News Column

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

July 30, 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. 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 36 -------------------------------------------------------------------------------- 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; 37

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• 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. 38 -------------------------------------------------------------------------------- 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." 39

-------------------------------------------------------------------------------- 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. 40

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• 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 $35 million. Excluding the impact of currency exchange, the increase in sales was primarily driven by Patient Monitoring and, to a lesser extent, Patient Care and Nursing Care. Sales growth in Patient Monitoring primarily resulted from increased sales of capnography products and, to a lesser extent, advanced parameter and pulse oximetry sensors. Patient Care sales growth was primarily due to increased sales of SharpSafetyTM products resulting from more a competitive shortage of pre-filled syringes and more favorable pricing. Finally, sales growth in Nursing Care was largely due to increased sales of enteral feeding and incontinence products. Net sales by geographic area, based primarily on the location of the customer, were as follows: Quarter Ended Nine Months Ended June 27, June 28, June 27, June 28, Operational (Dollars in Millions) 2014 2013 Percent change Currency impact Operational growth(1) 2014 2013 Percent change Currency impact growth(1) United States$ 494$ 466 6 % - % 6 % $ 1,421$ 1,362 4 % - % 4 % Non-U.S. Developed Markets(2) 561 517 9 2 7 1,631 1,563 4 (2 ) 6 Emerging Markets(3) 250 230 9 (3 ) 12 727 648 12 (4 ) 16 Surgical Solutions 1,305 1,213 8 1 7 3,779 3,573 6 (1 ) 7 United States 234 233 - - - 697 689 1 - 1 Non-U.S. Developed Markets(2) 125 126 (1 ) - (1 ) 381 384 (1 ) (3 ) 2 Emerging Markets(3) 58 58 - (2 ) 2 173 166 4 (3 ) 7 Vascular Therapies 417 417 - - - 1,251 1,239 1 (1 ) 2 United States 597 585 2 - 2 1,791 1,759 2 - 2 Non-U.S. Developed Markets(2) 262 267 (2 ) - (2 ) 808 825 (2 ) (3 ) 1 Emerging Markets(3) 107 96 11 (3 ) 14 296 279 6 (4 ) 10 Respiratory and 966 948 2 - 2 2,895 2,863 1 (1 ) 2 Patient Care United States 1,325 1,284 3 - 3 3,909 3,810 3 - 3 Non-U.S. Developed Markets(2) 948 910 4 1 3 2,820 2,772 2 (2 ) 4 Emerging Markets(3) 415 384 8 (3 ) 11 1,196 1,093 9 (4 ) 13 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."



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

and New Zealand. (3) Emerging Markets includes Eastern Europe, Middle East, Africa, Asia (excluding Japan) and Latin America. 41

