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

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

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

EXECUTIVE OVERVIEW

Description of the Company and Business Segments

We manage our business based on three geographic segments: Americas (North and South America), EMEA (Europe, Middle East and Africa) and APAC (Asia-Pacific). Each of our segments provides a broad portfolio of essential healthcare products 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. These products are used by hospitals, kidney dialysis centers, nursing homes, rehabilitation centers, doctors’ offices and patients at home under physician supervision. Our global footprint and the critical nature of our products and services play a key role in expanding access to healthcare in emerging and developed countries.

For financial information about our segments, see Note 16 in Item 8 of this Annual Report on Form 10-K.

Recent Business Combinations and Asset Acquisitions

Seprafilm Adhesion Barrier

In February 2020, we completed the acquisition of the product rights to Seprafilm Adhesion Barrier (Seprafilm) from Sanofi for approximately $342 million in cash. Seprafilm is indicated for use in patients undergoing abdominal or pelvic laparotomy as an adjunct intended to reduce the incidence, extent and severity of postoperative adhesions between the abdominal wall and the underlying viscera such as omentum, small bowel, bladder, and stomach, and between the uterus and surrounding structures such as tubes and ovaries, large bowel, and bladder. Refer to Note 2 in Item 8 of this Annual Report on Form 10-K for additional information regarding the acquisition of Seprafilm.

Cheetah Medical

In October 2019, we acquired 100 percent of Cheetah Medical, Inc. (Cheetah) for total cash consideration of $188 million, net of cash acquired, with the potential for additional cash consideration, up to $40 million, based on clinical and commercial milestones for which the acquisition date fair value was $18 million. Cheetah is a leading provider of hemodynamic monitoring technologies. Refer to Note 2 in Item 8 of this Annual Report on Form 10-K for additional information regarding the acquisition of Cheetah.

Recothrom and Preveleak

In March 2018, we acquired 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 included an upfront payment of approximately $163 million and potential contingent payments in the future. Refer to Note 2 in Item 8 of this Annual Report on Form 10-K for additional information regarding the acquisition of the Recothrom and Preveleak products.

Transderm Scop

In February 2021, we agreed to acquire the rights to Transderm Scop from subsidiaries of GlaxoSmithKline for an upfront purchase price of $55 million plus the cost of acquired inventory and the potential for additional cash consideration of $30 million based upon a successful technology transfer by a specified date. We currently sell this product under a distribution license to the U.S. institutional market. Transderm Scop is indicated for post-operative nausea and vomiting in the U.S. and motion sickness in European markets. We expect the transaction to close late in the first quarter or early in the second quarter of 2021, subject to the satisfaction of closing conditions.

Caelyx and Doxil

In December 2020, we agreed to acquire the rights to Caelyx and Doxil, the branded versions of liposomal doxorubicin, from a subsidiary of Johnson & Johnson for specified territories outside of the U.S for $325 million. We previously acquired the U.S. rights to this product in 2019. Liposomal doxorubicin is a chemotherapy medicine used

to treat various types of cancer. We expect the transaction to close late in the first quarter or early in the second quarter of 2021, subject to the satisfaction of regulatory approvals and other closing conditions.

Financial Results

Our global net sales totaled $11.7 billion in 2020, an increase of 3% over 2019 on both a reported and constant currency basis. International sales totaled $6.8 billion in 2020, an increase of 4% compared to 2019 on a reported basis and 5% on a constant currency basis. Sales in the United States totaled $4.9 billion in 2020, an increase of 1% compared to 2019. Refer to the Net Sales discussion in the Results of Operations section below for more information related to changes in net sales on a constant currency basis.

Our income from continuing operations totaled $1.1 billion, or $2.13 per diluted share, in 2020. Income from continuing operations in 2020 included special items which resulted in a net decrease to income from continuing operations of $495 million, or $0.96 per diluted share. Our special items are discussed in the Results of Operations section below.

Our financial results included R&D expenses totaling $521 million in 2020, which reflects our focus on balancing investments to support our new product pipeline with efforts to optimize overall R&D spending.

Our financial position remains strong, with operating cash flows from continuing operations totaling $1.9 billion in 2020. We have continued to execute on our disciplined capital allocation framework, which is designed to optimize stockholder value creation through reinvestment in our businesses, dividends and share repurchases, as well as acquisitions and other business development initiatives as discussed in the Strategic Objectives section below.

Capital expenditures totaled $709 million in 2020 as we continue to invest across our businesses to support future growth, including additional investments in support of new and existing product capacity expansions. Our investments in capital expenditures in 2020 were focused on projects that improve production efficiency and enhance manufacturing capabilities to support our strategy of geographic expansion with select investments in growing markets.

We also continued to return value to our stockholders in the form of dividends. During 2020, we paid cash dividends to our stockholders totaling $473 million. Additionally, in 2020 we repurchased 6.3 million shares through cash repurchases pursuant to a Rule 10b5-1 repurchase plan. For information on our share repurchase plans, see Note 8 in Item 8 of this Annual Report on Form 10-K.

Strategic Objectives

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

Optimizing the Core Portfolio Globally

Our global product portfolio optimization strategy identifies products that we believe to have characteristics of core growth, products that we expect to provide us with a core return on capital, products that we intend to maintain or manage differently and products that we consider to be strategic bets. For products with core growth characteristics, we look to invest for long-term, higher margin growth. For products that we expect to generate a core return on capital, we seek to optimize our return on investment and to maintain or enhance our market position. For products that we intend to maintain or manage differently, we look to sustain or reposition our underlying investment. Finally, we are evaluating our market position and investment strategy for products that we consider to be strategic bets.

As part of our portfolio management strategy, we seek to optimize our position in product areas where we have a stable, profitable business model, identify and alter investments in products that have reached the end of their life

cycles or for which market positions have evolved unfavorably. In the course of doing so, we expect to continue to reallocate capital to more promising opportunities or business groupings, as described above.

As part of this strategy, we are shifting our investments to drive innovation in product areas where we have compelling opportunities to serve patients and healthcare professionals while advancing our business and we are accelerating the pace in which we bring these advances to market. We are in the midst of launching several new products, geographic expansions and line extensions by 2023 including in such areas as chronic and acute renal care, smart pump technology, hospital pharmaceuticals and nutritionals, surgical sealants, and more. These comprise a mix of entirely new offerings, improvements on existing technologies, and the expansion of current products into new geographies.

Operational Excellence

We have undertaken a comprehensive review of all aspects of our operations and are actively implementing changes in line with our business goals. As part of our pursuit of improved margin performance, we are working to optimize our cost structure and we are critically assessing optimal support levels in light of our ongoing portfolio optimization efforts. We intend to continue to actively manage our cost structure to help ensure that we are committing resources to the highest value uses. Such high value activities include supporting innovation, building out the portfolio, expanding patient access and accelerating growth for our stockholders.

Maintaining Disciplined and Balanced Capital Allocation

Our capital allocation strategies include the following:

reinvest in the business by funding opportunities that are positioned to deliver sustainable growth, support our innovation efforts and improve margin performance;
return capital to stockholders through dividends, which we expect to meaningfully increase with earnings growth;
share repurchases; and
identify and pursue accretive merger and acquisition (M&A) opportunities.

Responsible Corporate Citizen

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

Throughout 2020, we continued to implement a range of water conservation strategies and facility-based energy saving initiatives. In the area of product stewardship and life cycle management, we are pursuing efforts such as sustainable design and reduced packaging. We are also responding to the challenges of climate change through innovative greenhouse gas emissions-reduction programs, such as shifting to less carbon-intensive energy sources in manufacturing and transport. Additionally, we monitor our progress against long-term goals to drive continued environmental stewardship while creating healthier, more sustainable communities where our employees work and live.

