FAIR VALUE MEASUREMENTS OF ASSETS AND LIABILITIES

12 Months Ended

Dec. 31, 2012

FAIR VALUE MEASUREMENTS OF ASSETS AND LIABILITIES

8. FAIR VALUE MEASUREMENTS OF ASSETS AND LIABILITIES

The following financial assets and liabilities are recorded at fair value on a recurring basis (in millions):

	As of December 31, 2012
			Fair Value Measurements at Reporting Date Using:
Description	Recorded Balance		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Available-for-sale securities
Corporate debt securities	$	383.8	$	–	$	383.8	$	–
U.S. government and agency debt securities		295.9		–		295.9		–
Foreign government debt securities		5.0		–		5.0		–
Commercial paper		138.7		–		138.7		–
Certificates of deposit		92.3		–		92.3		–
Total available-for-sale securities		915.7		–		915.7		–
Derivatives, current and long-term
Foreign currency forward contracts and options		28.4		–		28.4		–
Interest rate swaps		33.9		–		33.9		–
	$	978.0	$	–	$	978.0	$	–
Liabilities
Derivatives, current and long-term
Foreign currency forward contracts	$	10.8	$	–	$	10.8	$	–

	As of December 31, 2011
			Fair Value Measurements at Reporting Date Using:
Description	Recorded Balance		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Available-for-sale securities
Corporate debt securities	$	324.7		$–	$	324.7		$–
U.S. government and agency debt securities		177.2		–		177.2		–
Municipal bonds		1.0		–		1.0		–
Foreign government debt securities		6.8		–		6.8		–
Commercial paper		74.5		–		74.5		–
Certificates of deposit		88.5		–		88.5		–
Total available-for-sale securities		672.7		–		672.7		–
Derivatives, current and long-term
Foreign currency forward contracts and options		18.3		–		18.3		–
Interest rate swaps		27.8		–		27.8		–
	$	718.8	$	–	$	718.8	$	–
Liabilities
Derivatives, current and long-term
Foreign currency forward contracts	$	25.2	$	–	$	25.2	$	–
Cross-currency interest rate swaps		8.2		–		8.2		–
	$	33.4	$	–	$	33.4	$	–

We value our available-for-sale securities using a market approach based on broker prices for identical assets in over-the-counter markets and we perform ongoing assessments of counterparty credit risk.

We value our foreign currency forward contracts and foreign currency options using a market approach based on foreign currency exchange rates obtained from active markets and we perform ongoing assessments of counterparty credit risk.

We value our interest rate swaps using a market approach based on publicly available market yield curves and the terms of our swaps and we perform ongoing assessments of counterparty credit risk.

We valued our cross-currency interest rate swaps using a market approach based upon publicly available market yield curves, foreign currency exchange rates obtained from active markets and the terms of our swaps. We also performed ongoing assessments of counterparty credit risk.

The following nonfinancial assets were measured at fair value on a nonrecurring basis (in millions):

			Fair Value Measurements Using:
Description	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Losses
Year Ended December 31, 2012
Goodwill	$	41.0					$	41.0	$	96.0
Indefinite-lived intangible assets		24.2		–		–		24.2		11.6
Year Ended December 31, 2010
Goodwill		137.0		–		–		137.0		204.0

We conduct our annual goodwill impairment test in the fourth quarter of every year or whenever events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. In each of 2012 and 2010, it was determined that our U.S. Spine reporting unit’s carrying value was in excess of its fair value. In 2012, the goodwill for this reporting unit was written down to its implied fair value of $41.0 million from its previous carrying value of $137.0 million, resulting in a $96.0 million non-cash impairment charge. In 2010, the goodwill was written down to its implied fair value of $137.0 million from its previous carrying value of $341.0 million, resulting in a $204.0 million non-cash impairment charge. The implied fair value of goodwill equals the estimated fair value of a reporting unit minus the fair value of the reporting unit’s net assets. In determining the implied fair value of the U.S. Spine reporting unit’s goodwill, we used unobservable inputs to estimate the fair value of the reporting unit and its assets and liabilities. Fair value was determined using an equal weighting of income and market approaches.