-------------------------------------------------------------------------------- United States-Net sales in the United States increased $41 million, or 3%, during the third quarter of fiscal 2014, compared with the third quarter of fiscal 2013. This increase in sales was primarily driven by Surgical Solutions and, to a lesser extent, Respiratory and Patient Care. The increase in sales within Surgical Solutions primarily resulted from the acquisition of Given Imaging and increased sales of vessel sealing products, partially offset by the impact of the divestiture of our biosurgery sealant product line. Sales growth in Respiratory and Patient Care was mainly due to increased sales of capnography products and pulse oximetry sensors. Higher SharpSafetyTM product sales resulting from more favorable pricing, also contributed to the sales growth for Respiratory and Patient Care. These increases in net sales for Respiratory and Patient Care were partially offset by a decrease in sales of enteral feeding products. Net sales in the United States increased $99 million, or 3%, during the first nine months of fiscal 2014, compared with the first nine months of fiscal 2013. This increase was due to sales growth in Surgical Solutions and Respiratory and Patient Care. Increased sales of Surgical Solutions primarily resulted from the impact of the acquisition of Given Imaging and increased sales of vessel sealing products, partially offset by the impact of the divestiture of our biosurgery sealant product line and decreased sales of surgical instruments. Sales growth in Respiratory and Patient Care was primarily due to increased sales of capnography, SharpSafetyTM and incontinence products, partially offset by a decline in monitor sales. Non-U.S. Developed Markets-Net sales in Non-U.S. Developed Markets increased $38 million, or 4%, during the third quarter of fiscal 2014, compared with the third quarter of fiscal 2013. Favorable currency increased net sales by $12 million. Excluding the impact of currency exchange, the increase in sales was primarily driven by Surgical Solutions and resulted largely from the Given Imaging acquisition. Increased sales of vessel sealing and stapling products, primarily in Western Europe, also contributed to Surgical Solutions sales growth. These increases were partially offset by decreased sales in Japan primarily resulting from the impact of the recently enacted Japanese consumption tax and the launch of a stapling product by a competitor. Net sales in Non-U.S. Developed Markets increased $48 million, or 2%, during the first nine months of fiscal 2014, compared with the first nine months of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $57 million. Excluding the impact of currency exchange, the increase in sales primarily resulted from sales growth in Surgical Solutions, driven by stapling and vessel sealing products. The Given Imaging acquisition also resulted in higher sales. These increases were partially offset by decreased sales of ventilators and airway products in Western Europe and Japan and declines in sales of neurovascular products, particularly in Western Europe. Emerging Markets-Net sales in Emerging Markets increased $31 million, or 8%, during the third quarter of fiscal 2014, compared with the third quarter of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $12 million. Excluding the impact of currency exchange, the increase in sales was primarily driven by Surgical Solutions and Respiratory and Patient Care. Surgical Solutions sales growth primarily resulted from increased sales of stapling products, primarily in Asia, and, to a lesser extent, increased sales of vessel sealing products and sutures across all regions. The sales growth in Respiratory and Patient Care primarily resulted from increased sales of ventilators across all regions. Net sales in Emerging Markets increased $103 million, or 9%, during the first nine months of fiscal 2014, compared with the first nine months of fiscal 2013. Unfavorable currency exchange fluctuations decreased net sales by $40 million. Excluding the impact of currency exchange, the increase in sales was due to growth in all product groups. Surgical Solutions sales growth primarily resulted from increased sales of stapling and vessel sealing products in Eastern Europe and Asia and increased sales of sutures across all regions. The sales growth in Respiratory and Patient Care primarily resulted from increased sales of sensors across all regions and increased ventilator sales in Latin America and Asia. Finally, the sales growth in Vascular Therapies was primarily driven by increased sales of neurovascular stents in Asia. Operating Expenses A summary of certain operating expenses were as follows: Quarter Ended Nine Months Ended June 27, 2014 June 28, 2013 June 27, 2014 June 28, 2013 % of Net % of Net % of Net % of Net



(Dollars in Millions) $ Amount Sales $ Amount Sales

$ Amount Sales $ Amount Sales Cost of goods sold $ 1,104 41.1 % $ 1,045 40.5 % $ 3,260 41.1 % $ 3,077 40.1 % Selling, general and administrative expenses 1,034 38.5 853 33.1 2,780 35.1 2,505 32.6 Research and development expenses 137 5.1 129 5.0 397 5.0 362 4.7 42

