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

| --- | --- |

The following commentary should be read in conjunction with the consolidated financial statements and accompanying notes.

EXECUTIVE OVERVIEW

Description of the Company and Business Segments

Baxter International Inc., through its subsidiaries, provides a broad portfolio of essential healthcare products across its portfolio, including acute and chronic dialysis therapies; sterile IV solutions; infusion systems and devices; parenteral nutrition therapies; inhaled anesthetics; generic injectable pharmaceuticals; and surgical hemostat and sealant products. The company’s global footprint and critical nature of its products and services play a key role in expanding access to healthcare in emerging and developed countries. These products are used by hospitals, kidney dialysis centers, nursing homes, rehabilitation centers, doctors’ offices and by patients at home under physician supervision.

Separation of Baxalta Incorporated

On July 1, 2015, Baxter completed the distribution of approximately 80.5% of the outstanding common stock of its biopharmaceuticals business, Baxalta Incorporated (Baxalta), to Baxter stockholders (the Distribution). As a result of the separation, the operating results of Baxalta have been reflected as discontinued operations for the years ended December 31, 2017, 2016, and 2015. Refer to Note 2 in Item 8 for additional information regarding the separation of Baxalta. Unless otherwise stated, financial results herein reflect continuing operations.

Acquisition of Claris Injectables Limited

On July 27, 2017, Baxter acquired 100 percent of Claris Injectables Limited (Claris), a wholly owned subsidiary of Claris Lifesciences Limited, for total cash consideration of approximately $629 million, net of cash acquired. Through the acquisition, Baxter added capabilities in production of essential generic injectable medicines, such as anesthesia and analgesics, renal, anti-infectives and critical care in a variety of presentations including bags, vials and ampoules. Refer to Note 5 in Item 8 for additional information regarding the acquisition of Claris.

Pending Acquisition of Recothrom and Preveleak

In January 2018, Baxter agreed to acquire two hemostat and sealant products from Mallinckrodt plc: RECOTHROM Thrombin topical

(Recombinant), the first and only stand-alone recombinant thrombin, and PREVELEAK Surgical Sealant, which is used in vascular

reconstruction. The purchase price includes an upfront payment of approximately $153 million and potential contingent payments in

the future. The transaction is expected to close in the first half of 2018, subject to the satisfaction of regulatory approvals and other closing conditions. Total sales of both products approximated $56 million during the twelve months ended September 29, 2017.

Segments

In 2017, Baxter announced a change in its commercial structure to improve performance, optimize costs, increase speed in the decision-making process and drive improved accountability across the company. As a result, the company now reports its financial performance based on its new segments: Americas (North and South America), EMEA (Europe, Middle East and Africa) and APAC (Asia-Pacific).

For financial information about Baxter’s segments, see Note 17 in Item 8 of this Annual Report on Form 10-K.

Baxter had approximately 47,000 employees and conducted business in over 100 countries as of December 31, 2017. In 2017, the company generated approximately 60% of its revenues outside the United States. The company maintained approximately 50 manufacturing facilities and over 100 distribution facilities in the United States, Europe, Asia-Pacific, Latin America and Canada as of December 31, 2017.

Financial Results

Baxter’s global net sales totaled $10.6 billion in 2017, an increase of 4% over 2016 on a reported and constant currency basis. International sales totaled $6.1 billion in 2017, an increase of 2% compared to 2016 on a reported and constant currency basis. Sales in the United States totaled $4.5 billion in 2017, an increase of 6% compared to 2016.

Baxter’s income from continuing operations for 2017 totaled $724 million or $1.30 per diluted share, compared to $4,966 million, or $9.01 per diluted share, in the prior year. Income from continuing operations in 2017 included special items which resulted in a net decrease to income from continuing operations of $652 million, or $1.18 per diluted share. Income from continuing operations in 2016 included special items which resulted in a net increase to income from continuing operations of $3.9 billion, or $7.05 per diluted share. The company’s special items are discussed further in the Results of Operations section below.

Baxter’s financial results included R&D expenses totaling $617 million in 2017, which reflects the company’s focus on balancing increased investments to support the company’s new product pipeline with efforts to optimize overall R&D spending through continuous evaluation of the portfolio.

The company’s financial position remains strong, with operating cash flows from continuing operations totaling $1.9 billion in 2017. The company has continued to execute on its disciplined capital allocation framework, which is designed to optimize stockholder value creation through reinvestment in the businesses, dividends and share repurchases, as well as acquisitions and other business development initiatives as discussed in the Strategic Objectives section below.

Capital investments totaled $634 million in 2017 as the company continues to invest across its businesses to support future growth, including additional investments in support of new and existing product capacity expansions. The company’s investments in capital expenditures in 2017 were focused on projects that improve production efficiency and enhance manufacturing capabilities to support its strategy of geographic expansion with select investments in growing markets.

The company also continued to return value to its stockholders in the form of dividends. During 2017, the company paid cash dividends to its shareholders totaling $315 million. Additionally, in 2017 the company repurchased 9.2 million shares through cash repurchases pursuant to Rule 10b5-1 repurchase plans and otherwise.

Strategic Objectives

Baxter continues to focus on several key objectives to successfully execute its long-term strategy to achieve sustainable growth and deliver enhanced stockholder value. Baxter’s diversified and broad portfolio of medical products that treat life-threatening acute or chronic conditions and its global presence are core components of the company’s strategy to achieve these objectives. The company is focused on three strategic factors as part of its pursuit of industry leading performance: optimizing its core portfolio globally; operational excellence focused on streamlining the cost structure and enhancing operational efficiency; and following a disciplined and balanced approach to capital allocation.

Optimizing the Core Portfolio Globally

Baxter has categorized its product portfolio into four strategic business groupings. Those groupings include core growth, core return on capital, maintain or manage differently and strategic bets. Within the core growth grouping, Baxter looks to invest for long-term, higher margin growth. Baxter looks to optimize its return on investment and to maintain or enhance its market position with its core return on capital products. Maintain or manage differently products are those for which Baxter looks to sustain or reposition its underlying investment. Finally, the strategic bet grouping includes products for which Baxter is evaluating its market position and investment strategy. These products cover mature and emerging markets. Baxter continues to evaluate each product category’s placement in light of shifting market dynamics and company priorities and may reassign a product category into a different business grouping from time to time.

As part of this portfolio review, Baxter seeks to optimize its position in product areas where the company has a stable, profitable business model, identify and alter investments in products that have reached the end of their life cycles or with respect to which market positions have evolved unfavorably. In the course of doing so, Baxter expects to continue to reallocate capital to more promising opportunities or business groupings, as described above.

As part of this strategy, Baxter is shifting its investments to drive innovation where it has compelling opportunities to serve patients and healthcare professionals while advancing the business and will accelerate the pace in bringing these advances to market. Baxter is in the midst of launching more than 200 new products, geographic expansions and line extensions by 2020 including in such areas as chronic and acute renal care; smart pump technology; hospital pharmaceuticals and nutritionals; surgical sealants, and more. These comprise a mix of entirely new offerings, marked improvements on existing technologies, and the expansion of current products into new geographies.

Operational Excellence

As part of its pursuit of improved margin performance, Baxter is working to optimize its cost structure and as such is critically assessing optimal support levels in light of the company’s ongoing portfolio optimization efforts.

The company intends to continue to actively manage its cost structure to help ensure it is committing resources to the highest value uses. Such high value activities include supporting innovation, building out the portfolio, expanding patient access and accelerating growth for the company’s stockholders.

Baxter has undertaken a comprehensive review of all aspects of its operations and has already begun to implement changes in line with its business goals.

Maintaining Disciplined and Balanced Capital Allocation

Baxter’s capital allocation strategies include the following:

	•	reinvest in the business, by funding opportunities that are positioned to deliver sustainable growth, support the company’s innovation efforts and improve margin performance;

	•	return capital to stockholders through stock dividends, to meaningfully increase with earnings growth;

	•	share repurchases; and

	•	identify and pursue accretive M&A opportunities that generate returns above targeted thresholds.

Responsible Corporate Citizen

The company strives for continued growth and profitability, while furthering its focus on acting as a responsible corporate citizen. At Baxter, sustainability means creating lasting social, environmental and economic value by addressing the needs of the company’s wide-ranging stakeholder base. Baxter’s comprehensive sustainability program is focused on areas where the company is uniquely positioned to make a positive impact. Priorities include providing employees a safe, healthy and inclusive workplace, fostering a culture that drives integrity, strengthening access to healthcare, enhancing math and science education, and driving environmental performance across the product life cycle including development, manufacturing and transport. Baxter and the Baxter International Foundation provide financial support and product donations in support of critical needs, from assisting underserved communities to providing emergency relief for countries experiencing natural disasters.

Throughout 2017 the company continued to implement a range of water conservation strategies and facility-based energy saving initiatives. In the area of product stewardship and life cycle management, Baxter is pursuing efforts such as sustainable design and reduced packaging. Baxter is also responding to the challenges of climate change through innovative greenhouse gas emissions-reduction programs, such as shifting to less carbon-intensive energy sources in manufacturing and transport. Additionally, the company developed new long-term goals to drive continued environmental stewardship while creating healthier, more sustainable communities where Baxter employees work and live.

Risk Factors

The company’s ability to sustain long-term growth and successfully execute the strategies discussed above depends in part on the company’s ability to manage within an increasingly competitive and regulated environment and to address the other risk factors described in Item 1A of this Annual Report on Form 10-K.

