Item 8. Financial Statements and Supplementary Data.

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Item 8. Financial Statements and Supplementary Data.

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CONSOLIDATED BALANCE SHEETS

as of December 31 (in millions, except share information)		2017			2016
Current assets	Cash and equivalents	$	3,394		$	2,801
	Accounts and other current receivables, net		1,793			1,691
	Inventories		1,475			1,430
	Prepaid expenses and other		601			602
	Current assets held for disposition		—			50
	Total current assets		7,263			6,574
Property, plant and equipment, net			4,588			4,289
Other assets	Goodwill		3,099			2,595
	Other intangible assets, net		1,374			1,111
	Other		787			977
	Total other assets		5,260			4,683
	Total assets	$	17,111		$	15,546
Current liabilities	Current maturities of long-term debt and lease obligations	$	3		$	3
	Accounts payable and accrued liabilities		2,733			2,612
	Current income taxes payable		85			126
	Current liabilities held for disposition		—			3
	Total current liabilities		2,821			2,744
Long-term debt and lease obligations			3,509			2,779
Other long-term liabilities			1,665			1,743
Commitments and contingencies
Equity	Common stock, $1 par value, authorized 2,000,000,000 shares, issued 683,494,944 shares in 2017 and 2016		683			683
	Common stock in treasury, at cost, 142,017,600 shares in 2017 and 143,890,064 shares in 2016		(7,981	)		(7,995	)
	Additional contributed capital		5,940			5,958
	Retained earnings		14,483			14,200
	Accumulated other comprehensive (loss) income		(4,001	)		(4,556	)
	Total Baxter shareholders’ equity		9,124			8,290
	Noncontrolling interests		(8	)		(10	)
	Total equity		9,116			8,280
	Total liabilities and equity	$	17,111		$	15,546

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF INCOME

years ended December 31 (in millions, except per share data)	2017			2016			2015
Net sales	$	10,561		$	10,163		$	9,968
Cost of sales		6,099			6,053			5,822
Gross margin		4,462			4,110			4,146
Marketing and administrative expenses		2,587			2,739			3,094
Research and development expenses		617			647			603
Operating income		1,258			724			449
Net interest expense		55			66			126
Other income, net		(14	)		(4,296	)		(105	)
Income from continuing operations before income taxes		1,217			4,954			428
Income tax (benefit) expense		493			(12	)		35
Income from continuing operations		724			4,966			393
(Loss) income from discontinued operations, net of tax		(7	)		(1	)		575
Net income	$	717		$	4,965		$	968
Income from continuing operations per common share
Basic	$	1.33		$	9.10		$	0.72
Diluted	$	1.30		$	9.01		$	0.72
(Loss) income from discontinued operations per common share
Basic	$	(0.01	)	$	(0.01	)	$	1.06
Diluted	$	(0.01	)	$	—		$	1.04
Net income per common share
Basic	$	1.32		$	9.09		$	1.78
Diluted	$	1.29		$	9.01		$	1.76
Weighted-average number of common shares outstanding
Basic		543			546			545
Diluted		555			551			549

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

years ended December 31 (in millions)	2017			2016			2015
Net income	$	717		$	4,965		$	968
Other comprehensive income (loss), net of tax:
Currency translation adjustments, net of tax expense (benefit) of $91 in 2017, ($39) in 2016 and ($107) in 2015		425			(247	)		(1,094	)
Pension and other employee benefits, net of tax expense (benefit) of $62 in 2017, ($36) in 2016, and $104 in 2015		141			(97	)		165
Hedging activities, net of tax (benefit) expense of ($6) in 2017, ($2) in 2016, and $9 in 2015		(13	)		(4	)		15
Available-for-sale securities, net of tax expense of zero in 2017, zero in 2016, and $6 in 2015		2			(4,432	)		4,438
Total other comprehensive income (loss), net of tax		555			(4,780	)		3,524
Comprehensive income	$	1,272		$	185		$	4,492

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

years ended December 31 (in millions) (brackets denote cash outflows)		2017			2016			2015
Cash flows from	Net income	$	717		$	4,965		$	968
operations	Adjustments to reconcile income from continuing operations to net cash from operating activities:
	Loss (income) from discontinued operations, net of tax		7			1			(575	)
	Depreciation and amortization		761			800			759
	Deferred income taxes		211			(302	)		(50	)
	Stock compensation		107			115			126
	Realized excess tax benefits from stock issued under employee benefit plans		—			(39	)		(7	)
	Net periodic pension benefit and OPEB costs		126			116			227
	Business optimization items		70			285			130
	Net realized gains on Baxalta common stock		—			(4,387	)		—
	Infusion pump and other product-related charges		(4	)		(18	)		(28	)
	Other		40			264			42
	Changes in balance sheet items
	Accounts and other current receivables, net		30			15			(4	)
	Inventories		76			80			(118	)
	Accounts payable and accrued liabilities		84			(197	)		236
	Business optimization payments		(143	)		(164	)		(89	)
	Other		(229	)		90			(364	)
	Cash flows from operations – continuing operations		1,853			1,624			1,253
	Cash flows from operations – discontinued operations		(16	)		30			518
	Cash flows from operations		1,837			1,654			1,771
Cash flows from	Capital expenditures		(634	)		(719	)		(911	)
investing activities	Acquisitions and investments, net of cash acquired		(686	)		(48	)		(34	)
	Divestitures and other investing activities		10			37			84
	Cash flows from investing activities – continuing operations		(1,310	)		(730	)		(861	)
	Cash flows from investing activities – discontinued operations		—			15			(946	)
	Cash flows from investing activities		(1,310	)		(715	)		(1,807	)
Cash flows from	Issuances of debt		633			1,641			6,868
financing activities	Payments of obligations		(1	)		(1,381	)		(3,786	)
	Debt extinguishment costs		—			(16	)		(114	)
	Decrease in debt with original maturities of three months or less, net		—			(300	)		(575	)
	Transfer of cash and equivalents to Baxalta		—			—			(2,122	)
	Cash dividends on common stock		(315	)		(268	)		(910	)
	Proceeds from stock issued under employee benefit plans		347			286			193
	Purchases of treasury stock		(564	)		(292	)		—
	Other		(39	)		6			(35	)
	Cash flows from financing activities		61			(324	)		(481	)
Effect of foreign exchange rate changes on cash and equivalents			5			(27	)		(195	)
Increase (decrease) in cash and equivalents			593			588			(712	)
Cash and equivalents at beginning of year			2,801			2,213			2,925
Cash and equivalents at end of year		$	3,394		$	2,801		$	2,213
Supplemental schedule of non-cash investing and financing activities
Net proceeds on Retained Shares transactions		$	—		$	4,387		$	—
Payment of obligations in exchange for Retained Shares		$	—		$	3,646		$	—
Exchange of Baxter shares with Retained Shares		$	—		$	611		$	—
Other supplemental information
Interest paid, net of portion capitalized		$	80		$	99		$	178
Income taxes paid		$	255		$	500		$	466

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

	2017						2016						2015
as of and for the years ended December 31 (in millions)	Shares			Amount			Shares			Amount			Shares			Amount
Common stock
Balance, beginning and end of year		683		$	683			683		$	683			683		$	683
Common stock in treasury
Beginning of year		144			(7,995	)		136			(7,646	)		141			(7,993	)
Purchases of common stock		9			(564	)		18			(902	)		—			—
Stock issued under employee benefit plans and other		(11	)		578			(10	)		553			(5	)		347
End of year		142			(7,981	)		144			(7,995	)		136			(7,646	)
Additional contributed capital
Beginning of year					5,958						5,902						5,853
Stock issued under employee benefit plans and other					(19	)					43						49
Other					1						13						—
End of year					5,940						5,958						5,902
Retained earnings
Beginning of year					14,200						9,683						13,227
Net income					717						4,965						968
Dividends declared on common stock					(334	)					(276	)					(695	)
Stock issued under employee benefit plans					(134	)					(190	)					(90	)
Distribution of Baxalta					34						18						(3,727	)
End of year					14,483						14,200						9,683
Accumulated other comprehensive income (loss)
Beginning of year					(4,556	)					224						(3,650	)
Other comprehensive income (loss)					555						(4,780	)					3,524
Distribution of Baxalta					—						—						350
End of year					(4,001	)					(4,556	)					224
Total Baxter shareholders’ equity				$	9,124					$	8,290					$	8,846
Noncontrolling interests
Beginning of year				$	(10	)				$	19					$	36
Change in noncontrolling interests					2						(29	)					(17	)
End of year				$	(8	)				$	(10	)				$	19
Total equity				$	9,116					$	8,280					$	8,865

The accompanying notes are an integral part of these consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Baxter International Inc., through its subsidiaries, provides a broad portfolio of essential healthcare products across its portfolio, including acute and chronic dialysis therapies; sterile intravenous (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 the 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. The company operates in three segments: Americas, EMEA and APAC, which are described in Note 17.

Use of Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles (GAAP) requires the company to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates.

Basis of Presentation

The consolidated financial statements include the accounts of Baxter and its majority-owned subsidiaries that Baxter controls, after elimination of intercompany transactions. Certain reclassifications have been made to conform prior period consolidated financial statements to the current period presentation.

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 $629 million, net of cash acquired. Beginning July 27, 2017, Baxter’s financial statements include the assets, liabilities and operating results of Claris. Refer to Note 5 for additional information.

On July 1, 2015, Baxter completed the distribution of approximately 80.5% of the outstanding common stock of Baxalta Incorporated (Baxalta), to Baxter shareholders (the Distribution). The Distribution was made to Baxter’s shareholders of record as of the close of business on June 17, 2015 (the Record Date), who received one share of Baxalta common stock for each Baxter common share held as of the Record Date. As a result of the Distribution, Baxalta became an independent public company.

In 2016, Baxter disposed of its remaining 19.5% interest in Baxalta through a series of transactions including debt-for-equity exchanges, an equity-for-equity exchange and a contribution to its U.S. pension plan. As a result of these transactions, the company extinguished approximately $3.65 billion in company indebtedness, repurchased 11,526,638 Baxter shares and contributed 17,145,570 Baxalta shares to its U.S. pension plan. On June 3, 2016, Baxalta became a wholly-owned subsidiary of Shire plc (Shire).

References in this report to Baxalta prior to the Merger closing date refers to Baxalta as a stand-alone public company. References in this report to Baxalta subsequent to the Merger closing date refer to Baxalta as a subsidiary of Shire.

As a result of the separation, the consolidated statements of income, consolidated balance sheets, consolidated statements of cash flow, and related financial information reflect Baxalta’s operations, assets and liabilities, and cash flows as discontinued operations for all periods presented. Refer to Note 2 for additional information regarding the separation of Baxalta.

Currency restrictions enacted in Venezuela require Baxter to obtain approval from the Venezuelan government to exchange Venezuelan bolivars for U.S. dollars and require such exchange to be made at the official exchange rate established by the government. In the first quarter of 2016, the Venezuelan government moved from the three-tier exchange rate system to a two-tiered exchange rate system and the official rate for food and medicine imports was adjusted from 6.3 to 10 bolivars per U.S. dollar. Due to a recent decline in transactions settled at the official rate or the secondary rate and limitations on the company’s ability to repatriate funds generated by its Venezuela operations, the company concluded in the second quarter of 2017 that it no longer met the accounting criteria for control over its business in Venezuela and the company deconsolidated its Venezuelan operations on June 30, 2017. As a result of deconsolidating the Venezuelan operations, the company recorded a pre-tax charge of $33 million in other income, net in 2017. This charge included the write-off of the company’s investment in its Venezuelan operations, related cumulative unrealized translation adjustments and elimination of intercompany amounts. Beginning in the third quarter of 2017, the company no longer includes the results of its Venezuelan business in its consolidated financial statements.

In September 2017, Hurricane Maria caused damage to certain of the company's assets in Puerto Rico and disrupted operations. Insurance, less applicable deductibles and subject to any coverage exclusions, covers the repair or replacement of the company's assets that suffered loss or damage, and the company is working with its insurance carriers and claims adjusters to ascertain the full amount of insurance proceeds due to the company as a result of the damages and the loss the company suffered. The company's insurance policies also provide coverage for interruption to the company’s business, including lost profits, and reimbursement for other expenses and costs that have been incurred relating to the damages and losses suffered. In 2017, the Company recorded $32 million of pre-tax charges related to damages caused by the hurricane, including $11 million related to the impairment of damaged inventory and fixed assets as well as $21 million of idle facility and other costs. These amounts were recorded as a component of cost of sales in the consolidated statement of income for year ended December 31, 2017. At this time, the full amount of business interruption costs and recoveries cannot be estimated, and accordingly, no additional amounts, including amounts for anticipated insurance recoveries, have been recorded as of December 31, 2017

Revenue Recognition

The company recognizes 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 FOB destination. The recognition of revenue is delayed if there are significant post-delivery obligations, such as training, installation or other services. Provisions for discounts, rebates to customers, chargebacks to wholesalers and returns are provided for at the time the related sales are recorded, and are reflected as a reduction to gross sales to arrive at net sales.

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 and by 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.

Accounts Receivable and Allowance for Doubtful Accounts

In the normal course of business, the company provides credit to its customers, performs credit evaluations of these customers and maintains reserves for potential credit losses. In determining the amount of the allowance for doubtful accounts, the company considers, among other items, historical credit losses, the past-due status of receivables, payment histories and other customer-specific information. Receivables are written off when the company determines they are uncollectible. The allowance for doubtful accounts was $120 million at December 31, 2017 and $127 million at December 31, 2016.

Product Warranties

The company provides for the estimated costs relating to product warranties 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. Product warranty liabilities are adjusted based on changes in estimates.

Cash and Equivalents

Cash and equivalents include cash, certificates of deposit and money market funds with an original maturity of three months or less.

Inventories

as of December 31 (in millions)	2017		2016
Raw materials	$	347	$	319
Work in process		116		122
Finished goods		1,012		989
Inventories	$	1,475	$	1,430

Inventories are stated at the lower of cost (first-in, first-out method) or market value. Market value for raw materials is based on replacement costs, and market value for work in process and finished goods is based on net realizable value. The company reviews

inventories on hand at least quarterly and records provisions for estimated excess, slow-moving and obsolete inventory, as well as inventory with a carrying value in excess of net realizable value.

Property, Plant and Equipment, Net

as of December 31 (in millions)	2017			2016
Land	$	144		$	118
Buildings and leasehold improvements		1,687			1,486
Machinery and equipment		6,220			5,551
Equipment with customers		1,403			1,297
Construction in progress		694			710
Total property, plant and equipment, at cost		10,148			9,162
Accumulated depreciation		(5,560	)		(4,873	)
Property, plant and equipment (PP&E), net	$	4,588		$	4,289

Depreciation expense is calculated using the straight-line method over the estimated useful lives of the related assets, which range from 20 to 50 years for buildings and improvements and from three to 15 years for machinery and equipment. Leasehold improvements are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. Baxter capitalizes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use as part of machinery and equipment. Capitalized software costs are amortized on a straight-line basis over the estimated useful lives of the software, and are included in depreciation expense. Straight-line and accelerated methods of depreciation are used for income tax purposes. Depreciation expense was $607 million in 2017, $632 million in 2016 and $597 million in 2015. Depreciation expense in 2017 and 2016 included accelerated depreciation of $18 million and $48 million, respectively, related to business optimization and separation costs.