Risk Factors

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

RESULTS OF OPERATIONS

Special Items

The following table provides a summary of our special items and the related impact by line item on our results of continuing operations for 2020, 2019 and 2018.


years ended December 31 (in millions)	2020		2019		2018
Gross Margin
Intangible asset amortization expense	$	(222)	$	(183)	$	(169)
Intangible asset impairment1	(17)		(31)		—
Business optimization items2	(53)		(69)		(49)
Product-related items3	(29)		—		6
Acquisition and integration expenses4	(11)		(30)		(27)
Litigation5	—		—		(8)
Hurricane Maria insurance recoveries6	—		—		32
European medical devices regulation7	(33)		(25)		(6)
Investigation and related costs8	(3)		—		—
Total Special Items	$	(368)	$	(338)	$	(221)
Impact on Gross Margin Ratio	(3.1 pts)		(3.0 pts)		(2.0 pts)
Selling, General and Administrative (SG&A) Expenses
Business optimization items2	$	78	$	70	$	145
Acquisition and integration expenses4	9		20		23
Litigation5	—		—		2
Investigation and related costs8	19		8		—
Total Special Items	$	106	$	98	$	170
Impact on SG&A Expense Ratio	1.0 pts		0.9 pts		1.5 pts
R&D Expenses
Business optimization items2	$	3	$	45	$	26
Acquisition and integration expenses4	22		8		7
European medical devices regulation7	—		—		3
Investigation and related costs8	1		—		—
Total Special Items	$	26	$	53	$	36
Impact on R&D Expense Ratio	0.3 pts		0.4 pts		0.3 pts
Other Operating Income, net
Business optimization items2	$	(17)	$	—	$	—
Acquisition and integration expenses4	(2)		(4)		—
Hurricane Maria insurance recoveries6	—		(100)		(10)
Claris Settlement⁹	—		—		(80)
Insurance recoveries from a legacy product-related matter10	—		(37)		—
Total Special Items	$	(19)	$	(141)	$	(90)
Other (Income) Expense, Net
Acquisition and integration activities4	$	—	$	—	$	(24)
Pension settlements11	43		755		—
Loss on debt extinguishment12	110		—		—
Total Special Items	$	153	$	755	$	(24)
Income Tax Expense
Tax effects of special items and impact of U.S. Tax Reform13	$	(139)	$	(387)	$	(277)
Total Special Items	$	(139)	$	(387)	$	(277)
Impact on Effective Tax Rate	(2.6 pts)		(20.9) pts		(13.7) pts

Intangible asset amortization expense is identified as a special item to facilitate an evaluation of current and past operating performance and is consistent with how management and our Board of Directors internally assess performance. Additional special items are identified above because they are highly variable, difficult to predict and of a size that may substantially impact our results of operations for a period. Management believes that providing the separate impact of the above items on our results in accordance with U.S. GAAP may provide a more complete understanding of our operations and can facilitate a fuller analysis of our results of operations, particularly in evaluating performance from one period to another.

1In 2020 and 2019, our results included charges of $17 million and $31 million, respectively, for asset impairments related to developed-technology intangible assets. Refer to Note 4 in Item 8 of this Annual Report on Form 10-K for further information regarding these asset impairments.

2In 2020, 2019 and 2018, our results were impacted by costs associated with our execution of programs to optimize our organization and cost structure. These actions included streamlining our international operations, rationalizing our manufacturing facilities, reducing our general and administrative infrastructure, re-aligning certain R&D activities and canceling certain R&D programs. Our results in 2020, 2019 and 2018 included business optimization charges of $134 million, $184 million and $220 million, respectively. Additionally, we recognized a gain of $17 million in 2020 for property we sold in conjunction with our business optimization initiatives. Refer to Note 10 in Item 8 of this Annual Report on Form 10-K for further information regarding these charges and related liabilities.

3Our results in 2020 included a charge of $29 million related to Sigma Spectrum infusion pump inspection and remediation activities. Our results in 2018 included a net benefit of $6 million related to an adjustment to our accrual for Sigma Spectrum infusion pump inspection and remediation activities.

4Our results in 2020 included $40 million of acquisition and integration expenses related to the acquisitions of Cheetah and Seprafilm and in-process R&D assets, partially offset by a benefit related to the change in the estimated fair value of contingent consideration liabilities. Our results in 2019 included $54 million of acquisition and integration expenses. This included integration expenses relate to our acquisitions of Claris Injectables Limited (Claris) and the Recothrom and Preveleak products in prior periods, as well as the 2019 acquisitions of Cheetah and in-process R&D assets, partially offset by a benefit related to the change in the estimated fair value of contingent consideration liabilities. Our results in 2018 included $33 million of acquisition and integration costs related to our acquisitions of Claris and the Recothrom and Preveleak products, upfront payments related to R&D collaborations and license agreements, and a gain from remeasuring our previously held investment to fair value upon acquisition of a controlling interest in our joint venture in Saudi Arabia. Refer to Note 2 in Item 8 of this Annual Report on Form 10-K for further information regarding business development activities.

5Our results in 2018 included charges of $10 million related to certain product litigation.

6Our results in 2019 and 2018 included benefits of $100 million and $42 million, respectively, related to insurance recoveries as a result of losses incurred due to Hurricane Maria. Refer to Note 7 in Item 8 of this Annual Report on Form 10-K for further information.

7Our results in 2020, 2019 and 2018 included costs of $33 million, $25 million and $9 million, respectively, related to updating our quality systems and product labeling to comply with the new medical device reporting regulation and other requirements of the European Union’s regulations for medical devices that are scheduled to become effective in 2021.

8Our results in 2020 and 2019 included charges of $23 million and $8 million, respectively, for investigation and related costs. This included $15 million in 2020 and $8 million in 2019 related to our investigation of foreign exchange gains and losses associated with certain intra-company transactions and related legal matters. Additionally, we recorded incremental stock compensation expense of $8 million in 2020 as we extended the term of certain stock options that were scheduled to expire in the first quarter of 2020. Refer to Notes 7 and 8 in Item 8 of this Annual Report on Form 10-K for further information regarding the investigation and stock compensation expense.

9Our results in 2018 included a benefit of $80 million for the settlement of certain claims related to the acquired operations of Claris. Refer to Note 2 in Item 8 of this Annual Report on Form 10-K for further information.

10Our results in 2019 included a benefit of $37 million for our allocation of insurance proceeds received pursuant to a settlement and cost-sharing arrangement for a legacy product-related matter. Refer to Note 7 in Item 8 of this Annual Report on Form 10-K for further information.

11Our results in 2020 included a charge of $43 million related to lump-sum settlement distributions made to certain former U.S. employees with vested pension benefits. Our results in 2019 included a charge of $755 million related to the annuitization of a portion of our U.S. pension plan. Refer to Note 11 in Item 8 of this Annual Report on Form 10-K for further information regarding the lump-sum settlements and the pension annuitization.

12Our results in 2020 included a loss of $110 million on the November 2020 early extinguishment of $750 million of 3.75% senior notes that were issued in March 2020. Refer to Note 5 in Item 8 of this Annual Report on Form 10-K for further information.

13Reflected in this item is the income tax impact of the special items identified in this table. The tax effect of each special item is based on the jurisdiction in which the item was incurred and the tax laws in effect for each such jurisdiction. Additionally, our results in 2019 included a net tax benefit of $125 million related to income tax reform in Switzerland and India and an adjustment for U.S. federal tax reform. Our results in 2018 included a net tax benefit of $196 million related to updates to the estimated impact of U.S. federal tax reform previously made in 2017.

Net Sales


							Percent change
							At actual currency rates				At constant currency rates
years ended December 31 (in millions)	2020		2019		2018		2020		2019		2020		2019
United States	$	4,878	$	4,826	$	4,723	1	%	2	%	1	%	2	%
International	6,795		6,536		6,376		4	%	3	%	5	%	7	%
Total net sales	$	11,673	$	11,362	$	11,099	3	%	2	%	3	%	5	%

Net sales for the year ended December 31, 2020 increased 3% at actual and constant currency rates. Net sales for the year ended December 31, 2019 increased 2% at actual rates and 5% at constant currency rates.

Foreign currency exchange rates had no net impact on 2020 net sales growth. Foreign currency exchange rates unfavorably impacted 2019 net sales growth by three percentage points principally due to the strengthening of the U.S Dollar relative to the Euro, Australian Dollar, British Pound, Chinese Yuan and Colombian Peso.

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

In 2020, the acquisition of Seprafilm contributed $94 million in revenue. In 2020 and 2019, the acquisition of Cheetah had an insignificant impact on reported revenues. The Recothrom and Preveleak products acquired in 2018 contributed $80 million and $52 million of revenues in 2019 and 2018, respectively.