RESULTS OF OPERATIONS

Special Items

The following table provides a summary of the company’s special items and the related impact by line item on the company’s results of continuing operations for 2017, 2016 and 2015.

years ended December 31 (in millions)		2017				2016				2015
Gross Margin
Intangible asset amortization expense		$	(154	)		$	(163	)		$	(158	)
Business optimization items1			(53	)			(156	)			(38	)
Intangible asset impairment2			—				(51	)			—
Separation-related costs3			(1	)			(1	)			—
Product-related items4			(17	)			18				28
Claris acquisition and integration expenses¹⁰			(8	)			—				—
Hurricane Maria costs¹¹			(32	)			—				—
Total Special Items		$	(265	)		$	(353	)		$	(168	)
Impact on Gross Margin Ratio		(2.6 pts)				(3.5 pts)				(1.7 pts)
Marketing and Administrative Expenses
Business optimization items1		$	116			$	173			$	152
Separation-related costs3			18				53				110
Claris acquisition and integration expenses¹⁰			20				—				—
Historical reserve adjustments¹²			(12	)			—				—
Litigation and contractual disputes¹⁴			21				—				—
Total Special Items		$	163			$	226			$	262
Impact on Marketing and Administrative Expense Ratio		1.5 pts				2.3 pts				2.6 pts
Research and Development Expenses
Business optimization items1		$	—			$	80			$	13
Separation-related costs3			—				—				1
Total Special Items		$	—			$	80			$	14
Other Income, Net
Business optimization items1		$	—			$	—			$	(3	)
Net realized gains on Retained Shares transactions⁵			—				(4,391	)			—
Loss on debt extinguishment⁶			—				149				130
Reserve items and adjustments⁷			—				—				(52	)
Business development items⁸			—				—				(20	)
Tax matter⁹			—				9				—
Venezuela deconsolidation¹³			33				—				—
Total Special Items		$	33			$	(4,233	)		$	55
Income Tax Expense
Impact of special items⁹		$	191			$	(314	)		$	(137	)
Total Special Items		$	191			$	(314	)		$	(137	)
Impact on Effective Tax Rate		22.5 pts				(22.1 pts)				(10.4 pts)

Intangible asset amortization expense is identified as a special item to facilitate an evaluation of current and past operating performance and is similar to how management internally assesses performance. Additional special items are identified above because they are highly variable, difficult to predict and of a size that may substantially impact the company’s reported operations for a period. Management believes that providing the separate impact of the above items on the company’s results in accordance with generally accepted accounting principles (GAAP) in the United States may provide a more complete understanding of the company’s operations and can facilitate a fuller analysis of the company’s results of operations, particularly in evaluating performance from one period to another. This information should be considered in addition to, and not as a substitute for, information prepared in accordance with GAAP.

1

In 2017, 2016 and 2015, the company’s results were impacted by costs associated with the company’s execution of certain strategies to optimize its organization and cost structure on a global basis. These actions included streamlining the company’s international operations, rationalizing its manufacturing facilities, reducing its general and administrative infrastructure, re-aligning certain R&D activities and cancelling certain R&D programs. The company recorded net business optimization charges of $169 million, $409 million and $203 million in 2017, 2016 and 2015, respectively. The company’s results in 2017 included a net charge of $70 million related to restructuring activities, $89 million of costs to implement business optimization programs which primarily included external consulting and project employee costs and $10 million of accelerated depreciation associated with facilities to be closed. The $70 million of restructuring charges included net $59 million of employee termination costs, $6 million of asset impairment charges related to facility closure costs and $5 million of other exit costs. The company’s results in 2016 included a net charge of $285 million related to restructuring activities, $65 million of costs to implement business optimization programs which primarily included external consulting and project employee costs, $33 million of accelerated depreciation associated with facilities to be closed, and $26 million of Gambro integration costs. The $285 million of restructuring charges included net $180 million of employee termination costs, $54 million of costs related to the discontinuance of the VIVIA home hemodialysis development program, $47 million of asset impairment charges related to acquired in-process R&D and facility closure costs and $4 million of other exit costs. The company’s results in 2015 included a net charge of $130 million related to restructuring activities and $73 million of Gambro integration costs. The $130 million of net restructuring charges included net $83 million of employee termination costs, a $20 million intangible asset impairment and $27 million of other asset impairments and other exit costs. Refer to Note 7 in Item 8 for further information regarding these charges and related reserves.

2	The company’s results in 2016 included a $51 million asset impairment primarily related to developed technology.

3	The company’s results in 2017, 2016 and 2015 included costs related to the Baxalta separation of $19 million, $54 million and $111 million, respectively.

4

The company’s results in 2017 included a net charge of $17 million related to SIGMA SPECTRUM infusion pump inspection and remediation activities and other historical product reserves. The company’s results in 2016 and 2015 included a net benefit of $18 million and $28 million, respectively, primarily related to adjustments to the COLLEAGUE and SIGMA SPECTRUM infusion pump reserves. Refer to Note 7 in Item 8 for further information regarding these charges and related reserves.

5	The company’s results in 2016 included net realized gains of $4.4 billion related to the debt-for-equity exchanges of the company’s retained shares in Baxalta for certain indebtedness, the exchange of retained shares in Baxalta for Baxter shares and the contribution of retained shares in Baxalta to Baxter’s U.S. pension fund.

6

The company’s results in 2016 included a net debt extinguishment loss totaling $149 million related to the March 2016 debt-for-equity exchange for certain company indebtedness and certain debt redemptions. The company’s results in 2015 included a loss of $130 million related to its July 2015 tender offer for certain of its outstanding indebtedness. Refer to Note 8 in Item 8 for additional information.

7	The company’s results in 2015 included income of $52 million related to a litigation settlement in which Baxter was the beneficiary.

8	The company’s results in 2015 included a benefit of $20 million relating to the reversal of contingent consideration milestone liabilities. Refer to Note 5 in Item 8 for further information regarding the company’s acquisitions and other arrangements.

9

Reflected in this item is the tax impact of the special items identified in this table as well as a net tax charge of $322 million related to the estimated impact of tax reform on the company’s tax related assets and liabilities. The company’s results in 2016 included a net after-tax benefit of $10 million related to the settlement of an income tax matter in the company’s non-wholly owned joint venture in Turkey. This amount was comprised of $19 million included in income tax expense offset by $9 million in non-controlling interest recorded in other income, net.

10	The company’s results in 2017 include acquisition and integration costs of $28 million related to the company’s acquisition of Claris.

11	The company’s results in 2017 included a charge of $32 million related to the impact of Hurricane Maria on the company’s operations in Puerto Rico. The costs primarily include inventory and fixed asset impairments as well as idle facility costs.

12	The company's results in 2017 included a benefit of $12 million related to an adjustment to the company's historical rebates and discounts reserve.

13	The company’s results in 2017 included a charge of $33 million related to the deconsolidation of its Venezuelan operations.

14	The company’s results in 2017 included charges of $21 million related to litigation and contractual disputes for businesses or arrangements in which the company is no longer engaged or a party thereto.

Net Sales

														Percent change
														At actual currency rates								At constant currency rates
years ended December 31 (in millions)		2017				2016				2015				2017				2016				2017				2016
United States		$	4,510			$	4,259			$	4,001				6	%			6	%			6	%			6	%
International			6,051				5,904				5,967				2	%			(1	)%			2	%			3	%
Total net sales		$	10,561			$	10,163			$	9,968				4	%			2	%			4	%			4	%

Net sales for the year ended December 31, 2017 increased 4% at actual and constant currency rates. Net sales for the year ended December 31, 2016 increased 2% at actual currency rates and 4% on a constant currency basis.

Changes in foreign currency exchange rates had no net impact on net sales during 2017 compared to the prior year. Foreign currency exchange rates unfavorably impacted net sales by two percentage points during 2016 compared to 2015 principally due to the strengthening of the U.S. dollar relative to the British Pound, Mexican Peso, Colombian Peso and the Chinese Yuan, as well as other currencies, partially offset by the weakening of the U.S. dollar relative to the Japanese Yen.

The comparisons presented at constant currency rates reflect comparative local currency sales at the prior year’s foreign exchange rates. This measure provides information on the change in net sales assuming that foreign currency exchange rates had not changed between the prior and the current period. The company believes that the non-GAAP measure of change in net sales at constant currency rates, when used in conjunction with the GAAP measure of change in net sales at actual currency rates, may provide a more complete understanding of the company’s operations and can facilitate a fuller analysis of the company’s results of operations, particularly in evaluating performance from one period to another.

During 2016, the company made a strategic decision to exit select products in certain markets including Venezuela, India and Turkey. Overall, these items had a negative impact to the company’s net sales growth rate of one percentage point during 2017. In addition, the impact of generic competition for U.S. cyclophosphamide had a negative impact on net sales of $25 million in 2017 compared to 2016. The company expects net sales of U.S. cyclophosphamide to decrease by approximately $90 million in 2018 due to the entrance of additional competitors.

On July 27, 2017, the company completed the acquisition of Claris, a wholly owned subsidiary of Claris Lifesciences Limited, for total cash consideration of $629 million, net of cash acquired. In 2017, consolidated results include $57 million of net sales related to the Claris acquisition.

In September 2017, the company’s three Puerto Rico manufacturing facilities sustained minimal structural damage from the impact of Hurricane Maria. Notwithstanding intermittent and continuing challenges with local infrastructure, limited production activities resumed soon thereafter and the company is currently back to pre-hurricane production levels at these facilities. Given the disruptions to the company’s manufacturing facilities as a result of the storm, the company’s net sales in the fourth quarter of 2017 were negatively impacted by approximately $70 million. The company currently expects these disruptions to negatively impact net sales in the first quarter of 2018 by approximately $25 million.

Global Business Unit Net Sales Reporting

The company’s global business units (GBUs) reflect the reorganization of the company’s business consistent with its new strategic framework. These groupings replace the company’s former franchises and include the following:

	•	Renal Care includes sales of the company’s peritoneal dialysis (PD) and hemodialysis (HD) and additional dialysis therapies and services.

	•	Acute Therapies includes sales of the company’s continual renal replacement therapies (CRRT) and other organ support therapies focused in the intensive care unit (ICU).

	•	Medication Delivery includes sales of the company’s IV therapies, infusion pumps, administration sets and drug reconstitution devices.