Acquisitions

Results of operations of acquired companies are included in the company’s results of operations as of the respective acquisition dates. The purchase price of each acquisition is allocated to the net assets acquired based on estimates of their fair values at the date of the acquisition. Any purchase price in excess of these net assets is recorded as goodwill. The allocation of purchase price in certain cases may be subject to revision based on the final determination of fair values during the measurement period, which may be up to one year from the acquisition date.

Contingent consideration is recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent payments are recognized in earnings as a component of other income, net. Contingent payments related to acquisitions may consist of development, regulatory and commercial milestone payments, in addition to sales-based payments, and are valued using discounted cash flow techniques. The fair value of development, regulatory and commercial milestone payments reflects management’s expectations of probability of payment, and increases or decreases as the probability of payment or expectation of timing of payments changes. The fair value of sales-based payments is based upon probability-weighted future revenue estimates and increases or decreases as revenue estimates or expectation of timing of payments changes.

Research and Development

Research and development (R&D) costs, including R&D acquired in transactions that are not business combinations, are expensed as incurred. Pre-regulatory approval contingent milestone obligations to counterparties in collaborative arrangements which include acquired R&D are expensed when the milestone is achieved. Contingent milestone payments made to such counterparties on or after regulatory approval are capitalized and amortized over the remaining useful life of the related product. Amounts capitalized for such payments are included in other intangible assets, net of accumulated amortization.

Acquired in-process R&D (IPR&D) is the value assigned to technology or products under development acquired in a business combination which have not received regulatory approval and have no alternative future use.

Acquired IPR&D 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 accounted for as a finite-lived intangible asset and amortized on a straight-line basis over the estimated economic life of the related technology or product, subject to annual impairment reviews as discussed below. If the R&D project is abandoned, the indefinite-lived asset is charged to expense.

Collaborative Arrangements

The company enters into collaborative arrangements in the normal course of business. These collaborative arrangements take a number of forms and structures, and are designed to enhance and expedite long-term sales and profitability growth. These arrangements may provide that Baxter obtain commercialization rights to a product under development, and require Baxter to make upfront payments, contingent milestone payments, profit-sharing, and/or royalty payments. Baxter may be responsible for ongoing costs associated with the arrangements, including R&D cost reimbursements to the counterparty. See above regarding the accounting treatment of upfront and contingent payments. Any royalty and profit-sharing payments during the commercialization phase are expensed as cost of sales when they become due and payable.

Business Optimization Charges

The company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. Employee termination costs are primarily recorded when actions are probable and estimable. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Refer to the discussion below regarding the accounting for asset impairment charges.

Goodwill, Intangible Assets, and Other Long-Lived Assets

Goodwill is the excess of purchase price over the fair value of acquired assets and liabilities in a business combination. Goodwill is not amortized, but is subject to an impairment review annually and whenever indicators of impairment exist. Goodwill would be impaired if the carrying amount of a reporting unit exceeded the fair value of that reporting unit, calculated as the present value of estimated cash flows discounted using a risk-free market rate adjusted for a market participant’s view of similar companies and perceived risks in the cash flows. The implied fair value of goodwill is then determined by subtracting the fair value of all identifiable net assets other than goodwill from the fair value of the reporting unit, with an impairment charge recorded for the excess, if any, of carrying amount of goodwill over the implied fair value.

Indefinite-lived intangible assets, such as IPR&D acquired in business combinations and certain trademarks with indefinite lives, are subject to an impairment review annually and whenever indicators of impairment exist. Indefinite-lived intangible assets are impaired if the carrying amount of the asset exceeded the fair value of the asset.

The company reviews the carrying amounts of long-lived assets, other than goodwill and intangible assets not subject to amortization, for potential impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In evaluating recoverability, the company groups assets and liabilities at the lowest level such that the identifiable cash flows relating to the group are largely independent of the cash flows of other assets and liabilities. The company then compares the carrying amounts of the assets or asset groups with the related estimated undiscounted future cash flows. In the event impairment exists, an impairment charge is recorded as the amount by which the carrying amount of the asset or asset group exceeds the fair value.

Shipping and Handling Costs

Shipping costs, which are costs incurred to physically move product from Baxter’s premises to the customer’s premises, are classified as marketing and administrative expenses. Handling costs, which are costs incurred to store, move and prepare products for shipment, are classified as cost of sales. Approximately $291 million in 2017, $311 million in 2016 and $272 million in 2015 of shipping costs were classified in marketing and administrative expenses.

Income Taxes

Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The company maintains valuation allowances unless it is more likely than not that the deferred tax asset will be realized. With respect to uncertain tax positions, the company determines whether the position is more likely than not to be sustained upon examination, based on the technical merits of the position. Any tax position that meets the more likely than not recognition threshold is measured and recognized in the consolidated financial statements at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The liability relating to uncertain tax positions is classified as current in the consolidated balance sheets to the extent the company anticipates making a payment within one year. Interest and penalties associated with income taxes are classified in the income tax expense line in the consolidated statements of income.

Refer to the Recently Adopted Accounting Pronouncements section of this note and Note 15 for additional information related to the 2017 Tax Act.

Foreign Currency Translation

Currency translation adjustments (CTA) related to foreign operations are included in other comprehensive income (OCI). For foreign operations in highly inflationary economies, translation gains and losses are included in other income, net, and were not material in 2017, 2016 and 2015.

Derivatives and Hedging Activities

All derivative instruments are recognized as either assets or liabilities at fair value in the consolidated balance sheets and are classified as short-term or long-term based on the scheduled maturity of the instrument. Based upon the exposure being hedged, the company designates its hedging instruments as cash flow, fair value or net investment hedges.

For each derivative instrument that is designated and effective as a cash flow hedge, the gain or loss on the derivative is accumulated in accumulated other comprehensive income (AOCI) and then recognized in earnings consistent with the underlying hedged item. Option premiums or net premiums paid are initially recorded as assets and reclassified to OCI over the life of the option, and then recognized in earnings consistent with the underlying hedged item. Cash flow hedges are classified in net sales, cost of sales, and net interest expense, and primarily related to forecasted third-party sales denominated in foreign currencies, forecasted intercompany sales denominated in foreign currencies and anticipated issuances of debt, respectively.

For each derivative instrument that is designated and effective as a fair value hedge, the gain or loss on the derivative is recognized into earnings, with an offsetting loss or gain recognized against the carrying value on the underlying hedged item. Changes in the fair value of the hedges are classified in net interest expense, as they hedge the interest rate risk associated with certain of the company’s fixed-rate debt.

For a portion of the company’s senior notes, the company has designated this debt as a hedge of its net investment in its European operations, and, as a result, mark to spot rate adjustments of the outstanding debt balances have been and will be recorded as a component of AOCI.

For derivative instruments that are not designated as hedges, the change in fair value is recorded directly to other income, net.

If it is determined that a derivative or nonderivative hedging instrument is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If the company removes the cash flow hedge designation because the hedged forecasted transactions are no longer probable of occurring, any gains or losses are immediately reclassified from AOCI to earnings. Gains or losses relating to terminations of effective cash flow hedges in which the forecasted transactions are still probable of occurring are deferred and recognized consistent with the income or loss recognition of the underlying hedged items. If the company terminates a fair value hedge, an amount equal to the cumulative fair value adjustment to the hedged items at the date of termination is amortized to earnings over the remaining term of the hedged item. If the company removes the net investment hedge designation, any gains or losses recognized in AOCI are not reclassified to earnings until the company sells, liquidates, or deconsolidates the foreign investments that were being hedged.

Derivatives, including those that are not designated as a hedge, are principally classified in the operating section of the consolidated statements of cash flows.

Refer to Note 9 for further information regarding the company’s derivative and hedging activities.

New Accounting Standards

Recently issued accounting standards not yet adopted

In February 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. As a result of the enactment of the 2017 Tax Act, the FASB issued new accounting guidance on the reclassification of certain tax effects from AOCI to retained earnings. The optional guidance is effective January 1, 2019, with early adoption permitted. The Company is evaluating whether it will adopt the new guidance along with any impacts on the company’s financial position, results of operations and cash flows.

In August 2017, the FASB issued ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities, which amends ASC 815, Derivatives and Hedging. The purpose of this ASU is to better align a company’s risk management activities and financial reporting for hedging relationships, simplify the hedge accounting requirements, and improve the disclosures of hedging arrangements. The effective date for this ASU is January 1, 2019, with early adoption permitted. The company is evaluating the potential effects on its consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which amends ASC 715, Compensation – Retirement Benefits, to require employers that present a measure of operating income in their statements of earnings to include only the service cost component of net periodic postretirement benefit cost in operating expenses. The service cost component of net periodic postretirement benefit cost should be presented in the same operating expense line items as other employee compensation costs arising from services rendered during the period. The other components of net benefit cost, including interest costs, expected return on assets, amortization of prior service cost/credit, and settlement and curtailment effects, are to be included separately and outside of any subtotal of operating income. The company will adopt the standard effective January 1, 2018. This guidance will impact the presentation of the company’s consolidated statements of income with no significant impact on net income. Upon adoption of the standard on January 1, 2018, operating income for 2017 and 2016 will be recast to increase $33 million and $21 million, respectively, with a corresponding decrease in other income, net.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory. ASU No. 2016-16 generally accelerates the recognition of income tax consequences for asset transfers between entities under common control. Entities are required to adopt using a modified retrospective approach with a cumulative adjustment to opening retained earnings in the year of adoption for previously unrecognized income tax expense. The company anticipates a negative retained earnings adjustment of approximately $66 million upon adoption of the standard on January 1, 2018 related to the unrecognized income tax effects of asset transfers that occurred prior to adoption.

In February 2016, the FASB issued ASU No. 2016-02, Leases. Under the new guidance, lessees are required to recognize a right-of-use asset and a lease liability on the balance sheet for all leases, other than those that meet the definition of a short-term lease. This update will establish a lease asset and lease liability by lessees for those leases classified as operating under current GAAP. Leases will be classified as either operating or finance under the new guidance. Operating leases will result in straight-line expense in the income statement, similar to current operating leases, and finance leases will result in more expense being recognized in the earlier years of the lease term, similar to current capital leases. This ASU is effective for the company beginning January 1, 2019. The company is currently evaluating the impact of this standard on its consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which amends the existing accounting standards for revenue recognition. ASU No. 2014-09 is based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when products are transferred to customers. ASU No. 2014-09 will be effective for the company beginning on January 1, 2018. The standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The company has completed an assessment of the new standard and is currently executing its detailed implementation plan and developing processes and controls for gathering information for required disclosures. The company will adopt the standard using the modified retrospective method. The primary impact of the new standard relates to the company’s contract manufacturing operations and software arrangements. Certain contract manufacturing arrangements may require revenue recognition over-time in situations in which the company produces products that have no alternative use and the company has an enforceable right to payment for performance completed to date, inclusive of a reasonable profit margin. This may result in an acceleration of revenue recognition for certain contractual arrangements as compared to recognition under current accounting literature. The new guidance is also expected to impact the company’s arrangements subject to current software revenue recognition guidance, as the company may be required to recognize as revenue a significant portion of the contract consideration upon delivery of the software compared to the current practice of recognizing the contract consideration ratably over time for certain arrangements. The company expects the adjustment to increase its opening balance of retained earnings by approximately $50 million, net of tax, upon adoption. The company does not expect ASU 2014-09 to have a material impact to reported revenue in subsequent reporting periods.

Recently adopted accounting pronouncements

As of January 1, 2017, the company adopted on a prospective basis ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation – Stock Compensation. The updated guidance requires all tax effects related to share-based payments to be recorded in income tax expense in the consolidated statement of income. Previous guidance required that tax effects of deductions in excess of share-based compensation costs (windfall tax benefits) be recorded in additional paid-in capital, and tax deficiencies be recorded in additional paid-in capital to the extent of previously recognized windfall tax benefits, with the remainder recorded in income tax expense. The new guidance also requires the cash flows resulting from windfall tax benefits to be reported as operating activities in the consolidated statement of cash flows, rather than the previous requirement to present windfall tax benefits as an inflow from financing activities. As a result of the adoption, net income and operating cash flow for 2017 increased by approximately $56 million. The prior periods have not been restated and therefore, windfall tax benefits of $39 million and $7 million, respectively, for 2016 and 2015 were not included in net income and were included as cash flows from financing activities in the consolidated statement of cash flows.

In December 2017, the SEC issued guidance for situations where the accounting for certain elements of the 2017 Tax Act cannot be completed prior to the release of a company's financial statements. For specific elements of the 2017 Tax Act, the company has determined a reasonable estimate for certain effects and has recorded that estimate as a provisional amount. The guidance provides a measurement period to allow a company to account for these specific elements, which begins in the reporting period that includes the enactment of the 2017 Tax Act and ends when the company has obtained, prepared and analyzed the information needed in order to complete its accounting assessments. The resulting tax effects must be recognized in the period the assessment is complete, and included in income tax (benefit) expense, accompanied by appropriate disclosures. The measurement period shall not exceed one year from enactment, December 22, 2018.

NOTE 2

SEPARATION OF BAXALTA INCORPORATED

On July 1, 2015, Baxter completed the distribution of approximately 80.5% of the outstanding common stock of Baxalta Incorporated (Baxalta) to Baxter shareholders (the Distribution). After giving effect to the Distribution, the company retained 19.5% of the outstanding common stock, or 131,902,719 shares of Baxalta (Retained Shares). The Distribution was made to Baxter’s shareholders of record as of the close of business on June 17, 2015 (Record Date), who received one share of Baxalta common stock for each Baxter common share held as of the Record Date. As a result of the Distribution, Baxalta became an independent public company trading under the symbol “BXLT” on the New York Stock Exchange.

On June 3, 2016, Baxalta became a wholly-owned subsidiary of Shire plc (Shire) through a merger of a wholly-owned Shire subsidiary with and into Baxalta, with Baxalta as the surviving subsidiary (the Merger). References in this report to Baxalta prior to the Merger closing date refer to Baxalta as a stand-alone public company. References in this report to Baxalta subsequent to the Merger closing date refer to Baxalta as a subsidiary of Shire.

On July 1, 2015, Baxter transferred net assets of $4.1 billion to Baxalta as a result of the separation. In 2016 and 2017, Baxter recorded certain separation related adjustments within equity of $18 million and $34 million, respectively. For a portion of Baxalta’s operations, the legal transfer of Baxalta’s assets and liabilities did not occur with the separation of Baxalta on July 1, 2015 due to the time required to transfer marketing authorizations and other regulatory requirements in certain countries. Under the terms of the International Commercial Operations Agreement (ICOA), Baxalta is subject to the risks and entitled to the benefits generated by these operations and assets until legal transfer; therefore, the net economic benefit and any cash collected by these entities by Baxter are transferred to Baxalta. As of December 31, 2016, Baxter recorded a liability of $47 million for its obligation to transfer these net assets, primarily accounts and other current receivables, net, to Baxalta. As of December 31, 2017, all operations and assets in all countries have been separated.