-------------------------------------------------------------------------------- Cost of goods sold-Cost of goods sold was 41.1% and 40.5% of net sales in the third quarter of fiscal 2014 and 2013, respectively. The increase in cost of goods sold as a percent of net sales during the current year period primarily resulted from pricing pressure and increased freight and warehousing costs at one of our non-U.S. distribution centers, partially offset by manufacturing cost reductions, as well as increased sales volume and a more favorable product mix. Cost of goods sold was 41.1% and 40.1% of net sales in the first nine months of fiscal 2014 and 2013, respectively. The increase in cost of goods sold as a percent of net sales during the first nine months of fiscal 2014 primarily resulted from pricing pressure, unfavorable currency exchange fluctuations, and higher freight and warehousing costs at one of our non-U.S. distribution centers. 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 third quarter of fiscal 2014 increased $181 million, or 21.2%, to $1.034 billion, compared with $853 million in the third quarter of fiscal 2013. This increase was primarily driven by the $181 million legal charge recorded during the current quarter related to an increase in our estimated indemnification obligation for certain pelvic mesh products liability cases. In addition, increased expenses resulting from acquisitions and continued investments in our sales and marketing presence in Emerging Markets were offset by the impact of cost savings initiatives. As a percentage of our net sales, selling, general and administrative expenses were 38.5% for the third quarter of fiscal 2014, compared with 33.1% for the third quarter of fiscal 2013. Selling, general and administrative expenses increased $275 million, or 11.0%, to $2.780 billion in the first nine months of fiscal 2014, compared with $2.505 billion in the first nine months of fiscal 2013. This increase was largely attributable to the $181 million legal charge noted above; sales force expansion, primarily in Emerging Markets; a $65 million environmental charge associated with a site in Orrington, Maine; acquisitions; and charges incurred in connection with the discontinuance of our renal denervation program. These increases in selling, general and administrative expenses were partially offset by the impact of 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 35.1% for the first nine months of fiscal 2014, compared with 32.6% for the first nine months of fiscal 2013. Research and development expenses-Research and development expenses increased $8 million, or 6.2%, to $137 million in the third quarter of fiscal 2014, compared with $129 million in the third quarter of fiscal 2013. This increase was primarily due to spending resulting from recent acquisitions. As a percentage of our net sales, research and development expenses were 5.1% and 5.0% for the third quarter of fiscal 2014 and 2013, respectively. Research and development expenses increased $35 million, or 9.7% to $397 million in the first nine months of fiscal 2014, compared with $362 million in the first nine months of fiscal 2013. This increase was primarily due to spending on drug coated balloon treatment for peripheral arterial diseases and, to a lesser extent, recent acquisitions. As a percentage of our net sales, research and development expenses were 5.0% and 4.7% for the first nine months of fiscal 2014 and 2013, respectively. Restructuring and related charges, net-During the third quarter and first nine months of fiscal 2014, we recorded net restructuring and related charges of $45 million and $121 million, respectively, of which charges of $2 million and $5 million, respectively, related to accelerated depreciation and were included in cost of goods sold. The remaining $43 million and $116 million for the third quarter and first nine months of fiscal 2014, respectively, primarily related to severance and employee benefit costs incurred under our 2013 program to reorganize our European operations and, to a lesser extent, costs incurred as a result of acquisitions. During the third quarter and first nine months of fiscal 2013, we recorded net restructuring and related charges of $10 million and $73 million, respectively, of which charges of $1 million and $2 million, respectively, related to accelerated depreciation and were included in cost of goods sold. The remaining $9 million and $71 million for the third quarter and first nine months of fiscal 2013, respectively, primarily related to severance and employee benefit costs incurred under our 2011 program. Segment Operating Income Refer to note 3 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 third quarter of fiscal 2014 increased $42 million to $652 million, compared with $610 million in the third quarter of fiscal 2013. Operating margin was 28.3% for the third quarter of fiscal 2014, compared with 27.9% for the third quarter of fiscal 2013. The increase in operating income and margin was primarily due to the gross profit resulting from increased sales and the impact of cost savings initiatives. These increases to operating income were partially offset by pricing pressure, the impact of recent acquisitions and investments in sales force expansion in Emerging Markets. 