	•	Pharmaceuticals includes sales of the company’s premixed and oncology drug platforms, inhaled anesthesia and critical care products and pharmacy compounding services.

	•	Nutrition includes sales of the company’s parenteral nutrition (PN) therapies.

	•	Advanced Surgery includes sales of the company’s biological products and medical devices used in surgical procedures for hemostasis, tissue sealing and adhesion prevention.

	•	Other includes sales primarily from the company’s pharmaceutical partnering business.

The following is a summary of net sales by GBU.

														Percent change
														At actual currency rates								At constant currency rates
years ended December 31 (in millions)		2017				2016				2015				2017				2016				2017				2016
Renal Care		$	3,480			$	3,421			$	3,401				2	%			1	%			2	%			4	%
Acute Therapies			456				429				385				6	%			11	%			6	%			14	%
Medication Delivery			2,698				2,596				2,375				4	%			9	%			4	%			11	%
Pharmaceuticals			1,883				1,722				1,801				9	%			(4	)%			9	%			(2	)%
Nutrition			882				858				857				3	%			0	%			2	%			2	%
Advanced Surgery			707				690				693				2	%			0	%			2	%			1	%
Other			455				447				456				2	%			(2	)%			1	%			(2	)%
Total Baxter		$	10,561			$	10,163			$	9,968				4	%			2	%			4	%			4	%

Renal Care net sales increased 2% and 1% in 2017 and 2016, respectively. Excluding the impact of foreign currency, net sales increased 2% and 4% in 2017 and 2016, respectively. The increase in 2017 was driven by continued growth of PD patients and adoption of the company’s new Automated Peritoneal Dialysis Cyclers (APD) AMIA in the U.S. and HomeChoice CLARIA in international markets, partially offset by lower sales of HD products internationally. Additionally, net sales were negatively impacted in 2017 by approximately $50 million as compared to 2016 due to certain international strategic market exits. The increase in 2016 was driven by continued global growth of patients, new product launches and improved pricing in the U.S. PD business.

Acute Therapies net sales increased 6% and 11% in 2017 and 2016, respectively. Excluding the impact of foreign currency, net sales increased 6% and 14%, respectively, driven by higher sales of the company’s CRRT systems to treat acute kidney injuries.

Medication Delivery net sales increased 4% and 9% in 2017 and 2016, respectively. Excluding the impact of foreign currency, net sales increased 4% and 11%, respectively. The increase in both years was driven by select pricing and improved volumes for U.S. IV solutions. This increase was also positively impacted by increased sales of the company’s IV access administrative sets, reflecting the on-going pull through from the company’s growing SPECTRUM infusion pump base. Net sales were negatively impacted in 2017 by approximately $35 million as compared to 2016 due to certain international strategic market exits. Additionally, 2017 net sales were negatively impacted by approximately $45 million due to the impact of Hurricane Maria.

Pharmaceuticals net sales increased 9% in 2017 and decreased 4% in 2016. Excluding the impact of foreign currency, net sales increased 9% in 2017 and decreased 2% in 2016. The increase in 2017 was a result of increased sales of pre-mixed injectable drugs (as a result of recent product launches), a one-time benefit from a pharmacy compounding early contract settlement, improved pricing for BREVIBLOC, a fast-acting IV beta blocker, and increased sales of TransDerm Scop resulting from temporary supply disruptions. The acquisition of Claris in 2017 also contributed $57 million of net sales. The increase was partially offset by a reduction in sales of U.S. cyclophosphamide from $210 million in 2016 to $185 million in 2017 due to the entry of competitors into the market and an approximate $10 million reduction in sales due to the impact of Hurricane Maria. Additionally, net sales were negatively impacted in 2017 by approximately $10 million as compared to 2016 due to certain international strategic market exits. The decrease in 2016 was a result of U.S. Department of Defense PROTOPAM orders in 2015 that did not reoccur in 2016 and a reduction in sales of U.S. cyclophosphamide from $270 million in 2015 to $210 million in 2016.

Nutrition net sales increased 3% in 2017 and were flat in 2016. Excluding the impact of foreign currency, net sales increased 2% in each period driven by improved volumes, new product launches and ongoing geographic expansion for the company’s PN therapies. Partially offsetting the increase in 2017 was an approximate $15 million reduction in sales due to the impact of Hurricane Maria.

Advanced Surgery net sales increased 2% in 2017 and were flat in 2016. Excluding the impact of foreign currency, net sales increased 2% and 1% in 2017 and 2016, respectively, primarily driven by improved volumes internationally. Offsetting performance in both periods were reduced sales of non-core surgical products Actifuse and Peristrips.

Other net sales increased 2% in 2017 and decreased 2% in 2016. Excluding the impact of foreign currency, net sales increased 1% in 2017 and decreased 2% in 2016. The increase in 2017 was a result of favorable volumes for products manufactured by Baxter on behalf of its pharmaceutical partners, including the benefit of increasing the safety stock levels of select products. The decrease in 2016 was driven by lower demand for products manufactured by Baxter on behalf of one of its pharmaceutical partners as that partner transitioned to self-manufacture of products previously manufactured by Baxter.

Gross Margin and Expense Ratios

														Change
years ended December 31 (as a percent of net sales)		2017				2016				2015				2017		2016
Gross margin			42.2	%			40.4	%			41.6	%		1.8 pts		(1.2 pts)
Marketing and administrative expenses			24.5	%			27.0	%			31.0	%		(2.5 pts)		(4.0 pts)

Gross Margin

The special items identified above had an unfavorable impact of 2.6, 3.5 and 1.7 percentage points on the gross margin ratio in 2017, 2016 and 2015, respectively. Refer to the Special Items section above for additional detail.

Excluding the impact of the special items, the gross margin ratio increased 0.9 percentage points in 2017. The gross margin ratio was impacted by select price increases, favorable manufacturing performance and a benefit from the company’s business transformation initiatives aimed at simplifying the portfolio to drive efficiency and reduce costs, partially offset by the impact of foreign currency.

Excluding the impact of the special items, the gross margin ratio increased 0.6 percentage points in 2016. The gross margin ratio was impacted by a positive sales mix, improved pricing in select areas of the portfolio and favorable manufacturing performance, offset by reduced sales of cyclophosphamide in the United States and foreign exchange.

Marketing and Administrative Expenses

The special items identified above had an unfavorable impact of 1.5, 2.3 and 2.6 percentage points on the marketing and administrative expenses ratio in 2017, 2016 and 2015, respectively. Refer to the Special Items section above for additional detail.

Excluding the impact of the special items, the marketing and administrative expense ratio decreased 1.7 percentage points in 2017 due to the actions taken by the company to restructure its cost position and focus on expense management. These savings were partially offset by decreased benefits to the marketing and administrative expenses ratio from lower transition service income as the agreement with Baxalta for these services continues to wind down.

Excluding the impact of the special items, the marketing and administrative expense ratio decreased 3.7 percentage points in 2016 and was impacted by reduced pension expense, benefits from the company’s actions taken to restructure its cost position and continued focus on expense management, and a reduction to expense under the transition services agreement with Baxalta.

Pension and Other Postemployment Benefit Plan Expense

Expense related to the company’s pension and other postemployment benefit (OPEB) plans increased $9 million in 2017 primarily due to a reduction in the expected return on assets. Expense related to the company’s pension and other postemployment benefit plans decreased $111 million in 2016 primarily due to a change in approach to estimating employer service and interest costs and a $706 million voluntary, non-cash contribution to the U.S. qualified plan using Retained Shares. The company expects expenses from pension and other postemployment benefit plans to decrease in 2018 as a result of the split and freeze of its U.S. pension plans announced in January 2018 coupled with stronger investment returns as a result of additional contributions made in 2017 and better-than expected investment returns realized in 2017. Refer to Notes 1 and 13 in Item 8 for further information regarding pension and other postemployment benefit plan expenses and a change in income statement presentation for these expenses.

Business Optimization Items

Beginning in the second half of 2015, the company has initiated actions to transform the company’s cost structure and enhance operational efficiency. These efforts include restructuring the organization, optimizing the manufacturing footprint, R&D operations and supply chain network, employing disciplined cost management, and centralizing and streamlining certain support functions. Through December 31, 2017, the company incurred cumulative pre-tax costs of $576 million related to these actions. The costs consisted primarily of employee termination costs, implementation costs, and accelerated depreciation. The company expects to incur additional pretax costs of approximately $240 million and capital expenditures of $50 million related to these initiatives by the end of 2018. These costs will primarily include employee termination costs and implementation costs. These actions in the aggregate are expected to provide future annual pretax savings of approximately $975 million. The savings from these actions will impact cost of sales, marketing and administrative expenses, and R&D expenses. The company estimates that actions taken through December 31,

2017 have resulted in approximately $730 million of savings in 2017. Approximately 90 percent of the expected annual pretax savings are expected to be realized by the end of 2018, with the remainder by the end of 2020.

In addition to the programs above, the company recorded additional net business optimization charges of $125 million in 2016. These charges primarily include employee termination costs, contract termination costs, asset impairments, and Gambro integration costs. Approximately 40% of these costs were non-cash. The company does not anticipate incurring any additional costs related to these programs in the future. The actions in the aggregate are expected to provide future annual pre-tax savings of approximately $19 million. The savings from these actions will impact cost of sales, marketing and administrative expenses, and R&D expenses.

Refer to Note 7 in Item 8 for additional information regarding the company’s business optimization initiatives.

Research and Development

														Percent change
years ended December 31 (in millions)		2017				2016				2015				2017				2016
Research and development expenses		$	617			$	647			$	603				(5	)%			7	%
as a percent of net sales			5.8	%			6.4	%			6.0	%		(0.6) pts				0.4 pts

The special items identified above had an unfavorable impact of $80 million and $14 million in 2016 and 2015, respectively.