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
Major classes of line items constituting income from discontinued operations before income taxes
Net sales	$	7		$	148		$	2,895
Cost of sales		(5	)		(139	)		(1,214	)
Marketing and administrative expenses		(1	)		(20	)		(547	)
Research and development expenses		—			—			(389	)
Other income and expense items that are not major		—			1			7
Total (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

In 2016, the company transferred $161 million of net assets to Baxalta resulting in a pre-tax gain of $19 million. In 2017, the remaining assets were transferred resulting in a pre-tax gain of $2 million. These gains are recorded within (loss) income from discontinued operations, net of tax.

Baxter and Baxalta entered into several additional agreements in connection with the July 1, 2015 separation, including a transition services agreement (TSA), separation and distribution agreement, manufacturing and supply agreements (MSA), tax matters agreement and a long-term services agreement.

Pursuant to the TSA, Baxter and Baxalta and their respective subsidiaries are providing to each other, on an interim, transitional basis, various services. Services being provided by Baxter include, among others, finance, information technology, human resources, quality, supply chain and certain other administrative services. The services generally commenced on the Distribution date and are expected to terminate within 36 months of the Distribution date. Billings by Baxter under the TSA are recorded as a reduction of the costs to provide the respective service in the applicable expense category, primarily in marketing and administrative expenses, in the consolidated statements of income. In 2017, 2016 and 2015, the company recognized approximately $56 million, $101 million and $75 million, respectively, as a reduction to marketing and administrative expenses related to the TSA.

Pursuant to the MSA, Baxalta or Baxter, as the case may be, manufactures, labels, and packages products for the other party. The terms of the agreements range in initial duration from five to 10 years. In 2017, 2016 and 2015, Baxter recognized approximately $22 million, $39 million and $37 million, respectively, in sales to Baxalta. In addition, in 2017, 2016 and 2015, Baxter recognized approximately $170 million, $189 million and $100 million, respectively, in cost of sales related to purchases from Baxalta pursuant to the MSA. The cash flows associated with these agreements are included in cash flows from operations — continuing operations.

In December 2015, Baxter sold to Baxalta certain assets for approximately $28 million with no resulting impact to net income.

Cash outflows of $16 million in 2017, inflows of $30 million in 2016, and inflows of $518 million in 2015 were reported in cash flows from operations – discontinued operations. These cash flows relate to non-assignable tenders whereby Baxter remains the seller of Baxalta products, transactions related to importation services Baxter provides in certain countries, in addition to trade payables settled following local separation on Baxalta’s behalf.

NOTE 3

SUPPLEMENTAL FINANCIAL INFORMATION

Prepaid Expenses and Other

as of December 31 (in millions)	2017		2016
Prepaid value added taxes	$	134	$	114
Prepaid income taxes		99		147
Other		368		341
Prepaid expenses and other	$	601	$	602

Other Long-Term Assets

as of December 31 (in millions)	2017		2016
Deferred income taxes	$	408	$	629
Other long-term receivables		187		181
All other		192		167
Other long-term assets	$	787	$	977

Accounts Payable and Accrued Liabilities

as of December 31 (in millions)	2017		2016
Accounts payable, principally trade	$	920	$	791
Common stock dividends payable		87		70
Employee compensation and withholdings		548		542
Property, payroll and certain other taxes		143		143
Business optimization reserves		100		153
Accrued rebates		218		206
Separation-related reserves		—		46
All other		717		661
Accounts payable and accrued liabilities	$	2,733	$	2,612

Other Long-Term Liabilities

as of December 31 (in millions)	2017		2016
Pension and other employee benefits	$	1,211	$	1,492
Deferred tax liabilities		280		93
Litigation reserves		27		19
Business optimization reserves		12		11
All other		135		128
Other long-term liabilities	$	1,665	$	1,743

Net Interest Expense

years ended December 31 (in millions)	2017			2016			2015
Interest costs	$	98		$	107		$	197
Interest costs capitalized		(13	)		(18	)		(51	)
Interest expense		85			89			146
Interest income		(30	)		(23	)		(20	)
Net interest expense	$	55		$	66		$	126

Other Income, net

years ended December 31 (in millions)	2017			2016			2015
Foreign exchange	$	(50	)	$	(28	)	$	(113	)
Net loss on debt extinguishment		—			153			130
Net realized gains on Retained Shares transaction		—			(4,387	)		—
Gain on litigation settlement		—			—			(52	)
Gain on sale of investments and other assets		(3	)		(3	)		(38	)
Venezuela deconsolidation		33			—			—
All other		6			(31	)		(32	)
Other income, net	$	(14	)	$	(4,296	)	$	(105	)

NOTE 4

EARNINGS PER SHARE

The numerator for both basic and diluted earnings per share (EPS) is either net income, income from continuing operations, or income from discontinued operations. The denominator for basic EPS is the weighted-average number of common shares outstanding during the period. The dilutive effect of outstanding stock options, restricted stock units (RSUs) and performance share units (PSUs) is reflected in the denominator for diluted EPS using the treasury stock method.

The following table is a reconciliation of basic shares to diluted shares.

years ended December 31 (in millions)
Basic shares	543	546	545
Effect of dilutive securities	12	5	4
Diluted shares	555	551	549

The effect of dilutive securities included unexercised stock options, unvested RSUs and contingently issuable shares related to granted PSUs. The computation of diluted EPS excluded 2 million, nil, and 18 million equity awards in 2017, 2016, and 2015, respectively, because their inclusion would have had an anti-dilutive effect on diluted EPS. Refer to Note 12 for additional information regarding items impacting basic shares.

NOTE 5

ACQUISITIONS AND OTHER ARRANGEMENTS

Claris Injectables Limited

On July 27, 2017, Baxter acquired 100 percent of 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.

In the fourth quarter of 2017, the company adjusted its preliminary estimates of the fair value of assets acquired and liabilities assumed as of the acquisition date. The measurement period adjustments included a $45 million increase to other intangible assets and a $26 million increase to deferred tax and uncertain tax position liabilities. The adjustments resulted in a corresponding decrease in goodwill of $19 million. The measurement period adjustments did not have a material impact on Baxter’s results of operations in 2017.

The following table summarizes the fair value of the assets acquired and liabilities assumed as of the acquisition date for the company’s acquisition of Claris:

(in millions)
Assets acquired and liabilities assumed
Cash	$	11
Accounts and other current receivables		16
Inventories		30
Prepaid expenses and other		16
Property, plant and equipment		132
Goodwill		291
Other intangible assets		280
Other		20
Accounts payable and accrued liabilities		(22	)
Other long-term liabilities		(134	)
Total assets acquired and liabilities assumed	$	640

The valuation of total assets acquired and liabilities assumed are preliminary and measurement period adjustments may be recorded in the future as the company finalizes its fair value estimates. The results of operations of Claris have been included in the company’s consolidated statement of income since the date the business was acquired and were not material. Acquisition and integration costs associated with the Claris acquisition were $28 million in 2017, and were primarily included within marketing and administrative expenses in the consolidated statements of income.

Baxter allocated $280 million of the total consideration to acquired intangible assets. The acquired intangible assets include $140 million of developed technology with a weighted-average useful life of 8 years and $140 million of IPR&D with an indefinite useful life. For the IPR&D, additional R&D will be required prior to technological feasibility.

The fair value of intangible assets was determined using the income approach. The income approach is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset will generate over its remaining useful life, discounted to present value at a rate to reflect the internal rate of return and uncertainty in the cash flow projections. The discount rates used to measure the developed technology and IPR&D intangible assets were 12% and 13%, respectively. The company considers the fair value of each of the acquired intangible assets to be Level 3 assets due to the significant estimates and assumptions used by management in establishing the estimated fair values. Refer to Note 10 for additional information regarding fair value measurements.

The goodwill, which is not deductible for tax purposes, includes the value of potential future technologies as well as the overall strategic benefits to Baxter in the injectables market, and is included in the Americas segment.

Baxter and Claris Lifesciences Limited have reached an agreement to settle certain claims related to the acquired operations and to terminate a development agreement with Dorizoe Lifesciences Limited. As a result, Baxter received $73 million in February 2018 and released an accrued liability to Claris Lifesciences Limited of $7 million. The total of $80 million will be reflected as a benefit in the 2018 consolidated income statement.

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.

Celerity Pharmaceuticals, LLC

In September 2013, Baxter entered into an agreement with Celerity Pharmaceutical, LLC (Celerity) to develop certain acute care generic injectable premix and oncolytic molecules through regulatory approval. Baxter transferred its rights in these molecules to Celerity and Celerity assumed ownership and responsibility for development of the molecules. Baxter is obligated to purchase the individual product rights from Celerity if the products obtain regulatory approval. In 2017, 2016 and 2015, Baxter paid $20 million, $23 million and $14 million, respectively, to acquire the rights to various molecules. Baxter capitalized the purchase prices as intangible assets and is amortizing the assets over their estimated economic lives of 12 years. As of December 31, 2017, Baxter’s estimated future payments total up to $243 million upon Celerity’s achievement of specified regulatory approvals.

Other

In addition to the significant arrangements described above, Baxter has entered into several other collaborative arrangements. Baxter could make additional payments of up to $25 million upon the achievement of certain development and regulatory milestones, in addition to future payments related to contingent commercialization milestones, profit-sharing, and royalties.

NOTE 6

GOODWILL AND OTHER INTANGIBLE ASSETS, NET

Goodwill

The following table is a summary of the activity in goodwill by segment.

(in millions)	Americas			EMEA			APAC			Total
December 31, 2015	$	2,144		$	341		$	202		$	2,687
Additions		3			—			—		$	3
Currency translation and other adjustments		(76	)		(12	)		(7	)	$	(95	)
December 31, 2016	$	2,071		$	329		$	195		$	2,595
Additions		242			38			23			303
Currency translation and other adjustments		161			25			15			201
December 31, 2017	$	2,474		$	392		$	233		$	3,099

As of December 31, 2017, there were no reductions in goodwill relating to impairment losses.

As discussed in Note 17 – Segment Information, 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. This resulted in a change in the company’s operating segments and reporting units. The company allocated goodwill to its new reporting units using a relative fair value approach. In addition, the company completed an assessment of any potential goodwill impairment for all reporting units immediately prior to and after the reallocation and determined that no impairment existed.

Other Intangible Assets, Net

The following table is a summary of the company’s other intangible assets.

(in millions)	Developed technology, including patents			Other amortized intangible assets			Indefinite-lived intangible assets		Total
December 31, 2017
Gross other intangible assets	$	2,002		$	435		$	172	$	2,609
Accumulated amortization		(1,010	)		(225	)		—		(1,235	)
Other intangible assets, net	$	992		$	210		$	172	$	1,374
December 31, 2016
Gross other intangible assets	$	1,690		$	384		$	57	$	2,131
Accumulated amortization		(855	)		(165	)		—		(1,020	)
Other intangible assets, net	$	835		$	219		$	57	$	1,111

Intangible asset amortization expense was $154 million in 2017, $163 million in 2016, and $158 million in 2015. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2017 is $163 million in 2018, $158 million in 2019, $152 million in 2020, $147 million in 2021 and $145 million in 2022.

In 2016, the company recorded an impairment charge of $27 million related to an indefinite-lived intangible asset (acquired IPR&D) relating to its in-center hemodialysis program. The asset was written down to estimated fair value and recorded in R&D expenses. Additionally, the company recorded an impairment charge of $51 million, of which $41 million was related to a developed technology asset, relating to the company’s synthetic bone repair products business which was acquired from ApaTech Limited in 2010. The assets of the business were written down to estimated fair value and the impairment charge was recorded in cost of sales.

In 2015, the company recorded impairments of approximately $10 million related to acquired IPR&D and $13 million related to developed technology.

NOTE 7

INFUSION PUMP AND BUSINESS OPTIMIZATION CHARGES

Infusion Pump Charges

In 2017, the company recorded a charge of $22 million related to a second field corrective action with respect to the SIGMA Spectrum Infusion Pump, which is predominantly sold in the United States. Remediation primarily includes inspection and repair charges as well as a temporary replacement pump in a limited number of cases. The charge includes estimated cash costs associated with remediation efforts and $2 million of these charges have been utilized as of December 31, 2017.

In 2014, the company recorded a charge of $93 million related to a field corrective action with respect to the SIGMA Spectrum Infusion Pump. The United States Food and Drug Administration (FDA) categorized the action as a Class 1 recall during the second quarter of 2014. Remediation primarily included software-related corrections and a replacement pump in a limited number of cases. In 2014,the company utilized $4 million of the established reserve. During 2015, the company refined its expectations relating to the costs associated with the remediation effort and recorded partial reversals of the cash and non-cash reserves totaling $26 million and $10 million, respectively. Additionally, the company utilized $13 million of the cash reserves during 2015. In 2016, the company recorded utilization of cash and non-cash reserves of $22 million and $3 million, respectively, as well as partial reversals of cash and non-cash reserves of $11 million and $1 million, respectively. As of December 31, 2016, the remediation efforts were substantially complete and the remaining costs and reserves were considered immaterial to the company.

Business Optimization Charges

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, implementation costs, and accelerated depreciation. The company expects to incur additional pre-tax cash costs of approximately $240 million and capital expenditures of $50 million through the completion of these initiatives. These costs will primarily include employee termination costs, implementation costs, and accelerated depreciation.

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 and these programs were substantially complete by the end of 2017.

The company recorded the following charges related to business optimization programs in 2017, 2016, and 2015:

years ended December 31 (in millions)	2017		2016		2015
Restructuring charges, net	$	70	$	285	$	130
Costs to implement business optimization programs		89		65		—
Gambro integration costs		—		26		73
Accelerated depreciation		10		33		—
Total business optimization charges	$	169	$	409	$	203

For segment reporting, business optimization charges are unallocated expenses.

Included in the restructuring charges for 2017 were net employee termination costs of $59 million which primarily consisted of a global workforce reduction program. In addition, $6 million of asset impairment charges related to facility closure costs and $5 million of other exit costs were incurred.

Included in the restructuring charges for 2016 were net employee termination costs of $180 million which primarily consisted of a global workforce reduction program and $27 million related to the impairment of acquired IPR&D as described in Note 6. Restructuring charges for 2016 also included $54 million for costs associated with the discontinuation of the VIVIA home hemodialysis development program. These costs consist of contract termination costs of $21 million, asset impairments of $31 million and other exit costs of $2 million.

Included in the restructuring charges for 2015 were net employee termination costs of $83 million which primarily related to the global workforce reduction program mentioned above. Additionally, asset impairments of $13 million and $29 million were recorded related to a developed technology intangible assets and a manufacturing facility rationalization program, respectively.