Our global operations expose us to risks associated with public health crises and epidemics/pandemics, such as the COVID-19 pandemic. COVID-19 has had, and we expect will continue to have, an adverse impact on our operations, supply chains and distribution systems and has increased and we expect will continue to increase our expenses, including as a result of impacts associated with preventive and precautionary measures that we, other businesses and governments are taking. These measures have led to unprecedented restrictions on, disruptions in, and other related impacts on businesses and personal activities. In addition to travel restrictions put in place in early

2020, governments have closed borders, imposed prolonged quarantines and may continue those measures or implement other restrictions and requirements in light of the continuing spread of the pandemic. We expect that these evolving restrictions and requirements, as well as the corresponding need to adapt to new methods of conducting business remotely, will continue to have an adverse effect on our business. For further discussion, refer to the Global Business Unit Net Sales Reporting section below and Item 1A of this Annual Report on Form 10-K.

Global Business Unit Net Sales Reporting

Our global business units (GBUs) include the following:

Renal Care** includes sales of our peritoneal dialysis (PD), hemodialysis (HD) and additional dialysis therapies and services.
Medication Delivery** includes sales of our intravenous (IV) therapies, infusion pumps, administration sets and drug reconstitution devices.
Pharmaceuticals** includes sales of our premixed and oncology drug platforms, inhaled anesthesia and critical care products and pharmacy compounding services.
Clinical Nutrition** includes sales of our parenteral nutrition (PN) therapies and related products.
Advanced Surgery** includes sales of our biological products and medical devices used in surgical procedures for hemostasis, tissue sealing and adhesion prevention.
Acute Therapies** includes sales of our continuous renal replacement therapies (CRRT) and other organ support therapies focused in the intensive care unit (ICU).
Other** primarily includes sales of contract manufacturing services from our pharmaceutical partnering business.

The following is a summary of net sales by GBU.


							Percent change
							At actual currency rates				At constant currency rates
years ended December 31 (in millions)	2020		2019		2018		2020		2019		2020		2019
Renal Care	$	3,757	$	3,639	$	3,651	3	%	—	%	4	%	3	%
Medication Delivery	2,735		2,799		2,664		(2)	%	5	%	(2)	%	7	%
Pharmaceuticals	2,123		2,155		2,087		(1)	%	3	%	(1)	%	6	%
Clinical Nutrition	922		872		875		6	%	—	%	6	%	3	%
Advanced Surgery	888		877		798		1	%	10	%	1	%	12	%
Acute Therapies	740		535		515		38	%	4	%	39	%	7	%
Other	508		485		509		5	%	(5)	%	4	%	(2)	%
Total Baxter	$	11,673	$	11,362	$	11,099	3	%	2	%	3	%	5	%

Renal Care net sales increased 3% in 2020 and were flat in 2019. The increase in 2020 was driven by global patient growth in PD, partially offset by a 1% negative impact from foreign exchange rate changes, as compared to the prior-year period. Global patient growth in PD in 2019 was offset by lower U.S. in-center HD sales and a 3% negative impact from foreign exchange rate changes, as compared to the prior-year period.

Medication Delivery net sales decreased 2% in 2020 and increased 5% in 2019. The decrease in 2020 was primarily driven by lower demand for our infusion systems and related IV administration sets and solutions due to lower hospital admission rates and a reduction in elective surgeries resulting from the COVID-19 pandemic, including the impact from shelter in place initiatives as well as patient safety concerns related to potential COVID-19 infection risk. The increase in 2019 was attributable to increased sales of our Spectrum IQ Infusion System in the U.S. and EVO IQ Infusion System internationally and related IV access administration sets. Changes in foreign exchange rates had a negative impact on Medication Delivery net sales of 2% in 2019, compared to the prior-year period.

Pharmaceuticals net sales decreased 1% in 2020 and increased 3% in 2019. The decrease in 2020 was driven by lower demand for inhaled anesthesia products resulting from the COVID-19 pandemic and new competitive entrants for TransDerm Scop. Those impacts were partially offset by increased demand for our international pharmacy compounding services along with certain generic injectables and a nonrecurring purchase from the U.S.

government. The increase in 2019 was due to growth in international pharmacy compounding sales and increased sales of our generic injectables. Partially offsetting those increases were reduced sales of inhaled anesthetics as well as BREVIBLOC and U.S. cylophosphamide due to increased generic competition. Changes in foreign exchange rates had a negative impact on Pharmaceuticals net sales of 3% in 2019, compared to the prior-year period.

Clinical Nutrition net sales increased 6% in 2020 and were flat in 2019. The increase in 2020 was driven by increased demand for our PN therapies and related products, recent product launches and competitor shortages of amino acids. A positive impact on net sales in 2019 from the launch of new products was offset by a 3% negative impact from foreign exchange rate changes, as compared to the prior-year period.

Advanced Surgery net sales increased 1% and 10% in 2020 and 2019, respectively. The increase in 2020 was driven by the acquisition of Seprafilm, which contributed $94 million in net sales during 2020, and a benefit from increased demand for our hemostats and sealants early in the year due, in part, to competitive supply disruptions. Partially offsetting the increase was the impact of the COVID-19 pandemic as many elective surgeries were postponed. The increase in 2019 was primarily driven by higher sales as a result of a temporary supply disruption of a competitor, partially offset by a 2% negative impact from foreign exchange rate changes, as compared to the prior-year period.

Acute Therapies net sales increased 38% and 4% in 2020 and 2019, respectively. The increase in 2020 was driven by increased global demand for our CRRT systems to treat acute kidney injuries during the COVID-19 pandemic, partially offset by a 1% negative impact from foreign exchange rate changes, as compared to the prior-year period. The increase in 2019 was due to higher global demand for our CRRT systems to treat acute kidney injuries, including the launch of PrisMax in several countries across the Americas, Europe and Asia. Partially offsetting the increase in 2019 was a 3% negative impact from foreign exchange rate changes, as compared to the prior-year period.

Other net sales increased 5% in 2020 and decreased 5% in 2019. The increase in 2020 was driven by increased demand for our contract manufacturing services and a 1% positive impact from foreign exchange rate changes, as compared to the prior-year period. The decrease in 2019 was due to strong sales performance in 2018 and a 3% negative impact from foreign exchange rate changes, as compared to the prior-year period.

Gross Margin and Expense Ratios


													2020				2019
years ended December 31	2020		% of net sales		2019		% of net sales		2018		% of net sales		$ change		% change		$ change		% change
Gross margin	$	4,587	39.3	%	$	4,761	41.9	%	$	4,759	42.9	%	$	(174)	(3.7)	%	$	2	—	%
SG&A	$	2,469	21.2	%	$	2,535	22.3	%	$	2,620	23.6	%	$	(66)	(2.6)	%	$	(85)	(3.2)	%
R&D	$	521	4.5	%	$	595	5.2	%	$	654	5.9	%	$	(74)	(12.4)	%	$	(59)	(9.0)	%

Gross Margin

The gross margin ratio was 39.3%, 41.9% and 42.9% in 2020, 2019 and 2018, respectively. The special items identified above had an unfavorable impact of 3.1, 3.0 and 2.0 percentage points on the gross margin ratio in 2020, 2019 and 2018, respectively. Refer to the Special Items section above for additional detail.

Excluding the impact of the special items, the gross margin ratio decreased 2.5 percentage points in 2020 compared to 2019 due to an unfavorable product mix, additional compensation costs, primarily for our manufacturing employees, reduced manufacturing efficiencies and incremental logistics costs, all resulting from the COVID-19 pandemic.

Excluding the impact of the special items, the gross margin ratio was unchanged in 2019 compared to 2018. The gross margin ratio was impacted by an unfavorable product mix as well as inventory write-downs and incremental costs relating to improvements at a dialyzer facility in the U.S. that experienced manufacturing issues during the second quarter of 2019, offset by manufacturing efficiencies.

SG&A

The SG&A expenses ratio was 21.2%, 22.3% and 23.6% in 2020, 2019 and 2018, respectively. The special items identified above had an unfavorable impact of 1.0, 0.9 and 1.5 percentage points on the SG&A expenses ratio in 2020, 2019 and 2018, respectively. Refer to the Special Items section above for additional detail.