Excluding the impact of the special items, the research and development expenses ratio increased in 2017 as a result of the company’s increased investment in new product development and geographic expansion.

Excluding the impact of special items, the research and development expenses ratio decreased in 2016 primarily due to the optimization of the infrastructure, the exit of certain programs and the impact of foreign currency.

Net Interest Expense

Net interest expense was $55 million, $66 million and $126 million in 2017, 2016 and 2015, respectively. The decrease in 2017 was principally driven by lower outstanding debt as a result of the first quarter 2016 debt-for-equity exchanges and reduced coupon rates resulting from the third quarter 2016 and second quarter 2017 debt issuances, partially offset by lower capitalized interest compared to 2016. The decrease in 2016 was principally driven by lower outstanding debt as a result of the first quarter 2016 debt-for-equity exchanges and reduced coupon rates resulting from the third quarter 2016 debt issuance, partially offset by lower capitalized interest compared to 2015. Refer to Note 3 in Item 8 for a summary of the components of net interest expense for 2017, 2016 and 2015.

Other Income, Net

Other income, net was $14 million, $4,296 million and $105 million in 2017, 2016 and 2015, respectively. The current year results included $50 million of income related to foreign currency fluctuations principally relating to intercompany receivables, payables and monetary assets denominated in a foreign currency, partially offset by the $33 million loss on the deconsolidation of the company’s Venezuela operations and $8 million of losses related to investment impairments. The 2016 results included net realized gains of $4.4 billion on the Retained Shares transactions, dividend income of $16 million from the Retained Shares, and $28 million of income related to foreign currency fluctuations principally relating to intercompany receivables, payables and monetary assets denominated in a foreign currency. These income items were partially offset by net debt extinguishment losses of $153 million. The 2015 results were driven primarily by $52 million of income related to a favorable litigation settlement, $38 million income from the sale of available-for-sale securities, and $113 million of income related to foreign currency fluctuations principally relating to intercompany receivables, payables and monetary assets denominated in a foreign currency, partially offset by a $130 million loss on extinguishment of debt related to the July 2015 debt tender offer.

Income Taxes

Effective Income Tax Rate

The effective income tax rate for continuing operations was 40.5% in 2017, (0.2%) in 2016 and 8.2% in 2015. The special items identified above had an unfavorable impact of 22.5 percentage points on the effective income tax rate in 2017 and a favorable impact of 22.1 and 10.4 percentage points in 2016 and 2015, respectively. Refer to the Special Items section above for additional detail.

The company’s provision for income taxes and its effective rate increased in 2017 compared to 2016 primarily due to special items including the recently enacted Tax Cuts and Jobs Act of 2017 (the 2017 Tax Act), the tax-free net realized gains recognized in 2016 on the Baxalta Retained Shares and resolution of uncertain tax positions related to the company’s former Turkish joint venture in 2016. In addition, the company’s provision for income taxes and its effective tax rate in 2017 increased due to tax benefits recognized

in 2016 from partially settling an IRS (2008-2013) income tax audit, settling a German (2008-2011) income tax audit, and other miscellaneous transfer pricing matters including partial settlement of interest expense deductions related to the company’s acquisition of Gambro. Partially offsetting the increase in the effective tax rate was a benefit of $56 million in 2017 related to deductions in excess of share-based compensation costs (windfall tax benefits) and the mix of earnings in lower tax jurisdictions relative to higher tax jurisdictions. Refer to Note 15 in Item 8 for further information related to the 2017 Tax Act.

The company’s provision for income taxes and its effective tax rate in 2016 decreased compared to 2015 primarily due to special items in 2016 including the tax-free net realized gains recognized on the Baxalta Retained Shares and resolution of uncertain tax positions related to the company’s former Turkish joint venture. In addition, the company’s provision for income taxes and its effective tax rate decreased in 2016 compared to 2015 due to tax benefits recognized in 2016 from partially settling an IRS (2008-2013) income tax audit, settling a German (2008-2011) income tax audit, other miscellaneous transfer pricing matters including partial settlement of interest expense deductions related to the company’s acquisition of Gambro and the mix of earnings in lower tax jurisdictions relative to higher tax jurisdictions. Also, the 2016 effective tax rate decreased from 2015 due to charges recognized in 2015 related to contingent tax matters primarily related to transfer pricing and the separation of Baxalta as well as the need to record valuation allowances for loss-making entities. Partially offsetting the decrease were benefits recognized in 2015 from reaching a settlement of a Puerto Rico excise tax matter as well as the U.S. R&D credit resulting from the retroactive reinstatement in December 2015 of the Protecting Americans from Tax Hikes Act of 2015.

The company anticipates that the effective income tax rate from continuing operations, calculated in accordance with GAAP, will be approximately 19.5% in 2018. This rate may be further impacted by a number of factors including discrete items such as tax windfalls or deficiencies attributable to stock compensation exercises as well as additional audit developments, or the tax effect of other special items. The company’s future effective tax rate will be affected by the 2017 Tax Act. Effective in 2018, the Tax Act reduces the U.S. statutory tax rate from 35% to 21% and creates new taxes on certain foreign-sourced earnings and certain related-party payments, which are referred to as the global intangible low-taxed income tax (GILTI) and the base erosion and anti-abuse tax (BEAT), respectively. The company is currently evaluating whether it will be subject to either of these taxes and it will continue to review guidance as it is released. The company’s future effective tax rate could be adversely affected by earnings being lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates, changes in the valuation of the company’s deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items. In addition, the charge recognized in 2017 related to the 2017 Tax Act is provisional and any changes recognized during the one-year measurement period may have an impact on the 2018 effective tax rate.

Income from Continuing Operations and Earnings per Diluted Share

Income from continuing operations was $724 million in 2017, $5.0 billion in 2016 and $393 million in 2015. Income from continuing operations per diluted share was $1.30 in 2017, $9.01 in 2016 and $0.72 in 2015. The significant factors and events causing the net changes from 2016 to 2017 and 2015 to 2016 are discussed above. Additionally, income from continuing operations per diluted share was positively impacted by the repurchase of 17.8 million shares through cash repurchases and an equity-for-equity exchange of Retained Shares for outstanding Baxter shares in 2016, and the repurchase of 9.2 million shares in 2017 through Rule 10b5-1 purchase plans and otherwise. Refer to Note 12 in Item 8 for further information regarding the company’s stock repurchases.

(Loss) Income from Discontinued Operations

The following table is a summary of the operating results of Baxalta, which have been reflected as discontinued operations for the years ended December 31, 2017, 2016 and 2015.

Years ended December 31 (in millions)		2017				2016				2015
Net sales		$	7			$	148			$	2,895
(Loss) income from discontinued operations before income taxes			1				(10	)			752
Gain on disposal of discontinued operations			2				19				—
Income tax expense			—				10				177
Total (loss) income from discontinued operations		$	3			$	(1	)		$	575

Refer to Note 2 in Item 8 for additional information regarding the separation of Baxalta.

In addition, the company recognized additional expense of $10 million, net of tax, in 2017 related to environmental clean-up costs at a former location. Refer to Note 16 in Item 8 for additional information regarding environmental liabilities.

Segment results

The company uses operating income on a segment basis to make resource allocation decisions and assess the ongoing performance of the company’s segments. Refer to Note 17 in Item 8 for additional details regarding the company’s segments. The following is a summary of significant factors impacting the reportable segments’ financial results.

		Net sales												Operating income
years ended December 31 (in millions)		2017				2016				2015				2017				2016				2015
Americas		$	5,720			$	5,437			$	5,222			$	2,227			$	2,070			$	1,816
EMEA			2,731				2,697			$	2,774				564				476				342
APAC			2,110				2,029				1,972				512				464				405
Corporate and other			—				—				—				(2,045	)			(2,286	)			(2,114	)
Total		$	10,561			$	10,163			$	9,968			$	1,258			$	724			$	449

Americas

Segment operating income was $2,227 million, $2,070 million and $1,816 million in 2017, 2016 and 2015, respectively. The increase in 2017 was primarily driven by increased sales and gross margin largely due to strength in the Medication Delivery, Renal Care and Pharmaceuticals GBUs. In addition, marketing and administrative expenses were lower as cost savings were realized from the company’s business optimization programs and continued focus on expense management. Operating income improved in 2016 due to strong performance in the Medication Delivery and Renal Care GBUs partially offset by weaker performance in the Pharmaceuticals GBU. Performance in the Pharmaceuticals GBU was impacted by reduced sales of U.S. cyclophosphamide and a U.S. Department of Defense PROTOPAM order from 2015 that did not reoccur in 2016.

EMEA

Segment operating income was $564 million, $476 million and $342 million in 2017, 2016 and 2015, respectively. The increase in 2017 was largely driven by lower marketing and administrative expenses as cost savings were realized from the company’s business optimization programs and continued focus on expense management. Improved performance in 2016 compared to 2015 was largely a result of lower marketing and administrative expenses from the company’s business optimization programs and continued focus on expense management. These savings were partially offset by reduced sales and margin within the Renal Care GBU resulting from the decision to forgo certain lower margin sales opportunities, increased austerity measures in Western Europe and competitive pressures for dialyzers.

APAC

Segment operating income was $512 million, $464 million and $405 million in 2017, 2016 and 2015, respectively. The increase in 2017 was largely driven by strong performance in the Renal Care and Acute Therapies GBUs along with lower marketing and administrative expenses as cost savings were realized from the company’s business optimization programs and continued focus on expense management. Improved performance in 2016 was the result of stronger sales in the Pharmaceuticals GBU as a result of new contracts and lower marketing and administrative expenses from the company’s business optimization programs and continued focus on expense management.

Corporate and other

Certain income and expense amounts are not allocated to a segment. These amounts primarily include corporate headquarters costs, certain R&D costs, certain GBU support costs, stock compensation expense, non-strategic investments and related income and expense, certain employee benefit plan costs as well as certain gains, losses, and other charges (such as business optimization and asset impairments).