The company recorded the following components of restructuring costs in 2017, 2016 and 2015:

	2017
(in millions)	COGS			SGA			R&D			Total
Employee termination costs	$	31		$	47		$	—		$	78
Contract termination costs		—			5			—			5
Asset impairments		5			1			—			6
Reserve adjustments
Employee termination costs		(9	)		(8	)		(2	)		(19	)
Total restructuring charges	$	27		$	45		$	(2	)	$	70

	2016
(in millions)	COGS			SGA			R&D			Total
Employee termination costs	$	72		$	109		$	13		$	194
Contract termination costs		9			5			13			27
Asset impairments		38			—			40			78
Reserve adjustments
Employee termination costs		(1	)		(11	)		(2	)		(14	)
Total restructuring charges	$	118		$	103		$	64		$	285

	2015
(in millions)	COGS			SGA			R&D			Total
Employee termination costs	$	14		$	86		$	15		$	115
Contract termination costs		3			2			—			5
Asset impairments		40			—			2			42
Reserve adjustments
Employee termination costs		(19	)		(10	)		(3	)		(32	)
Total restructuring charges	$	38		$	78		$	14		$	130

Costs to implement business optimization programs in 2017 were $89 million. These costs consisted primarily of external consulting and transition costs, as well as employee salary and related costs. The costs were included within marketing and administrative and R&D expense.

Costs related to the integration of Gambro were included within marketing and administrative expense for all referenced periods.

In 2017 and 2016, the company recognized accelerated depreciation primarily associated with facilities to be closed of $10 million and $33 million, respectively. The costs were recorded in cost of sales.

The following table summarizes activity in the reserves related to the company’s business optimization initiatives.

(in millions)
Reserve at December 31, 2014	$	127
2015 charges		120
Reserve adjustments		(32	)
Utilization in 2015		(89	)
Currency translation		(10	)
Reserve at December 31, 2015		116
2016 charges		221
Reserve adjustments		(14	)
Utilization in 2016		(164	)
Currency translation		5
Reserve at December 31, 2016		164
2017 charges		83
Reserve adjustments		(19	)
Utilization in 2017		(143	)
Currency translation		27
Reserve at December 31, 2017	$	112

Reserve adjustments primarily relate to employee termination cost reserves established in prior periods.

Approximately 90% of the company’s restructuring reserves as of December 31, 2017 relate to employee termination costs, with the remaining reserves attributable to contract termination costs. Of the $112 million liability, $100 million is included within accounts payable and accrued liabilities and $12 million is included within other long-term liabilities on the consolidated balance sheet. The reserves are expected to be substantially utilized by the end of 2020.

NOTE 8

DEBT, CREDIT FACILITIES AND LEASE COMMITMENTS

Debt Outstanding

At December 31, 2017 and 2016, the company had the following debt outstanding:

as of December 31 (in millions)			20172			20162
Variable-rate loan due 2020	1.0	%	$	300		$	294
1.7% notes due 2021	1.9	%		398			397
2.4% notes due 2022	2.5	%		206			208
1.3% notes due in 2025	1.2	%		714			—
2.6% notes due 2026	2.7	%		744			744
7.65% debentures due 2027	7.7	%		5			5
6.625% debentures due 2028	6.7	%		99			99
6.25% notes due 2037	6.3	%		265			265
3.65% notes due 2042	3.7	%		6			6
4.5% notes due 2043	4.5	%		255			255
3.5% notes due 2046	3.6	%		439			439
Other	—			81			70
Total debt and capital lease obligations				3,512			2,782
Current portion				(3	)		(3	)
Long-term portion			$	3,509		$	2,779

1	Excludes the effect of any related interest rate swaps.

2	Book values include any discounts, premiums and adjustments related to hedging instruments.

Significant Debt Issuances

In May 2017, Baxter issued €600 million of senior notes at a fixed coupon rate of 1.30% due in May 2025. The company has designated this debt as a nonderivative net investment hedge of its European operations for accounting purposes.

In August 2016, Baxter issued senior notes with a total aggregate principal amount of $1.6 billion, comprised of $400 million at a fixed coupon rate of 1.70% due in August 2021, $750 million at a fixed coupon rate of 2.60% due in August 2026 and $450 million at a fixed coupon rate of 3.50% due in August 2046.

Debt Redemption

In September 2016, Baxter redeemed an aggregate of approximately $1 billion in principal amount of its 1.850% Senior Notes due 2017, 1.850% Senior Notes due 2018, 5.375% Senior Notes due 2018, 4.500% Senior Notes due 2019, 4.250% Senior Notes due 2020 and 3.200% Senior Notes due 2023. Baxter paid approximately $1 billion, including accrued and unpaid interest and tender premium, to redeem such notes. As a result of the debt redemptions, the company recognized a loss on extinguishment of debt in 2016 of approximately $52 million, which is included in other income, net.

Debt-for-Equity Exchanges

On January 27, 2016, Baxter exchanged Retained Shares for the extinguishment of $1.45 billion aggregate principal amount outstanding under its $1.8 billion U.S. dollar-denominated revolving credit facility. This exchange extinguished the indebtedness under the facility, which was terminated in connection with such debt-for-equity exchange. There were no material prepayment penalties or breakage costs associated with the termination of the facility. Baxter recognized a net realized gain of $1.25 billion related to the Retained Shares exchanged, which is included in other income, net in 2016.

On March 16, 2016, the company exchanged Retained Shares for the extinguishment of approximately $2.2 billion in principal amount of its 0.950% Notes due May 2016, 5.900% Notes due August 2016, 1.850% Notes due January 2017, 5.375% Notes due May 2018, 1.850% Notes due June 2018, 4.500% Notes due August 2019 and 4.250% Notes due February 2020 purchased by certain third party purchasers in previously announced debt tender offers. As a result, the company recognized a net loss on extinguishment of debt totaling $101 million and a net realized gain of $2.0 billion on the Retained Shares exchanged, which are included in other income, net in 2016.

Debt Maturities

In 2016, the company repaid the $190 million outstanding balance of its 0.95% senior unsecured notes that matured in June 2016. In addition, the company repaid the $130 million outstanding balance of its 5.9% senior unsecured notes that matured in September 2016.

Debt Tender Offer

On July 6, 2015 and July 21, 2015 the company purchased an aggregate of approximately $2.7 billion in principal amount of its 5.900% Notes due September 2016, 6.625% Debentures due February 2028, 6.250% Notes due December 2037, 3.650% Notes due August 2042, 4.500% Notes due June 2043, 3.200% Notes due June 2023, and 2.400% Notes due August 2022 pursuant to a debt tender offer. Baxter paid approximately $2.9 billion, including accrued and unpaid interest and tender premium, to purchase such notes. As a result of the debt tender offers the company recognized a loss on extinguishment of debt in 2015 of $130 million, which is included in other income, net within the consolidated statements of income.

Credit Facilities

The company’s U.S. dollar-denominated revolving credit facility and Euro-denominated senior revolving credit facility have a maximum capacity of $1.5 billion and approximately €200 million, respectively. As of December 31, 2017 and 2016, there were no borrowings outstanding under the company’s revolving credit facilities. 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, which totaled $134 million at December 31, 2017, and $271 million at December 31, 2016. There were no borrowings outstanding under these arrangements at December 31, 2017 and December 31, 2016.

At December 31, 2017, the company was in compliance with the financial covenants in these agreements. The non-performance of any financial institution supporting any of the credit facilities would reduce the maximum capacity of these facilities by each institution’s respective commitment

Leases

The company leases certain facilities and equipment under capital and operating leases expiring at various dates. The leases generally provide for the company to pay taxes, maintenance, insurance and certain other operating costs of the leased property. Most of the operating leases contain renewal options. For the years ending December 31, 2017, 2016, and 2015 operating lease rent expense was $154 million, $174 million, and $184 million, respectively.

Future Minimum Lease Payments and Debt Maturities

as of and for the years ended December 31 (in millions)	Operating leases		Debt maturities and capital leases
2018	$	129	$	3
2019		107		2
2020		84		302
2021		69		402
2022		63		210
Thereafter		246		2,612
Total obligations and commitments		698		3,531
Discounts, premiums, and adjustments relating to hedging instruments		—		(19	)
Total debt and lease obligations	$	698	$	3,512

NOTE 9

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY

Foreign Currency and Interest Rate Risk Management

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.

The company is primarily exposed to foreign exchange risk with respect to recognized assets and liabilities, forecasted transactions and net assets 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 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 equity volatility resulting from foreign exchange. Financial market and currency volatility may limit the company’s ability to cost-effectively hedge these exposures.

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 does not hold any instruments for trading purposes and none of the company’s outstanding derivative instruments contain credit-risk-related contingent features.

Cash Flow Hedges

The company may use options, including collars and purchased options, forwards and cross-currency swaps to hedge the foreign exchange risk to earnings relating to forecasted transactions and recognized assets and liabilities. The company periodically uses forward-starting interest rate swaps and treasury rate locks to hedge the risk to earnings associated with movements in interest rates relating to anticipated issuances of debt. Certain other firm commitments and forecasted transactions are also periodically hedged. Cash flow hedges primarily related to forecasted intercompany sales denominated in foreign currencies, and anticipated issuances of debt.

The notional amounts of foreign exchange contracts were $660 million and $561million as of December 31, 2017 and 2016, respectively. The company did not have any interest rate contracts designated as cash flow hedges outstanding at December 31, 2017 and 2016. 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.

Fair Value Hedges

The company uses interest rate swaps to convert a portion of its fixed-rate debt into variable-rate debt. These instruments hedge the company’s earnings from changes in the fair value of debt due to fluctuations in the designated benchmark interest rate.

The total notional amount of interest rate contracts designated as fair value hedges was $200 million as of December 31, 2017 and 2016, respectively.

Net Investment Hedges

In May 2017, the company issued €600 million of senior notes due May 2025. The company has designated this debt as a hedge of a portion of its net investment in its European operations and, as a result, mark to spot rate adjustments of the outstanding debt balances have been and will be recorded as a component of AOCI. As of December 31, 2017, the company had an accumulated pre-tax unrealized translation loss in AOCI of $79 million related to the Euro-denominated senior notes.

Dedesignations

There were no hedge dedesignations in 2017, 2016 or 2015 resulting from changes in the company’s assessment of the probability that the hedged forecasted transactions would occur.

If the company terminates a fair value hedge, an amount equal to the cumulative fair value adjustment to the hedged items at the date of termination is amortized to earnings over the remaining term of the hedged item. In 2016, the company terminated a total notional value of $765 million of interest rate contracts in connection with the March 2016 debt tender offers, resulting in a $34 million reduction to the debt extinguishment loss.

If the company terminates a net investments hedge, any gain or loss recognized in AOCI is not reclassified to earnings until the company sells, liquidates, or deconsolidates the foreign investments that were being hedged.

Undesignated Derivative Instruments

The company uses forward contracts to hedge earnings from the effects of foreign exchange relating to certain of the company’s intercompany and third-party receivables and payables denominated in a foreign currency. These derivative instruments are generally not formally designated as hedges and the terms of these instruments generally do not exceed one month.

The total notional amount of undesignated derivative instruments was $885 million as of December 31, 2017 and $822 million as of December 31, 2016.

Gains and Losses on Derivative Instruments

The following table summarizes the gains and losses on the company’s derivative instruments for the years ended December 31, 2017, 2016, and 2015.

	Gain (loss) recognized in OCI								Location of gain (loss) in	Gain (loss) reclassified from AOCI into income
(in millions)	2017			2016		2015			income statement	2017			2016			2015
Cash flow hedges
Interest rate contracts	$	(3	)	$	—	$	—		Other income, net	$	—		$	9		$	—
Foreign exchange contracts		—		—			(1	)	Net sales		—			—			—
Foreign exchange contracts		(24	)		1		4		Cost of sales		(8	)		(3	)		47
Net investment hedge		(79	)		—		—		Other income, net		—			—			—
Total	$	(106	)	$	1	$	3			$	(8	)	$	6		$	47

	Location of gain (loss) in income statement	Gain (loss) recognized in income
(in millions)		2017			2016		2015
Fair value hedges
Interest rate contracts	Net interest expense	$	(3	)	$	9	$	(43	)
Undesignated derivative instruments
Foreign exchange contracts	Other income, net	$	(20	)	$	4	$	(13	)

For the company’s fair value hedges, equal and offsetting gains of $3 million, losses of $9 million and gains of $43 million were recognized in net interest expense in 2017, 2016 and 2015, respectively, as adjustments to the underlying hedged items, fixed-rate debt. Ineffectiveness related to the company’s cash flow and fair value hedges for the year ended December 31, 2017 was not material.

The following table summarizes net-of-tax activity in AOCI, a component of shareholders’ equity, related to the company’s cash flow hedges.

as of and for the years ended December 31 (in millions)	2017			2016			2015
Accumulated other comprehensive income (loss) balance at beginning of year	$	3		$	7		$	34
(Loss) gain in fair value of derivatives during the year		(18	)		1			4
Amount reclassified to earnings during the year		5			(5	)		(31	)
Accumulated other comprehensive income balance at end of year		(10	)	$	3		$	7

As of December 31, 2017, $8 million of deferred, net after-tax gains on derivative instruments included in AOCI are expected to be recognized in earnings during the next 12 months, coinciding with when the hedged items are expected to impact earnings.

Fair Values of Derivative Instruments

The following table summarizes the classification and fair value amounts of derivative instruments reported in the consolidated balance sheet as of December 31, 2017.

	Derivatives in asset positions			Derivatives in liability positions
(in millions)	Balance sheet location	Fair value		Balance sheet location	Fair value
Derivative instruments designated as hedges
Interest rate contracts	Other long-term assets		4	Other long-term liabilities		—
Foreign exchange contracts	Prepaid expenses and other		14	Accounts payable and accrued liabilities		3
Total derivative instruments designated as hedges		$	18		$	3
Undesignated derivative instruments
Foreign exchange contracts	Prepaid expenses and other	$	1	Accounts payable and accrued liabilities	$	1
Total derivative instruments		$	19		$	4

The following table summarizes the classification and fair value amounts of derivative instruments reported in the consolidated balance sheet as of December 31, 2016.

	Derivatives in asset positions			Derivatives in liability positions
(in millions)	Balance sheet location	Fair value		Balance sheet location	Fair value
Derivative instruments designated as hedges
Interest rate contracts	Other long-term assets	$	7	Other long-term liabilities	$	—
Foreign exchange contracts	Prepaid expenses and other		22	Accounts payable and accrued liabilities		1
Total derivative instruments designated as hedges		$	29		$	1
Undesignated derivative instruments
Foreign exchange contracts	Prepaid expenses and other	$	1	Accounts payable and accrued liabilities	$	2
Total derivative instruments		$	30		$	3

While the company’s derivatives are all subject to master netting arrangements, the company presents its assets and liabilities related to derivative instruments on a gross basis within the consolidated balance sheets. Additionally, the company is not required to post collateral for any of its outstanding derivatives. The following table provides information on the company’s derivative positions as if they were presented on a net basis, allowing for the right of offset by counterparty.