43 -------------------------------------------------------------------------------- Operating income for the first nine months of fiscal 2014 increased $49 million to $1.920 billion, compared with $1.871 billion in the first nine months of fiscal 2013. Operating margin was 28.4% for the first nine months of fiscal 2014, compared with 28.7% for the first nine months of fiscal 2013. The increase in operating income was primarily due to the gross profit resulting from increased sales and the impact of cost savings initiatives. These increases to operating income were partially offset by investments in sales force expansion in Emerging Markets, the impact of recent acquisitions and increased spending on development of a drug coated balloon treatment for peripheral arterial diseases. The increases in operating expenses, coupled with pricing pressure, resulted in a decrease in operating margin for the segment. U.S. Medical Supplies-Operating income for the third quarter of fiscal 2014 increased $8 million to $47 million, compared with $39 million in the third quarter of fiscal 2013. Operating margin was 12.2% for the third quarter of fiscal 2014, compared with 10.0% for the third quarter of fiscal 2013. The increases in operating income and margin primarily resulted from decreased manufacturing costs, partially offset by pricing pressure. Operating income for the first nine months of fiscal 2014 decreased $7 million to $125 million, compared with $132 million in the first nine months of fiscal 2013. Operating margin was 10.7% for the first nine months of fiscal 2014, compared with 11.4% for the first nine months of fiscal 2013. The decreases in operating income and margin primarily resulted from increased manufacturing costs, including freight and warehousing, pricing pressure 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 $90 million and $95 million for the third quarter of fiscal 2014 and 2013, respectively. The $5 million decrease in corporate expenses primarily resulted from an impairment of property, plant and equipment associated with a software development project in the prior period and lower professional fees in the current year. These decreases in corporate expenses were partially offset by higher legal expenses. Corporate expenses were $277 million and $274 million for the first nine months of fiscal 2014 and 2013, respectively. The $3 million increase in corporate expenses primarily resulted from higher legal expenses and costs associated with employee compensation programs, partially offset by lower finance departmental costs and professional fees. Non-Operating Items Interest Expense and Interest Income-Interest expense decreased $5 million to $48 million in the third quarter of fiscal 2014, compared with $53 million in the third quarter of fiscal 2013. This decrease resulted from the impact of interest rate swaps entered into during fiscal 2014. Note 13 to our condensed consolidated financial statements contains additional information regarding these swaps. Interest expense was $155 million for the first nine months of both fiscal 2014 and 2013. During the third quarter of fiscal 2014 and 2013, interest income was $4 million and $2 million, respectively. Interest income was $12 million and $7 million for the first nine months of fiscal 2014 and 2013, respectively. The increases in interest income for both fiscal 2014 periods, compared to the same prior year periods, resulted from the favorable impact of interest on previously collected receivables. Other (Expense) Income, Net-During the third quarter of fiscal 2014, we recorded other expense of $14 million and a corresponding decrease to our receivable from Tyco International Ltd. and TE Connectivity Ltd. During the first nine months of fiscal 2014, we recorded other income, net of $86 million, which includes income resulting from a net increase to our receivable from Tyco International and TE Connectivity of $80 million. The expense and income resulting from changes in the receivable from Tyco International and TE Connectivity primarily reflect 58% of the interest and other income taxes payable amounts released or recorded that are subject to the Tyco tax sharing agreement. The $80 million for the first nine 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 third quarter and first nine months of fiscal 2013, we recorded other income of $56 million and $74 million, respectively. Other income for the third quarter and first nine months of fiscal 2013 includes income of $44 million and $49 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. In addition, other income for the third quarter and first nine months of fiscal 2013 includes a gain on investment of $12 million and $21 million, respectively. Other income for the first nine months of fiscal 2013 also includes a $4 million gain resulting from the demutualization of an insurance carrier. Income Tax Expense-Income tax expense was $2 million and $147 million on income from continuing operations before income taxes of $308 million and $547 million for the third quarter of fiscal 2014 and 2013, respectively. This resulted in effective tax rates of 0.6% and 26.9% for the third quarter of fiscal 2014 and 2013, respectively. The substantial decrease in our effective tax rate primarily resulted from a favorable non-U.S. audit settlement in the current period, compared with charges 44 -------------------------------------------------------------------------------- recorded in the prior period in connection with the potential settlement of certain tax matters within the 2005 through 2007 audit cycle. Income tax expense was $277 million and $350 million on income from continuing operations before income taxes of $1.422 billion and $1.586 billion for the first nine months of fiscal 2014 and 2013, respectively. This resulted in effective tax rates of 19.5% and 22.1% for the first nine months of fiscal 2014 and 2013, respectively. The decrease in our effective tax rate primarily resulted from a favorable non-U.S. audit settlement and the absence of taxable gains generated in connection with the restructuring of legal entities in advance of the 2013 separation. These decreases in our effective tax rate were partially offset by an increase in charges recorded in connection with the potential settlement of certain tax matters within the 2005 through 2007 audit cycle. Discontinued Operations-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. Net sales and (loss) income from Mallinckrodt's operations and adjustments to the loss recorded on prior dispositions were as follows: Quarter Ended June 28, Nine Months Ended June (Dollars in Millions) 2013 28, 2013 Net sales $ 556



