ACQUISITIONS AND STRATEGIC INVESTMENTS

2016 Acquisitions

LumenR™ Tissue Retractor System

On November 1, 2016, we acquired LumenR™ Tissue Retractor System from LumenR LLC, a privately held Newark, California based company. The LumenR Tissue Retractor System is currently in development for use during endoscopic resection of lesions in the colon, esophagus or stomach. We plan to begin the process of integrating the LumenR Tissue Retractor System into our Endoscopy business during the fourth quarter of 2016.

EndoChoice Holdings, Inc.

On September 27, 2016, we entered into a definitive agreement to acquire EndoChoice Holdings, Inc. (EndoChoice) for approximately $210 million. The transaction is expected to close in the fourth quarter of 2016, subject to customary closing conditions. EndoChoice develops and commercializes innovative products and services for specialists treating a wide range of gastrointestinal conditions. Upon completion of the transaction, EndoChoice will be integrated into our Endoscopy business.

Cosman Medical, Inc.

On July 27, 2016, we acquired Cosman Medical, Inc. (Cosman), a privately held manufacturer of radiofrequency ablation systems, expanding our Neuromodulation portfolio and offering physicians treating patients with chronic pain a wider choice of non-opioid therapeutic options. Total consideration was comprised of $71 million in up-front cash plus related fees and expenses, and a potential additional $20 million in consideration based on future sales through June 30, 2019. We are in the process of integrating Cosman into our Neuromodulation business, and expect the integration to be substantially complete by the end of 2017.

Purchase Price Allocation

We accounted for the acquisition of Cosman as a business combination and, in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification® (ASC) Topic 805, Business Combinations, we recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition date. The components of the aggregate preliminary purchase price are as follows (in millions):



Cash, net of cash acquired	$	70
Fair value of contingent consideration	4
	$	74

The following summarizes the preliminary purchase price allocation for the Cosman acquisition as of September 30, 2016 (in millions):



Goodwill	$	23
Amortizable intangible assets	46
Inventory	4
Other net assets	1
	$	74

We allocated a portion of the purchase price to specific intangible asset categories as follows:



	Amount Assigned (in millions)		Amortization Period (in years)	Risk-Adjusted Discount Rates used in Purchase Price Allocation
Amortizable intangible assets:
Technology-related	$	43	13	12%
Customer relationships	$	3	13	12%
	$	46

2015 Acquisitions

AMS Portfolio Acquisition

On August 3, 2015, we completed the acquisition of the American Medical Systems male urology portfolio (AMS Portfolio Acquisition), which includes the men's health and prostate health businesses, from Endo International plc. Total consideration was comprised of $1.616 billion in up-front cash plus related fees and expenses, and a potential additional $50 million in consideration based on 2016 sales. The AMS male urology portfolio is being integrated with our formerly named Urology and Women's Health business, and the joint businesses have become Urology and Pelvic Health. The integration is expected to be substantially completed by the end of 2016. In addition, as part of the acquisition agreement, we made a $60 million Series B non-voting preferred stock investment in the Women's Health business of Endo Health Solutions, a wholly owned subsidiary of Endo International, plc., representing the remaining Women's Health business of the American Medical Systems' Portfolio. This investment was subsequently repaid in the fourth quarter of 2015.

Xlumena, Inc.

On April 2, 2015, we acquired Xlumena, Inc. (Xlumena), a medical device company that developed minimally invasive devices for Endoscopic Ultrasound (EUS) guided transluminal drainage of targeted areas within the gastrointestinal tract. The purchase agreement called for an up-front payment of $63 million, an additional payment of $13 million upon FDA clearance of the HOT AXIOS™ product, and further sales-based milestones based on sales achieved through 2018. We substantially completed the integration of Xlumena into our Endoscopy business during the third quarter of 2016.