Fair value under the income approach was determined by discounting to present value the estimated future cash flows of the reporting unit. Fair value under the market approach utilized the guideline public company methodology, which uses valuation indicators from publicly traded companies that are similar to our U.S. Spine reporting unit and considers control premiums that would result from a sale of the reporting unit and the level of assets in the reporting unit versus the comparable companies.

In estimating the future cash flows of the reporting unit, we utilized a combination of market and company specific inputs that a market participant would use in assessing the fair value of the reporting unit. The primary market input was revenue growth rates. These rates were based upon historical trends and estimated future growth drivers such as an aging global population, obesity and more active lifestyles. Significant company specific inputs included assumptions regarding how the reporting unit could leverage operating expenses as revenue grows and the impact any new products will have on revenues.

Under the guideline public company methodology, we took into consideration specific risk differences between our reporting unit and the comparable companies, such as recent financial performance, size risks and product portfolios, among other considerations. Based upon our reporting unit’s recent financial performance, market share and product portfolio, we valued ourselves near the bottom of the valuation indicators of the comparable companies.

The fair value of the reporting unit’s assets and liabilities was determined by using the same methods that are used in business combination purchase accounting.

Factors that contributed to impairment of the U.S. Spine reporting unit include broader market issues as well as company specific issues. The U.S. spine market has been under pressure due to a constrained economic environment leading to continuing high unemployment and payer pushback on the necessity of certain procedures. Additionally, pricing has continued to decline across the industry. Company specific issues have included turnover with our independent sales agents and lack of execution in developing new, competitive products which has resulted in a less than optimal product portfolio in our U.S. Spine reporting unit.

The U.S. spine market five years ago was growing in the low double digits, but now we estimate is flat or in the low single digits. Previous goodwill impairment tests forecasted some recovery in the market which has not come to fruition. Through the first three quarters of 2012, while U.S. Spine sales were lower than we expected, cash flows were not significantly lower as expenses were favorable and net working capital was better than planned. As we completed our annual operating plan in the fourth quarter of 2012, it became clearer that the U.S. spine market recovery may take longer than we planned, including the persistence of significant negative pricing pressures. Additionally, we concluded that new product introductions made in 2012 will not have as significant of a positive effect as we had previously forecasted. As a result, we have tempered our expectations of recovery in the U.S. market and for our U.S. Spine reporting unit and have recognized an impairment charge.

In 2010, the implied fair value of goodwill was determined using similar methodologies utilized in the 2012 valuation. An impairment charge was caused by similar market and company-specific factors discussed above.

We have six other reporting units with goodwill assigned to them. We estimate the fair value of those reporting units using the income approach by discounting to present value the estimated future cash flows of the reporting unit. For each of those six reporting units, the estimated fair value substantially exceeded its carrying value.

We will continue to monitor the fair value of our U.S. Spine reporting unit as well as our other six reporting units in our interim and annual reporting periods. If our estimated cash flows for these reporting units decrease, we may have to record further impairment charges in the future. Factors that could result in our cash flows being lower than our current estimates include: 1) decreased revenues caused by unforeseen changes in the healthcare market, or our inability to generate new product revenue from our research and development activities, and 2) our inability to achieve the estimated operating margins in our forecasts due to unforeseen factors. Additionally, changes in the broader economic environment could cause changes to our estimated discount rates or comparable company valuation indicators, which may impact our estimated fair values.

In 2012, we also recorded $11.6 million of impairment charges in “Special items” related to certain indefinite lived intangible assets. The impairment was a result of lower future estimated revenues from products using certain trademarks. The lower future estimated revenue resulted from our challenges in the global spine market and from negative publicity in the marketplace related to certain hip devices that have adversely affected sales of these products. Further information regarding how the fair value of these indefinite lived trademarks was determined has not been provided as we do not believe this non-cash charge was significant to our results for 2012.