Excluding the impact of the special items, the SG&A expenses ratio decreased 1.2 percentage points in 2020 primarily due to lower bonus accruals under our annual employee incentive compensation plans, actions we took to restructure our cost position and focus on expense management and reduced travel and related expenses due to the COVID-19 pandemic.

Excluding the impact of the special items, the SG&A expenses ratio decreased 0.7 percentage points in 2019 primarily due to actions we took to restructure our cost position and focus on expense management.

R&D

The R&D expenses ratio was 4.5%, 5.2% and 5.9% in 2020, 2019 and 2018, respectively. The special items identified above had an unfavorable impact of 0.3, 0.4 and 0.3 percentage points on the R&D expenses ratio in 2020, 2019 and 2018, respectively. Refer to the Special Items section above for additional detail.

Excluding the impact of the special items, the R&D expenses ratio decreased 0.6 percentage points in 2020 as a result of reduced project-related expenditures compared to the prior year and actions we took to restructure our cost position and focus on expense management.

Excluding the impact of the special items, the R&D expenses ratio decreased 0.8 percentage points in 2019 as a result of reduced project-related expenditures compared to the prior year and actions we took to restructure our cost position and focus on expense management.

Business Optimization Items

In recent years, we have undertaken actions to transform our cost structure and enhance our operational efficiency. These efforts have included restructuring the organization, optimizing our manufacturing footprint, R&D operations and supply chain network, employing disciplined cost management, and centralizing and streamlining certain support functions. From the commencement of our business optimization actions in the second half of 2015 through December 31, 2020, we have incurred cumulative pre-tax costs of $1.1 billion related to these actions. The costs consisted primarily of employee termination costs, implementation costs, contract termination costs, asset impairments, and accelerated depreciation. We currently expect to incur additional pre-tax costs of approximately $14 million through the completion of the initiatives that are currently underway, primarily related to implementation costs. We continue to pursue cost savings initiatives and, to the extent further cost savings opportunities are identified, we may incur additional restructuring charges and costs to implement business optimization programs in future periods. The reductions in our cost base from these actions in the aggregate are expected to provide cumulative annual pretax savings of more than $1.2 billion once the remaining actions are complete. The savings from these actions will impact cost of sales, SG&A expenses, and R&D expenses. Approximately 95 percent of the expected annual pre-tax savings has been realized through December 31, 2020, with the remainder expected to be realized by the end of 2023. Refer to Note 10 in Item 8 of this Annual Report on Form 10-K for additional information regarding our business optimization programs.

Other Operating Income, Net

Other operating income, net was $19 million, $141 million and $99 million in 2020, 2019 and 2018, respectively. In 2020, we recognized a $17 million gain on the sale of property in conjunction with our business optimization initiatives. In 2020 and 2019, we recognized benefits of $2 million and $4 million, respectively, related to the change in the estimated fair value of contingent consideration liabilities. In 2019 and 2018, we recognized $100 million and $10 million, respectively, of insurance recoveries related to losses incurred due to Hurricane Maria within Other operating income, net. In 2019, we also recognized a benefit of $37 million when our share of the proceeds under a cost-sharing agreement became realizable following the resolution of a dispute with an insurer related to a legacy product-related matter. In 2018, we settled certain claims with the seller related to the acquired operations of Claris, which resulted in a benefit of $80 million. Additionally, included in other operating income in 2018 was $9 million of transition service income earned in connection with our separation of Baxalta in 2015. The agreement for these services terminated as of July 1, 2018.

Interest Expense, Net

Interest expense, net was $134 million, $71 million and $45 million in 2020, 2019 and 2018, respectively. The increase in 2020 was primarily driven by higher average debt outstanding as a result of the March 2020 issuance of $750 million of 3.75% senior notes due October 2025 and $500 million of 3.95% senior notes due April 2030, and the May 2019 issuance of €750 million of 0.40% senior notes due May 2024 and €750 million of 1.3% senior notes due May 2029. The 3.75% senior notes due October 2025 were repaid in November 2020 with the proceeds from the issuance of $650 million of 1.73% senior notes due April 2031 and cash on hand. The increase in 2019 was primarily driven by higher average debt outstanding as a result of the issuance of €750 million of 0.40% senior notes due May 2024 and €750 million of 1.3% senior notes due May 2029. Refer to Note 5 in Item 8 of this Annual Report on Form 10-K for a summary of the components of interest expense, net for 2020, 2019 and 2018.

Other (Income) Expense, Net

Other (income) expense, net was an expense of $190 million in 2020, expense of $731 million in 2019 and income of $78 million in 2018. The net expense in 2020 was primarily driven by a $110 million loss on the early extinguishment of debt related to our November 2020 redemption of $750 million of senior notes that were issued in March 2020, foreign exchange net losses of $49 million and $46 million of pension settlement charges, which included a $43 million charge related to lump-sum settlement distributions made to certain former U.S. employees with vested pension benefits. These expenses in 2020 were partially offset by net unrealized gains of $13 million related to marketable equity securities. The net expense in 2019 was primarily driven by a $755 million pension settlement charge related to the transfer of U.S. pension plan liabilities to an insurance company and $37 million of foreign exchange net losses, partially offset by $53 million of pension and OPEB plan net benefits. The income in 2018 was primarily driven by $49 million of pension and OPEB plan net benefits, a $24 million gain from remeasuring our previously held investment to fair value upon acquisition of a controlling interest in our joint venture in Saudi Arabia and foreign exchange net gains of $14 million.

We expect expenses from pension and OPEB plans to increase in 2021 primarily due to lower discount rates and a lower expected return on assets. Refer to Note 11 in Item 8 of this Annual Report on Form 10-K for further information regarding pension and OPEB plan expenses.

Income Taxes

The effective income tax rate for continuing operations was 14.1% in 2020, (4.2)% in 2019, and 4.0% in 2018. The special items identified above had a favorable impact of 2.6, 20.9 and 13.7 percentage points on the effective income tax rate in 2020, 2019 and 2018, respectively. Refer to the Special Items section above for additional detail. Our effective income tax rate can differ from the 21% U.S. federal statutory rate due to a number of factors, including foreign rate differences, tax incentives, increases or decreases in valuation allowances and liabilities for uncertain tax positions and excess tax benefits on stock compensation awards.

For the twelve months ended December 31, 2020, the difference between our effective income tax rate and the U.S. federal statutory rate was primarily attributable to favorable geographic earnings mix and excess tax benefits on stock compensation awards.

For the twelve months ended December 31, 2019, the difference between our effective income tax rate and the U.S. federal statutory rate was primarily due to special items, the most significant of which was the impact of recently enacted tax reform in Switzerland and India. We recognized a deferred tax benefit of $90 million to reflect a tax basis step-up, net of a valuation allowance, partially offset by a $5 million deferred tax revaluation to reflect an increase in the statutory tax rate, under the newly enacted Swiss tax laws. We also recognized a net deferred tax benefit of $24 million associated with deferred tax revaluation in India to reflect a decrease in the statutory tax rate.

In addition to the Swiss and Indian tax reform impacts, our effective rate in 2019 was different from the U.S. federal statutory rate due to the recognition of tax benefits associated with a favorable tax ruling, a benefit related to a notional interest deduction on the share capital of a foreign subsidiary, and excess tax benefits on stock compensation awards.

For the twelve months ended December 31, 2018, the difference between our effective income tax rate and the U.S. federal statutory rate was primarily due to special items, the most significant of which was our finalization of our provisional adjustments resulting from the 2017 Tax Act. SEC Staff Accounting Bulletin 118 (SAB 118) allowed a one-year measurement period from the December 22, 2017 Tax Act enactment date to refine the provisional amounts recognized in the 2017 financial statements.

We recorded several SAB 118 measurement period provisional adjustments in 2018. First, after further studying the 2017 Tax Act and related U.S. Treasury Regulations, we refined our provisional estimate of a full valuation allowance against our U.S. foreign tax credit deferred tax assets and released a $194 million valuation allowance due to our ability to utilize a portion of our U.S. foreign tax credit deferred tax assets. Second, the 2017 Tax Act requires us 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. During 2018, we refined our estimated one-time transition tax expense, recognizing a benefit of $5 million. Third, the 2017 Tax Act lowered the U.S. federal rate from 35% to 21% and generally exempts foreign income from U.S. taxation. We finalized our provisional revaluation of U.S. deferred tax assets, recording an additional $8 million benefit. Refer to Note 12 in Item 8 of this Annual Report on Form 10-K for further information related to the 2017 Tax Act and the finalization of associated SAB 118 provisional adjustments. Additionally, our effective rate in 2018 was different from the U.S. federal statutory rate due to excess tax benefits on stock compensation.

