Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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The following discussion and analysis should be read in conjunction with the consolidated financial statements and the corresponding notes included elsewhere in this Annual Report on Form 10-K. Certain percentages presented in this discussion and analysis are calculated from the underlying whole-dollar amounts and therefore may not recalculate from the rounded numbers used for disclosure purposes. Certain amounts in the 2017 and 2016 consolidated financial statements have been reclassified to conform to the 2018 presentation.

EXECUTIVE LEVEL OVERVIEW

2018 Results

In December 2017, we announced the appointment of a new Chief Executive Officer (“CEO”). After evaluating the state of our business, our CEO expects it will be a two-year (consisting of 2018 and 2019) effort to get the Company operating at market level or above in terms of sales growth rates. One of his first priorities was to improve our supply chain. Starting in 2016 and continuing into 2017, production delays at our Warsaw North Campus facility directly impacted our ability to fully meet demand in our Knees, Hips and S.E.T. product categories. We successfully reduced backorders and increased safety stock levels in 2018 and no longer consider supply to be a barrier to delivering our financial commitments. This resulted in improved sales growth in 2018 in our largest product categories of Knees and Hips. Knees and Hips sales growth in 2018 was 1.5 percent and 2.6 percent, respectively, compared to a sales decline in Knees of 0.6 percent and sales growth of 0.5 percent in Hips in 2017. Additionally, this sales growth improved in the second half of 2018 compared to the first half of 2018. Overall, net sales increased by 1.7 percent in 2018 compared to 2017, primarily due to the improved product supply and completion of key research and development (“R&D”) projects in our Knees product category.

Our net earnings (loss) decreased significantly in 2018 compared to 2017 primarily due to $979.7 million of goodwill and intangible asset impairments and $186.0 million of litigation-related charges in 2018 compared to a $1,272.4 million income tax benefit recognized in 2017 related to the Tax Cuts and Jobs Act of 2017 (“2017 Tax Act”). Net earnings (loss) also decreased in 2018 due to increased excess and obsolescence charges and continued investments in R&D and selling, general and administrative (“SG&A”).

2019 Outlook

2019 will mark the second year of our two-year turnaround effort. In late 2018 and early 2019, we had various product launches in our Knees product category, which we anticipate will drive improving commercial momentum, especially in the second half of 2019. We estimate the change in sales in 2019 compared to 2018 will be in a range of negative 0.5 percent to positive 0.5 percent. This range includes estimated negative effects of changes in foreign currency exchange rates of 1.0 percent to 1.5 percent. We anticipate that most of the negative effects of foreign currency exchange rates will occur in the first half of the year.

Assuming we have no significant goodwill and intangible asset impairments or litigation charges in 2019, we expect our net earnings to increase significantly compared to the net loss recognized in 2018. We expect our costs of products sold will continue to reflect costs associated with our quality remediation efforts. We anticipate continuing to make investments in operating expenses to support our new product launches. However, we expect expenses related to our acquisition and integration activities and quality remediation will decline as we complete these projects during 2019. We believe that our interest expense, net, will continue to decline throughout the year due to lower anticipated debt levels.

RESULTS OF OPERATIONS

We analyze sales by three geographies, the Americas, EMEA and Asia Pacific, and by the following product categories: Knees, Hips, S.E.T., Dental, Spine & CMF and Other. This sales analysis differs from our reportable operating segments, which are based upon our senior management organizational structure and how we allocate resources towards achieving operating profit goals. We analyze sales by geography because the underlying market trends in any particular geography tend to be similar across product categories and because we primarily sell the same products in all geographies.

Net Sales by Geography

The following tables present net sales by geography and the components of the percentage changes (dollars in millions):

		Year Ended December 31,												Volume/								Foreign
		2018				2017				% Inc/(Dec)				Mix				Price				Exchange
Americas		$	4,837.2			$	4,844.8				(0.2	)	%		2.3		%		(2.4	)	%		(0.1	)	%
EMEA			1,801.9				1,745.2				3.2				1.7				(1.6	)			3.1
Asia Pacific			1,293.8				1,213.3				6.6				9.2				(3.5	)			0.9
Total		$	7,932.9			$	7,803.3				1.7				3.2				(2.4	)			0.9

		Year Ended December 31,												Volume/								Foreign
		2017				2016				% Inc				Mix				Price				Exchange
Americas		$	4,844.8			$	4,786.7				1.2		%		3.7		%		(2.6	)	%		0.1		%
EMEA			1,745.2				1,730.4				0.9				2.1				(1.9	)			0.7
Asia Pacific			1,213.3				1,151.3				5.4				9.4				(3.1	)			(0.9	)
Total		$	7,803.3			$	7,668.4				1.8				4.2				(2.5	)			0.1

“Foreign Exchange” used in the tables in this report represents the effect of changes in foreign currency exchange rates on sales.

