the end of each period were as follows: March 28, September 27, (Dollars in Millions) 2014



2013

Accounts receivable, net in Spain, Italy and Portugal$ 311 $

406

Percentage of total accounts receivable, net 20 % 27 % 49

-------------------------------------------------------------------------------- Net sales to customers in Spain, Italy and Portugal totaled $163 million and $165 million during the quarters ended March 28, 2014 and March 29, 2013, respectively. Net sales to customers in Spain, Italy and Portugal totaled $307 million and $309 million during the six months ended March 28, 2014 and March 29, 2013, respectively. Accounts receivable, net in Spain, Italy and Portugal over 365 days past due were $24 million and $54 million as of March 28, 2014 and September 27, 2013, respectively. In February 2014, we collected $115 million from the Spanish government, which related to invoices issued prior to June 2013. Contingent Consideration In connection with acquisitions, we may be required to pay future consideration that is contingent upon the achievement of certain milestones, such as revenue, regulatory or commercialization based milestones. As of the respective acquisition dates, we recorded contingent liabilities representing the estimated fair value of the contingent consideration we expected to pay. We remeasure these liabilities each reporting period and record changes in the fair value in our consolidated statements of income. Increases or decreases in the fair value of the contingent consideration liabilities can result from such things as changes in the timing, expected probability and/or amount of revenue estimates or changes in the expected probability and/or timing of achieving regulatory, commercialization or other milestones, as well as changes in discount rates and periods. During the first six months of fiscal 2014, we recorded income totaling $29 million for reductions in the fair value of contingent consideration liabilities, primarily associated with our fiscal 2012 acquisition of Maya Medical. Critical Accounting Policies and Estimates The preparation of our condensed 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, goodwill, other intangible assets, contingent consideration, other contingencies, pension 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 27, 2013. 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 27, 2013 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. 50



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