Our tax provisions for 2020, 2019 and 2018 do not include any tax charges related to either the Base Erosion and Anti-Abuse Tax (BEAT) or Global Intangible Low Taxed Income (GILTI) provisions, except for the inability to fully utilize foreign tax credits against such GILTI.

We anticipate that our effective income tax rate from continuing operations, calculated in accordance with U.S. GAAP, will be approximately 18% in 2021. This rate may be further impacted by a number of factors including discrete items, such as tax windfalls or deficiencies attributable to stock compensation awards, additional audit developments, or the tax effects of any future special items.

Income from Continuing Operations and Earnings per Diluted Share

Income from continuing operations was $1.1 billion in 2020, $1.0 billion in 2019 and $1.6 billion in 2018. Diluted earnings per share from continuing operations was $2.13 in 2020, $1.93 in 2019 and $2.84 in 2018. The significant factors and events causing the net changes from 2019 to 2020 and 2018 to 2019 are discussed above. Additionally, earnings per share from continuing operations was positively impacted by the repurchase of 35.8 million shares in 2018 through Rule 10b5-1 purchase plans, an accelerated share repurchase plan and otherwise and the repurchase of 16.5 million shares in 2019 through Rule 10b5-1 purchase plans, an accelerated share repurchase plan and otherwise. Refer to Note 8 in Item 8 of this Annual Report on Form 10-K for further information regarding our stock repurchases.

Loss from Discontinued Operations

Loss from discontinued operations, net of tax was $6 million in 2018 and related to Baxalta.

Segment results

We use operating income on a segment basis to make resource allocation decisions and assess the ongoing performance of our segments. Refer to Note 16 in Item 8 of this Annual Report on Form 10-K for additional details regarding our segments. The following is a summary of significant factors impacting our reportable segments’ financial results.


	Net sales						Operating income
years ended December 31 (in millions)	2020		2019		2018		2020		2019		2018
Americas	$	6,069	$	6,094	$	5,951	$	2,235	$	2,374	$	2,411
EMEA	3,129		2,968		2,946		677		652		666
APAC	2,475		2,300		2,202		591		549		532
Corporate and other	—		—		—		(1,887)		(1,803)		(2,025)
Total	$	11,673	$	11,362	$	11,099	$	1,616	$	1,772	$	1,584

Americas

Segment operating income was $2.2 billion, $2.4 billion and $2.4 billion in 2020, 2019 and 2018, respectively. The decrease in 2020 was primarily driven by decreased sales and gross margin in multiple GBUs, particularly Medication Delivery, Pharmaceuticals and Advanced Surgery, and lower gross profit as a result of an unfavorable product mix and incremental logistics costs due primarily to the impact of the COVID-19 pandemic. The decreases

were partially offset by favorable performance in Acute Therapies and Clinical Nutrition as well as the acquisition of Seprafilm. The decrease in 2019 was primarily driven by lower sales and gross margin in Pharmaceuticals and lower U.S. in-center HD sales, partially offset by favorable performance in Medication Delivery and Advanced Surgery, primarily due to a temporary supply disruption of a competitor. Additionally, results in 2019 were adversely impacted by unfavorable foreign exchange rates.

EMEA

Segment operating income was $677 million, $652 million and $666 million in 2020, 2019 and 2018, respectively. The increase in 2020 was primarily driven by increased sales and gross margin in Acute Therapies, Clinical Nutrition, Pharmaceuticals and Renal Care, partially offset by decreased sales in Advanced Surgery. The decrease in 2019 was primarily driven by unfavorable foreign exchange rates, partially offset by increased local currency sales and gross margin in Renal Care and Pharmaceuticals.

APAC

Segment operating income was $591 million, $549 million and $532 million in 2020, 2019 and 2018, respectively. The increase in 2020 was primarily driven by increased sales and gross margin in multiple GBUs, particularly Renal Care, Acute Therapies and Pharmaceuticals. The acquisition of Seprafilm also positively contributed to results in 2020. Results in 2019 were driven by higher sales and gross margin, primarily from China and Australia, in Renal Care and Pharmaceuticals.

Corporate and other

Certain items are maintained at Corporate and are not allocated to a segment. They primarily include certain foreign currency hedging activities, corporate headquarters costs, certain R&D costs, certain GBU support costs, stock compensation expense, certain employee benefit plan costs, and certain gains, losses, and other charges (such as business optimization, acquisition and integration costs, intangible asset amortization and asset impairments). The operating loss in 2020 was higher than 2019 due to insurance recoveries received in 2019 from a legacy product-related matter and Hurricane Maria, as well as the Sigma Spectrum infusion pump inspection and remediation charge in 2020 and higher investigation and related costs and intangible asset amortization in 2020. Partially offsetting the increase in 2020 was lower business optimization charges, lower intangible asset impairment charges, lower bonus accruals under our annual employee incentive compensation plans and reduced travel and related expenses. The operating loss in 2019 decreased due to higher Hurricane Maria insurance recoveries in 2019, a benefit for our allocation of insurance proceeds received pursuant to a settlement and cost-sharing arrangement for a legacy product-related matter in 2019, lower SG&A and R&D expenses in 2019 and lower business optimization charges in 2019, partially offset by an impairment of a developed-technology intangible asset in 2019 and the benefit from the Claris settlement in 2018.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows from Operations — Continuing Operations

In 2020, 2019 and 2018, cash provided by operating activities was $1.9 billion, $2.1 billion and $2.0 billion, respectively. Operating cash flows decreased in 2020 primarily due to payments of $173 million to settle interest rate derivative contracts in 2020, an increase in inventory levels in 2020 and insurance recoveries received in 2019 from a legacy product-related matter and Hurricane Maria, partially offset by the timing of vendor payments and lower restructuring and employee incentive compensation payments in 2020. Operating cash flows increased in 2019 primarily due to an increase in our operating income, which included the insurance recoveries related to Hurricane Maria and a legacy product-related matter.

Cash Flows from Investing Activities

In 2020, cash used for investing activities included payments for acquisitions of $494 million, primarily related to Seprafilm and multiple product acquisitions, and capital expenditures of $709 million. In 2019, cash used for investing activities included payments for acquisitions of $418 million, primarily related to Cheetah and multiple product acquisitions, and capital expenditures of $696 million. In 2018, cash used in investing activities included

payments for acquisitions of $268 million, primarily related to Recothrom and Preveleak and multiple product acquisitions, and capital expenditures of $659 million.

We expect that our capital expenditures will increase in 2021 as we make investments in our manufacturing capacity in response to proposed regulatory changes of the U.S. Department of Health and Human Services in kidney health policy and reimbursement, which may substantially change the U.S. end stage renal disease market and demand for our peritoneal dialysis products.

In December 2020, we agreed to acquire the rights to Caelyx and Doxil, the branded versions of liposomal doxorubicin, from a subsidiary of Johnson & Johnson for specified territories outside of the U.S for $325 million. We expect the transaction to close late in the first quarter or early in the second quarter of 2021, subject to the satisfaction of regulatory approvals and other closing conditions.

Refer to Note 2 in Item 8 of this Annual Report on Form 10-K for further information about our significant acquisitions and other arrangements.

Cash Flows from Financing Activities

In 2020, cash generated from financing activities included $1.2 billion of net proceeds from the March 2020 issuance of $750 million of senior notes due in 2025 and $500 million of senior notes due in 2030. In November 2020, we issued $650 million of senior notes due in 2031 and used the proceeds, along with cash on hand, to redeem the $750 million senior notes due in 2025 that were issued in March 2020 for $854 million, which included a $104 million make-whole premium. We have used the net proceeds from the senior notes issuances and redemptions for general corporate purposes, including to strengthen our balance sheet as a precautionary measure in light of the COVID-19 pandemic. In 2020, we also repaid $322 million of variable rate notes that matured and the borrowings under our Euro-denominated credit facility of €200 million ($225 million). Financing activities in 2020 also included payments for stock repurchases of $500 million, dividend payments of $473 million and receipts from stock issued under employee benefit plans of $202 million.