Net Sales by Product Category

The following tables present net sales by product category and the components of the percentage changes (dollars in millions):

		Year Ended December 31,												Volume/								Foreign
		2018				2017				% Inc/(Dec)				Mix				Price				Exchange
Knees		$	2,773.7			$	2,734.0				1.5		%		3.6		%		(2.9	)	%		0.8		%
Hips			1,921.4				1,871.8				2.6				4.3				(2.8	)			1.1
S.E.T.			1,751.8				1,701.8				2.9				3.9				(1.8	)			0.8
Dental			411.2				418.6				(1.8	)			(1.7	)			(1.5	)			1.4
Spine & CMF			763.9				757.9				0.8				2.1				(1.7	)			0.4
Other			310.9				319.2				(2.6	)			(1.7	)			(1.5	)			0.6
Total		$	7,932.9			$	7,803.3				1.7				3.2				(2.4	)			0.9

		Year Ended December 31,												Volume/								Foreign
		2017				2016				% Inc/(Dec)				Mix				Price				Exchange
Knees		$	2,734.0			$	2,751.2				(0.6	)	%		2.1		%		(2.8	)	%		0.1		%
Hips			1,871.8				1,861.8				0.5				3.5				(3.0	)			-
S.E.T.			1,701.8				1,639.1				3.8				5.9				(2.0	)			(0.1	)
Dental			418.6				427.9				(2.2	)			(0.3	)			(2.3	)			0.4
Spine & CMF			757.9				660.7				14.7				15.8				(1.4	)			0.3
Other			319.2				327.7				(2.6	)			(0.9	)			(1.8	)			0.1
Total		$	7,803.3			$	7,668.4				1.8				4.2				(2.5	)			0.1

The following table presents net sales by product category by geography for our Knees and Hips product categories, which represent our most significant product categories (dollars in millions):

		Year Ended December 31,
		2018				2017				2016				2018 vs. 2017 % Inc/(Dec)				2017 vs. 2016 % Inc/(Dec)
Knees
Americas		$	1,642.7			$	1,656.5			$	1,686.5				(0.8	)	%		(1.8	)	%
EMEA			672.3				644.4				638.1				4.4				1.0
Asia Pacific			458.7				433.1				426.6				5.9				1.5
Total		$	2,773.7			$	2,734.0			$	2,751.2				1.5				(0.6	)
Hips
Americas		$	996.3			$	968.9			$	982.1				2.8		%		(1.3	)	%
EMEA			519.9				518.4				522.1				0.3				(0.7	)
Asia Pacific			405.2				384.5				357.6				5.4				7.5
Total		$	1,921.4			$	1,871.8			$	1,861.8				2.6				0.5

Demand (Volume/Mix) Trends

Increased volume and changes in the mix of product sales contributed 3.2 percentage points of year-over-year sales growth during 2018. Volume/mix growth was driven by recent product introductions, sales in key emerging markets and an aging population. 2017 year-over-year volume/mix growth of 4.2 percent benefited from acquisitions made in 2016 that resulted in a full year of the sales of acquired companies reflected in the 2017 results.

We believe long-term indicators point toward sustained growth driven by an aging global population, growth in emerging markets, obesity, proven clinical benefits, new material technologies, advances in surgical techniques and more active lifestyles, among other factors. In addition, demand for clinically proven premium products and patient specific devices are expected to continue to positively affect sales growth in markets that recognize the value of these advanced technologies.

Pricing Trends

Global selling prices had a negative effect of 2.4 percentage points on year-over-year sales during 2018. In the majority of countries in which we operate, we continue to experience pricing pressure from governmental healthcare cost containment efforts and from local hospitals and health systems.

Foreign Currency Exchange Rates

In 2018, changes in foreign currency exchange rates had a positive effect of 0.9 percent on sales. We address currency risk through regular operating and financing activities and through the use of forward contracts solely to manage foreign currency volatility and risk. Changes in foreign currency exchange rates affect sales growth, but due to offsetting gains/losses on hedge contracts, which are recorded in cost of products sold, the effect on net earnings in the near term is reduced. If foreign currency exchange rates remain at levels consistent with recent rates, we estimate 2019 sales will be negatively affected by 1.0 percent to 1.5 percent.

Sales by Product Category

Knees

Knee sales increased in 2018 compared to a year-over-year decline in 2017. Knee sales have improved due to recent product launches and improved supply. Knee sales volume/mix growth was led by Persona The Personalized Knee System and the Oxford Partial Knee.

Hips

Hip sales continued to experience year-over-year sales growth driven primarily by volume/mix growth, which principally resulted from strong performance in our Asia Pacific and Americas operating segments. Improved supply contributed positively to our results in the Hips product category. Hip sales volume/mix growth was led by our Taperloc Hip System, Arcos Modular Hip System and G7 Acetabular System.

S.E.T.

Our S.E.T. sales continued to increase in 2018, driven primarily by strong performance in key surgical and upper extremity brands.

Dental

Dental sales continued to decline in 2018. In the past few years, our Dental business has been affected by ongoing competitive challenges in the U.S. and EMEA and restructuring of our dental organization in certain European markets.

Spine & CMF

Spine and CMF sales continued to increase in 2018, primarily due to continuing strong sales of our Thoracic products, partially offset by a decline in Spine sales driven by continuing U.S. distributor integration issues. Year-over-year sales growth in 2017 benefited significantly from the full year impact of an acquisition made in 2016.

