Significant Accounting Policies (Policies)

9 Months Ended

Sep. 30, 2018

We use the financial statement line item “Acquisition, integration and related” to recognize expenses resulting from the consummation of business mergers and acquisitions and the related integration of those businesses. In 2015, we completed our merger with LVB Acquisition, Inc. (“LVB”), the parent company of Biomet, Inc. (“Biomet”) (which merger is sometimes referred to herein as the “Biomet merger”). In 2016, we acquired LDR Holding Corporation and other individually immaterial companies. Acquisition, integration and related expenses are primarily composed of:

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Consulting and professional fees related to third-party integration consulting performed in a variety of areas, such as tax, compliance, logistics and human resources, and legal fees related to the consummation of mergers and acquisitions.

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Employee termination benefits in various areas of our business.

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Dedicated project personnel expenses which include the salary, benefits, travel expenses and other costs directly associated with employees who are 100 percent dedicated to our integration of acquired businesses and employees who have been notified of termination.

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Contract termination expenses related to terminated contracts, primarily with sales agents and distribution agreements.

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Other various expenses to relocate facilities, integrate information technology, losses incurred on assets resulting from the applicable acquisition, and other various expenses.

We use the financial statement line item “Quality remediation” to recognize expenses related to addressing inspectional observations on Form 483 and a warning letter issued by the U.S. Food and Drug Administration (“FDA”) following its inspections of our Warsaw North Campus facility, among other matters. See Note 15 for additional information about the Form 483 and warning letter. The majority of these expenses are related to consultants who are helping us to update previous documents and redesign certain processes.

Accounting Pronouncements Recently Adopted

In August 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2017-12 – Targeted Improvements to Accounting for Hedging Activities. This ASU amends the hedge accounting guidance to simplify the application of hedge accounting, makes more financial and nonfinancial hedging strategies eligible for hedge accounting treatment, changes how companies assess effectiveness and updates presentation and disclosure requirements. We early adopted this ASU in the first quarter of 2018. Based upon our hedging portfolio that existed prior to adoption, the adoption of this ASU did not have any impact on our financial position, results of operations or cash flows. However, after adoption we entered into cross-currency interest rate swaps that we designated as net investment hedges. Under this ASU, we have made a policy election for changes in the fair value of the cross-currency component of the cross-currency interest rate swaps to be recorded in accumulated other comprehensive income. Therefore, all changes in the fair value of the cross-currency interest rate swaps are recorded as a component of accumulated other comprehensive loss in the condensed consolidated balance sheet. The portion of this change related to the excluded component will be amortized into earnings over the life of the derivative while the remainder will be recorded in accumulated other comprehensive loss until the hedged net investment is sold or substantially liquidated. Under previous guidance, the fair value change related to the cross-currency component was recognized in earnings. See Note 10 for additional information.

In February 2018, the FASB issued ASU 2018-02 – Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. Under GAAP, when there is a change in tax rates, it requires remeasurement of deferred tax assets and liabilities to be recognized as part of income, even if the deferred tax asset or liability had been recorded and recognized in Accumulated Other Comprehensive Income (Loss) (“AOCI”). As a result, a portion of the amount recognized in AOCI at the previous tax rate would remain stranded in AOCI permanently. ASU 2018-02 allows the stranded tax effects in AOCI related only to the Tax Cuts and Jobs Act of 2017 (“2017 Tax Act”) to be reclassified from AOCI to retained earnings. The only stranded tax effects in AOCI we had related to the 2017 Tax Act were due to changes in the U.S. federal corporate income tax rate. We early adopted this ASU in the first quarter of 2018 and elected to use the beginning of period transition method, which means we recognized the reclassification as of January 1, 2018. As a result, we reclassified $42.9 million from AOCI to retained earnings.

In March 2017, the FASB issued ASU 2017-07 – Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This ASU requires us to report the service cost component of pensions in the same location as other compensation costs arising from services rendered by the pertinent employees during the period. We are required to report the other components of net benefit costs in other income (expense) in the statements of earnings. This ASU was effective for us as of January 1, 2018. This ASU must be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost in the statements of earnings and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic pension cost in assets. This ASU provides a practical expedient that allows companies to use the amounts disclosed in prior financial statements as the basis for the retrospective application. We elected to use this practical expedient. The impacts of this ASU on our condensed consolidated financial statements for the three and nine month periods ended September 30, 2017 are included in the tables below. See Note 12 for further information on the components of our net benefit cost.