In 2019, cash generated from financing activities included $1.7 billion in net proceeds from the issuance of €750 million of senior notes due in 2024 and €750 million of senior notes due in 2029, €200 million ($222 million) of borrowings under our Euro-denominated credit facility and stock issued under employee benefit plans of $356 million, partially offset by payments for stock repurchases of $1.3 billion and dividend payments of $423 million. In 2018, cash used for financing activities included payments for stock repurchases of $2.5 billion and dividend payments of $376 million, partially offset by the proceeds from stock issued under employee benefit plans of $258 million.

As authorized by the Board of Directors, we repurchase our stock depending upon our cash flows, net debt levels and market conditions. In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of our common stock. The Board of Directors increased this authority by an additional $1.5 billion in each of November 2016 and February 2018, by an additional $2.0 billion in November 2018 and by an additional $1.5 billion in October 2020. We paid $500 million in cash to repurchase approximately 6.3 million shares under this authority pursuant to a Rule 10b5-1 plan in 2020 and had $1.9 billion remaining available under this authorization as of December 31, 2020.

In December 2018, we entered into a $300 million accelerated share repurchase agreement (ASR Agreement) with an investment bank. We funded the ASR Agreement with available cash. Under the ASR Agreement, we received 3.6 million shares upon execution. Based on the volume-weighted average price of our common stock during the term of the ASR Agreement, we received an additional 0.6 million shares from the investment bank at settlement in May 2019.

Credit Facilities and Access to Capital and Credit Ratings

Credit Facilities

As of December 31, 2020, our U.S. dollar-denominated revolving credit facility had capacity of $2.0 billion. As of December 31, 2020, our Euro-denominated revolving credit facility had a capacity of approximately €200 million. Each of the facilities matures in 2024. There were no amounts outstanding under our credit facilities as of December 31, 2020. There was no amount outstanding under our U.S. dollar-denominated credit facility as of December 31, 2019 and €200 million ($224 million) was outstanding at a 0.91% interest rate under our Euro-denominated credit facility as of December 31, 2019. As of December 31, 2020, we were in compliance with the financial covenants in these agreements. The non-performance of any financial institution supporting either of the credit facilities would reduce the maximum capacity of these facilities by the institution’s respective commitment.

We also maintain other credit arrangements, as described in Note 5 in Item 8 of this Annual Report on Form 10-K.

Access to Capital and Credit Ratings

We intend to fund short-term and long-term obligations as they mature through cash on hand and future cash flows from operations or by issuing additional debt. We had $3.7 billion of cash and cash equivalents as of December 31, 2020, with adequate cash available to meet operating requirements in each jurisdiction in which we operate. We invest our excess cash in money market and other funds and diversify the concentration of cash among different financial institutions. As of December 31, 2020, we had approximately $6.2 billion of long-term debt and finance lease obligations, including current maturities. Subject to market conditions, we regularly evaluate opportunities with respect to our capital structure.

Our ability to generate cash flows from operations, issue debt, including commercial paper, or enter into other financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for our products or in the solvency of our customers or suppliers, deterioration in our key financial ratios or credit ratings or other significantly unfavorable changes in conditions. However, we believe we have sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support our growth objectives.

Our credit ratings at December 31, 2020 were as follows:


	Standard & Poor’s	Fitch	Moody’s
Ratings
Senior debt	A-	A-	Baa1
Short-term debt	A2	F2	P2
Outlook	Stable	Stable	Stable

LIBOR Reform

In 2017, the United Kingdom’s Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit the rates required to calculate the London Interbank Offered Rate (LIBOR) and other interbank offered rates, which have been widely used as reference rates for various securities and financial contracts, including loans, debt and derivatives. This announcement indicated that the continuation of LIBOR on the current basis was not guaranteed after 2021. Regulators in the U.S. and other jurisdictions have been working to replace these rates with alternative reference interest rates that are supported by transactions in liquid and observable markets, such as the Secured Overnight Financing Rate (SOFR). In 2020, it was announced that certain U.S. dollar LIBOR tenors would not cease until 2023. Currently, our credit facilities reference LIBOR-based rates. The discontinuation of LIBOR will require these arrangements to be modified in order to replace LIBOR with an alternative reference interest rate, which could impact our cost of funds. Our credit facilities include a provision specifying that we and the lenders will negotiate in good faith for the determination of a successor LIBOR rate.

Contractual Obligations

As of December 31, 2020, we had contractual obligations, excluding accounts payable and accrued liabilities, payable or maturing in the following periods.


(in millions)	Total		Less than one year		One to three years		Three to five years		More than five years
Long-term debt and finance lease obligations, including current maturities	6,233		406		212		1,664		3,951
Interest on short- and long-term debt and finance lease obligations 1	1,627		142		267		251		967
Operating leases	673		121		186		126		240
Other non-current liabilities2	408		—		84		48		276
Purchase obligations3	1,209		485		352		198		174
Contractual obligations2	$	10,150	$	1,154	$	1,101	$	2,287	$	5,608

1.Interest payments on debt and finance lease obligations are calculated for future periods using interest rates in effect at the end of 2020. Certain of these projected interest payments may differ in the future based on foreign currency fluctuations or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2020. Refer to Note 5 and Note 6, respectively, in Item 8 of this Annual Report on Form 10-K for further discussion regarding our debt instruments outstanding and finance lease obligations at December 31, 2020.

2.The primary components of other non-current liabilities in our consolidated balance sheet as of December 31, 2020 are pension and other postretirement benefits, deferred tax liabilities, long-term tax liabilities, and litigation and environmental reserves. We projected the timing of the related future cash payments based on contractual maturity dates (where applicable) and estimates of the timing of payments (for liabilities with no contractual maturity dates). The actual timing of payments could differ from our estimates.

We contributed $74 million, $69 million, and $51 million to our defined benefit pension plans in 2020, 2019, and 2018, respectively. The timing of funding in future periods is uncertain and is dependent on future movements in interest rates, investment returns, changes in laws and regulations, and other variables. Therefore, the table above excludes cash outflows related to our pension plans. The amount included within other non-current liabilities (and excluded from the table above) related to our pension plan liabilities was $1.0 billion as of December 31, 2020. In 2021, we have no obligation to fund our principal plans in the United States and we expect to make contributions of at least $45 million to our foreign pension plans. Additionally, we have excluded long-term tax liabilities, which include liabilities for unrecognized tax positions, and deferred tax liabilities from the table above because we are unable to estimate the timing of the related cash outflows. The amounts of long-term tax liabilities and deferred tax liabilities included within other non-current liabilities (and excluded from the table above) were $84 million and $143 million, respectively, as of December 31, 2020.

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

Off-Balance Sheet Arrangements

We periodically enter into off-balance sheet arrangements. Certain contingencies arise in the normal course of business and are not recorded in the consolidated balance sheets in accordance with U.S. GAAP (such as contingent joint development and commercialization arrangement payments). Also, upon resolution of uncertainties, we may incur charges in excess of presently established liabilities for certain matters (such as contractual indemnifications). For a discussion of our significant off-balance sheet arrangements, refer to Note 14 in Item 8 of this Annual Report on Form 10-K for information regarding receivable transactions, and Note 2 and Note 7 in Item 8 of this Annual Report on Form 10-K regarding joint development and commercialization arrangements, indemnifications and legal contingencies.

FINANCIAL INSTRUMENT MARKET RISK

We operate on a global basis and are exposed to the risk that our earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange and interest rates. Our hedging policy attempts to manage these risks to an acceptable level based on our judgment of the appropriate trade-off between risk, opportunity and costs. Refer to Note 14 and Note 15 in Item 8 of this Annual Report on Form 10-K for further information regarding our financial instruments and hedging strategies.