The following table presents estimated* 2018 global market size and market share information (dollars in billions):

		Global				Global		Zimmer Biomet				Zimmer Biomet
		Market				Market		Market				Market
		Size				% Growth**		Share				Position
Knees		$	7.9			2	%		35		%		1
Hips			6.1			2			31				1
S.E.T.			16.6			4			11				5
Dental			5.0			5			8				4
Spine & CMF			10.5			2			7				5

*	Estimates are not precise and are based on competitor annual filings, Wall Street equity research and Company estimates

**	Excludes the effect of changes in foreign currency exchange rates on sales growth

Expenses as a Percent of Net Sales

		Year Ended December 31,
		2018				2017				2016				2018 vs. 2017 Inc/(Dec)				2017 vs. 2016 Inc/(Dec)
Cost of products sold, excluding intangible asset amortization			28.6	%			27.3	%			31.1	%			1.3		%		(3.8	)	%
Intangible asset amortization			7.5				7.7				7.4				(0.2	)			0.3
Research and development			4.9				4.7				4.8				0.2				(0.1	)
Selling, general and administrative			42.6				39.8				38.4				2.8				1.4
Goodwill and intangible asset impairment			12.3				4.2				0.4				8.1				3.8
Acquisition, integration and related			1.7				3.6				6.6				(1.9	)			(3.0	)
Quality remediation			1.9				2.3				0.7				(0.4	)			1.6
Operating Profit			0.4				10.2				10.7				(9.8	)			(0.5	)

Cost of Products Sold and Intangible Asset Amortization

The following table sets forth the factors that contributed to the gross margin changes in each of 2018 and 2017 compared to the prior year:

		Year Ended December 31,
		2018				2017
Prior year gross margin			64.9	%			61.5	%
Lower average selling prices			(0.6	)			(0.6	)
Average cost per unit			0.8				(0.1	)
Excess and obsolete inventory			(1.0	)			-
Discontinued products inventory charges			(0.1	)			1.0
Foreign currency hedges			(0.4	)			(1.1	)
Inventory step-up			0.4				3.8
U.S. medical device excise tax			(0.3	)			0.7
Intangible asset amortization			0.2				(0.3	)
Current year gross margin			63.9	%			64.9	%

The decrease in gross margin percentage in 2018 compared to 2017 was primarily due to higher excess and obsolete inventory charges, lower average selling prices and the effect of our hedging program. We incurred hedge losses of $26.2 million in 2018 compared to hedge gains of $5.1 million in 2017. For derivatives which qualify as hedges of future cash flows, the effective portion of changes in fair value is temporarily recorded in other comprehensive income and then recognized in cost of products sold when the hedged items affect earnings.

The increase in gross margin percentage in 2017 compared to 2016 was primarily due to a decrease in inventory step-up charges. The reduction in inventory step-up charges resulted from the Biomet inventory that was stepped-up to fair value having been fully recognized by June 30, 2016. In 2016, we recognized significant excess and obsolete inventory charges for certain product lines we intend to discontinue, but did not recognize significant charges in 2017, resulting in improvement to our gross margin percentage. Additional favorability was driven by lower medical device excise tax expense due to the two year moratorium on the U.S. medical device excise tax and a favorable resolution on past excise taxes that were paid. Under the applicable accounting rules that we apply to the U.S. medical device excise tax, we had a portion of the tax paid prior to the moratorium included in the cost of inventory and recognized expense through the fourth quarter of 2016. In January 2018, the moratorium on this tax was extended through December 31, 2019. These favorable items were partially offset by lower hedge gains of $5.1 million in 2017 compared to $87.7 million in 2016 and the effect of lower average selling prices.

Operating Expenses

R&D spending has remained generally consistent as a percentage of sales, as we continue to invest in new technologies to address unmet clinical needs. In 2018, with tax savings resulting from the 2017 Tax Act, we were able to invest in R&D at a higher rate on projects such as our recent Knee product launches.

SG&A expenses and SG&A expenses as a percentage of sales increased significantly in 2018 compared to 2017 due to higher litigation-related charges, increased expenses related to our compliance with the DPA, increased incentive compensation due to better performance versus our operating budgets and various spending on other special business transformation initiatives. Our 2017 SG&A expenses and SG&A expenses as a percentage of sales increased in 2017 compared to 2016 due to higher litigation-related charges, increased freight costs due to expedited product shipments and increased investments in our specialized sales forces.

In 2018, we recognized goodwill impairment charges primarily related to our EMEA and Spine reporting units. In 2017, we recognized goodwill impairment charges related to our Spine and Office Based Technologies reporting units. For more information regarding these charges, see Note 9 to our consolidated financial statements.

Acquisition, integration and related expenses declined in both 2017 and 2018 due to the natural regression of integration activities related to the 2015 Biomet merger and other various acquisitions that were consummated in 2016. We are nearing completion of our integration plans for these businesses.

Our quality enhancement and remediation efforts began in late 2016, accelerated throughout 2017 and continued throughout 2018. These costs primarily relate to fees paid to temporary external consultants engaged to assist in the quality remediation at our Warsaw North Campus facility. We have completed many of our remediation milestones and expect quality remediation costs to continue to decline in 2019.

Other Expense, net, Interest Expense, net, and Income Taxes

In 2018, other expense, net, was primarily related to certain components of pension expense and remeasuring monetary assets and liabilities denominated in a foreign currency other than an entity’s functional currency, partially offset by foreign currency forward exchange contracts we entered into to mitigate any gain or loss. In 2017, other expense, net, primarily related to certain components of pension expense and remeasuring monetary assets and liabilities denominated in a foreign currency other than an entity’s functional currency, partially offset by foreign currency forward exchange contracts we entered into to mitigate any gain or loss. In 2016, other expense, net, primarily included a $53.3 million loss on debt extinguishment. It also included certain components of pension expense and losses on the sale of certain assets and the net expense related to remeasuring monetary assets and liabilities denominated in a foreign currency other than an entity’s functional currency, offset by foreign currency forward exchange contracts we entered into to mitigate any gain or loss.

Interest expense, net, declined in 2018 and 2017 when compared to the same prior year periods primarily due to continued debt repayments. Additionally, we implemented hedging strategies that have lowered our interest expense, net, and we extinguished higher-rate debt by issuing notes with lower interest rates.