In May 2014, the FASB issued ASU 2014-09 – Revenue from Contracts with Customers (Topic 606). This ASU provides a five-step model for revenue recognition that all industries will apply to recognize revenue when a customer obtains control of a good or service. This ASU was effective for us as of January 1, 2018. Entities were permitted to apply the standard and related amendments either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. We adopted this new standard using the retrospective method, which resulted in us restating prior reporting periods presented. This ASU did not result in a change to the timing of our revenue recognition. However, we were required to reclassify certain immaterial costs from selling, general and administrative (“SG&A”) expense to net sales, which resulted in a reduction of net sales, but had no impact on operating profit or retained earnings. This ASU also required us to reclassify our estimated refund liability for products expected to be returned from a reduction of accounts receivable to other current liabilities and the related right to receive products from the return from inventories to prepaid expenses and other current assets. The impacts of this ASU on our condensed consolidated financial statements for the three and nine month periods ended September 30, 2017 and as of December 31, 2017 are included in the tables below.

				New			New
	As			Revenue			Pension
	Previously			Standard			Standard						As
(in millions)	Reported			Adjustment			Adjustment			Reclassifications			Restated
Statement of Earnings
Three Months Ended September 30, 2017


Net Sales	$	1,818.1		$	(5.0	)	$	-		$	-		$	1,813.1
Selling, general and administrative		694.5			(5.0	)		2.2			20.0			711.7
Goodwill and intangible asset impairment		-			-			-			32.7			32.7
Acquisition, integration and related		-			-			-			61.6			61.6
Quality remediation		-			-			-			51.1			51.1
Special items		165.4			-			-			(165.4	)		-
Operating expenses		1,604.7			(5.0	)		2.2			-			1,601.9
Operating Profit		213.4			-			(2.2	)		-			211.2
Other expense, net		(4.5	)		-			2.2			-			(2.3	)

				New			New
	As			Revenue			Pension
	Previously			Standard			Standard						As
(in millions)	Reported			Adjustment			Adjustment			Reclassifications			Restated
Statement of Earnings
Nine Months Ended September 30, 2017


Net Sales	$	5,749.8		$	(14.8	)	$	-		$	-		$	5,735.0
Research and development		272.4			-			-			2.5			274.9
Selling, general and administrative		2,203.3			(14.8	)		6.7			44.4			2,239.6
Goodwill and intangible asset impairment		-			-			-			59.5			59.5
Acquisition, integration and related		-			-			-			192.3			192.3
Quality remediation		-			-			-			135.4			135.4
Special items		434.1			-			-			(434.1	)		-
Operating expenses		4,903.7			(14.8	)		6.7			-			4,895.6
Operating Profit		846.1			-			(6.7	)		-			839.4
Other expense, net		(11.2	)		-			6.7			-			(4.5	)

			New
	As		Revenue
	Previously		Standard			As
(in millions)	Reported		Adjustment			Restated
Balance Sheet
December 31, 2017

Accounts receivable, less allowance for doubtful accounts	$	1,494.6	$	49.5		$	1,544.1
Inventories		2,081.8		(13.5	)		2,068.3
Prepaid expenses and other current assets		414.5		13.5			428.0
Other current liabilities		1,299.8		49.5			1,349.3

Accounting Pronouncements Not Yet Adopted

In February 2016, the FASB issued ASU 2016-02 – Leases. This ASU requires lessees to recognize right-of-use assets and lease liabilities on the balance sheet. This ASU will be effective for us beginning January 1, 2019. We own most of our manufacturing facilities, but lease various office space, vehicles and other less significant assets throughout the world. We have collected all of our lease agreements from across the organization that were entered into prior to 2018. We substantially completed our analysis of the key terms of these lease agreements to determine the appropriate accounting treatment. We are also nearing completion of our methodology to determine discount rates as well as our implementation of software that will be utilized to account for this ASU. We will continue evaluating our leases, including the collection and analysis of leases entered into during 2018, and the related impact this ASU will have on our consolidated financial statements through the remainder of 2018.

There are no other recently issued accounting pronouncements that we have not yet adopted that are expected to have a material effect on our financial position, results of operations or cash flows.

Revenue Recognition

We recognize revenue when our performance obligations under the terms of a contract with our customer are satisfied. This happens when we transfer control of our products to the customer, which generally occurs upon implantation or when title passes upon shipment. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring our product. Taxes collected from customers and remitted to governmental authorities are excluded from revenues.