Currency Risk

We are primarily exposed to foreign exchange risk with respect to revenues generated outside of the United States denominated in the Euro, British Pound, Chinese Yuan, Korean Won, Australian Dollar, Canadian Dollar, Japanese Yen, Colombian Peso, Brazilian Real, Mexican Peso, Indian Rupee and Swedish Krona. We manage our foreign currency exposures on a consolidated basis, which allows us to net exposures and take advantage of any natural offsets. In addition, we use derivative and nonderivative financial instruments to further reduce the net exposure to foreign exchange. Gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders’ equity volatility relating to foreign exchange. However, we don't hedge our entire foreign exchange exposure and are still subject to earnings and stockholders' equity volatility relating to foreign exchange risk. Financial market and currency volatility may limit our ability to cost-effectively hedge these exposures.

We use options and forwards to hedge the foreign exchange risk to earnings relating to forecasted transactions and recognized assets and liabilities denominated in foreign currencies. The maximum term over which we have cash flow hedge contracts in place related to foreign exchange risk on forecasted transactions as of December 31, 2020 is 12 months. We also enter into derivative instruments to hedge foreign exchange risk on certain intra-company and third-party receivables and payables and debt denominated in foreign currencies.

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

A sensitivity analysis of changes in the fair value of foreign exchange contracts outstanding as of December 31, 2020, while not predictive in nature, indicated that if the U.S. Dollar uniformly weakened by 10% against all currencies, the net pre-tax liability balance of $8 million with respect to those contracts would increase by $32 million, resulting in a net asset position. A similar analysis performed with respect to contracts outstanding as of December 31, 2019 indicated that, on a pre-tax basis, the net asset balance of $9 million would decrease by $18 million, resulting in a net liability position.

The sensitivity analysis model recalculates the fair value of the foreign exchange contracts outstanding as of December 31, 2020 by replacing the actual exchange rates as of December 31, 2020 with exchange rates that are 10% weaker compared to the actual exchange rates for each applicable currency. All other factors are held constant. These sensitivity analyses disregard the possibility that currency exchange rates can move in opposite directions and that gains from one currency may or may not be offset by losses from another currency. The analyses also disregard the offsetting change in value of the underlying hedged transactions and balances.

Our operations in Argentina are reported using highly inflationary accounting effective July 1, 2018. Changes in the value of the Argentine peso applied to our peso-denominated net monetary asset positions are recorded in income at the time of the change. As of December 31, 2020, our net monetary assets denominated in Argentine pesos are not significant.

Interest Rate Risk

We are also exposed to the risk that our earnings and cash flows could be adversely impacted by fluctuations in interest rates. Our policy is to manage interest costs using the mix of fixed- and floating-rate debt that we believe is appropriate at that time. To manage this mix in a cost-efficient manner, we periodically enter into interest rate swaps in which we agree to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. We also periodically use forward-starting interest rate swaps and treasury rate locks to hedge the risk to earnings associated with fluctuations in interest rates relating to anticipated issuances of term debt. As of December 31, 2020, all of our outstanding debt obligations were at fixed interest rates and no interest rate derivative instruments were outstanding.

CHANGES IN ACCOUNTING STANDARDS

Refer to Note 1 in Item 8 of this Annual Report on Form 10-K for information on changes in accounting standards.

RECENT ACCOUNTING PRONOUNCEMENTS

There are no accounting standards issued but not yet effective that we believe will have a material impact on our condensed consolidated financial statements.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. A summary of our significant accounting policies is included in Note 1 in Item 8 of this Annual Report on Form 10-K. Certain of our accounting policies are considered critical, as these policies are the most important to the depiction of our financial statements and require significant, difficult or complex judgments by us, often employing the use of estimates about the effects of matters that are inherently uncertain. Actual results that differ from our estimates could have an unfavorable effect on our results of operations and financial position. The following is a summary of accounting policies that we consider critical to the consolidated financial statements.

Revenue Recognition and Related Provisions and Allowances

Revenues from product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration primarily related to rebates and wholesaler chargebacks. These reserves are based on estimates of the amounts earned or to be claimed on the related sales. Our estimates take into consideration historical experience, current contractual and statutory requirements, specific known market events and trends, industry data, and forecasted customer buying and payment patterns. Overall, these reserves reflect our best estimates of the amount of consideration to which we are entitled based on the terms of the contract. The amount of variable consideration included in the net sales price is limited to the amount that is probable not to result in a significant reversal in the amount of the cumulative revenue recognized in a future period. Additionally, our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately and determining the allocation of the transaction price may require significant judgment.

Pension and OPEB Plans

We provide pension and other postretirement benefits to certain of our employees. The service component of employee benefit expenses is reported in the same line items in the consolidated income statements as the applicable employee’s compensation expense. All other components of these employee benefit expenses are reported in other (income) expense, net in our consolidated statements of income. The valuation of the funded status and net periodic benefit cost for the plans is calculated using actuarial assumptions. These assumptions are reviewed annually and revised if appropriate. The significant assumptions include the following:

interest rates used to discount pension and OPEB plan liabilities;
the long-term rate of return on pension plan assets;
rates of increases in employee compensation (used in estimating liabilities);
anticipated future healthcare trend rates (used in estimating the OPEB plan liability); and
other assumptions involving demographic factors such as retirement, mortality and turnover (used in estimating liabilities).

Selecting assumptions involves an analysis of both short-term and long-term historical trends and known economic and market conditions at the time of the valuation (also called the measurement date). The use of different assumptions would result in different measures of the funded status and net cost. Actual results in the future could differ from expected results.

Our key assumptions are listed in Note 11 in Item 8 of this Annual Report on Form 10-K. The most critical assumptions relate to the plans covering U.S. and Puerto Rico employees, because these plans are the most significant to our consolidated financial statements.

Discount Rate Assumption

Effective for the December 31, 2020 measurement date, we utilized discount rates of 2.73% and 2.33% to measure our benefit obligations for the U.S. and Puerto Rico pension plans and OPEB plan, respectively. We used a broad population of approximately 200 Aa-rated corporate bonds as of December 31, 2020 to determine the discount rate assumption. All bonds were denominated in U.S. dollars, with a minimum amount outstanding of $50 million. This population of bonds was narrowed from a broader universe of approximately 700 Moody’s Aa rated, non-callable (or callable with make-whole provisions) bonds by eliminating the top 10th percentile and bottom 40th percentile to adjust for any pricing anomalies and to represent the bonds we would most likely select if we were to actually annuitize our pension and OPEB plan liabilities. This portfolio of bonds was used to generate a yield curve and associated spot rate curve to discount the projected benefit payments for the U.S. and Puerto Rico plans. The discount rate is the single level rate that produces the same result as the spot rate curve.

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

To understand the impact of changes in discount rates on pension and OPEB plan cost, we perform a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point (i.e., one-half of one percent) increase in the discount rate, global pre-tax pension and OPEB plan cost would decrease by approximately $25 million, and for each 50 basis point decrease in the discount rate, global pre-tax pension and OPEB plan cost would increase by approximately $30 million.

Return on Plan Assets Assumption

In measuring the net periodic cost for 2020, we used a long-term expected rate of return of 6.5% for the pension plans covering U.S. and Puerto Rico employees. This assumption will decrease to 5.5% in 2021. This assumption is not applicable to our OPEB plan because it is not funded.

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

To understand the impact of changes in the expected asset return assumption on net cost, we perform a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point increase (decrease) in the asset return assumption, global pre-tax pension plan cost would decrease (increase) by approximately $15 million.

Other Assumptions

For the U.S. and Puerto Rico plans, we used the Pri-2012 combined mortality table with improvements projected using the MP-2019 projection scale adjusted to a long-term improvement of 0.8% as of December 31, 2020. For all other pension plans, we utilized country- and region-specific mortality tables to calculate the plans’ benefit obligations. We periodically analyze and update our assumptions concerning demographic factors such as retirement, mortality and turnover, considering historical experience as well as anticipated future trends.

The assumptions relating to employee compensation increases and future healthcare costs are based on historical experience, market trends, and anticipated future company actions.

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

We maintain valuation allowances unless it is more likely than not that all or a portion of the deferred tax asset will be realized. Changes in valuation allowances are included in our tax provision in the period of change. In determining whether a valuation allowance is warranted, we evaluate factors such as prior earnings history,

expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. The realizability assessments made at a given balance sheet date are subject to change in the future, particularly if earnings of a subsidiary are significantly higher or lower than expected, or if we take operational or tax planning actions that could impact the future taxable earnings of a subsidiary.