Our effective tax rate (“ETR”) on earnings before income taxes was negative 39.9 percent, negative 290.3 percent and positive 23.8 percent for the years ended December 31, 2018, 2017 and 2016, respectively. In 2018, our negative ETR was primarily due to goodwill impairment that resulted in us having a net loss before income taxes with no associated tax benefit recognized for this charge. In 2018, we also recognized an additional $8.3 million of income tax provision as we completed our estimate of the effects of the 2017 Tax Act. In 2017, the negative ETR was driven by the provisional income tax benefit we recorded of $1,272.4 million from the 2017 Tax Act, as well as $111.3 million of tax benefit we recorded from lower tax rates unrelated to the impact of the 2017 Tax Act. In 2016, we recognized $40.6 million of tax benefit from the favorable resolution of certain tax matters with taxing authorities, which was partially offset by $27.6 million of additional tax provision related to finalizing the tax accounts related to the Biomet merger.

Absent additional discrete tax events, we expect our future ETR will be lower than the U.S. corporate income tax rate of 21.0 percent, due to our mix of earnings between U.S. and foreign locations which have lower corporate income tax rates. Our ETR in future periods could also potentially be impacted by changes in tax rates, tax laws or their interpretation, including the European Union rules on state aid; the outcome of various federal, state and foreign audits; and the expiration of certain statutes of limitations. Currently, we cannot reasonably estimate the impact of these items on our financial results.

Segment Operating Profit

																										Operating Profit as a
		Net Sales												Operating Profit												Percentage of Net Sales
		Year Ended December 31,												Year Ended December 31,												Year Ended December 31,
(dollars in millions)		2018				2017				2016				2018				2017				2016				2018				2017				2016
Americas		$	3,932.6			$	3,928.9			$	3,927.9			$	2,055.9			$	2,126.8			$	2,133.3				52.3		%		54.1		%		54.3		%
EMEA			1,576.1				1,523.4				1,512.7				478.4				478.3				498.2				30.4				31.4				32.9
Asia Pacific			1,236.9				1,158.3				1,095.6				427.3				417.6				431.8				34.5				36.1				39.4

In the Americas, operating profit as a percentage of net sales decreased in 2018, primarily due to price declines and higher excess and obsolete inventory charges. In 2017, the Americas segment was unfavorably impacted by price

declines, higher contribution of sales from products with lower gross profit margins and higher freight costs. These unfavorable impacts were offset by lower U.S. medical device excise tax expense.

In EMEA, operating profit as a percentage of net sales decreased in 2018 due to price declines and higher excess and obsolete inventory charges. In 2017, operating profit as a percentage of sales decreased primarily due to price declines and a reduced impact of hedge gains.

In Asia Pacific, operating profit as a percentage of net sales decreased in 2018 primarily due to price declines and higher excess and obsolete inventory charges. In 2017, operating profit as a percentage of sales decreased primarily due to price declines and a reduced impact of hedge gains.

Non-GAAP Operating Performance Measures

We use financial measures that differ from financial measures determined in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) to evaluate our operating performance. These non-GAAP financial measures exclude the impact of inventory step-up; certain inventory and manufacturing-related charges including charges to discontinue certain product lines; intangible asset amortization; goodwill and intangible asset impairment; acquisition, integration and related expenses; quality remediation expenses; certain litigation gains and charges; expenses to comply with the new European Union Medical Device Regulation; other charges; any related effects on our income tax provision associated with these items; the effect from finalizing the tax accounts for the Biomet merger; the effect of the 2017 Tax Act; other certain tax adjustments; and, with respect to earnings per share information, provide for the effect of dilutive shares assuming net earnings in a period of a reported net loss. We use these non-GAAP financial measures internally to evaluate the performance of the business. Additionally, we believe these non-GAAP measures provide meaningful incremental information to investors to consider when evaluating our performance. We believe these measures offer the ability to make period-to-period comparisons that are not impacted by certain items that can cause dramatic changes in reported income but that do not impact the fundamentals of our operations. The non-GAAP measures enable the evaluation of operating results and trend analysis by allowing a reader to better identify operating trends that may otherwise be masked or distorted by these types of items that are excluded from the non-GAAP measures. In addition, adjusted diluted earnings per share is used as a performance metric in our incentive compensation programs.

Our non-GAAP adjusted net earnings used for internal management purposes for the years ended December 31, 2018, 2017 and 2016 were $1,565.4 million, $1,636.4 million, and $1,610.8 million, respectively, and our non-GAAP adjusted diluted earnings per share were $7.64, $8.03, and $7.96, respectively.

The following are reconciliations from our GAAP net earnings and diluted earnings per share to our non-GAAP adjusted net earnings and non-GAAP adjusted diluted earnings per share used for internal management purposes (in millions, except per share amounts):

		Year ended December 31,
		2018				2017				2016
Net (Loss) Earnings of Zimmer Biomet Holdings, Inc.		$	(379.2	)		$	1,813.8			$	305.9
Inventory step-up and other inventory and manufacturing related charges(1)			32.5				70.8				468.3
Intangible asset amortization(2)			595.9				603.9				565.9
Goodwill and intangible asset impairment(3)			979.7				331.5				31.1
Acquisition, integration and related(4)			133.7				279.8				504.9
Quality remediation(5)			165.4				195.1				54.3
Litigation(6)			186.0				104.0				33.3
European Union Medical Device Regulation(7)			3.7				-				-
Other charges(8)			82.8				43.8				45.9
Taxes on above items (9)			(239.6	)			(421.5	)			(449.0	)
Biomet merger-related measurement period tax adjustments (10)			-				-				52.7
U.S. tax reform (11)			8.3				(1,272.4	)			-
Other certain tax adjustments (12)			(3.8	)			(112.4	)			(2.5	)
Adjusted Net Earnings		$	1,565.4			$	1,636.4			$	1,610.8

