UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, ~~2018~~2019

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 1-4448

BAXTER INTERNATIONAL INC.

(Exact name of registrant as specified in its charter)

Delaware		36-0781620
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

One Baxter Parkway, Deerfield, Illinois		60015
(Address of principal executive offices)		(Zip Code)

		224-948-2000
		(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $1.00 par value	BAX (NYSE)	New York Stock Exchange
		Chicago Stock Exchange
0.4% Global Notes due 2024	BAX 24	New York Stock Exchange
1.3% Global Notes due 2025	BAX 25	New York Stock Exchange
1.3% Global Notes due 2029	BAX 29	New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically ~~and posted on its corporate Web site, if any,~~ every Interactive Data File required to be submitted ~~and posted~~ pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit ~~and post~~ such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☒		Accelerated filer	☐
Non-accelerated filer	☐	~~(Do not check if a smaller reporting company)~~	Smaller reporting company	☐
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

The number of shares of the registrant’s Common Stock, par value $1.00 per share, outstanding as of July ~~31, 2018~~25, 2019 was ~~534,266,043~~510,555,869 shares.

BAXTER INTERNATIONAL INC.

FORM 10-Q

For the quarterly period ended June 30, ~~2018~~2019

TABLE OF CONTENTS

		Page Number
PART I.	FINANCIAL INFORMATION	2
Item 1.	Financial Statements (unaudited)	2
	Condensed Consolidated ~~Statements of Income~~Balance Sheets	2
	Condensed Consolidated Statements of ~~Comprehensive~~ Income	3
	Condensed Consolidated ~~Balance Sheets~~Statements of Comprehensive Income	4
	Condensed Consolidated Statements of ~~Cash Flows~~Changes in Equity	5
	Condensed Consolidated Statements of Cash Flows	7
	Notes to Condensed Consolidated Financial Statements	68
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	2829
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	41
Item 4.	Controls and Procedures	42
Review by Independent Registered Public Accounting Firm		43
Report of Independent Registered Public Accounting Firm		44

PART II.	OTHER INFORMATION	45
Item 1.	Legal Proceedings	45
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 6.	Exhibits	46
Signature		47

PART I. ~~FINANCI~~ALFINANCIAL INFORMATION

Item 1.

Financial Statements

Baxter International Inc.

Condensed Consolidated Balance Sheets (unaudited)

(in millions, except shares)

	June 30,			December 31,
	2019			2018
Current assets:
Cash and cash equivalents	$	2,925		$	1,832
Accounts and other current receivables, net		1,885			1,812
Inventories		1,757			1,653
Prepaid expenses and other		651			622
Total current assets		7,218			5,919
Property, plant and equipment, net		4,541			4,542
Goodwill		2,938			2,958
Other intangible assets, net		1,364			1,398
Operating lease right-of-use assets		588			—
Other non-current assets		895			824
Total assets	$	17,544		$	15,641
Current liabilities:
Short-term debt	$	2		$	2
Current maturities of long-term debt and finance lease obligations		2			2
Accounts payable and accrued liabilities		2,593			2,832
Total current liabilities		2,597			2,836
Long-term debt and finance lease obligations		5,157			3,473
Operating lease liabilities		490			—
Other non-current liabilities		1,464			1,516
Total liabilities		9,708			7,825
Equity:
Common stock, $1 par value, authorized 2,000,000,000 shares, issued 683,494,944 shares in 2019 and 2018		683			683
Common stock in treasury, at cost, 173,275,586 shares in 2019 and 170,495,859 shares in 2018		(10,322	)		(9,989	)
Additional contributed capital		5,906			5,898
Retained earnings		16,184			15,626
Accumulated other comprehensive (loss) income		(4,639	)		(4,424	)
Total Baxter stockholders’ equity		7,812			7,794
Noncontrolling interests		24			22
Total equity		7,836			7,816
Total liabilities and equity	$	17,544		$	15,641

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

Baxter International Inc.

Condensed Consolidated Statements of Income (unaudited)

(in millions, except per share data)

	Three months ended					Six months ended					Three months ended						Six months ended
	June 30,					June 30,					June 30,						June 30,
	2018			2017		2018			2017		2019			2018			2019			2018
Net sales	$	2,842		$	2,605	$	5,519		$	5,080	$	2,840		$	2,842		$	5,472		$	5,519
Cost of sales		1,603			1,473		3,166			2,904		1,681			1,603			3,233			3,166
Gross margin		1,239			1,132		2,353			2,176		1,159			1,239			2,239			2,353
Marketing and administrative expenses		681			630		1,303			1,194
Selling, general and administrative expenses												642			681			1,242			1,303
Research and development expenses		174			155		314			282		166			174			295			314
Claris settlement		—			—		(80	)		—
Other operating income, net												(4	)		—			(37	)		(80	)
Operating income		384			347		816			700		355			384			739			816
Net interest expense		11			13		23			27
Other (income) expense, net		(31	)		28		(49	)		39
Income from continuing operations before income taxes		404			306		842			634
Interest expense, net												20			11			38			23
Other income, net												(28	)		(31	)		(53	)		(49	)
Income before income taxes												363			404			754			842
Income tax expense		61			42		110			97		20			61			64			110
Income from continuing operations		343			264		732			537
Income from discontinued operations, net of tax		—			1		—			—
Net income	$	343		$	265	$	732		$	537	$	343		$	343		$	690		$	732
Income from continuing operations per common share
Basic	$	0.64		$	0.49	$	1.36		$	0.99
Diluted	$	0.63		$	0.48	$	1.33		$	0.97
Income from discontinued operations per common share
Basic	$	—		$	—	$	—		$	—
Diluted	$	—		$	—	$	—		$	—
Net income per common share
Basic	$	0.64		$	0.49	$	1.36		$	0.99	$	0.67		$	0.64		$	1.35		$	1.36
Diluted	$	0.63		$	0.48	$	1.33		$	0.97	$	0.66		$	0.63		$	1.33		$	1.33
Weighted-average number of common shares outstanding
Basic		535			544		537			542		510			535			511			537
Diluted		547			555		549			553		519			547			520			549
Cash dividends declared per common share	$	0.190		$	0.160	$	0.350		$	0.290

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

Baxter International Inc.