LIQUIDITY AND CAPITAL RESOURCES

The company’s cash flows reflect both continuing and discontinued operations.

Cash Flows from Operations — Continuing Operations

Operating cash flows from continuing operations totaled $1.9 billion in 2017, $1.6 billion in 2016 and $1.3 billion in 2015. The increases were driven by the factors described below.

Net Income

Net income, as adjusted for certain non-cash items, such as depreciation and amortization, net periodic pension benefit and OPEB costs, stock compensation, deferred income taxes and other items increased in 2017 compared to 2016 as well as in 2016 as compared to 2015. Additionally, non-cash items in 2016 included net realized gains of $4.4 billion related to the debt-for-equity exchanges of Baxalta Retained Shares for certain company indebtedness and for the equity-for-equity exchange.

Accounts Receivable

Cash flows relating to accounts receivable increased in 2017 and 2016 as the days sales outstanding decreased in each period. Days sales outstanding were 53.0 days, 54.5 days and 56.2 days for 2017, 2016 and 2015, respectively. Days sales outstanding decreased in 2017 and 2016 primarily driven by timing of collections in certain international markets.

Inventories

Cash flows relating to inventory decreased from an inflow of $80 million in 2016 to an inflow of $76 million in 2017. The following is a summary of inventories at December 31, 2017 and 2016, as well as inventory turns for 2017, 2016 and 2015. Inventory turns for the year are calculated as the annualized fourth quarter cost of sales divided by the year-end inventory balance.

		Inventories								Inventory turns
(in millions, except inventory turn data)		2017				2016				2017				2016				2015
Total company		$	1,475			$	1,430				4.2				4.1				3.6

Other

The changes in accounts payable and accrued liabilities were an inflow of $84 million in 2017, an outflow of $197 million in 2016 and a $236 million inflow in 2015. The changes were primarily driven by an increase in tax payments in 2016 primarily due to a tax settlement as well as the timing of payments to suppliers. Refer to Note 15 in Item 8 for additional details regarding the tax settlement.

Payments related to the execution of the company’s business optimization initiatives were $143 million in 2017, $164 million in 2016 and $89 million in 2015. Refer to Note 7 in Item 8 for further information regarding the business optimization initiatives.

Other balance sheet items had net cash outflows of $229 million in 2017, a net inflow of $90 million in 2016 and a net outflow of $364 million in 2015, respectively. In 2016, the company received a U.S. federal income tax refund of $250 million. Additionally, cash contributions to the company’s pension plans totaled $242 million, $66 million and $157 million in 2017, 2016 and 2015, respectively. Additional changes in 2015 were primarily driven by prepaid expenses and hedging activity.

Cash Flows from Investing Activities — Continuing Operations

Capital Expenditures

Capital expenditures relating to continuing operations totaled $634 million in 2017, $719 million in 2016 and $911 million in 2015. The company’s capital expenditures consisted of targeted investments in projects to support production of PD and IV solutions as well as expansion activities for dialyzers. The decline in capital expenditures over the three years was due to a reduction in spending related to ongoing projects and the completion of certain expansion activities.

Acquisitions and Investments

Net cash outflows related to acquisitions and investments were $686 million in 2017, $48 million in 2016 and $34 million in 2015. The cash outflows in 2017 were driven by the acquisition of Claris and the rights to certain molecules from Celerity. The cash outflows in 2016 were driven primarily by the acquisition of the rights to vancomycin from Celerity. The cash outflows in 2015 were driven by the acquisition of the rights to cefazolin injection in GALAXY Container (2g/100mL) from Celerity.

Refer to Note 5 in Item 8 for further information about the company’s significant acquisitions and other arrangements.

Divestitures and Other Investing Activities

Net cash inflows relating to divestitures and other investing activities were $10 million in 2017, $37 million in 2016 and $84 million in 2015. The net inflow in 2017 was driven by proceeds received from asset sales partially offset by the impact of the deconsolidation of the company’s Venezuelan operations. The decrease from 2015 to 2016 was primarily driven by the sale of certain investments and other assets in 2015.

Cash Flows from Financing Activities

Debt Issuances, Net of Payments of Obligations

Net cash inflows related to debt and other financing obligations totaled $632 million in 2017 primarily related to the issuance of €600 million of senior notes at a fixed coupon rate of 1.30% due in May 2025. Refer to Note 8 in Item 8 for additional details regarding the debt transactions in 2017.

Net cash inflows related to debt and other financing obligations totaled $56 million in 2016 primarily related to a $190 million repayment of the company’s 0.95% senior unsecured notes that matured in June 2016, a $130 million repayment of the company’s 5.9% senior unsecured notes that matured in September 2016 and the redemption of approximately $1 billion in aggregate principal amount of senior notes in September 2016, as well as the repayment of other short-term obligations. The company also had $300 million of net repayments related to its commercial paper program. These cash outflows were partially offset by issuances of debt totaling $1.6 billion of senior notes in August 2016. Refer to Note 8 in Item 8 for additional details regarding the debt transactions in 2016.

Net cash outflows related to debt and other financing obligations totaled $2.4 billion in 2015 driven by approximately $6.9 billion in issuances of debt primarily related to the Baxalta senior notes and borrowings under the company’s revolving credit facilities. The company purchased an aggregate of approximately $2.7 billion in principal amount of its notes in 2015. Additionally, the company repaid $600 million of 4.625% senior unsecured notes that matured in March 2015 and borrowings under the company’s Euro-denominated revolving credit facility. The company issued and redeemed commercial paper throughout the year, and had $300 million outstanding as of December 31, 2015.

The company’s debt instruments discussed above are unsecured and contain certain covenants, including restrictions relating to the company’s issuance of secured debt.

Other Financing Activities

In connection with the separation, Baxter transferred $2.1 billion of cash to Baxalta in 2015.

Cash dividend payments totaled $315 million in 2017, $268 million in 2016 and $910 million in 2015. The decrease in cash dividend payments in 2017 and 2016 was primarily due to the decrease of the quarterly dividend after the separation of Baxalta in 2015, from $0.52 per share for quarterly dividends beginning after May 2014 to $0.115 per share for quarterly dividends beginning after July 2015. The Baxter cash dividend was increased to $0.13 per share for quarterly dividends beginning after May 2016 and to $0.16 per share for quarterly dividends after May 2017.

Proceeds from stock issued under employee benefit plans totaled $347 million, $286 million and $193 million in 2017, 2016 and 2015, respectively.

Total realized excess tax benefits, which were $39 million in 2016 and $7 million in 2015, are presented in the consolidated statements of cash flows as an inflow in the financing section. Total realized excess tax benefits of $56 million in 2017 are presented as an inflow from operating activities as required under new accounting guidance implemented in 2017. Refer to Note 2 in Item 8 for additional information regarding the change in accounting.

In 2016, the company executed an equity-for-equity exchange of Retained Shares for 11.5 million outstanding Baxter shares. As authorized by the Board of Directors, the company repurchases its stock depending on the company’s cash flows, net debt level and market conditions. In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of the company’s common stock. The Board of Directors increased this authority by an additional $1.5 billion in November 2016. The company paid $287 million in cash to repurchase approximately 6.3 million shares pursuant to this authority in 2016. In 2017, the company paid $564 million to repurchase approximately 9.2 million shares under this authority pursuant to Rule 10b5-1 plans and otherwise and had $1.1 billion remaining available under this authorization as of December 31, 2017. The Board of Directors increased this authority by an

additional $1.5 billion in February 2018. After giving effect to the February 2018 approval and 2018 share repurchases, $2.3 billion of repurchase authority remained available as of February 20, 2018.

Credit Facilities, Access to Capital and Credit Ratings

Credit Facilities

As of December 31, 2017, the company’s U.S. dollar-denominated senior revolving credit facility and Euro-denominated senior revolving credit facility had a maximum capacity of $1.5 billion and approximately €200 million, respectively, both maturing in 2020. As of December 31, 2017, the company was in compliance with the financial covenants in these agreements. The non-performance of any financial institution supporting either of the credit facilities would reduce the maximum capacity of these facilities by each institution’s respective commitment. The company may, at its option, seek to increase the aggregate commitment under the U.S. facility by up to an additional $750 million. The facilities enable the company to borrow funds on an unsecured basis at variable interest rates, and contain various covenants, including a maximum net leverage ratio and maximum interest coverage ratio.

The company also maintains other credit arrangements, as described in Note 8 in Item 8.

Access to Capital

The company intends to fund short-term and long-term obligations as they mature through cash on hand, future cash flows from operations or by issuing additional debt. The company had $3.4 billion of cash and equivalents as of December 31, 2017, with adequate cash available to meet operating requirements in each jurisdiction in which the company operates. The company invests its excess cash in certificates of deposit and money market funds, and diversifies the concentration of cash among different financial institutions.

The company’s ability to generate cash flows from operations, issue debt or enter into other financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company’s products or in the solvency of its customers or suppliers, deterioration in the company’s key financial ratios or credit ratings or other significantly unfavorable changes in conditions. However, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company’s growth objectives.

The company continues to do business with foreign governments in certain countries, including Greece, Spain, Portugal and Italy, which have experienced deterioration in credit and economic conditions. As of December 31, 2017, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $149 million.

While these economic conditions have not significantly impacted the company’s ability to collect receivables, global economic conditions and liquidity issues in certain countries have resulted, and may continue to result, in delays in the collection of receivables and credit losses.

Credit Ratings

The company’s credit ratings at December 31, 2017 were as follows:

		Standard & Poor’s		Fitch		Moody’s
Ratings
Senior debt		A-		BBB+		Baa2
Short-term debt		A2		F2		P2
Outlook		Stable		Stable		Stable

Contractual Obligations

As of December 31, 2017, the company had contractual obligations, excluding accounts payable and accrued liabilities, payable or maturing in the following periods.