		Year ended December 31,
		2018				2017				2016
Diluted (Loss) Earnings per share		$	(1.86	)		$	8.90			$	1.51
Inventory step-up and other inventory and manufacturing related charges(1)			0.16				0.35				2.32
Intangible asset amortization(2)			2.93				2.96				2.80
Goodwill and intangible asset impairment(3)			4.81				1.63				0.15
Acquisition, integration and related(4)			0.66				1.37				2.49
Quality remediation(5)			0.81				0.96				0.27
Litigation(6)			0.91				0.51				0.16
European Union Medical Device Regulation(7)			0.02				-				-
Other charges(8)			0.41				0.22				0.23
Taxes on above items (9)			(1.18	)			(2.07	)			(2.22	)
Biomet merger-related measurement period tax adjustments (10)			-				-				0.26
U.S. tax reform (11)			0.04				(6.25	)			-
Other certain tax adjustments (12)			(0.02	)			(0.55	)			(0.01	)
Effect of dilutive shares assuming net earnings(13)			(0.05	)			-				-
Adjusted Diluted EPS		$	7.64			$	8.03			$	7.96

(1)

Inventory step-up and other inventory and manufacturing-related charges relate to inventory step-up expense, excess and obsolete inventory charges on certain product lines we intend to discontinue and other inventory and manufacturing-related charges. Inventory step-up expense represents the incremental expense of inventory sold recognized at its fair value after business combination accounting is applied versus the expense that would have been recognized if sold at its cost to manufacture. Since only the inventory that existed at the business combination date was stepped-up to fair value, we believe excluding the incremental expense provides investors useful information as to what our costs may have been if we had not been required to increase the inventory’s book value to fair value. The excess and obsolete inventory charges on certain product lines are driven by acquisitions where there are competing product lines and we have plans to discontinue one of the competing product lines.

(2)	We exclude intangible asset amortization from our non-GAAP financial measures because we internally assess our performance against our peers without this amortization. Due to various levels of acquisitions among our peers, intangible asset amortization can vary significantly from company to company.

(3)

In 2018, we recognized $3.8 million of intangible asset impairment from merger-related in-process research and development (“IPR&D) intangible assets and a goodwill impairment charge of $975.9 million. The impairment was comprised of $401.2 million in our Spine reporting unit, $567.0 million in our EMEA reporting unit and $7.7 million in an insignificant reporting unit. In 2017, we recognized $18.8 million and $8.0 million of intangible asset impairment from Biomet merger-related IPR&D and trademark intangible assets, respectively. Also in 2017, we recognized goodwill impairment charges of $32.7 million and $272.0 million on our Office Based Technologies and Spine reporting units, respectively. In 2016, we recognized $31.1 million of intangible asset impairment primarily from Biomet merger-related IPR&D intangible assets.

(4)

The acquisition, integration and related expenses we have excluded from our non-GAAP financial measures resulted from our merger with Biomet in 2015 and various acquisitions we consummated in 2016. For Biomet, we have detailed integration roadmaps that cover a three year period from the merger date to accomplish the tasks we feel are necessary to integrate the businesses. For the various 2016 acquisitions, we also have integration plans that are necessary to integrate the businesses. The acquisition, integration and related expenses include the following types of expenses:

	•	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.

	•	Employee termination benefits related to terminating employees with overlapping responsibilities in various areas of our business.

	•	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, but are continuing to work on transferring their responsibilities.

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

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

(5)

We are 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. This quality remediation has required us to devote significant financial resources and is for a discrete period of time. The majority of the expenses are related to consultants who are helping us to update previous documents and redesign certain processes.

(6)

We are involved in routine patent litigation, product liability litigation, commercial litigation and other various litigation matters. We review litigation matters from both a qualitative and quantitative perspective to determine if excluding the losses or gains will provide our investors with useful incremental information. Litigation matters can vary in their characteristics, frequency and significance to our operating results. The litigation charges and gains excluded from our non-GAAP financial measures in the periods presented relate to product liability matters where we have received numerous claims on specific products and intellectual property litigation. In regards to the product liability matters, due to the complexities involved and claims filed in multiple districts, the expenses associated with these matters are significant to our operating results. Once the litigation matter has been excluded from our non-GAAP financial measures in a particular period, any additional expenses or gains from changes in estimates are also excluded, even if they are not significant, to ensure consistency in our non-GAAP financial measures from period-to-period.

(7)

The new European Union Medical Device Regulation imposes significant additional premarket and postmarket requirements. The new regulations will require currently-approved medical devices a transition period until May 2020 to meet the additional requirements. For certain devices, this transition period can be extended until May 2024. We are excluding from our non-GAAP financial measures the incremental costs incurred to comply with the regulations related to our currently-approved medical devices. The incremental costs primarily include third-party consulting necessary to supplement our internal resources.

(8)

We have incurred other various expenses from specific events or projects that we consider highly variable or have a significant impact to our operating results that we have excluded from our non-GAAP financial measures. This includes legal entity and operational restructuring as well as our costs of complying with our DPA with the U.S. government related to certain FCPA matters involving Biomet and certain of its subsidiaries. Under the DPA, which has a three-year term, we are subject to oversight by an independent compliance monitor, which monitorship commenced in July 2017. The excluded costs include the fees paid to the independent compliance monitor and to external legal counsel assisting in the matter.