In the normal course of business, we are audited by federal, state and foreign tax authorities, and are periodically challenged regarding the amount of taxes due. These challenges relate to the timing and amount of deductions and the allocation of income among various tax jurisdictions. We believe our tax positions comply with applicable tax law and we intend to defend our positions. In evaluating the exposure associated with various tax filing positions, we record reserves for uncertain tax positions in accordance with U.S. GAAP based on the technical support for the positions, our past audit experience with similar situations, and potential interest and penalties related to the matters. Our results of operations and effective tax rate in a given period could be impacted if, upon final resolution with taxing authorities, we prevail in positions for which reserves have been established, or we are required to pay amounts in excess of established reserves.

On December 22, 2017, the 2017 Tax Act was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the U.S. corporate income tax rate to 21% effective January 1, 2018, among others. We were required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, remeasuring our U.S. deferred tax assets and liabilities and reassessing the realizability of our deferred tax assets. In December 2017, the SEC staff issued SAB 118 which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. We updated our accounting for the initial impact of the 2017 Tax Act in 2018 in accordance with the guidance in SAB 118. Refer to Note 12 within Item 8 of this Annual Report on Form 10-K for further information.

Valuation of Intangible Assets, Including IPR&D

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

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

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

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

Due to a change in the timing and amount of projected cash flows associated with $140 million of acquired in-process R&D intangible assets from a historical acquisition, we updated the estimated fair values of these assets in 2020. While no impairment has been recorded because the estimated fair values of those assets exceeded their carrying values, the estimated excess of fair value over carrying value of these assets declined in 2020 and are at risk of future impairment should the estimated timing or amount of projected cash flows further deteriorate.

CERTAIN REGULATORY MATTERS

The U.S. Food and Drug Administration (FDA) commenced an inspection of Claris’ facilities in Ahmedabad, India in July 2017, immediately prior to the closing of the Claris acquisition. FDA completed the inspection and subsequently issued a Warning Letter based on observations identified in the 2017 inspection (Claris Warning Letter).¹ FDA has not yet re-inspected the facilities and management cannot speculate on when the Claris Warning Letter will be lifted. However, we are continuing to implement corrective and preventive actions to address FDA’s prior observations and other items we identified and management continues to pursue and implement other manufacturing locations, including contract manufacturing organizations, to support the production of new products for distribution in the U.S. As of December 31, 2020, we have secured alternative locations to produce a majority of the planned new products to be manufactured in Ahmedabad for distribution into the U.S.

On May 6, 2019, we received a Show Cause Notice under the Drugs & Cosmetics Act, 1940 and Rules thereunder (Show Cause Notice) from the Commissioner of the Food & Drugs Control Administration in the Gujarat State in Gandhinagar, India (Commissioner). The Show Cause Notice was issued regarding an April 9, 2019 inspection of our Claris facilities in Ahmedabad, India by the Commissioner. The Show Cause Notice contained a number of observations of alleged Good Manufacturing Practice related issues across a variety of areas, some of which overlap with the areas covered in the Claris Warning Letter. We responded to the Show Cause Notice and a follow up inspection occurred in July 2019. This matter resulted in a two-day suspension order for certain manufacturing operations, which occurred on March 19 and 20, 2020. This matter is now closed.

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

1 Available online at https://www.fda.gov/ICECI/EnforcementActions/WarningLetters/ucm613538.htm

FORWARD-LOOKING INFORMATION

This annual report includes forward-looking statements. Use of the words “may,” “will,” “would,” “could,” “should,” “believes,” “estimates,” “projects,” “potential,” “expects,” “plans,” “seeks,” “intends,” “evaluates,” “pursues,” “anticipates,” “continues,” “designs,” “impacts,” “affects,” “forecasts,” “target,” “outlook,” “initiative,” “objective,” “designed,” “priorities,” “goal,” or the negative of those words or other similar expressions is intended to identify forward-looking statements that represent our current judgment about possible future events. These forward-looking statements may include statements with respect to accounting estimates and assumptions, impacts of the COVID-19 pandemic, litigation-related matters including outcomes, impacts of the internal investigation related to foreign exchange gains and losses, future regulatory filings and our R&D pipeline, strategic objectives, sales from new product offerings, credit exposure to foreign governments, potential developments with respect to credit ratings, investment of foreign earnings, estimates of liabilities including those related to uncertain tax positions, contingent payments, future pension plan contributions, costs, discount rates and rates of return, our exposure to financial market volatility and foreign currency and interest rate risks, potential tax liabilities associated with the separation of our biopharmaceuticals business from our medical products businesses, the impact of competition, future sales growth, business development activities (including the acquisitions of Cheetah and Seprafilm and the proposed acquisitions of Caelyx and Doxil and Transderm Scop), business optimization initiatives, cost saving initiatives, future capital and R&D expenditures, future debt issuances, manufacturing expansion, the sufficiency of our facilities and financial flexibility, the adequacy of credit facilities, tax provisions and reserves, the effective tax rate and all other statements that do not relate to historical facts.

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


			•			demand for, market acceptance risks for and competitive pressures related to new and existing products (including challenges with our ability to accurately predict these pressures and the resulting impact on customer inventory levels and the impact of reduced hospital admission rates and elective surgery volumes), and the impact of those products on quality and patient safety concerns;


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


			•			our ability to finance and develop new products or enhancements on commercially acceptable terms or at all;


			•			our ability to identify business development and growth opportunities and to successfully execute on business development strategies;


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


			•			the impact of global economic conditions (including potential trade wars) and pandemics, epidemics or other public health crises, such as COVID-19, on us and our customers and suppliers, including foreign governments in countries in which we operate;


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


			•			inability to create additional production capacity in a timely manner or the occurrence of other manufacturing, sterilization or supply difficulties (including as a result of natural disaster, public health crises and epidemics/pandemics, regulatory actions or otherwise);


			•			breaches or failures of our information technology systems or products, including by cyber-attack, data leakage, unauthorized access or theft (as a result of increased remote working arrangements or otherwise);


			•			future actions of (or failures to act or delays in acting by) FDA, the European Medicines Agency or any other regulatory body or government authority (including the SEC, DOJ or the Attorney General of any State) that could delay, limit or suspend product development, manufacturing or sale or result in seizures, recalls, injunctions, monetary sanctions or criminal or civil liabilities, including the continued delay in lifting the warning letter at our Ahmedabad facility or proceedings related to the misstatements in previously reported non-operating income related to foreign exchange gains and losses;


			•			developments that would require the correction of additional misstatements in our previously issued financial statements;


			•			failures with respect to our quality, compliance or ethics programs;


			•			future actions of third parties, including third-party payers, the impact of healthcare reform and its implementation, suspension, repeal, replacement, amendment, modification and other similar actions undertaken by the United States or foreign governments, including with respect to pricing, reimbursement, taxation and rebate policies; legislation, regulation and other governmental pressures in the United States or globally, including the cost of compliance and potential penalties for purported noncompliance thereof, all of which may affect pricing, reimbursement, taxation and rebate policies of government agencies and private payers or other elements of our business, including new or amended laws, rules and regulations (such as the California Consumer Privacy Act of 2018, the European Union’s General Data Protection Regulation and proposed regulatory changes of the U.S. Department of Health and Human Services in kidney health policy and reimbursement, which may substantially change the U.S. end stage renal disease market and demand for our peritoneal dialysis products, necessitating significant multi-year capital expenditures, which are difficult to estimate in advance, for example);


			•			the outcome of pending or future litigation or government investigations, including the opioid litigation and litigation related to the internal investigation of foreign exchange gains and losses;


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


			•			global regulatory, trade and tax policies;


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


			•			the impact of any goodwill or other intangible asset impairments on our operating results;


			•			any failure by Baxalta or Shire to satisfy its obligations under the separation agreements, including the tax matters agreement, or that certain letter agreement entered into with Shire and Baxalta;


			•			fluctuations in foreign exchange and interest rates;


			•			any changes in law concerning the taxation of income (whether with respect to current or future tax reform), including income earned outside the United States and potential taxes associated with the Base Erosion and Anti-Abuse Tax;


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


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


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

Actual results may differ materially from those projected in the forward-looking statements. We do not undertake to update our forward-looking statements.

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