	December 31, 2017						December 31, 2016
(in millions)	Asset			Liability			Asset			Liability
Gross amounts recognized in the consolidated balance sheet	$	19		$	4		$	30		$	3
Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet		(4	)		(4	)		(3	)		(3	)
Total	$	15		$	—		$	27		$	—

NOTE 10

FINANCIAL INSTRUMENTS AND RELATED FAIR VALUE MEASUREMENTS

Receivable Securitizations

For trade receivables originated in Japan, the company has entered into agreements with financial institutions in which the entire interest in and ownership of the receivable is sold. The company continues to service the receivables in its Japanese securitization arrangement. Servicing assets or liabilities are not recognized because the company receives adequate compensation to service the sold receivables. The Japanese securitization arrangement includes limited recourse provisions, which are not material.

The following is a summary of the activity relating to the securitization arrangement.

as of and for the years ended December 31 (in millions)	2017			2016			2015
Sold receivables at beginning of year	$	68		$	81		$	104
Proceeds from sales of receivables		270			348			361
Cash collections (remitted to the owners of the receivables)		(270	)		(367	)		(384	)
Effect of currency exchange rate changes		3			6			—
Sold receivables at end of year	$	71		$	68		$	81

The net losses relating to the sales of receivables were immaterial for each year.

Concentrations of Credit Risk

The company invests excess cash in certificates of deposit or money market funds and diversifies the concentration of cash among different financial institutions. With respect to financial instruments, where appropriate, the company has diversified its selection of counterparties, and has arranged collateralization and master-netting agreements to minimize the risk of loss.

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 and 2016, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $149 million and $137 million, respectively.

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. Global economic conditions, governmental actions and customer-specific factors may require the company to re-evaluate the collectability of its receivables and the company could potentially incur additional credit losses. These conditions may also impact the stability of the Euro.

Fair Value Measurements

The fair value hierarchy under the accounting standard for fair value measurements consists of the following three levels:

	•	Level 1 — Quoted prices in active markets that the company has the ability to access for identical assets or liabilities;

	•	Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuations in which all significant inputs are observable in the market; and

	•	Level 3 — Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company’s management about the assumptions market participants would use in pricing the asset or liability.

The following table summarizes the bases used to measure financial assets and liabilities that are carried at fair value on a recurring basis in the consolidated balance sheets.

			Basis of fair value measurement
(in millions)	Balance as of December 31, 2017		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets
Foreign currency hedges	$	15	$	—	$	15	$	—
Interest rate hedges		4		—		4		—
Available-for-sale securities		8		8		—		—
Total assets	$	27	$	8	$	19	$	—
Liabilities
Foreign currency hedges	$	4	$	—	$	4	$	—
Contingent payments related to acquisitions		9		—		—		9
Total liabilities	$	13	$	—	$	4	$	9

			Basis of fair value measurement
(in millions)	Balance as of December 31, 2016		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets
Foreign currency hedges	$	23	$	—	$	23	$	—
Interest rate hedges		7		—		7		—
Available-for-sale securities		9		9		—		—
Total assets	$	39	$	9	$	30	$	—
Liabilities
Foreign currency hedges	$	3	$	—	$	3	$	—
Contingent payments related to acquisitions		19		—		—		19
Total liabilities	$	22	$	—	$	3	$	19

As of December 31, 2017, cash and equivalents of $3.4 billion included money market funds of approximately $0.7 billion, which are considered Level 2 in the fair value hierarchy.

Contingent payments related to acquisitions consist of commercial milestone payments and sales-based payments, and are valued using discounted cash flow techniques. The fair value of commercial milestone payments reflects management’s expectations of probability of payment, and increases as the probability of payment increases or expectation of timing of payments is accelerated. The fair value of sales-based payments is based upon probability-weighted future revenue estimates, and increases as revenue estimates increase, probability weighting of higher revenue scenarios increase or expectation of timing of payment is accelerated.

The following table is a reconciliation of the fair value measurements that use significant unobservable inputs (Level 3), which consist of contingent payments related to acquisitions.

(in millions)	Contingent payments
Fair value as of December 31, 2015	$	20
Additions		—
Payments		(1	)
Net gains recognized in earnings		—
Fair value as of December 31, 2016		19
Additions		—
Payments		(9	)
Net gains recognized in earnings		(1	)
Fair value as of December 31, 2017	$	9

The following table provides information relating to the company’s investments in available-for-sale equity securities.

(in millions)		Amortized cost				Unrealized gains				Unrealized losses				Fair value
December 31, 2017		$	8			$	—			$	—			$	8
December 31, 2016		$	13			$	—			$	4			$	9

Book Values and Fair Values of Financial Instruments

In addition to the financial instruments that the company is required to recognize at fair value in the consolidated balance sheets, the company has certain financial instruments that are recognized at historical cost or some basis other than fair value. For these financial instruments, the following table provides the values recognized in the consolidated balance sheets and the approximate fair values.

	Book values				Approximate fair values
as of December 31 (in millions)	2017		2016		2017		2016
Assets
Investments	$	43	$	31	$	43	$	31
Liabilities
Current maturities of long-term debt and lease obligations		3		3		3		3
Long-term debt and lease obligations		3,509		2,779		3,595		2,756

The following table summarizes the bases used to measure the approximate fair value of the financial instruments as of December 31, 2017 and 2016.

			Basis of fair value measurement
(in millions)	Balance as of December 31, 2017		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets
Investments	$	43	$	—	$	—	$	43
Total assets	$	43	$	—	$	—	$	43
Liabilities
Current maturities of long-term debt and lease obligations		3		—		3		—
Long-term debt and lease obligations		3,595		—		3,595		—
Total liabilities	$	3,598	$	—	$	3,598	$	—

			Basis of fair value measurement
(in millions)	Balance as of December 31, 2016		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets
Investments	$	31	$	—	$	—	$	31
Total assets	$	31	$	—	$	—	$	31
Liabilities
Current maturities of long-term debt and lease obligations		3		—		3		—
Long-term debt and lease obligations		2,756		—		2,756		—
Total liabilities	$	2,759	$	—	$	2,759	$	—

Investments in 2017 and 2016 include certain cost method investments.

In determining the fair value of cost method investments, the company takes into consideration recent transactions, as well as the financial information of the investee, which represents a Level 3 basis of fair value measurement.

The estimated fair values of current and long-term debt were computed by multiplying price by the notional amount of the respective debt instrument. Price is calculated using the stated terms of the respective debt instrument and yield curves commensurate with the company’s credit risk. The carrying values of the other financial instruments approximate their fair values due to the short-term maturities of most of these assets and liabilities.

In 2017, the company recorded $8 million of other-than-temporary impairment charges within other income, net related to the company’s investments. In 2016, the company recorded net $4.4 billion of realized gains within other income, net related to exchanges of available-for-sale equity securities, which represented gains from the Retained Shares transactions. On May 6, 2016, Baxter made a voluntary non-cash contribution of 17,145,570 Retained Shares to the company’s U.S. pension fund. The company recorded $611 million of realized gains within other income, net related to the contribution of Retained Shares. On May 26, 2016, Baxter completed an exchange of 13,360,527 Retained Shares for 11,526,638 outstanding shares of Baxter common stock. The company recorded $537 million of realized gains within other income, net related to the exchange of the Retained Shares. The company held no shares of Baxalta as of December 31, 2016. Refer to the debt-for-equity exchange section in Note 8 for discussion related to the 2016 Retained Shares transactions.

NOTE 11

COMMITMENTS AND CONTINGENCIES

Collaborative and Other Arrangements

Refer to Note 5 for information regarding the company’s unfunded contingent payments associated with collaborative and other arrangements.

Indemnifications

During the normal course of business, Baxter makes indemnities, commitments and guarantees pursuant to which the company may be required to make payments related to specific transactions. Indemnifications include: (i) intellectual property indemnities to customers in connection with the use, sales or license of products and services; (ii) indemnities to customers in connection with losses incurred while performing services on their premises; (iii) indemnities to vendors and service providers pertaining to claims based on negligence or willful misconduct; (iv) indemnities involving the representations and warranties in certain contracts; (v) contractual indemnities related to the separation and distribution as set forth in certain of the agreements entered into in connection with such transactions (including the separation and distribution agreement and the tax matters agreement with Baxalta); and (vi) contractual indemnities for its directors and certain of its executive officers for services provided to or at the request of Baxter. In addition, under Baxter’s Amended and Restated Certificate of Incorporation, and consistent with Delaware General Corporation Law, the company has agreed to indemnify its directors and officers for certain losses and expenses upon the occurrence of certain prescribed events. The majority of these indemnities, commitments and guarantees do not provide for any limitation on the maximum potential for future payments that the company could be obligated to make. To help address some of these risks, the company maintains various insurance

coverages. Based on historical experience and evaluation of the agreements, the company does not believe that any significant payments related to its indemnities will occur, and therefore the company has not recorded any associated liabilities.

Legal Contingencies

Refer to Note 16 for a discussion of the company’s legal contingencies.

NOTE 12

SHAREHOLDERS’ EQUITY

Stock-Based Compensation

The company’s stock-based compensation generally includes stock options, restricted stock units (RSUs), performance share units (PSUs) and purchases under the company’s employee stock purchase plan. Shares issued relating to the company’s stock-based plans are generally issued out of treasury stock.

Approved in 2015, the Baxter International Inc. 2015 Incentive Plan provided for 35 million additional shares of common stock available for issuance with respect to awards for participants. As of December 31, 2017, approximately 36 million authorized shares are available for future awards under the company’s stock-based compensation plans.

Stock Compensation Expense

Stock compensation expense was $107 million, $115 million and $126 million in 2017, 2016 and 2015, respectively. The related tax benefit recognized was $31 million in 2017, $34 million in 2016 and $38 million in 2015.

Stock compensation expense is recorded at the corporate level and is not allocated to the segments. Approximately 70% of stock compensation expense is classified in marketing and administrative expenses, with the remainder classified in cost of sales and R&D expenses. Costs capitalized in the consolidated balance sheets at December 31, 2017 and 2016 were not material.

Stock compensation expense is based on awards expected to vest, and therefore has been reduced by estimated forfeitures.

Stock Options

Stock options are granted to employees and non-employee directors with exercise prices equal to 100% of the market value on the date of grant. Stock options granted to employees generally vest in one-third increments over a three-year period. Stock options granted to non-employee directors generally vest immediately on the grant date and are issued with a six-month claw-back provision. Stock options typically have a contractual term of 10 years. The grant-date fair value, adjusted for estimated forfeitures, is recognized as expense on a straight-line basis over the substantive vesting period.

The fair value of stock options is determined using the Black-Scholes model. The weighted-average assumptions used in estimating the fair value of stock options granted during each year, along with the weighted-average grant-date fair values, were as follows:

years ended December 31	2017			2016			2015
Expected volatility		19	%		20	%		20	%
Expected life (in years)		5.5			5.5			5.5
Risk-free interest rate		2.1	%		1.4	%		1.7	%
Dividend yield		1.0	%		1.2	%		2.9	%
Fair value per stock option	$	10		$	7		$	9

The following table summarizes stock option activity for the year ended December 31, 2017 and the outstanding stock options as of December 31, 2017.

(options and aggregate intrinsic values in thousands)			Weighted- average exercise price			Aggregate intrinsic value
Outstanding as of January 1, 2017	33,076		$	35.73
Granted	5,822		$	51.42
Exercised	(9,031	)	$	33.80
Forfeited	(1,605	)	$	41.81
Expired	(54	)	$	34.25
Outstanding as of December 31, 2017	28,208		$	39.25	6.2	$	715,900
Vested or expected to vest as of December 31, 2017	27,712		$	39.07	6.1	$	708,533
Exercisable as of December 31, 2017	16,364		$	35.51	4.8	$	476,756

The aggregate intrinsic value in the table above represents the difference between the exercise price and the company’s closing stock price on the last trading day of the year. The total intrinsic value of options exercised in 2017, 2016 and 2015 were $203 million, $162 million and $43 million, respectively.

As of December 31, 2017, $55 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over a weighted-average period of approximately 1.8 years.

RSUs

RSUs are granted to employees and non-employee directors. RSUs granted to employees generally vest in one-third increments over a three-year period. RSUs granted to non-employee directors generally vest immediately on the grant date and are issued with a six-month claw-back provision. The grant-date fair value, adjusted for estimated forfeitures, is recognized as expense on a straight-line basis over the substantive vesting period. The fair value of RSUs is determined based on the number of shares granted and the close price of the company’s common stock on the date of grant.

The following table summarizes nonvested RSU activity for the year ended December 31, 2017.

(share units in thousands)			Weighted- average grant-date fair value
Nonvested RSUs as of January 1, 2017	2,698		$	32.90
Granted	1,145		$	55.11
Vested	(1,355	)	$	29.84
Forfeited	(287	)	$	38.41
Nonvested RSUs as of December 31, 2017	2,201		$	45.65

As of December 31, 2017 $65 million of unrecognized compensation cost related to RSUs is expected to be recognized as expense over a weighted-average period of approximately 2.0 years. The weighted-average grant-date fair value of RSUs granted in 2017, 2016 and 2015 was $55.11, $40.32 and $66.65, respectively. The fair value of RSUs vested in 2017, 2016 and 2015 was $88 million, $50 million and $73 million, respectively.

PSUs

The company’s annual equity awards stock compensation program for senior management includes the issuance of PSUs based on adjusted operating margin as well as stock performance relative to the company’s peer group. Fifty percent of the PSUs granted 2015 were based on return on invested capital (ROIC) instead of adjusted operating margin. The vesting condition for adjusted operating margin or ROIC PSUs is set at the beginning of the year for each tranche of the award during the three-year service period. Compensation cost for the adjusted operating margin or ROIC 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 or ROIC PSUs is adjusted at each reporting date to reflect the estimated probability of achieving the vesting condition.

The fair value for PSUs based on stock performance relative to the company’s peer group is determined using a Monte Carlo model. The assumptions used in estimating the fair value of these PSUs granted during the period, along with the grant-date fair values, were as follows:

years ended December 31	2017		2016		2015
Baxter volatility		19%		20%		19%
Peer group volatility	16%-54%		17%-51%		16%-38%
Correlation of returns	0.19-0.58		0.22-0.73		0.24-0.55
Risk-free interest rate		1.6%		1.0%		1.1%
Fair value per PSU	$	69	$	51	$	46

Unrecognized compensation cost related to all unvested PSUs of $23 million at December 31, 2017 is expected to be recognized as expense over a weighted-average period of 1.7 years.

The following table summarizes nonvested PSU activity for the year ended December 31, 2017.

(share units in thousands)			Weighted- average grant-date fair value
Nonvested PSUs as of January 1, 2017	278		$	46.82
Granted	461		$	62.22
Vested	(194	)	$	34.35
Forfeited	(85	)	$	52.31
Nonvested PSUs as of December 31, 2017	460		$	66.50

Realized Excess Income Tax Benefits and the Impact on the Statements of Cash Flows

Realized excess tax benefits associated with stock compensation are presented in the consolidated statements of cash flows as an inflow within the operating section for 2017 and as an inflow within the financing section in 2016 and 2015, respectively. Realized excess tax benefits from stock-based compensation related to continuing operations were $56 million, $39 million and $7 million in 2017, 2016 and 2015, respectively.