(in millions)		Total				Less than one year				One to three years				Three to five years				More than five years
Long-term debt and capital lease obligations, including current maturities		$	3,531			$	3			$	304			$	612			$	2,612
Interest on short- and long-term debt and capital lease obligations 1			1,522				99				195				180				1,048
Operating leases			698				129				191				132				246
Other long-term liabilities2			611				—				118				39				454
Purchase obligations3			571				358				184				20				9
Contractual obligations4		$	6,933			$	589			$	992			$	983			$	4,369

1

Interest payments on debt and capital lease obligations are calculated for future periods using interest rates in effect at the end of 2017. Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates, foreign currency fluctuations or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2017. Refer to Note 8 and Note 9 in Item 8 for further discussion regarding the company’s debt instruments and related interest rate agreements outstanding at December 31, 2017.

2

The primary components of other long-term liabilities in the company’s consolidated balance sheet are liabilities relating to pension and other postemployment benefit plans, litigation, and foreign currency hedges. The company projected the timing of the future cash payments based on contractual maturity dates (where applicable) and estimates of the timing of payments (for liabilities with no contractual maturity dates). The actual timing of payments could differ from the estimates.

The company contributed $260 million, $772 million and $178 million to its defined benefit pension and OPEB plans in 2017, 2016 and 2015, respectively. The timing of funding in the future is uncertain and is dependent on future movements in interest rates and investment returns, changes in laws and regulations, and other variables. Therefore, the table above excludes pension plan cash outflows. The pension plan balance included in other long-term liabilities (and excluded from the table above) totaled $952 million at December 31, 2017.

3	Includes the company’s significant contractual unconditional purchase obligations. For cancelable agreements, any penalty due upon cancellation is included. These commitments do not exceed the company’s projected requirements and are in the normal course of business. Examples include firm commitments for raw material purchases, utility agreements and service contracts.

4	Excludes contingent liabilities and uncertain tax positions. These amounts have been excluded from the contractual obligations above due to uncertainty regarding the timing and amount of future payments. Refer to Notes 10 and 15 in Item 8 for additional information regarding these commitments.

Off-Balance Sheet Arrangements

Baxter periodically enters into off-balance sheet arrangements. Certain contingencies arise in the normal course of business, and are not recorded in the consolidated balance sheet in accordance with GAAP (such as contingent joint development and commercialization arrangement payments). Also, upon resolution of uncertainties, the company may incur charges in excess of presently established liabilities for certain matters (such as contractual indemnifications). For a discussion of the company’s significant off-balance sheet arrangements, refer to Note 10 in Item 8 for information regarding receivable securitizations, Note 11 in Item 8 regarding joint development and commercialization arrangements and indemnifications, and Note 16 in Item 8 regarding legal contingencies.

FINANCIAL INSTRUMENT MARKET RISK

The company operates on a global basis and is exposed to the risk that its earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange and interest rates. The company’s hedging policy attempts to manage these risks to an acceptable level based on the company’s judgment of the appropriate trade-off between risk, opportunity and costs. Refer to Note 9 and Note 10 in Item 8 for further information regarding the company’s financial instruments and hedging strategies.

Currency Risk

The company is primarily exposed to foreign exchange risk with respect to revenues generated outside of the United States denominated in the Euro, British Pound, Chinese Yuan, Korean Won, Australian Dollar, Canadian Dollar, Japanese Yen, Colombian Peso, Brazilian Real, Mexican Peso, and New Zealand Dollar. The company manages its foreign currency exposures on a consolidated basis, which allows the company to net exposures and take advantage of any natural offsets. In addition, the company uses derivative and nonderivative financial instruments to further reduce the net exposure to foreign exchange. Gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders’ equity volatility relating to foreign exchange. Financial market and currency volatility may limit the company’s ability to cost-effectively hedge these exposures.

The company may use options, forwards and cross-currency swaps to hedge the foreign exchange risk to earnings relating to forecasted transactions denominated in foreign currencies and recognized assets and liabilities. The maximum term over which the company has cash flow hedge contracts in place related to forecasted transactions at December 31, 2017 is 12 months. The company also enters into derivative instruments to hedge certain intercompany and third-party receivables and payables and debt denominated in foreign currencies.

As part of its risk-management program, the company performs sensitivity analyses to assess potential changes in the fair value of its foreign exchange instruments relating to hypothetical and reasonably possible near-term movements in foreign exchange rates.

A sensitivity analysis of changes in the fair value of foreign exchange option and forward contracts outstanding at December 31, 2017, while not predictive in nature, indicated that if the U.S. Dollar uniformly weakened by 10% against all currencies, on a net-of-tax basis, the net asset balance of $7 million with respect to those contracts would decrease by $25 million, resulting in a net liability position. A similar analysis performed with respect to option and forward contracts outstanding at December 31, 2016 indicated that, on a net-of-tax basis, the net asset balance of $13 million would decrease by $34 million, resulting in a net liability position.

The sensitivity analysis model recalculates the fair value of the foreign exchange option and forward contracts outstanding at December 31, 2017 by replacing the actual exchange rates at December 31, 2017 with exchange rates that are 10% weaker compared to the actual exchange rates for each applicable currency. All other factors are held constant. These sensitivity analyses disregard the possibility that currency exchange rates can move in opposite directions and that gains from one currency may or may not be offset by losses from another currency. The analyses also disregard the offsetting change in value of the underlying hedged transactions and balances.

Interest Rate and Other Risks

The company is also exposed to the risk that its earnings and cash flows could be adversely impacted by fluctuations in interest rates. The company’s policy is to manage interest costs using a mix of fixed- and floating-rate debt that the company believes is appropriate. To manage this mix in a cost-efficient manner, the company periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. The company also periodically uses forward-starting interest rate swaps and treasury rate locks to hedge the risk to earnings associated with fluctuations in interest rates relating to anticipated issuances of term debt.

As part of its risk management program, the company performs sensitivity analyses to assess potential gains and losses in earnings relating to hypothetical movements in interest rates. A 15 basis-point increase in interest rates (approximately 10% of the company’s weighted-average interest rate during 2017) affecting the company’s financial instruments, including debt obligations and related derivatives, would have an immaterial effect on the company’s 2017, 2016 and 2015 earnings and on the fair value of the company’s fixed-rate debt as of the end of each fiscal year.

CHANGES IN ACCOUNTING STANDARDS

Refer to Note 1 in Item 8 for information on changes in accounting standards.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with GAAP requires the company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. A summary of the company’s significant accounting policies is included in Note 1 in Item 8. Certain of the company’s accounting policies are considered critical because these policies are the most important to the depiction of the company’s financial statements and require significant, difficult or complex judgments by the company, often requiring the use of estimates about the effects of matters that are inherently uncertain. Actual results that differ from

the company’s estimates could have an unfavorable effect on the company’s results of operations and financial position. The following is a summary of accounting policies that the company considers critical to the consolidated financial statements.

Revenue Recognition and Related Provisions and Allowances

The company’s policy is to recognize revenues from product sales and services when earned. Specifically, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred (or services have been rendered), the price is fixed or determinable, and collectability is reasonably assured. For product sales, revenue is not recognized until title and risk of loss have transferred to the customer. The shipping terms for the majority of the company’s revenue arrangements are free on board (FOB) destination. The company sometimes enters into arrangements in which it commits to delivering multiple products or services to its customers. In these cases, total arrangement consideration is allocated to the deliverables based on their relative selling prices. Then the allocated consideration is recognized as revenue in accordance with the principles described above. Selling prices are determined by applying a selling price hierarchy. Selling prices are determined using vendor specific objective evidence (VSOE), if it exists. Otherwise, selling prices are determined using third party evidence (TPE). If neither VSOE nor TPE is available, the company uses its best estimate of selling prices.

Provisions for rebates, chargebacks to wholesalers and distributors, returns, and discounts (collectively, sales deductions) are provided for at the time the related sales are recorded, and are reflected as a reduction of sales. The sales deductions are based primarily on estimates of the amounts earned or that will be claimed on such sales.

The company periodically and systematically evaluates the collectability of accounts receivable and determines the appropriate reserve for doubtful accounts. In determining the amount of the reserve, the company considers historical credit losses, the past-due status of receivables, payment history and other customer-specific information, and any other relevant factors or considerations.

The company also provides for the estimated costs that may be incurred under its warranty programs when the cost is both probable and reasonably estimable, which is at the time the related revenue is recognized. The cost is determined based on actual company experience for the same or similar products as well as other relevant information. Estimates of future costs under the company’s warranty programs could change based on developments in the future. The company is not able to estimate the probability or amount of any future developments that could impact the reserves, but believes presently established reserves are adequate.

Pension and OPEB Plans

The company provides pension and other postemployment benefits to certain of its employees. These employee benefit expenses are reported in the same line items in the consolidated income statement as the applicable employee’s compensation expense. The valuation of the funded status and net periodic benefit cost for the plans is calculated using actuarial assumptions. These assumptions are reviewed annually, and revised if appropriate. The significant assumptions include the following:

	•	interest rates used to discount pension and OPEB plan liabilities;

	•	the long-term rate of return on pension plan assets;

	•	rates of increases in employee compensation (used in estimating liabilities);

	•	anticipated future healthcare trend rates (used in estimating the OPEB plan liability); and

	•	other assumptions involving demographic factors such as retirement, mortality and turnover (used in estimating liabilities).

Selecting assumptions involves an analysis of both short-term and long-term historical trends and known economic and market conditions at the time of the valuation (also called the measurement date). The use of different assumptions would result in different measures of the funded status and net cost. Actual results in the future could differ from expected results. The company is not able to estimate the probability of actual results differing from expected results, but believes its assumptions are appropriate.

The company’s key assumptions are listed in Note 13 in Item 8. The most critical assumptions relate to the plans covering U.S. and Puerto Rico employees, because these plans are the most significant to the company’s consolidated financial statements.