$ 1,618 (Loss) income from operations, net of tax expense of $19 and $58(1)

$ (4 ) $ 94 Loss on dispositions, net of tax of $- and $- - (2 ) (Loss) income from discontinued operations, net of income taxes $ (4 ) $ 92 (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 $69 million and $124 million for the quarter and nine months ended June 28, 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. 45 --------------------------------------------------------------------------------



A summary of our cash flows from operating, investing and financing activities is provided in the following table:

Nine Months Ended June 27, June 28, (Dollars in Millions) 2014 2013 Net cash provided by (used in): Operating activities $ 1,237$ 1,387 Investing activities (1,197 ) (614 ) Financing activities (667 )



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

(13 )



(48 ) Net (decrease) increase in cash and cash equivalents $ (640 )$ 253

Operating Activities Net cash provided by operating activities of $1.237 billion for the first nine 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 $288 million. The working capital outflow was driven largely by a $537 million decrease in income taxes payable, partially offset by a $277 million increase in other working capital. The decrease in income taxes payable primarily resulted from a $680 million advance payment that we made to the IRS in connection with the proposed settlements of U.S. tax audits for the years 2005 through 2007. The increase in other working capital primarily resulted from the $355 million reimbursement we received from Tyco International and TE Connectivity for this tax payment under the Tyco tax sharing agreement. Additionally, the increase in accounts receivable resulting from 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 $1.387 billion for the first nine months of fiscal 2013 was primarily attributable to net income, as adjusted for depreciation and amortization, partially offset by a working capital outflow of $623 million. The working capital outflow was driven largely by a decrease in accrued and other liabilities of $256 million and an increase in accounts receivable of $243 million. The decrease in accrued and other liabilities was predominantly related to the annual payout of cash bonuses for performance in the prior fiscal year and interest payments. In addition, we made $50 million in voluntary pension contributions during the first nine months of fiscal 2013. This payment was primarily made to provide additional funding to Mallinckrodt plans prior to Mallinckrodt's separation from Covidien. Investing Activities Net cash used in investing activities was $1.197 billion and $614 million for the first nine months of fiscal 2014 and 2013, respectively. Acquisitions and Divestiture-During the first nine months of fiscal 2014, we paid cash of $1.219 billion to acquire seven businesses, of which $925 million was for the acquisition of Given Imaging. In addition, during the first nine months of fiscal 2014, we received net cash proceeds of $227 million for the sale of our biosurgery sealant product line. During the first nine months of fiscal 2013, we paid cash of $248 million for acquisitions, $110 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 $256 million and $369 million for the first nine months of fiscal 2014 and 2013, respectively. The decrease in capital expenditures 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 $667 million and $472 million for the first nine months of fiscal 2014 and 2013, respectively. Debt