(9)	Represents the tax effects on the previously specified items. The tax effect for the U.S. jurisdiction is calculated based on an effective rate considering federal and state taxes, as well as permanent items. For jurisdictions outside the U.S., the tax effect is calculated based upon the statutory rates where the items were incurred.

(10)	The 2016 period includes negative effects from finalizing the tax accounts for the Biomet merger. Under the applicable U.S. GAAP rules, these measurement period adjustments are recognized on a prospective basis in the period of change.

(11)

The 2017 Tax Act resulted in a net favorable provisional adjustment due to the reduction of deferred tax liabilities for unremitted earnings and revaluation of deferred tax liabilities to a 21 percent rate, which was partially offset by provisional tax charges related to the toll charge provision of the 2017 Tax Act. In 2018, we finalized our estimates of the effects of the 2017 Tax Act based upon final guidance issued by U.S. tax authorities.

(12)

Other certain tax adjustments in 2018 primarily related to changes in tax rates on deferred tax liabilities recorded on intangible assets recognized in acquisition-related accounting and adjustments from internal restructuring transactions that provide us access to offshore funds in a tax efficient manner. In 2017, other certain tax adjustments relate to tax benefits from lower tax rates unrelated to the impact of the 2017 Tax Act, net favorable resolutions of various tax matters and net favorable adjustments from internal restructuring transactions. The 2016 adjustment primarily related to a favorable adjustment to certain deferred tax liabilities recognized as part of acquisition-related accounting and favorable resolution of certain tax matters with taxing authorities offset by internal restructuring transactions that provide us access to offshore funds in a tax efficient manner.

(13)	Diluted share count used in Adjusted Diluted EPS:

		Year ended December 31, 2018
Diluted shares			203.5
Dilutive shares assuming net earnings			1.5
Adjusted diluted shares			205.0

LIQUIDITY AND CAPITAL RESOURCES

Cash flows provided by operating activities were $1,747.4 million in 2018 compared to $1,582.3 million and $1,632.2 million in 2017 and 2016, respectively. The increase in operating cash flows in 2018 compared to 2017 was driven by additional cash flows from our sale of accounts receivable in certain countries, lower acquisition and integration expenses and lower quality remediation expenses, as well as certain significant payments made in the 2017 period. In the 2017 period, we made payments related to the U.S. Durom Cup Settlement Program, and we paid $30.5 million in Settlement Payments to resolve previously-disclosed FCPA matters involving Biomet and certain of its subsidiaries as discussed in Note 19 to our consolidated financial statements included in Item 8 of this report. The decline in operating cash flows in 2017 compared to 2016 was driven by additional investments in inventory, additional expenses for quality remediation and the significant payments made in the 2017 period as discussed in the previous sentence. These unfavorable items were partially offset by $174.0 million of incremental cash flows in 2017 from our sale of accounts receivable in certain countries.

Cash flows used in investing activities were $416.6 million in 2018 compared to $510.8 million and $1,691.5 million in 2017 and 2016, respectively. Instrument and property, plant and equipment additions reflected ongoing investments in our product portfolio and optimization of our manufacturing and logistics network. In 2018, we entered into receive-fixed-rate, pay-fixed-rate cross-currency interest rate swaps. Our investing cash flows reflect the net cash inflows from the fixed-rate interest rate receipts/payments, as well as the termination of certain of these swaps that were in a gain position in the year. The 2016 period included cash outflows for the acquisition of LDR Holding Corporation (“LDR”) and other business acquisitions. Additionally, the 2016 period reflects the maturity of available-for-sale debt securities. As these investments matured, we used the cash to pay off debt and have not reinvested in any additional debt securities.

Cash flows used in financing activities were $1,302.2 million in 2018. Our primary use of available cash in 2018 was for debt repayment. We received net proceeds of $749.5 million from the issuance of additional senior notes and borrowed $400.0 million from our Multicurrency Revolving Facility to repay $1,150.0 million of senior notes that became due on April 2, 2018. We subsequently repaid the $400.0 million of Multicurrency Revolving Facility borrowings. Also in 2018, we borrowed another $675.0 million under a new U.S. Term Loan C and used the cash proceeds along with cash generated from operations throughout the year to repay an aggregate of $835.0 million on U.S. Term Loan A, $450.0 million on U.S. Term Loan B, and we subsequently repaid $140.0 million on U.S. Term Loan C. Overall, we had approximately $1,150 million of net principal repayments on our senior notes and term loans in 2018. In 2017, our primary use of available cash was also for debt repayment compared to 2016 when we were not able to repay as much debt due to financing requirements to complete the LDR and other business acquisitions. Additionally in 2017, we had net cash inflows of $103.5 million on factoring programs that had not been remitted to the third party. In 2018, we had net cash outflows related to these factoring programs as we remitted the $103.5 million and collected only $66.8 million which had not yet been remitted by the end of the year. Since our factoring programs started at the end of 2016, we did not have similar cash flows in that year.

In January 2019, we borrowed an additional $200.0 million under U.S. Term Loan C and used those proceeds, along with cash on hand, to repay the remaining $225.0 million outstanding under U.S. Term Loan B.

In February, May, August and December 2018, our Board of Directors declared cash dividends of $0.24 per share. We expect to continue paying cash dividends on a quarterly basis; however, future dividends are subject to approval of the Board of Directors and may be adjusted as business needs or market conditions change. As further discussed in Note 11 to our consolidated financial statements, our debt facilities restrict the payment of dividends in certain circumstances.