Discount Rate Assumption

Effective for the December 31, 2017 measurement date, the company utilized discount rates of 3.62% and 3.51% to measure its benefit obligations for the U.S. and Puerto Rico pension plans and OPEB plan, respectively. The company used a broad population of approximately 200 Aa-rated corporate bonds as of December 31, 2017 to determine the discount rate assumption. All bonds were

denominated in U.S. Dollars, with a minimum amount outstanding of $50 million. This population of bonds was narrowed from a broader universe of approximately 700 Moody’s Aa rated, non-callable (or callable with make-whole provisions) bonds by eliminating the top 10th percentile and bottom 40th percentile to adjust for any pricing anomalies and to represent the bonds Baxter would most likely select if it were to actually annuitize its pension and OPEB plan liabilities. This portfolio of bonds was used to generate a yield curve and associated spot rate curve to discount the projected benefit payments for the U.S. and Puerto Rico plans. The discount rate is the single level rate that produces the same result as the spot rate curve.

For plans in Canada, Japan, the United Kingdom and the Eurozone, the company uses a method essentially the same as that described for the U.S. and Puerto Rico plans. For the company’s other international plans, the discount rate is generally determined by reviewing country- and region-specific government and corporate bond interest rates.

To understand the impact of changes in discount rates on pension and OPEB plan cost, the company performs a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point (i.e., one-half of one percent) increase in the discount rate, global pre-tax pension and OPEB plan cost would decrease by approximately $40 million, and for each 50 basis point decrease in the discount rate, global pre-tax pension and OPEB plan cost would increase by approximately $44 million.

Effective January 1, 2016, the company changed its approach used to calculate the service and interest components of net periodic benefit cost. Previously, the company calculated the service and interest components utilizing a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation. The company elected an alternative approach that utilizes a full yield curve approach in the estimation of these components by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to their underlying projected cash flows. The company believes this approach provides a more precise measurement of service and interest costs by improving the correlation between projected benefit cash flows and their corresponding spot rates. The company accounted for this change prospectively as a change in estimate. As a result of this change, the service cost and interest cost for these plans was reduced by $40 million in 2016 compared to the previous method.

Return on Plan Assets Assumption

In measuring the net periodic cost for 2017, the company used a long-term expected rate of return of 6.50% for the pension plans covering U.S. and Puerto Rico employees. This assumption will decrease to 6.25% in 2018. This assumption is not applicable to the company’s OPEB plan because it is not funded.

The company establishes the long-term asset return assumption based on a review of historical compound average asset returns, both company-specific and relating to the broad market (based on the company’s asset allocation), as well as an analysis of current market and economic information and future expectations. The current asset return assumption is supported by historical market experience for both the company’s actual and targeted asset allocation. In calculating net pension cost, the expected return on assets is applied to a calculated value of plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over five years. The difference between this expected return and the actual return on plan assets is a component of the total net unrecognized gain or loss and is subject to amortization in the future.

To understand the impact of changes in the expected asset return assumption on net cost, the company performs a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point increase (decrease) in the asset return assumption, global pre-tax pension plan cost would decrease (increase) by approximately $22 million.

Other Assumptions

For the U.S. and Puerto Rico plans, beginning with the December 31, 2014 measurement date, the company used the RP 2014 combined mortality table adjusted to reflect Baxter specific past experience with improvements projected using the generational BB-2D projection scale adjusted to a long term improvement of 0.8% in 2027. For all other pension plans, the company utilized country- and region-specific mortality tables to calculate the plans’ benefit obligations. The company periodically analyzes and updates its assumptions concerning demographic factors such as retirement, mortality and turnover, considering historical experience as well as anticipated future trends.

The assumptions relating to employee compensation increases and future healthcare costs are based on historical experience, market trends, and anticipated future company actions. Refer to Note 13 in Item 8 for information regarding the sensitivity of the OPEB plan obligation and the total of the service and interest cost components of OPEB plan cost to potential changes in future healthcare trend rates.

Legal Contingencies

The company is involved in product liability, patent, commercial, regulatory and other legal proceedings that arise in the normal course of business. Refer to Note 16 in Item 8 for further information. The company records a liability when a loss is considered probable and the amount can be reasonably estimated. If the reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, the minimum amount in the range is accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. The company has established reserves for certain of its legal matters. At December 31, 2017, total legal liabilities were $41 million.

The company’s loss estimates are generally developed in consultation with outside counsel and are based on analyses of potential outcomes. With respect to the recording of any insurance recoveries, after completing the assessment and accounting for the company’s legal contingencies, the company separately and independently analyzes its insurance coverage and records any insurance recoveries that are probable of occurring at the gross amount that is expected to be collected. In performing the assessment, the company reviews available information, including historical company-specific and market collection experience for similar claims, current facts and circumstances pertaining to the particular insurance claim, the financial viability of the applicable insurance company or companies, and other relevant information.

While the liability of the company in connection with certain claims cannot be estimated and although the resolution in any reporting period of one or more of these matters could have a significant impact on the company’s results of operations and cash flows for that period, the outcome of these legal proceedings is not expected to have a material adverse effect on the company’s consolidated financial position. While the company believes it has valid defenses in these matters, litigation is inherently uncertain, excessive verdicts do occur, and the company may in the future incur material judgments or enter into material settlements of claims.

Deferred Tax Asset Valuation Allowances, Reserves for Uncertain Tax Positions and Tax Reform

The company maintains valuation allowances unless it is more likely than not that all or a portion of the deferred tax asset will be realized. Changes in valuation allowances are included in the company’s tax provision in the period of change. In determining whether a valuation allowance is warranted, the company evaluates factors such as prior earnings history, expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. The realizability assessments made at a given balance sheet date are subject to change in the future, particularly if earnings of a subsidiary are significantly higher or lower than expected, or if the company takes operational or tax planning actions that could impact the future taxable earnings of a subsidiary.

In the normal course of business, the company is audited by federal, state and foreign tax authorities, and is periodically challenged regarding the amount of taxes due. These challenges relate to the timing and amount of deductions and the allocation of income among various tax jurisdictions. The company believes its tax positions comply with applicable tax law and the company intends to defend its positions. In evaluating the exposure associated with various tax filing positions, the company records reserves for uncertain tax positions in accordance with GAAP, based on the technical support for the positions, the company’s past audit experience with similar situations, and potential interest and penalties related to the matters. The company’s results of operations and effective tax rate in a given period could be impacted if, upon final resolution with taxing authorities, the company prevailed in positions for which reserves have been established, or was required to pay amounts in excess of established reserves.

On December 22, 2017, the 2017 Tax Act was enacted into law and the new legislation contains several key tax provisions that affected the company, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the U.S. corporate income tax rate to 21% effective January 1, 2018, among others. The company is required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, remeasuring its U.S. deferred tax assets and liabilities as well as reassessing the net realizability of its deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allows the company to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. Since the Tax Act was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretations are expected over the next 12 months, the company considers the accounting for the transition tax, deferred tax re-measurements, and other items to be incomplete due to the forthcoming guidance and its ongoing analysis of final year-end data and tax positions. The company expects to complete its analysis within the measurement period in accordance with SAB 118.

Valuation of Intangible Assets, Including IPR&D

The company acquires intangible assets and records them at fair value. Valuations are generally completed for business acquisitions using a discounted cash flow analysis, incorporating the stage of completion and consideration of market participant assumptions. The most significant estimates and assumptions inherent in a discounted cash flow analysis include the amount and timing of projected future cash flows, the discount rate used to measure the risks inherent in the future cash flows, the assessment of the asset’s life cycle, and the competitive and other trends impacting the asset, including consideration of technical, legal, regulatory, economic and other factors. Each of these factors and assumptions can significantly affect the value of the intangible asset.

Acquired in-process R&D (IPR&D) is the value assigned to acquired technology or products under development which have not received regulatory approval and have no alternative future use. Acquired IPR&D included in a business combination is capitalized as an indefinite-lived intangible asset. Development costs incurred after the acquisition are expensed as incurred. Upon receipt of regulatory approval of the related technology or product, the indefinite-lived intangible asset is then accounted for as a finite-lived intangible asset and amortized on a straight-line basis over its estimated useful life. If the R&D project is abandoned, the indefinite-lived asset is charged to expense.

R&D acquired in transactions that are not business combinations is expensed immediately. For such transactions, payments made to third parties on or after regulatory approval are capitalized and amortized over the remaining useful life of the related asset, and are classified as intangible assets.

Due to the inherent uncertainty associated with R&D projects, there is no assurance that actual results will not differ materially from the underlying assumptions used to prepare discounted cash flow analyses, nor that the R&D project will result in a successful commercial product.

Impairment of Assets

Goodwill and other indefinite-lived intangible assets are subject to impairment reviews annually, and whenever indicators of impairment exist. The company assesses goodwill for impairment based on its reporting units, which are the same as its operating segments. As of December 31, 2017, the date of the company’s annual impairment review, the fair value of the company’s reporting units were in excess of their carrying values. As discussed in Note 6 of Item 8, the company performed the goodwill impairment test both prior to and after the reallocation of its goodwill to its new reporting units based on a change in operating segments. The company performs a qualitative assessment of other indefinite-lived intangible assets, including IPR&D, at least annually. If the intangible asset is determined to be more likely than not impaired as a result of the assessment, the company completes a quantitative impairment test. Intangible assets with definite lives and other long-lived assets (such as fixed assets) are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Refer to Note 1 in Item 8 for further information. The company’s impairment reviews are based on an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, foreign currency exchange rates, the selection of an appropriate discount rate, asset groupings, and other assumptions and estimates. The estimates and assumptions used are consistent with the company’s business plans and when applicable, market participant’s views of the company and similar companies. The use of alternative estimates and assumptions could increase or decrease the estimated fair values of the assets, and potentially result in different impacts to the company’s results of operations. Actual results may differ from the company’s estimates.