Employee Stock Purchase Plan

Nearly all employees are eligible to participate in the company’s employee stock purchase plan. The employee purchase price is 85% of the closing market price on the purchase date.

The Baxter International Inc. Employee Stock Purchase Plan provides for 10 million shares of common stock available for issuance to eligible participants, of which approximately four million shares were available for future purchases as of December 31, 2017.

During 2017, 2016, and 2015, the company issued approximately 0.8 million, 1.0 million and 1.1 million shares, respectively, under the employee stock purchase plan. The number of shares under subscription at December 31, 2017 totaled approximately 1 million.

Cash Dividends

Total cash dividends declared per common share for 2017, 2016, and 2015 were $0.61, $0.51 and $1.27, respectively.

A quarterly dividend of $0.13 per share ($0.52 on an annualized basis) was declared in February 2017 and was paid in April 2017. Quarterly dividends of $0.16 per share ($0.64 on an annualized basis) were declared in May and July of 2017 and were paid in July and October of 2017, respectively. Baxter’s board of directors declared a quarterly dividend of $0.16 per share in November of 2017, which was paid in January of 2018.

Stock Repurchase Programs

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. The company repurchased 9.2 million shares for $564 million in cash in 2017 and 6.3 million shares for $287 million in cash in 2016. The company did not repurchase shares in 2015. In July 2012, the board of directors authorized the repurchase of up to $2 billion of the company’s common stock. The board of directors increased this authority by an additional $1.5 billion in each of November 2016 and February 2018. $1.1 billion of purchase authority remained available as of December 31, 2017. 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.

NOTE 13

RETIREMENT AND OTHER BENEFIT PROGRAMS

The company sponsors a number of qualified and nonqualified pension plans for eligible employees. The company also sponsors certain unfunded contributory healthcare and life insurance benefits for substantially all domestic retired employees. Newly hired employees in the United States and Puerto Rico are not eligible to participate in the pension plans but receive a higher level of company contributions in the defined contribution plans.

In 2017, the company made a $115 million voluntary cash contribution to the qualified U.S. pension plan.

In 2016, the company made a $706 million voluntary, non-cash contribution to the qualified U.S. pension plan using Retained Shares. Refer to Note 2 for additional information regarding Retained Shares Transactions.

Reconciliation of Pension and OPEB Plan Obligations, Assets and Funded Status

The benefit plan information in the table below pertains to all of the company’s pension and OPEB plans, both in the United States and in other countries.

	Pension benefits						OPEB
as of and for the years ended December 31 (in millions)	2017			2016			2017			2016
Benefit obligations
Beginning of period	$	5,717		$	5,423		$	243		$	266
Service cost		91			93			1			2
Interest cost		180			183			7			8
Participant contributions		5			5			—			—
Actuarial loss		333			298			2			10
Benefit payments		(251	)		(234	)		(18	)		(20	)
Settlements		(9	)		(6	)		—			—
Acquisitions		2			—			—			—
Plan amendments		(7	)		—			—			(23	)
Foreign exchange and other		98			(45	)		—			—
End of period		6,159			5,717			235			243
Fair value of plan assets
Beginning of period		4,501			3,698			—			—
Actual return on plan assets		708			309			—			—
Employer contributions		242			752			18			20
Participant contributions		5			5			—			—
Benefit payments		(251	)		(234	)		(18	)		(20	)
Settlements		(9	)		(6	)		—			—
Foreign exchange and other		52			(23	)		—			—
End of period		5,248			4,501			—			—
Funded status at December 31	$	(911	)	$	(1,216	)	$	(235	)	$	(243	)
Amounts recognized in the consolidated balance sheets
Noncurrent asset	$	65		$	42		$	—		$	—
Current liability		(24	)		(23	)		(19	)		(19	)
Noncurrent liability		(952	)		(1,235	)		(216	)		(224	)
Net liability recognized at December 31	$	(911	)	$	(1,216	)	$	(235	)	$	(243	)

The pension obligation information in the table above represents the projected benefit obligation (PBO). The PBO incorporates assumptions relating to future compensation levels. The accumulated benefit obligation (ABO) is the same as the PBO except that it includes no assumptions relating to future compensation levels. The ABO for all of the company’s pension plans was $5.9 billion and $5.4 billion at the 2017 and 2016 measurement dates, respectively.

The information in the funded status table above represents the totals for all of the company’s pension plans. The following table is information relating to the individual plans in the funded status table above that have an ABO in excess of plan assets.

as of December 31 (in millions)		2017				2016
ABO		$	5,398			$	5,153
Fair value of plan assets			4,674				4,190

The following table is information relating to the individual plans in the funded status table above that have a PBO in excess of plan assets (many of which also have an ABO in excess of assets, and are therefore also included in the table directly above).

as of December 31 (in millions)		2017				2016
PBO		$	5,875			$	5,523
Fair value of plan assets			4,899				4,265

Expected Net Pension and OPEB Plan Payments for the Next 10 Years

(in millions)	Pension benefits		OPEB
2018	$	250	$	20
2019		260		19
2020		271		18
2021		283		17
2022		294		17
2023 through 2027		1,626		73
Total expected net benefit payments for next 10 years	$	2,984	$	164

The expected net benefit payments above reflect the company’s share of the total net benefits expected to be paid from the plans’ assets (for funded plans) or from the company’s assets (for unfunded plans). The federal subsidies relating to the Medicare Prescription Drug, Improvement and Modernization Act are not expected to be significant.

Amounts Recognized in AOCI

The pension and OPEB plans’ gains or losses, prior service costs or credits, and transition assets or obligations not yet recognized in net periodic benefit cost are recognized on a net-of-tax basis in AOCI and will be amortized from AOCI to net periodic benefit cost in the future. The company utilizes the average future working lifetime as the amortization period for prior service.

The following table is a summary of the pre-tax losses included in AOCI at December 31, 2017 and December 31, 2016.

(in millions)	Pension benefits			OPEB
Actuarial loss (gain)	$	1,660		$	(76	)
Prior service credit and transition obligation		(12	)		(88	)
Total pre-tax loss recognized in AOCI at December 31, 2017	$	1,648		$	(164	)
Actuarial loss (gain)	$	1,885		$	(89	)
Prior service credit and transition obligation		(5	)		(103	)
Total pre-tax loss recognized in AOCI at December 31, 2016	$	1,880		$	(192	)

Refer to Note 14 for the net-of-tax balances included in AOCI as of each of the year-end dates. The following table is a summary of the net-of-tax amounts recorded in OCI relating to pension and OPEB plans.

years ended December 31 (in millions)	2017		2016			2015
Gain (loss) arising during the year, net of tax expense (benefit) of $16 in 2017, ($72) in 2016 and $44 in 2015	$	50	$	(191	)	$	45
Distribution to Baxalta, net of tax expense of $73		—		—			198
Amortization of loss to earnings, net of tax benefit of $46 in 2017, $36 in 2016 and $61 in 2015		91		94			120
Pension and other employee benefits (loss) gain	$	141	$	(97	)	$	363

In 2017 and 2016, OCI activity for pension and OPEB plans was primarily related to actuarial gains and losses.

Amounts Expected to be Amortized from AOCI to Net Periodic Benefit Cost in 2018

With respect to the AOCI balance at December 31, 2017, the following table is a summary of the pre-tax amounts expected to be amortized to net periodic benefit cost in 2018.

(in millions)	Pension benefits			OPEB
Actuarial loss/(gain)	$	174		$	(10	)
Prior service credit and transition obligation		(1	)		(15	)
Total pre-tax amount expected to be amortized from AOCI to net pension and OPEB cost in 2018	$	173		$	(25	)

Net Periodic Benefit Cost – Continuing Operations

years ended December 31 (in millions)	2017			2016			2015
Pension benefits
Service cost	$	91		$	93		$	128
Interest cost		180			183			211
Expected return on plan assets		(291	)		(298	)		(270	)
Amortization of net losses and other deferred amounts		163			149			192
Settlement losses		—			2			2
Net pension costs related to discontinued operations		—			—			(43	)
Net periodic pension benefit cost	$	143		$	129		$	220
OPEB
Service cost	$	1		$	2		$	4
Interest cost		7			8			14
Amortization of net loss and prior service credit		(26	)		(19	)		(11	)
Curtailment		—			(4	)		—
Net periodic OPEB cost	$	(18	)	$	(13	)	$	7

Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date

	Pension benefits						OPEB
	2017			2016			2017			2016
Discount rate
U.S. and Puerto Rico plans		3.62	%		4.09	%		3.51	%		3.89	%
International plans		2.02	%		2.05	%	n/a			n/a
Rate of compensation increase
U.S. and Puerto Rico plans		3.65	%		3.75	%	n/a			n/a
International plans		3.05	%		3.08	%	n/a			n/a
Annual rate of increase in the per-capita cost	n/a			n/a				6.25	%		6.25	%
Rate decreased to	n/a			n/a				5.00	%		5.00	%
by the year ended	n/a			n/a			2023			2022

The assumptions above, which were used in calculating the December 31, 2017 measurement date benefit obligations, will be used in the calculation of net periodic benefit cost in 2018.

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 has 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.

Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost

	Pension benefits									OPEB
	2017			2016			2015			2017			2016			2015
Discount rate
U.S. and Puerto Rico plans		4.09	%		4.36	%		4.00	%		3.89	%		4.12	%		3.95	%
International plans		2.03	%		2.60	%		2.26	%	n/a			n/a			n/a
Expected return on plan assets
U.S. and Puerto Rico plans		6.50	%		7.00	%		7.25	%	n/a			n/a			n/a
International plans		5.77	%		6.07	%		6.20	%	n/a			n/a			n/a
Rate of compensation increase
U.S. and Puerto Rico plans		3.75	%		3.75	%		3.76	%	n/a			n/a			n/a
International plans		3.11	%		3.37	%		3.33	%	n/a			n/a			n/a
Annual rate of increase in the per-capita cost	n/a			n/a			n/a				6.25	%		6.50	%		6.00	%
Rate decreased to	n/a			n/a			n/a				5.00	%		5.00	%		5.00	%
by the year ended	n/a			n/a			n/a			2023			2022			2019

The 2015 actuarial gain for the OPEB plan was primarily related to adjustments to the assumptions for retirees who are age 65 and older and receive a subsidy to be utilized on a medical insurance exchange.

The company establishes the expected return on plan assets assumption primarily 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 company plans to use a 6.25% assumption for its U.S. and Puerto Rico plans for 2018.

Effect of a One-Percent Change in Assumed Healthcare Cost Trend Rate on the OPEB Plan

The effect of a one-percent change in the assumed healthcare cost trend rate on the service and interest cost components of OPEB cost as well as the OPEB obligation were not significant for 2017 or 2016, respectively.

Pension Plan Assets

An investment committee of members of senior management is responsible for supervising, monitoring and evaluating the invested assets of the company’s funded pension plans. The investment committee, which meets at least quarterly, abides by documented policies and procedures relating to investment goals, targeted asset allocations, risk management practices, allowable and prohibited investment holdings, diversification, use of derivatives, the relationship between plan assets and benefit obligations, and other relevant factors and considerations.

The investment committee’s policies and procedures include the following:

	•	Ability to pay all benefits when due;

	•	Targeted long-term performance expectations relative to applicable market indices, such as Russell, MSCI EAFE, and other indices;

	•	Targeted asset allocation percentage ranges (summarized below), and periodic reviews of these allocations;

	•	Diversification of assets among third-party investment managers, and by geography, industry, stage of business cycle and other measures;

	•	Specified investment holding and transaction prohibitions (for example, private placements or other restricted securities, securities that are not traded in a sufficiently active market, short sales, certain derivatives, commodities and margin transactions);

	•	Specified portfolio percentage limits on holdings in a single corporate or other entity (generally 5% at time of purchase, except for holdings in U.S. government or agency securities);

	•	Specified average credit quality for the fixed-income securities portfolio (at least A- by Standard & Poor’s or A3 by Moody’s);

	•	Specified portfolio percentage limits on foreign holdings; and

	•	Periodic monitoring of investment manager performance and adherence to the investment committee’s policies.

Plan assets are invested using a total return investment approach whereby a mix of equity securities, debt securities and other investments are used to preserve asset values, diversify risk and exceed the planned benchmark investment return. Investment strategies and asset allocations are based on consideration of plan liabilities, the plans’ funded status and other factors, such as the plans’ demographics and liability durations. Investment performance is reviewed by the investment committee on a quarterly basis and asset allocations are reviewed at least annually.

Plan assets are managed in a balanced portfolio comprised of two major components: return-seeking investments and liability hedging investments. The target allocations for plan assets are 53% in return-seeking investments and 47% in liability hedging investments and other holdings. The documented policy includes an allocation range based on each individual investment type within the major components that allows for a variance from the target allocations of approximately two to five percentage points depending on the investment type. Return-seeking investments primarily include common stock of U.S. and international companies, common/collective trust funds, mutual funds, hedge funds, and partnership investments. Liability hedging investments and other holdings primarily include cash, money market funds with an original maturity of three months or less, U.S. and foreign government and governmental agency issues, corporate bonds, municipal securities, derivative contracts and asset-backed securities.

While the investment committee provides oversight over plan assets for U.S. and international plans, the summary above is specific to the plans in the United States. The plan assets for international plans are managed and allocated by the entities in each country, with input and oversight provided by the investment committee. The plan assets for the U.S. and international plans are included in the table below.

The following tables summarize the bases used to measure the pension plan assets and liabilities that are carried at fair value on a recurring basis.

				Basis of fair value measurement
(in millions)	Balance at December 31, 2017			Quoted prices in active markets for identical assets (Level 1)			Significant other observable inputs (Level 2)			Significant unobservable inputs (Level 3)		Measured at NAV
Assets
Fixed income securities
Cash and cash equivalents	$	230		$	12		$	218		$	—	$	—
U.S. government and government agency issues		641			—			641			—		—
Corporate bonds		1,052			16			1,036			—		—
Equity securities
Common stock:
Large cap		711			711			—			—		—
Mid cap		406			406			—			—		—
Small cap		89			89			—			—		—
Total common stock		1,206			1,206			—			—		—
Mutual funds		390			144			246			—		—
Common/collective trust funds		1,174			—			217			8		949
Partnership investments		413			—			—			—		413
Other holdings		142			10			122			10		—
Collateral held on loaned securities		193			—			193			—		—
Liabilities
Collateral to be paid on loaned securities		(193	)		(53	)		(140	)		—		—
Fair value of pension plan assets	$	5,248		$	1,335		$	2,533		$	18	$	1,362

				Basis of fair value measurement
(in millions)	Balance at December 31, 2016			Quoted prices in active markets for identical assets (Level 1)			Significant other observable inputs (Level 2)			Significant unobservable inputs (Level 3)		Measured at NAV
Assets
Fixed income securities
Cash and cash equivalents	$	443		$	16		$	427		$	—	$	—
U.S. government and government agency issues		457			—			457			—		—
Corporate bonds		850			13			837			—		—
Equity securities
Common stock:
Large cap		545			545			—			—		—
Mid cap		371			371			—			—		—
Small cap		94			94			—			—		—
Total common stock		1,010			1,010			—			—		—
Mutual funds		336			118			218			—		—
Common/collective trust funds		900			—			143			6		751
Partnership investments		388			—			—			—		388
Other holdings		117			10			97			10		—
Collateral held on loaned securities		126			—			126			—		—
Liabilities
Collateral to be paid on loaned securities		(126	)		(37	)		(89	)		—		—
Fair value of pension plan assets	$	4,501		$	1,130		$	2,216		$	16	$	1,139

The following table is a reconciliation of changes in fair value measurements that used significant unobservable inputs (Level 3).