In February 2016, our Board of Directors authorized a $1.0 billion share repurchase program effective March 1, 2016, with no expiration date. As of December 31, 2018, all $1.0 billion remained authorized for repurchase under the program.

We will continue to exercise disciplined capital allocation designed to drive stockholder value creation. We intend to use available cash for reinvestment in the business, debt repayment and dividends. If the right opportunities arise, we may also use available cash to pursue business development opportunities.

As discussed in Note 15 to our consolidated financial statements, the Internal Revenue Service (“IRS”) has issued proposed adjustments for years 2005 through 2012 reallocating profits between certain of our U.S. and foreign subsidiaries. We have disputed these proposed adjustments and continue to pursue resolution with the IRS. Although the ultimate timing for resolution of the disputed tax issues is uncertain, future payments may be significant to our operating cash flows.

As discussed in Note 19 to our consolidated financial statements, as of December 31, 2018, a short-term liability of $19.5 million and a long-term liability of $72.1 million related to Durom Cup product liability claims were recorded on our consolidated balance sheet. We expect to continue paying these claims over the next few years. We maintain insurance for product liability claims, subject to self-insurance retention requirements. We have recovered insurance proceeds from certain of our insurance carriers for Durom Cup-related claims. While we may recover additional insurance proceeds in the future for Durom Cup-related claims, we do not have a receivable recorded on our consolidated balance sheet as of December 31, 2018 for any possible future insurance recoveries for these claims. We also had a liability of $70.4 million recorded on our consolidated balance sheet as of December 31, 2018 related to Biomet metal-on-metal hip implant claims. Additionally, we have a liability of approximately $168 million related to the Stryker patent infringement lawsuit that we may be required to pay in 2019.

At December 31, 2018, we had 12 tranches of senior notes outstanding as follows (dollars in millions):

				Interest
Principal				Rate					Maturity Date
$	500.0				4.625		%		November 30, 2019
	1,500.0				2.700				April 1, 2020
	450.0			Floating					March 19, 2021
	300.0				3.375				November 30, 2021
	750.0				3.150				April 1, 2022
	571.6		*		1.414				December 13, 2022
	300.0				3.700				March 19, 2023
	2,000.0				3.550				April 1, 2025
	571.6		*		2.425				December 13, 2026
	253.4				4.250				August 15, 2035
	317.8				5.750				November 30, 2039
	395.4				4.450				August 15, 2045

*Euro denominated debt securities

We also had four term loans with total principal of $1,057.0 million outstanding as of December 31, 2018.

We have a five-year unsecured multicurrency revolving facility of $1.5 billion (the “Multicurrency Revolving Facility”) that will mature on September 30, 2021. There were no outstanding borrowings on this facility as of December 31, 2018. We also have other available uncommitted credit facilities totaling $55.0 million.

For additional information on our debt, see Note 11 to our consolidated financial statements.

We place our cash and cash equivalents in highly-rated financial institutions and limit the amount of credit exposure to any one entity. We invest only in high-quality financial instruments in accordance with our internal investment policy.

As of December 31, 2018, $386.1 million of our cash and cash equivalents were held in jurisdictions outside of the U.S. Of this amount, $89.8 million is denominated in U.S. Dollars and, therefore, bears no foreign currency translation risk. The balance of these assets is denominated in currencies of the various countries where we operate. We intend to repatriate at least $5.1 billion of unremitted earnings in future years.

Management believes that cash flows from operations and available borrowings under the Multicurrency Revolving Facility are sufficient to meet our working capital, capital expenditure and debt service needs, as well as to return cash to stockholders in the form of dividends and share repurchases. Should additional investment opportunities arise, we believe that our earnings, balance sheet and cash flows will allow us to obtain additional capital, if necessary.

CONTRACTUAL OBLIGATIONS

We have entered into contracts with various third parties in the normal course of business that will require future payments. The following table illustrates our contractual obligations and certain other commitments (in millions):

										2020				2022				2024
										and				and				and
Contractual Obligations		Total				2019				2021				2023				Thereafter
Long-term debt		$	8,966.8			$	525.0			$	2,985.0			$	1,918.6			$	3,538.2
Interest payments			1,869.5				251.9				374.5				286.4				956.7
Operating leases			309.6				67.1				101.0				59.9				81.6
Purchase obligations			385.6				197.5				148.0				29.7				10.4
Toll charge tax liability			302.4				26.3				52.6				75.6				147.9
Other long-term liabilities			276.3				-				193.3				16.9				66.1
Total contractual obligations		$	12,110.2			$	1,067.8			$	3,854.4			$	2,387.1			$	4,800.9

$67.1 million of the other long-term liabilities on our balance sheet as of December 31, 2018 are liabilities related to defined benefit pension plans. Defined benefit plan liabilities are based upon the underfunded status of the respective plans; they are not based upon future contributions. Due to uncertainties regarding future plan asset performance, changes in interest rates and our intentions with respect to voluntary contributions, we are unable to reasonably estimate future contributions beyond 2019. Therefore, this table does not include any amounts related to future contributions to our plans. See Note 14 to our consolidated financial statements for further information on our defined benefit plans.

Under the 2017 Tax Act, we have a $302.4 million toll charge liability for the one-time deemed repatriation of unremitted foreign earnings. This amount was recorded in current and non-current income tax liabilities on our consolidated balance sheet as of December 31, 2018. We have elected to pay the toll charge in installments over eight years.