Issuances-During the first nine months of fiscal 2014, we issued $14 million of debt. During the first nine months of fiscal 2013, we issued debt for net proceeds of approximately $1.629 billion, of which $886 million was issued by Mallinckrodt International Finance S.A., which became a wholly-owned subsidiary of Mallinckrodt upon separation. We used a portion of these proceeds to fund the redemption of all our outstanding $500 million 1.9% notes due June 2013. In addition, we transferred $180 million of the proceeds to Mallinckrodt in connection with the separation. 46 -------------------------------------------------------------------------------- Dividend Payments-Dividend payments were $433 million during the first nine months of fiscal 2014, compared with $368 million during the first nine months of fiscal 2013. Share Repurchases and Option Exercises-We repurchased approximately 5.6 million shares for $378 million during the first nine months of fiscal 2014 and approximately 17.0 million shares for $1.072 billion during the first nine 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 $10 million to acquire shares in connection with these equity-based awards during the first nine months of fiscal 2014 and 2013, respectively. Due to restrictions in the Medtronic transaction agreement entered into in June 2014 and under the Irish Takeover Rules, we currently do not expect to make any further purchases under our $3.0 billion share repurchase program. Share repurchases were somewhat offset by proceeds from option exercises of $150 million and $206 million during the first nine months of fiscal 2014 and 2013, respectively. Free Cash Flow We returned 67% and 105% of our operating cash flow to shareholders during the first nine months of fiscal 2014 and 2013, respectively, through a combination of both dividend payments and share repurchases. Free cash flow returned to shareholders was 84% and 142% for the first nine months of fiscal 2014 and 2013, respectively. Free cash flow was $981 million for the first nine months of fiscal 2014, compared with $1.018 billion for the first nine months of fiscal 2013. During the first nine months of fiscal 2014, we made a net payment of $337 million related to pre-separation tax matters under the Tyco tax sharing agreement for the anticipated settlement of the 2005 through 2007 audit cycle discussed under "Commitments and Contingencies-Income Taxes." This decrease in free cash flow was partially offset by $115 million in collections from the Spanish government in February 2014, which related to invoices issued prior to June 2013, a $113 million decrease in capital expenditures and a $50 million voluntary contribution to our pension plans during the prior period. 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 flow are as follows: Nine Months Ended June 27, June 28, (Dollars in Millions) 2014 2013 Net cash provided by operating activities $ 1,237$ 1,387 Capital expenditures (256 ) (369 ) Free cash flow $ 981$ 1,018 Capitalization



Shareholders' equity was $9.954 billion at June 27, 2014, compared with $9.242 billion at September 27, 2013. The increase in shareholders' equity was primarily due to net income of $1.145 billion, 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:

June 27, September 27, (Dollars in Millions) 2014 2013 Cash and cash equivalents $ 1,228$ 1,868 Current maturities of long-term debt 1,007 11 Long-term debt 4,042 5,018 Total debt 5,049 5,029 Shareholders' equity 9,954 9,242 Debt-to-total capital ratio 34 % 35 %