(in millions)	Total		Common/collective trust funds		Other holdings
Balance at December 31, 2015	$	8	$	6	$	2
Purchases, sales and settlements		8		—		8
Balance at December 31, 2016		16		6		10
Actual return on plan assets still held at year end		2		2		—
Balance at December 31, 2017	$	18	$	8	$	10

The assets and liabilities of the company’s pension plans are valued using the following valuation methods:

Investment category		Valuation methodology

Cash and cash equivalents		These largely consist of a short-term investment fund, U.S. Dollars and foreign currency. The fair value of the short-term investment fund is based on the net asset value

U.S. government and government agency issues		Values are based on reputable pricing vendors, who typically use pricing matrices or models that use observable inputs

Corporate bonds		Values are based on reputable pricing vendors, who typically use pricing matrices or models that use observable inputs

Common stock		Values are based on the closing prices on the valuation date in an active market on national and international stock exchanges

Mutual funds		Values are based on the net asset value of the units held in the respective fund which are obtained from national and international exchanges or based on the net asset value of the underlying assets of the fund provided by the fund manager

Common/collective trust funds		Values are based on the net asset value of the units held at year end

Partnership investments		Values are based on the net asset value of the participation by the company in the investment as determined by the general partner or investment manager of the respective partnership

Other holdings		The value of these assets vary by investment type, but primarily are determined by reputable pricing vendors, who use pricing matrices or models that use observable inputs

Collateral held on loaned securities		Values are based on the net asset value per unit of the fund in which the collateral is invested

Collateral to be paid on loaned securities		Values are based on the fair value of the underlying securities loaned on the valuation date

Expected Pension and OPEB Plan Funding

The company’s funding policy for its pension plans is to contribute amounts sufficient to meet legal funding requirements, plus any additional amounts that the company may determine to be appropriate considering the funded status of the plans, tax deductibility, the cash flows generated by the company, and other factors. Volatility in the global financial markets could have an unfavorable impact on future funding requirements. The company has no obligation to fund its principal plans in the United States in 2018. The company continually reassesses the amount and timing of any discretionary contributions. In 2018, the company does not expect to make a contribution to its Puerto Rico pension plan and expects to make a contribution of at least $26 million to its foreign pension plans. The company expects to have net cash outflows relating to its OPEB plan of approximately $20 million in 2018.

The following table details the funded status percentage of the company’s pension plans as of December 31, 2017, including certain plans that are unfunded in accordance with the guidelines of the company’s funding policy outlined above.

	United States and Puerto Rico					International
as of December 31, 2017 (in millions)	Qualified plans			Nonqualified plan		Funded plans			Unfunded plans		Total
Fair value of plan assets	$	4,426		n/a		$	822		n/a		$	5,248
PBO		4,629		$	223		908		$	399		6,159
Funded status percentage		96	%	n/a			91	%	n/a			85	%

U.S. Pension Plan Amendments

In January 2018, the company announced changes to its U.S. pension plans. The company spun off the assets and liabilities of the qualified plan attributable to current employees into a new plan and will freeze the pay and service amounts used to calculate pension benefits for active participants in the U.S. pension plans as of December 31, 2022. The assets and liabilities attributable to retired and former company employees remained with the original qualified plan. Years of additional service earned and eligible compensation received after December 31, 2022 will not be included in the determination of the benefits payable to participants. These changes resulted in a $57 million decline in the PBO upon the effective date of the changes. As a result of these changes, net periodic pension and OPEB expense is expected to decrease in 2018. Refer to Note 1 for more information related to a change in income statement presentation for net periodic pension and OPEB costs.

U.S. Defined Contribution Plan

Most U.S. employees are eligible to participate in a qualified defined contribution plan. Expense recognized by the company was $45 million in 2017, $50 million in 2016 and $46 million in 2015.

NOTE 14

ACCUMULATED OTHER COMPREHENSIVE INCOME

Comprehensive income includes all changes in shareholders’ equity that do not arise from transactions with stockholders, and consists of net income, CTA, pension and other employee benefits, unrealized gains and losses on cash flow hedges and unrealized gains and losses on available-for-sale equity securities. The following table is a net-of-tax summary of the changes in AOCI by component for the years ended December 31, 2017 and 2016.

(in millions)	CTA			Pension and other employee benefits			Hedging activities			Available- for-sale securities			Total
Gains (losses)
Balance as of December 31, 2016	$	(3,438	)	$	(1,122	)	$	3		$	1		$	(4,556	)
Other comprehensive income (loss) before reclassifications		396			50			(18	)		(1	)		427
Amounts reclassified from AOCI		29			91			5			3			128
Net other comprehensive (loss) income		425			141			(13	)		2			555
Balance as of December 31, 2017	$	(3,013	)	$	(981	)	$	(10	)	$	3		$	(4,001	)

(in millions)	CTA			Pension and other employee benefits			Hedging activities			Available- for-sale securities			Total
Gains (losses)
Balance as of December 31, 2015	$	(3,191	)	$	(1,025	)	$	7		$	4,433		$	224
Other comprehensive income (loss) before reclassifications		(247	)		(191	)		1			104			(333	)
Amounts reclassified from AOCI		—			94			(5	)		(4,536	)		(4,447	)
Net other comprehensive (loss) income		(247	)		(97	)		(4	)		(4,432	)		(4,780	)
Balance as of December 31, 2016	$	(3,438	)	$	(1,122	)	$	3		$	1		$	(4,556	)

The following table is a summary of the amounts reclassified from AOCI to net income during the years ended December 31, 2017 and 2016.

	Amounts reclassified from AOCI (a)
(in millions)	2017			2016			Location of impact in income statement
Translation adjustments
Loss on Venezuela deconsolidation	$	(29	)	$	—		Other income, net
		(29	)		—		Total before tax
		—			—		Income tax expense (benefit)
	$	(29	)	$	—		Net of tax
Amortization of pension and other employee benefits items
Actuarial losses and other(b)	$	(137	)	$	(130	)
		(137	)		(130	)	Total before tax
		46			36		Income tax expense (benefit)
	$	(91	)	$	(94	)	Net of tax
Gains (losses) on hedging activities
Interest rate contracts	$	—		$	9		Other income, net
Foreign exchange contracts		(8	)		(3	)	Cost of sales
		(8	)		6		Total before tax
		3			(1	)	Income tax expense (benefit)
	$	(5	)	$	5		Net of tax
Available-for-sale securities
Other-than-temporary impairment of equity securities	$	(5	)	$	—		Other income, net
Gain on available-for-sale equity securities		—			4,536		Other income, net
		(5	)		4,536		Total before tax
		2			—		Income tax expense (benefit)
	$	(3	)	$	4,536		Net of tax
Total reclassification for the period	$	(128	)	$	4,447		Total net of tax

(a)	Amounts in parentheses indicate reductions to net income.

(b)	These AOCI components are included in the computation of net periodic benefit cost disclosed in Note 13.

Refer to Note 9 for additional information regarding hedging activity and Note 13 for additional information regarding the amortization of pension and other employee benefits items.

NOTE 15

INCOME TAXES

Income from Continuing Operations Before Income Tax Expense by Category

years ended December 31 (in millions)	2017			2016		2015
United States	$	(291	)	$	3,906	$	(738	)
International		1,508			1,048		1,166
Income from continuing operations before income taxes	$	1,217		$	4,954	$	428

Income Tax Expense Related to Continuing Operations

years ended December 31 (in millions)	2017			2016			2015
Current
United States
Federal	$	8		$	10		$	(251	)
State and local		18			(3	)		(6	)
International		273			282			345
Current income tax expense		299			289			88
Deferred
United States
Federal		233			(286	)		(9	)
State and local		(7	)		3			(20	)
International		(32	)		(18	)		(24	)
Deferred income tax expense		194			(301	)		(53	)
Income tax expense (benefit)	$	493		$	(12	)	$	35

Deferred Tax Assets and Liabilities

as of December 31 (in millions)	2017			2016
Deferred tax assets
Accrued expenses	$	269		$	377
Retirement benefits		248			411
Tax credits and net operating losses		834			747
Valuation allowances		(483	)		(150	)
Total deferred tax assets		868			1,385
Deferred tax liabilities
Subsidiaries’ unremitted earnings		35			145
Asset basis differences		705			704
Total deferred tax liabilities		740			849
Net deferred tax asset	$	128		$	536

At December 31, 2017, the company had U.S. operating loss carryforwards totaling $413 million and tax credit carryforwards totaling $348 million. The U.S. operating loss carryforwards expire between 2018 and 2037 and the tax credits expire between 2018 and 2037. At December 31, 2017, the company had foreign operating loss carryforwards totaling $1.6 billion and foreign tax credit carryforwards totaling $59 million. Of these foreign amounts, $3 million expires in 2018, $2 million expires in 2019, $37 million expires in 2020, $47 million expires in 2021, $4 million expires in 2022, $440 million expires after 2022 and $1.1 billion has no expiration date. Realization of these operating loss and tax credit carryforwards depends on generating sufficient taxable income in future periods. A valuation allowance of $483 million and $150 million was recorded at December 31, 2017 and 2016, respectively, to reduce the deferred tax assets associated with net operating loss and tax credit carryforwards, because the company does not believe it is more likely than not that these assets will be fully realized prior to expiration. The company will continue to evaluate the need for additional valuation allowances and, as circumstances change, the valuation allowance may change. In the narrative following the “Income Tax Expense Related to Continuing Operations Reconciliation” table below, the company indicates which balances in the above table are provisional due to the enactment of the 2017 Tax Act.

Income Tax Expense Related to Continuing Operations Reconciliation

years ended December 31 (in millions)	2017			2016			2015
Income tax expense at U.S. statutory rate	$	424		$	1,734		$	150
Retained shares tax free exchange gains		—			(1,587	)		—
Tax incentives		(140	)		(126	)		(133	)
State and local taxes		(6	)		1			(13	)
Foreign tax expense (benefit)		(80	)		5			11
Valuation allowances		4			3			5
Contingent tax matters		(1	)		(48	)		9
Branded Prescription Drug Fee		—			1			1
Deferred tax charge on intangible intra-group transfers		14			13			14
R&D tax credit		(4	)		(2	)		(4	)
Puerto Rico excise tax credit		(2	)		(5	)		(9	)
Deferred Tax Revaluation due to 2017 Tax Act		(283	)		—			—
Transition Tax due to 2017 Tax Act		529			—			—
U.S. Valuation Allowance due to 2017 Tax Act		339			—			—
Stock options windfall tax benefits		(56	)		—			—
Foreign tax credits generated		(246	)		—			—
Other factors		1			(1	)		4
Income tax expense (benefit)	$	493		$	(12	)	$	35

In the above reconciliation, the Deferred Tax Revaluation, the Transition Tax and the U.S. Valuation Allowance, all of which result directly or indirectly from the enactment of the 2017 Tax Act, include, or are, provisional amounts. As additional US Treasury guidance is issued and more accurate earnings and tax estimates are available during 2018, the company expects to update its provisional tax amounts.

The 2017 Tax Act reduces the U.S. statutory tax rate from 35% to 21% for years after 2017. Accordingly, the company has remeasured its deferred tax assets and liabilities as of December 31, 2017 to reflect the reduced rate that will apply in future periods when these deferred taxes are settled or realized. The company recognized a deferred tax benefit of $283 million to reflect the reduced U.S. tax rate and other effects of the Tax Act. Although the tax rate reduction is known, the company has not collected all of the necessary data to complete its analysis of the effect of the 2017 Tax Act on the underlying deferred taxes and as such, the amounts recorded as of December 31, 2017 are provisional.

The 2017 Tax Act requires the company to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. The company recorded a provisional charge for its one-time transitional tax expense of $529 million, the majority of which was non-cash. This charge is inclusive of relevant non-U.S. withholding taxes and U.S. state income taxes on the portion of the earnings expected to be repatriated. The company has recorded provisional amounts based on estimates of the effects of the 2017 Tax Act as the analysis requires significant data from its foreign subsidiaries that has not yet been finalized as of December 31, 2017.

The U.S. Valuation Allowance was recorded in respect of the company’s foreign tax credit deferred tax assets (DTAs). The 2017 Tax Act moves the U.S. from a worldwide system of taxation to a territorial system; additionally, the 2017 Tax Act changed the rules that enabled taxpayers to generate foreign source income related to export sales that was eligible to utilize foreign tax credits. Consequently, the company does not believe at this time that it is more likely than not to utilize its existing foreign tax credit DTAs within the applicable carryforward periods. As such, the company recorded a provisional adjustment to its valuation allowance of $339 million. As the Transition Tax amount changes, the U.S. Valuation Allowance amount is expected to change in a like amount. Moreover, the company is studying the 2017 Tax Act and evaluating any elections or other opportunities that may be available, as well as updating its U.S. legal entity earnings projections, to determine if it will be able to monetize some, or all, of the foreign tax credit DTAs. The company will also continue to monitor state income tax law developments in light of the 2017 Tax Act and some state income tax DTAs may require a partial or full valuation allowance.

The company previously did not recognize U.S. income tax expense related to earnings outside the United States that were deemed indefinitely reinvested. U.S. federal and state income taxes, net of applicable credits, on these foreign unremitted earnings from continuing operations of $9.3 billion as of December 31, 2016 would be approximately $2.6 billion. As noted above, the enactment of the 2017 Tax Act created a territorial tax system that allows companies to repatriate certain foreign earnings without incurring additional U.S. federal tax by providing for a 100% dividend exemption. Under the dividend-exemption provision, 100% of the foreign source portion of dividends paid by certain foreign corporations to a U.S. corporate shareholder are exempt from U.S. federal

taxation. As a result of the U.S. change to a territorial tax system and the incurrence of the one-time transition tax charge (discussed above), the company now plans to repatriate foreign earnings that were previously considered indefinitely reinvested. Moreover, the company continues to evaluate if any portion of its outside basis difference not attributable to earnings will reverse in a taxable manner and whether it can identify and quantify those differences and the related U.S. deferred tax charges.

Unrecognized Tax Benefits

The company classifies interest and penalties associated with income taxes in the income tax expense line in the consolidated statements of income. Net interest and penalties recorded during 2017, 2016 and 2015 were $3 million, $6 million and $3 million, respectively. The liability recorded at December 31, 2017 and 2016 related to interest and penalties was $15 million and $11 million, respectively. The total amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate is approximately $108 million.