Also included in long-term liabilities on our consolidated balance sheets are liabilities related to unrecognized tax benefits and corresponding interest and penalties thereon. Due to the uncertainties inherent in these liabilities, such as the ultimate timing and resolution of tax audits, we are unable to reasonably estimate the amount or period in which potential tax payments related to these positions will be made. Therefore, this table does not include any obligations related to unrecognized tax benefits. See Note 15 to our consolidated financial statements for further information on these tax-related accounts.

We have entered into various agreements that may result in future payments dependent upon various events such as the achievement of certain product R&D milestones, sales milestones, or, at our discretion, maintenance of exclusive rights to distribute a product. Since there is uncertainty on the timing or whether such payments will have to be made, we have not included them in this table. These payments could range from $0 to $58 million.

CRITICAL ACCOUNTING ESTIMATES

Our financial results are affected by the selection and application of accounting policies and methods. Significant accounting policies which require management’s judgment are discussed below.

Excess Inventory and Instruments - We must determine as of each balance sheet date how much, if any, of our inventory may ultimately prove to be unsaleable or unsaleable at our carrying cost. Similarly, we must also determine if instruments on hand will be put to productive use or remain undeployed as a result of excess supply. Accordingly, inventory and instruments are written down to their net realizable value. To determine the appropriate net realizable value, we evaluate current stock levels in relation to historical and expected patterns of demand for all of our products and instrument systems and components. The basis for the determination is generally the same for all inventory and instrument items and categories except for work‑in‑process inventory, which is recorded at cost. Obsolete or discontinued items are generally destroyed and completely written off. Management evaluates the need for changes to the net realizable values of inventory and instruments based on market conditions, competitive offerings and other factors on a regular basis.

Income Taxes - Our income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated future taxes to be paid. We are subject to income taxes in the

U.S. and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense.

We estimate income tax expense and income tax liabilities and assets by taxable jurisdiction. Realization of deferred tax assets in each taxable jurisdiction is dependent on our ability to generate future taxable income sufficient to realize the benefits. We evaluate deferred tax assets on an ongoing basis and provide valuation allowances unless we determine it is “more likely than not” that the deferred tax benefit will be realized.

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. We are subject to regulatory review or audit in virtually all of those jurisdictions and those reviews and audits may require extended periods of time to resolve. We record our income tax provisions based on our knowledge of all relevant facts and circumstances, including existing tax laws, our experience with previous settlement agreements, the status of current examinations and our understanding of how the tax authorities view certain relevant industry and commercial matters.

We recognize tax liabilities in accordance with the FASB’s guidance on income taxes and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined.

Commitments and Contingencies - Accruals for product liability and other claims are established with the assistance of internal and external legal counsel based on current information and historical settlement information for claims, related legal fees and for claims incurred but not reported. We use an actuarial model to assist management in determining an appropriate level of accruals for product liability claims. Historical patterns of claim loss development over time are statistically analyzed to arrive at factors which are then applied to loss estimates in the actuarial model.

Goodwill and Intangible Assets - We evaluate the carrying value of goodwill and indefinite life intangible assets annually, or whenever events or circumstances indicate the carrying value may not be recoverable. We evaluate the carrying value of finite life intangible assets whenever events or circumstances indicate the carrying value may not be recoverable. Significant assumptions are required to estimate the fair value of goodwill and intangible assets, most notably estimated future cash flows generated by these assets and risk-adjusted discount rates. As such, these fair value measurements use significant unobservable inputs. Changes to these assumptions could require us to record impairment charges on these assets.

Prior to our annual impairment test in the fourth quarter of 2018, we had six reporting units with goodwill assigned to them. Our annual impairment test determined our EMEA and Spine reporting units’ carrying values were in excess of their estimated fair values. Fair value was determined using 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 units. Fair value under the market approach utilized the guideline public company methodology, which uses valuation indicators determined from other businesses that are similar to our EMEA and Spine reporting units. As a result of its carrying value being in excess of its estimated fair value, we recorded a goodwill impairment charge for the EMEA reporting unit of $567.0 million. As of December 31, 2018, $755.2 million of goodwill remains for this reporting unit. The goodwill impairment charge for the Spine reporting unit was $401.2 million in 2018. No goodwill balance remains for this reporting unit.

See Note 9 to our consolidated financial statements for further discussion and the factors that contributed to these impairment charges and the factors that could lead to further impairment.

Since the carrying value of the EMEA reporting unit was written down to its estimated fair value, future impairment could occur if the estimates used in the income and market approaches change. If our estimates of profitability in the reporting unit decline, the fair value estimate under the income approach will decline. Additionally, changes in the broader economic environment could cause changes to our estimated discount rates, foreign currency exchange rates used to translate cash flows and comparable company valuation indicators, which may impact our estimated fair values.

Additionally, in our annual impairment test in the fourth quarter of 2018, our Dental reporting unit’s fair value exceeded its carrying value by less than 5 percent. The goodwill balance of our Dental reporting unit was $387.2 million at December 31, 2018. If our future operating results are below the estimations used for our impairment

assessment, or there are negative impacts from the broader economic environment, then we may have to recognize goodwill impairment charges on this reporting unit in the future.

For our other three reporting units that have goodwill assigned to them, their estimated fair value exceeded their carrying value by more than 25 percent. We estimated the fair value of those reporting units using the income and market approaches. If we do not achieve our forecasted operating results or if market valuation indicators decline, we could be required to recognize additional goodwill impairment charges in the future.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 2 to our consolidated financial statements for information on how recent accounting pronouncements have affected or may affect our financial position, results of operations or cash flows.