Purchase Price Allocation

We accounted for these acquisitions as business combinations and, in accordance with FASB ASC Topic 805, Business Combinations, we have recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition dates. The components of the aggregate purchase price are as follows (in millions):



Cash, net of cash acquired	$	1,659
Fair value of contingent consideration	31
	$	1,690

The following summarizes the aggregate purchase price allocation for the 2015 acquisitions as of September 30, 2015 (in millions):



Goodwill	$	547
Amortizable intangible assets	992
Inventory	102
Property, plant and equipment	42
Other net assets	42
Deferred income taxes	(35		)
	$	1,690

We allocated a portion of the purchase price to specific intangible asset categories as follows:



	Amount Assigned (in millions)		Amortization Period (in years)	Range of Risk- Adjusted Discount Rates used in Purchase Price Allocation
Amortizable intangible assets:
Technology-related	$	358	11-12	13.5% - 15%
Customer relationships	616		12	13.5%
Other intangible assets	18		13	13.5%
	$	992

Our technology-related intangible assets consist of technical processes, intellectual property, and institutional understanding with respect to products and processes that we will leverage in future products or processes and will carry forward from one product generation to the next. We used the income approach and relief from royalty approach to derive the fair value of the technology-related intangible assets, and are amortizing them on a straight-line basis over their assigned estimated useful lives.

Customer relationships represent the estimated fair value of non-contractual customer and distributor relationships. Customer relationships are direct relationships with physicians and hospitals performing procedures with the acquired products, and distributor relationships are relationships with third parties used to sell the acquired products, both as of the acquisition date. These relationships were valued separately from goodwill because there is a history and pattern of conducting business with customers and distributors. We used the income approach or the replacement cost and lost profits methodology to derive the fair value of the customer relationships. The customer relationships intangible assets are amortized on a straight-line basis over their assigned estimated useful lives.

Other intangible assets primarily include acquired tradenames. These tradenames include brand names that we expect to continue using in our product portfolio and related marketing materials. The tradenames are valued using a relief from royalty methodology and are amortized on a straight-line basis over their assigned estimated useful lives.

We believe that the estimated intangible asset values represent the fair value at the date of acquisition and do not exceed the amount a third party would pay for the assets. These fair value measurements are based on significant unobservable inputs, including management estimates and assumptions and, accordingly, are classified as Level 3 within the fair value hierarchy prescribed by FASB ASC Topic 820, Fair Value Measurements and Disclosures.

We recorded the excess of the aggregate purchase price over the estimated fair values of the identifiable assets acquired as goodwill. Goodwill was established due primarily to synergies expected to be gained from leveraging our existing operations as well as revenue and cash flow projections associated with future technologies, and has been allocated to our reportable segments based on the relative expected benefit. Of the goodwill recorded, approximately $19 million, based on preliminary estimates, related to our 2016 acquisitions and approximately $453 million related to our 2015 acquisitions is deductible for tax purposes. See Note C - Goodwill and Other Intangible Assets for more information related to goodwill allocated to our reportable segments.

Contingent Consideration

Certain of our acquisitions involve contingent consideration arrangements. Payment of additional consideration is generally contingent on the acquired company reaching certain performance milestones, including attaining specified revenue levels, achieving product development targets and/or obtaining regulatory approvals. In accordance with U.S. GAAP, we recognize a liability equal to the fair value of the contingent payments we expect to make as of the acquisition date. We re-measure this liability each reporting period and record changes in the fair value through a separate line item within our condensed consolidated statements of operations.

We recorded a net benefit related to the changes in fair value of our contingent consideration liabilities of $13 million during the third quarter of 2016. We recorded net expenses related to the changes in fair value of our contingent consideration liabilities of $23 million during the first nine months of 2016, $40 million during the third quarter of 2015 and $86 million during the first nine months of 2015. We paid contingent consideration of $77 million during the first nine months of 2016, $15 million during the third quarter of 2015 and $125 million during the first nine months of 2015. We did not make any contingent consideration payments during the third quarter of 2016.

Changes in the fair value of our contingent consideration liabilities were as follows (in millions):



Balance as of December 31, 2015	$	246
Amounts recorded related to new acquisitions	4
Other amounts recorded related to prior acquisitions	2
Fair value adjustments	23
Contingent payments related to prior period acquisitions	(77		)
Balance as of September 30, 2016	$	198

As of September 30, 2016, the maximum amount of future contingent consideration (undiscounted) that we could be required to pay was approximately $1.587 billion.