The following table is a reconciliation of the company’s unrecognized tax benefits, including those related to discontinued operations for the years ended December 31, 2017, 2016 and 2015.

as of and for the years ended (in millions)	2017			2016			2015
Balance at beginning of the year	$	82		$	191		$	206
Increase associated with tax positions taken during the current year		33			7			24
Increase (decrease) associated with tax positions taken during a prior year		2			(31	)		(26	)
Settlements		(6	)		(75	)		(3	)
Decrease associated with lapses in statutes of limitations		(3	)		(10	)		(10	)
Balance at end of the year	$	108		$	82		$	191

Of the gross unrecognized tax benefits, $107 million and $74 million were recognized as liabilities in the consolidated balance sheets as of December 31, 2017 and 2016, respectively. Baxter has recorded net indemnification receivables from Baxalta in the amount of $48 million, $28 million and $93 million as of December 31, 2017, 2016 and 2015, respectively, related to the unrecognized tax benefits for which Baxter is the primary obligor but economically relate to Baxalta operations. Additionally, in the table above amounts related to 2015 included as a decrease a gross liability transferred to Baxalta in the amount of $10 million for which Baxalta is the primary obligor.

None of the positions included in the liability for uncertain tax positions related to tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility.

Tax Incentives

The company has received tax incentives in Puerto Rico, Switzerland, Dominican Republic, Costa Rica and certain other taxing jurisdictions outside the United States. The financial impact of the reductions as compared to the statutory tax rates is indicated in the income tax expense reconciliation table above. The Puerto Rico grant provides that the company’s manufacturing operations are and will be partially exempt from local taxes until the year 2026.

Examinations of Tax Returns

As of December 31, 2017, Baxter had ongoing audits in the United States, Germany, Sweden, Belgium and other jurisdictions. Baxter expects to reduce its gross unrecognized tax benefits within the next 12 months by $20 million due principally to the resolution of non-U.S. matters incident to the separation of Baxalta. While the final outcome of these matters is inherently uncertain, the company believes it has made adequate tax provisions for all years subject to examination.

During 2016, Baxter paid approximately $303 million to partially settle a U.S. federal income tax audit for the period 2008-2013. Additionally, the company settled a German income tax audit for the period 2008-2011 and settled an Italian audit for the period 2010-2012. As a result of these settlements, the company reduced its gross unrecognized tax benefits by $75 million. Pursuant to the tax matters agreement with Baxalta, Baxalta paid the company approximately $37 million related to its tax indemnity obligations in respect of its portion of the settled gross unrecognized tax benefits. See Note 2 for additional details regarding the separation of Baxalta.

NOTE 16

LEGAL PROCEEDINGS

Baxter is involved in product liability, patent, commercial, and other legal matters that arise in the normal course of the company’s business. 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. As of December 31, 2017 and 2016, the company’s total recorded reserves with respect to legal matters were $41 million and $53 million, respectively, and the total related receivables were nil and $10 million, respectively.

Baxter has established reserves for certain of the matters discussed below. The company is not able to estimate the amount or range of any loss for certain contingencies for which there is no reserve or additional loss for matters already reserved. While the liability of the company in connection with the claims cannot be estimated and the resolution thereof in any reporting period 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 that it has valid defenses in these matters, litigation is inherently uncertain, excessive verdicts do occur, and the company may incur material judgments or enter into material settlements of claims.

In addition to the matters described below, the company remains subject to the risk of future administrative and legal actions. With respect to governmental and regulatory matters, these actions may lead to product recalls, injunctions, and other restrictions on the company’s operations and monetary sanctions, including significant civil or criminal penalties. With respect to intellectual property, the company may be exposed to significant litigation concerning the scope of the company’s and others’ rights. Such litigation could result in a loss of patent protection or the ability to market products, which could lead to a significant loss of sales, or otherwise materially affect future results of operations.

Environmental

Baxter is involved as a potentially responsible party (PRP) for environmental clean-up costs at seven Superfund sites. Under the U.S. Superfund statute and many state laws, generators of hazardous waste sent to a disposal or recycling site are liable for site cleanup if contaminants from that property later leak into the environment. The laws generally provide that a PRP may be held jointly and severally liable for the costs of investigating and remediating the site. Separate from the Superfund cases noted above, Baxter is involved in an ongoing voluntary environmental remediation associated with historic operations at the company’s Irvine, California, United States, facility. As of December 31, 2017 and 2016, environmental reserves of approximately $21 million and $7 million, respectively, were established to address these specific estimated potential liabilities. In 2017, the company recorded a pre-tax charge of $15 million related to a former location and included that charge within (loss) income from discontinued operations, net of tax, on the consolidated statement of income. Such reserves are undiscounted and do not include anticipated recoveries, if any, from insurance companies. After considering these reserves, management is of the opinion that the outcome of these matters will not have a material adverse effect on the Company’s financial position or results of operations.

General litigation

On July 31, 2015, DaVita Inc. (f/k/a DaVita Healthcare Partners Inc.) filed suit against Baxter Healthcare Corporation in the District Court of the State of Colorado regarding an ongoing commercial dispute relating to the provision of peritoneal dialysis products. A bench trial concluded in third quarter 2016 and the parties were awaiting the court’s decision. On February 16, 2018, the parties entered into a settlement agreement providing for a full and final release of all claims and damages that were or could have been asserted in the commercial dispute in connection with their entry into a new peritoneal dialysis products supply agreement. The court granted an order to dismiss the litigation on February 21, 2018.

In November 2016, a purported antitrust class action complaint seeking monetary and injunctive relief was filed in the United States District Court for the Northern District of Illinois. The complaint alleges a conspiracy among manufacturers of IV solutions to restrict output and affect pricing in connection with a shortage of such solutions. Similar parallel actions subsequently were filed. In January 2017, a single consolidated complaint covering these matters was filed in the Northern District of Illinois. The company filed a motion to dismiss the consolidated complaint in February 2017. The parties await ruling.

In April 2017, the company became aware of a criminal investigation by the U.S. Department of Justice, Antitrust Division and a federal grand jury in the United States District Court for the Eastern District of Pennsylvania. The company and an employee received subpoenas seeking production of documents and testimony regarding the manufacturing, selling, pricing and shortages of IV solutions and containers (including saline solutions and certain other injectable medicines sold by the company) and communications with competitors regarding the same. The company is cooperating with the investigation. The New York Attorney General has also

requested that Baxter provide information regarding business practices in the IV saline industry. The company is cooperating with the New York Attorney General.

Other

In the fourth quarter of 2012, the company received two investigative demands from the United States Attorney for the Western District of North Carolina for information regarding its quality and manufacturing practices and procedures at its North Cove facility. In January 2017, the parties resolved this matter by entering into a deferred prosecution agreement and a civil settlement whereby the company agreed to pay approximately $18 million and implement certain enhanced compliance measures.

In December 2016, the company received a civil investigative demand from the Commercial Litigation Branch of the United States Department of Justice primarily relating to contingent discount arrangements for, and other promotion of, the company’s TISSEEL and ARTISS products. The company is cooperating in this matter.

NOTE 17

SEGMENT INFORMATION

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).

The company’s segments provide 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 uses operating income on a segment basis to make resource allocation decisions and assess the ongoing performance of the company’s business segments. Intersegment sales are eliminated in consolidation.

Certain items are maintained at Corporate and are not allocated to a segment. They primarily include most of the company’s debt and cash and equivalents and related net interest expense, foreign exchange rate fluctuations (principally relating to intercompany receivables, payables and loans denominated in a foreign currency) and the majority of the foreign currency hedging activities, corporate headquarters costs, certain research and development costs, certain Global Business Unit (GBU) support costs, stock compensation expense, nonstrategic investments and related income and expense, certain employee benefit plan costs as well as certain gains, losses, and other charges (such as business optimization, integration and separation-related costs, and asset impairments). The company’s chief operating decision maker does not receive any asset information by operating segment and, accordingly, the company does not report asset information by operating segment.

Financial information for the company’s segments is as follows:

for the years ended December 31 (in millions)	2017		2016		2015
Net sales
Americas	$	5,720	$	5,437	$	5,222
EMEA		2,731		2,697		2,774
APAC		2,110		2,029		1,972
Total net sales	$	10,561	$	10,163	$	9,968
Operating income
Americas	$	2,227	$	2,070	$	1,816
EMEA		564		476		342
APAC		512		464		405
Total segment operating income	$	3,303	$	3,010	$	2,563
Depreciation Expense
Americas	$	224	$	217	$	210
EMEA		166		178		179
APAC		85		86		78
Corporate and other		132		151		130
Total depreciation expense	$	607	$	632	$	597
Capital expenditures
Americas	$	267	$	332	$	408
EMEA		161		140		212
APAC		96		103		149
Corporate and other		101		116		137
Total capital expenditures	$	625	$	691	$	906

The following table is a reconciliation of segment operating income to income from continuing operations before income taxes per the consolidated statements of income.

for the years ended December 31 (in millions)	2017			2016			2015
Total segment operating income	$	3,303		$	3,010		$	2,563
Corporate and other		(2,045	)		(2,286	)		(2,114	)
Total operating income		1,258			724			449
Net interest expense		55			66			126
Other income, net		(14	)		(4,296	)		(105	)
Income from continuing operations before income taxes	$	1,217		$	4,954		$	428

Net Sales by GBU

The following table represents net sales by GBU.

years ended December 31	2017		2016		2015
Renal Care1		3,480		3,421		3,401
Acute Therapies2		456		429		385
Medication Delivery3		2,698		2,596		2,375
Pharmaceuticals⁴		1,883		1,722		1,801
Nutrition⁵		882		858		857
Advanced Surgery⁶		707		690		693
Other⁷		455		447		456
Total Baxter	$	10,561	$	10,163	$	9,968

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

2	Acute Therapies includes sales of the company’s continuous renal replacement therapies (CRRT) and other organ support therapies focused in the ICU.

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

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

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

⁶	Advanced Surgery includes sales of the company’s biological products and medical devices used in surgical procedures for hemostasis, tissue sealing and adhesion prevention.

⁷	Other includes sales primarily from the company’s pharmaceutical partnering business.

Geographic information

for the years ended December 31 (in millions)	2017		2016		2015
Net sales
United States	$	4,510	$	4,259	$	4,001
Latin America and Canada		1,210		1,178		1,221
Total Americas	$	5,720	$	5,437	$	5,222
Europe		2,731		2,697		2,774
Asia-Pacific		2,110		2,029		1,972
Total net sales	$	10,561	$	10,163	$	9,968

as of December 31 (in millions)	2017		2016
PP&E, net
United States	$	1,772	$	1,751
Europe		1,268		1,166
Asia-Pacific		903		752
Latin America and Canada		645		620
Consolidated PP&E, net	$	4,588	$	4,289

NOTE 18

QUARTERLY FINANCIAL RESULTS AND MARKET FOR THE COMPANY’S STOCK (UNAUDITED)

years ended December 31 (in millions, except per share data)	First quarter			Second quarter		Third quarter		Fourth quarter			Full year
2017
Net sales	$	2,475		$	2,605	$	2,707	$	2,774		$	10,561
Gross margin1		1,042			1,130		1,128		1,162			4,462
Income (loss) from continuing operations1		273			264		248		(61	)		724
Income (loss) from continuing operations per common share1
Basic		0.50			0.49		0.46		(0.11	)		1.33
Diluted		0.50			0.48		0.45		(0.11	)		1.30
(Loss) income from discontinued operations, net of tax		(1	)		1		3		(10	)		(7	)
(Loss) income from discontinued operations per common share
Basic		0.00			0.00		0.00		(0.02	)		(0.01	)
Diluted		(0.01	)		0.00		0.00		(0.02	)		(0.01	)
Net income (loss)1		272			265		251		(71	)		717
Net income (loss) per common share1
Basic		0.50			0.49		0.46		(0.13	)		1.32
Diluted		0.49			0.48		0.45		(0.13	)		1.29
Cash dividends declared per common share		0.130			0.160		0.160		0.160			0.610
Market price per common share
High		52.30			61.38		64.61		66.05			66.05
Low		44.44			52.29		59.50		61.45			44.44
2016
Net sales	$	2,375		$	2,585	$	2,558	$	2,645		$	10,163
Gross margin2		965			972		1,071		1,102			4,110
Income from continuing operations2		3,387			1,212		127		240			4,966
Income from continuing operations per common share2
Basic		6.17			2.21		0.23		0.44			9.10
Diluted		6.13			2.19		0.23		0.44			9.01
(Loss) income from discontinued operations, net of tax		(7	)		—		3		3			(1	)
(Loss) income from discontinued operations per common share
Basic		(0.01	)		0.00		0.01		0.01			(0.01	)
Diluted		(0.01	)		0.00		0.01		0.00			0.00
Net income2		3,380			1,212		130		243			4,965
Net income per common share2
Basic		6.16			2.21		0.24		0.45			9.09
Diluted		6.12			2.19		0.24		0.44			9.01
Cash dividends declared per common share		0.115			0.130		0.130		0.130			0.505
Market price per common share
High		41.28			46.39		49.03		49.16			49.16
Low		34.76			41.31		45.09		43.63			34.76

The first quarter of 2017 included charges of $17 million related to business optimization, separation-related costs and historical rebate and discount adjustments. The second quarter of 2017 included charges of $57 million related to business optimization, separation-related costs, Venezuela deconsolidation costs, Claris acquisition and integration expenses and adjustments to historical product reserves. The third quarter of 2017 included charges of $82 million related to business optimization, separation-related costs, Hurricane Maria costs, Claris acquisition and integration expenses and SIGMA SPECTRUM infusion pump inspection and remediation activities. The fourth quarter of 2017 included charges of $388 million related to business optimization, separation-related costs, Claris acquisition and integration expenses, Hurricane Maria costs, litigation and contractual disputes for business arrangements in which the company is no longer engaged or a party thereto and the impact of tax reform in the United States.

The first quarter of 2016 included benefits of $3.1 billion related to business optimization, separation-related costs, Retained Shares transactions, a loss on debt extinguishment, and product-related items. The second quarter of 2016 included benefits of $1.0 billion related to business optimization, separation-related costs, Retained Shares transactions, and asset impairment. The third quarter of 2016 included charges of $155 million related to business optimization, separation-related costs, a loss on debt extinguishment, and a tax matter. The fourth quarter of 2016 included charges of $47 million related to business optimization, Gambro integration costs, product-related items, separation-related costs, and reserve items and adjustments.

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Baxter International Inc.

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Baxter International Inc. and its subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2017, including the related notes and financial statement schedule listed in the index appearing under Item 15(2) of this Form 10-K (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

Basis for Opinions

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Assessment of Internal Control Over Financial Reporting appearing under Item 9A of this Form 10-K. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

As described in Management’s Assessment of Internal Control Over Financial Reporting, management has excluded Claris Injectables Limited (Claris) from its assessment of internal control over financial reporting as of December 31, 2017 because it was acquired by the Company in a purchase business combination during 2017. We have also excluded Claris from our audit of internal control over financial reporting. Claris is a wholly-owned subsidiary whose total assets and total revenues excluded from management’s assessment and our audit of internal control over financial reporting represent 2% and 1%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2017.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

Chicago, Illinois

February 23, 2018

We have served as the Company’s auditor since 1985.

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