As of June 27, 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

47 -------------------------------------------------------------------------------- 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 $1.5 billion five-year unsecured senior revolving credit facility, which expires in 2019. In addition, we may increase this facility by up to $500 million to a maximum of $2.00 billion provided certain conditions are met. We are required to maintain an available unused balance under our $1.5 billion revolving credit facility sufficient to support amounts outstanding under our commercial paper program. We had no commercial paper outstanding at June 27, 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. We are required to maintain an available unused balance under our $1.5 billion revolving credit facility sufficient to support amounts outstanding under our commercial paper program. We had no commercial paper outstanding at June 27, 2014 and September 27, 2013. Dividends On July 16, 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 July 29, 2014. The dividend is payable on August 19, 2014. The Medtronic transaction agreement limits any future dividends to a maximum of $0.36 per share per quarter without prior written consent from Medtronic. 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. We believe that these legal proceedings and claims likely will be resolved over an extended period of time. Although it is not feasible to predict the outcome of these proceedings, based upon our experience, current information and applicable law, we do not expect that these proceedings will have a material adverse effect on our financial condition. However, one or more of the proceedings could have a material adverse effect on our results of operations or cash flows for a future period. Further information regarding our legal proceedings is provided in note 17 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 $577 million relating to these guarantees were included on our condensed consolidated balance sheet at June 27, 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. 48 -------------------------------------------------------------------------------- Off-Balance Sheet Arrangements As of June 27, 2014, we had various outstanding letters of credit and guarantee and surety bonds totaling $183 million, none of which were individually significant. Income Taxes At June 27, 2014, we are the primary obligor to the taxing authorities for $1.104 billion of tax liabilities that are recorded on our condensed consolidated balance sheet, of which $814 million 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 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. During the quarter ended June 27, 2014, we made a $680 million advance payment to the IRS in connection with the anticipated settlement of the 2005 through 2007 audit cycle, which otherwise remains open and subject to further examination by the IRS. This payment was comprised of $465 million of tax and $215 million of interest. Pursuant to the Tyco tax sharing agreement, we received reimbursement payments totaling $355 million from Tyco International and TE Connectivity during the quarter ended June 27, 2014. In addition, we reimbursed Tyco International and TE Connectivity $12 million for our portion of their advance payments. We estimate that within the next 12 months, our uncertain tax positions, excluding interest, could decrease by as much as $135 million as a result of 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. 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 $361 million as of June 27, 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 15 to our condensed consolidated financial statements. 49 -------------------------------------------------------------------------------- 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 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: June 27, September 27, (Dollars in Millions) 2014



2013

Accounts receivable, net in Spain, Italy and Portugal$ 326$ 406 Percentage of total accounts receivable, net

21 %



27 %

Net sales to customers in Spain, Italy and Portugal totaled $162 million and $161 million during the quarters ended June 27, 2014 and June 28, 2013, respectively. Net sales to customers in Spain, Italy and Portugal totaled $469 million and $470 million during the nine months ended June 27, 2014 and June 28, 2013, respectively. Accounts receivable, net in Spain, Italy and Portugal over 365 days past due were $24 million and $54 million as of June 27, 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 nine months of fiscal 2014, we recorded income totaling $36 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 U.S. GAAP 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 Current Report on Form 8-K filed on July 11, 2014. 50 -------------------------------------------------------------------------------- Recently Issued Accounting Pronouncement In May 2014, the Financial Accounting Standards Board issued updated revenue recognition guidance to clarify the principles for recognizing revenue from contracts with customers. The guidance requires an entity to recognize revenue in an amount that reflects the consideration to which an entity expects to be entitled in exchange for the transfer of goods or services to customers. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In addition, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This accounting guidance is effective for Covidien beginning in the first quarter of fiscal 2018 using one of two prescribed retrospective methods. Early adoption is not permitted. We are currently assessing the impact of this revenue recognition guidance on our consolidated financial statements. 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. Item 3. Quantitative and Qualitative Disclosures about Market Risk Refer to "Part II. Item 7A. Quantitative and Qualitative Disclosures About Market Risk" in our Annual Report on Form 10-K for the fiscal year ended September 27, 2013 for a discussion of our exposures to market risk. We manage interest rate exposure through the use of interest rate swap transactions with financial institutions acting as principal counterparties to convert a portion of fixed-rate debt to variable-rate debt. These transactions are designated as fair value hedges. During the quarter ended June 27, 2014, 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. Under these contracts, we receive fixed amounts of interest applicable to the underlying notes and pay a floating amount based upon the three-month U.S. dollar London interbank offered rate, plus a margin. A 50 basis point increase or decrease in interest rates relative to interest rates as of June 27, 2014 would decrease or increase our annual earnings by approximately $5 million. There have been no other material changes in the information reported since the fiscal year ended September 27, 2013. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the specified time periods, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of that date, our disclosure controls and procedures were effective. 51 -------------------------------------------------------------------------------- Changes in Internal Control Over Financial Reporting There were no changes in our internal control over financial reporting during the quarter ended June 27, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 52



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