Stock-Based Compensation Plans

Stock-based compensation cost is estimated at the grant date based on the fair value of the award, and the cost is recognized as expense ratably over the substantive vesting period. The company’s stock compensation costs primarily relate to awards of stock options, restricted stock units (RSUs), and performance share units (PSUs). The company uses the Black-Scholes model for estimating the fair value of stock options, and significant assumptions include long-term projections regarding stock price volatility, employee exercise, post-vesting termination and pre-vesting forfeiture behaviors, interest rates and dividend yields. The company’s expected volatility assumption is based on a weighted-average of the historical volatility of Baxter’s stock and the implied volatility from traded options on Baxter’s stock, with historical volatility more heavily weighted. The expected life assumption is primarily based on the vesting terms of the stock option, historical employee exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield reflects historical experience as well as future expectations over the expected life of the option.

The fair value of RSUs is equal to the quoted price of the company’s common stock on the date of grant.

PSUs granted in 2017 are based either on adjusted operating margin or are based upon Baxter stock performance relative to the company’s peer group. The vesting condition for such PSUs based on adjusted operating margin have annual performance targets set at the beginning of the year for each tranche of the award during the three-year service period. The holder of the adjusted operating margin PSUs is entitled to receive a number of shares of common stock equal to a percentage, ranging from 0% to 200%, of the adjusted operating margin PSUs granted, depending on the actual results compared to the annual performance targets. Such results may be further adjusted based on an assessment of the individual’s future potential. Compensation cost for the adjusted operating margin PSUs is measured based on the fair value of the awards on the date that the specific vesting terms for each tranche of the award are established. The fair value of the awards is determined based on the quoted price of the company’s stock on the grant date for each tranche of the award. The compensation cost for adjusted operating margin PSUs is adjusted at each reporting date to reflect the estimated probability of achieving the adjusted operating margin vesting condition. The probability of achieving the operating margin vesting condition is such that the compensation cost has been adjusted to reflect 200% attainment as of the year ended December 31, 2017. The vesting condition for PSUs based on Baxter stock performance relative to the company’s peer group is fair valued using a Monte Carlo model. A Monte Carlo model uses stock price volatility and other variables to estimate the probability of satisfying the market conditions and the resulting fair value of the award. Refer to Note 12 in Item 8 for additional information.

CERTAIN REGULATORY MATTERS

The U.S. Food and Drug Administration (FDA) commenced an inspection of Claris’ facilities in Ahmedabad, India on July 27, 2017, immediately prior to the closing of the Claris acquisition. FDA completed the inspection on August 4, 2017, at which time FDA issued a related Form-483 (Claris 483). The Claris 483 includes a number of observations across a variety of areas. The company submitted its timely response to the Claris 483 and is in the process of implementing corrective and preventive actions, which have included product recalls that are financially immaterial to the company, to address FDA’s observations and other items identified in connection with integrating Claris into the company’s quality systems.

In January 2014, the company received a Warning Letter from FDA primarily directed to quality systems for the company’s Round Lake, Illinois, facility, particularly in that facility’s capacity as a specification developer for certain of the company’s medical devices. This Warning Letter was lifted in February 2017.

The company received a Warning Letter in December 2013 that included observations related to the company’s ambulatory infuser business in Irvine, California, which previously had been subject to agency action. This Warning Letter was lifted in May 2017.

In June 2013, the company received a Warning Letter from FDA regarding operations and processes at its North Cove, North Carolina and Jayuya, Puerto Rico facilities. The company attended Regulatory Meetings with the FDA in November 2015 (concerning the Jayuya facility). The company also requested and participated in a Regulatory Meeting regarding both facilities in July 2017. The Warning Letter addresses observations related to Current Good Manufacturing Practice violations at the two facilities.

In June 2010, the company received a Warning Letter from FDA in connection with an inspection of its McGaw Park, Illinois facility, which previously supported the Renal franchise. The company’s Round Lake facility now provides the related capacity for the Renal franchise. The Warning Letter pertains to the processes by which the company analyzes and addresses product complaints through corrective and preventative action, and reports relevant information to FDA. This Warning Letter was lifted in February 2017.

On October 9, 2014, the company had a Regulatory Meeting with FDA to discuss the Warning Letters described above. At the meeting, the company agreed to work closely with FDA to provide regular updates on its progress to meet all requirements and resolve all matters identified in the Warning Letters described above.

Refer to Item 1A of this Annual Report on Form 10-K for additional discussion of regulatory matters and how they may impact the company.

FORWARD-LOOKING INFORMATION

This annual report includes forward-looking statements. Use of the words “may,” “will,” “would,” “could,” “should,” “believes,” “estimates,” “projects,” “potential,” “expects,” “plans,” “seeks,” “intends,” “evaluates,” “pursues,” “anticipates,” “continues,” “designs,” “impacts,” “affects,” “forecasts,” “target,” “outlook,” “initiative,” “objective,” “designed,” “priorities,” “goal,” or the negative of those words or other similar expressions is intended to identify forward-looking statements that represent our current judgment about possible future events. These forward-looking statements may include statements with respect to accounting estimates and assumptions, litigation-related matters including outcomes, future regulatory filings and the company’s R&D pipeline, strategic objectives, credit exposure to foreign governments, potential developments with respect to credit ratings, investment of foreign earnings, estimates of liabilities including those related to uncertain tax positions, contingent payments, future pension plan contributions, costs, discount rates and rates of return, the company’s exposure to financial market volatility and foreign currency and

interest rate risks, potential tax liability associated with the separation of the company’s biopharmaceuticals and medical products businesses (including the 2016 disposition of the company’s Retained Shares in Baxalta), the impact of competition, future sales growth, the impact on sales of Hurricane Maria related production disruptions, future U.S. cyclophosphamide sales, business development activities (including the future pipeline and recent acquisitions, including that of Claris Injectables), business optimization initiatives, cost saving initiatives, future capital and R&D expenditures, future debt issuances, manufacturing expansion, the sufficiency of the company’s facilities and financial flexibility, the adequacy of credit facilities, tax provisions and reserves, the effective tax rate and all other statements that do not relate to historical facts.

These forward-looking statements are based on certain assumptions and analyses made in light of the company’s experience and perception of historical trends, current conditions, and expected future developments as well as other factors that the company believes are appropriate in the circumstances. While these statements represent the company’s current judgment on what the future may hold, and the company believes these judgments are reasonable, these statements are not guarantees of any events or financial results. Whether actual future results and developments will conform to expectations and predictions is subject to a number of risks and uncertainties, including the following factors, many of which are beyond our control:

	•	failure to achieve our long-term financial improvement goals;

	•	demand for and market acceptance risks for and competitive pressures related to new and existing products, and the impact of those products on quality and patient safety concerns;

	•	product development risks, including satisfactory clinical performance, the ability to manufacture at appropriate scale, and the general unpredictability associated with the product development cycle;

	•	product quality or patient safety issues, leading to product recalls, withdrawals, launch delays, warning letters, import bans, sanctions, seizures, litigation, or declining sales;

	•	the continuity, availability and pricing of acceptable raw materials and component supply, and therefore the continuity of our manufacturing and distribution;

	•	inability to repair existing production capacity or create additional production capacity in a timely manner or the occurrence of other manufacturing or supply difficulties (including as a result of natural disaster or otherwise);

	•	breaches or failures of the company’s information technology systems, including by cyber attack;

	•	future actions of (or failures to act or delays in acting by) the FDA, the European Medicines Agency or any other regulatory body or government authority (including the DOJ or the Attorney General of any State) that could delay, limit or suspend product development, manufacturing or sale or result in seizures, recalls, injunctions, monetary sanctions or criminal or civil liabilities;

	•	failures with respect to the company’s quality, compliance or ethics programs;

	•	future actions of third parties, including third-party payers;

	•	the impact of healthcare reform and its implementation, suspension, repeal, replacement, amendment, modification and other similar actions undertaken by the United States or foreign governments, including with respect to third-party payers, pricing, reimbursement, taxation and rebate policies;

	•	legislation, regulation and other governmental pressures in the United States or globally, which may affect pricing, reimbursement, taxation and rebate policies of government agencies and private payers or other elements of the company’s business;

	•	the impact of competitive products and pricing, including generic competition, drug reimportation and disruptive technologies;

	•	global regulatory, trade and tax policies;

	•	the company’s ability to identify business development and growth opportunities and to successfully execute on business development strategies;

	•	the company’s ability to finance and develop new products or enhancements, on commercially acceptable terms or at all;

	•	the ability to protect or enforce the company’s owned or in-licensed patent or other proprietary rights (including trademarks, copyrights, trade secrets and know-how) or patents of third parties preventing or restricting the company’s manufacture, sale or use of affected products or technology;

	•	the impact of any goodwill impairments on our operating results;

	•	the impact of any future tax liability with respect to the separation and distribution, including with respect to the Baxter Transactions (including the company’s prior disposition of the Retained Shares);

	•	any failure by Baxalta or Shire to satisfy its obligation under the separation agreements, including the tax matters agreement, or the Letter Agreement;

	•	the impact of global economic conditions on the company and its customers and suppliers, including foreign governments in countries in which the company operates;

	•	fluctuations in foreign exchange and interest rates;

	•	any changes in law concerning the taxation of income (including current or future tax reform), including income earned outside the United States;

	•	actions by tax authorities in connection with ongoing tax audits;

	•	loss of key employees or inability to identify and recruit new employees;

	•	the outcome of pending or future litigation;

	•	the adequacy of the company’s cash flows from operations to meet its ongoing cash obligations and fund its investment program; and

	•	other factors identified elsewhere in this Annual Report on Form 10-K including those factors described in Item 1A and other filings with the Securities and Exchange Commission, all of which are available on the company’s website.

Actual results may differ materially from those projected in the forward-looking statements. The company does not undertake to update its forward-looking statements.