Contingent consideration liabilities are remeasured to fair value each reporting period using projected revenues, discount rates, probabilities of payment and projected payment dates. The recurring Level 3 fair value measurements of our contingent consideration liabilities include the following significant unobservable inputs:



Contingent Consideration Liabilities	Fair Value as of September 30, 2016	Valuation Technique	Unobservable Input	Range
R&D, regulatory and commercialization-based Milestones	$15 million	Discounted Cash Flow	Discount Rate	1.8% - 2.3%
			Probability of Payment	0% - 59%
			Projected Year of Payment	2018 - 2021
Revenue-based Payments	$40 million	Discounted Cash Flow	Discount Rate	14% - 15%
	$40 million	Discounted Cash Flow	Projected Year of Payment	2017 - 2020
	$143 million	Monte Carlo	Revenue Volatility	15% - 20%
			Risk Free Rate	LIBOR Term & Cost of Debt Structure
			Projected Year of Payment	2016 - 2022

Increases or decreases in the fair value of our contingent consideration liabilities can result from changes in discount periods and rates, as well as changes in the timing and amount of revenue estimates or in the timing or likelihood of achieving R&D, regulatory and commercialization-based and revenue-based milestones. Projected contingent payment amounts related to some of our R&D, regulatory and commercialization-based and revenue-based milestones are discounted back to the current period using a discounted cash flow (DCF) model. Other revenue-based payments are valued using a Monte Carlo valuation model, which simulates future revenues during the earn-out period using management's best estimates. Projected revenues are based on our most recent internal operational budgets and long-range strategic plans. Increases in projected revenues and probabilities of payment may result in higher fair value measurements. Increases in discount rates and the time to payment may result in lower fair value measurements. Increases or decreases in any of those inputs together, or in isolation, may result in a significantly lower or higher fair value measurement.

Strategic Investments

We did not close any material strategic investments during the first nine months of 2016.

On April 30, 2015, we acquired a 27 percent ownership interest in Preventice Solutions, Inc. (Preventice), which includes 18.5 percent of Preventice's common stock. Preventice is a privately-held company headquartered in Minneapolis, MN, and a leading developer of mobile health solutions and services. In addition to the equity agreement, we entered into a commercial agreement with Preventice, under which we became Preventice’s exclusive, worldwide sales and marketing representative. In October 2016, management notified Preventice of our intent to terminate the commercial agreement and will transition the sales force back to Preventice within the next twelve months under the terms of the agreement.

On April 13, 2015, we acquired 25 percent of the common stock of Frankenman Medical Equipment Company (Frankenman). Frankenman is a privately-held company headquartered in Suzhou, China, and is a local market leader in surgical staplers. Additionally, we entered into co-promotional and co-selling agreements with Frankenman to commercialize selected products jointly in China. We believe this alliance will enable us to reach more clinicians and treat more patients in China by providing access to training on less invasive endoscopic technologies with clinical and economic benefits.

We account for certain of our strategic investments as equity method investments, in accordance with FASB ASC Topic 323, Investments - Equity Method and Joint Ventures. The book value of investments that we accounted for under the equity method of accounting was $255 million as of September 30, 2016 and $173 million as of December 31, 2015. The aggregate value of our cost method investments was $20 million as of September 30, 2016 and $45 million as of December 31, 2015. In addition, we had notes receivable from certain companies, which we account for under the cost method, of $42 million as of September 30, 2016 and $30 million as of December 31, 2015.

As of September 30, 2016, the book value of our equity method investments exceeded our share of the book value of the investees’ underlying net assets by approximately $184 million, which represents amortizable intangible assets and in-process research and development, corresponding deferred tax liabilities, and goodwill. During the three and nine months ended September 30, 2016, the net losses from our equity method adjustments, presented within the Other, net caption of our condensed consolidated statement of operations were $4 million and $11 million, respectively. During the three and nine months ended September 30, 2015, the net losses from our equity method adjustments were immaterial.