We sell product through three principal channels: 1) direct to healthcare institutions, referred to as direct channel accounts; 2) through stocking distributors and healthcare dealers; and 3) directly to dental practices and dental laboratories. The direct channel accounts represented approximately 80 percent of our net sales in 2017. Through this channel, inventory is generally consigned to sales agents or customers so that products are available when needed for surgical procedures. No revenue is recognized upon the placement of inventory into consignment, as we retain the ability to control the inventory. Upon implantation, we issue an invoice and revenue is recognized. Pricing for products is generally predetermined by contracts with customers, agents acting on behalf of customer groups or by government regulatory bodies, depending on the market. Price discounts under group purchasing contracts are generally linked to volume of implant purchases by customer healthcare institutions within a specified group. At negotiated thresholds within a contract buying period, price discounts may increase. Payment terms vary by customer, but are typically less than 90 days.

Sales to stocking distributors, healthcare dealers, dental practices and dental laboratories accounted for approximately 20 percent of our net sales in 2017. With these types of sales, revenue is recognized when control of our product passes to the customer, either upon shipment of the product or in some cases upon implantation of the product. It is our accounting policy to account for shipping and handling activities as a fulfillment cost rather than as an additional promised service. We have contracts with these customers or orders may be placed from available price lists. Payment terms vary by customer, but are typically less than 90 days.

We offer standard warranties to our customers that our products are not defective. These standard warranties are not considered separate performance obligations. In limited circumstances, we offer extended warranties that are separate performance obligations. We have very few contracts that have multiple performance obligations. Since we do not have significant multiple element arrangements and essentially all of our sales are recognized upon implantation of a product or when title passes, very little judgment is required to allocate the transaction price of a contract or determine when control has passed to a customer. Our costs to obtain contracts consist primarily of sales commissions to employees or third party agents that are earned when control of our product passes to the customer. Therefore, sales commissions are expensed as part of selling, general and administrative expenses at the same time revenue is recognized. Accordingly, we do not have significant contract assets, liabilities or future performance obligations.

We offer variable consideration through volume-based discounts, rebates, prompt pay discounts, right of return and other various incentives. If sales incentives may be earned by a customer for purchasing a specified amount of our product, we estimate whether such incentives will be achieved and recognize these incentives as a reduction in revenue in the same period the underlying revenue transaction is recognized. We primarily use the expected value method to estimate incentives. Under the expected value method, we consider the historical experience of similar programs as well as review sales trends on a customer-by-customer basis to estimate what levels of incentives will be earned. Occasionally, products are returned and, accordingly, we maintain an estimated refund liability based upon the expected value method that is recorded as a reduction in revenue.

We analyze sales by three geographies, the Americas, Europe, Middle East and Africa (“EMEA”) and Asia Pacific, and by the following product categories: Knees; Hips; Surgical, Sports Medicine, Foot and Ankle, Extremities and Trauma (“S.E.T.”); Dental; Spine & Craniomaxillofacial and Thoracic products (“CMF”) and Other. As discussed in Note 14, we have seven operating segments that are based upon geography and product categories. The geographic segments include sales of all product categories exclusive of the specific product category operating segments. The geographic operating segments are the Americas, EMEA and Asia Pacific. These three operating segments are our reporting segments. The product category operating segments are Spine, less Asia Pacific; Office Based Technologies; CMF and Dental. The product operating segments do not constitute a reporting segment because they are, individually and on a combined basis, insignificant to our consolidated results.

Our sales analysis differs from our reporting operating segments because the underlying market trends in any particular geography tend to be similar across product categories, we primarily sell the same products in all geographies and the product category operating segments are not individually significant to our consolidated results.

Net sales by geography are as follows (in millions):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2018		2017		2018		2017
Americas	$	1,153.6	$	1,137.0	$	3,578.0	$	3,570.8
EMEA		372.1		381.1		1,326.3		1,272.5
Asia Pacific		311.0		295.0		957.6		891.7
Total	$	1,836.7	$	1,813.1	$	5,861.9	$	5,735.0

Net sales by product category are as follows (in millions):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2018		2017		2018		2017
Knees	$	627.9	$	622.9	$	2,044.2	$	2,003.7
Hips		444.8		432.8		1,423.7		1,374.6
S.E.T.		414.6		404.8		1,290.7		1,249.4
Dental		92.3		92.9		306.8		311.1
Spine & CMF		184.9		184.5		566.2		564.1
Other		72.2		75.2		230.3		232.1
Total	$	1,836.7	$	1,813.1	$	5,861.9	$	5,735.0