Condensed Consolidated Statements of Comprehensive Income (unaudited)

(in millions)

	Three months ended						Six months ended						Three months ended						Six months ended
	June 30,						June 30,						June 30,						June 30,
	2018			2017			2018			2017			2019			2018			2019			2018
Net income	$	343		$	265		$	732		$	537		$	343		$	343		$	690		$	732
Other comprehensive (loss) income, net of tax:
Currency translation adjustments, net of tax (benefit) expense of ($24) and $28 for the three months ended June 30, 2018 and 2017, respectively, and ($31) and $48 for the six months ended June 30, 2018 and 2017, respectively		(363	)		227			(282	)		349
Pension and other employee benefits, net of tax expense of $4 and $10 for the three months ended June 30, 2018 and 2017, respectively, and $17 and $20 for the six months ended June 30, 2018 and 2017, respectively		29			17			81			38
Hedging activities, net of tax expense (benefit) of $2 and ($1) for the three months ended June 30, 2018 and 2017, respectively, and $3 and ($5) for the six months ended June 30, 2018 and 2017, respectively		11			(3	)		6			(10	)
Available-for-sale securities, net of tax expense of zero and $1 for the three and six months ended June 30, 2018 and 2017, respectively		—			1			—			3
Currency translation adjustments, net of tax (benefit) expense of ($4) and ($24) for the three months ended June 30, 2019 and 2018, respectively, and $2 and ($31) for the six months ended June 30, 2019 and 2018, respectively														(78	)		(363	)		(48	)		(282	)
Pension and other postretirement benefits, net of tax expense of $3 and $4 for the three months ended June 30, 2019 and 2018, respectively, and $6 and $17 for the six months ended June 30, 2019 and 2018, respectively														13			29			21			81
Hedging activities, net of tax (benefit) expense of ($3) and $2 for the three months ended June 30, 2019 and 2018, respectively, and ($8) and $3 for the six months ended June 30, 2019 and 2018, respectively														(12	)		11			(27	)		6
Total other comprehensive (loss) income, net of tax		(323	)		242			(195	)		380			(77	)		(323	)		(54	)		(195	)
Comprehensive income	$	20		$	507		$	537		$	917		$	266		$	20		$	636		$	537

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

Baxter International Inc.

Condensed Consolidated ~~Balance Sheets~~Statements of Changes in Equity (unaudited)

(in ~~millions, except shares)~~millions)

June 30,

December 31,

2018

2017

Current assets

Cash and equivalents

$
2,857

$
3,394

Accounts and other current receivables, net

1,783

1,793

Inventories

1,622

1,475

Prepaid expenses and other

628

601

Total current assets

6,890

7,263

Property, plant and equipment, net

4,531

4,588

Other assets

Goodwill

2,984

3,099

Other intangible assets, net

1,427

1,374

Other

746

787

Total other assets

5,157

5,260

Total assets

$
16,578

$
17,111

Current liabilities

Current maturities of long-term debt and lease obligations

$
3

$
3

Accounts payable and accrued liabilities

2,524

2,733

Current income taxes payable

102

85

Total current liabilities

2,629

2,821

Long-term debt and lease obligations

3,495

3,509

Other long-term liabilities

1,585

1,665

Equity

Common stock, $1 par value, authorized 2,000,000,000
shares, issued 683,494,944 shares in 2018 and 2017

683

683

Common stock in treasury, at cost, 148,485,202 shares
in 2018 and 142,017,600 shares in 2017

(8,485
)

(7,981
)

Additional contributed capital

5,916

5,940

Retained earnings

14,966

14,483

Accumulated other comprehensive (loss) income

(4,199
)

(4,001
)

Total Baxter shareholders’ equity

8,881

9,124

Noncontrolling interests

(12
)

(8
)

Total equity

8,869

9,116

Total liabilities and equity

$
16,578

$
17,111

	For the three and six months ended June 30, 2019
	Baxter International Inc. stockholders' equity
	Common stock shares		Common stock		Common stock shares in treasury			Common stock in treasury			Additional contributed capital			Retained earnings			Accumulated other comprehensive income (loss)			Total Baxter stockholders' equity			Noncontrolling interests		Total equity
Balance as of January 1, 2019	683		$	683		170		$	(9,989	)	$	5,898		$	15,626		$	(4,424	)	$	7,794		$	22	$	7,816
Adoption of new accounting standards		—		—		—			—			—			161			(161	)		—			—		—
Net income		—		—		—			—			—			347			—			347			—		347
Other comprehensive income (loss)		—		—		—			—			—			—			23			23			—		23
Purchases of treasury stock		—		—		8			(586	)		—			—			—			(586	)		—		(586	)
Stock issued under employee benefit plans and other		—		—		(5	)		291			(59	)		(66	)		—			166			—		166
Dividends declared on common stock		—		—		—			—			—			(98	)		—			(98	)		—		(98	)
Change in noncontrolling interests		—		—		—			—			—			—			—			—			1		1
Balance as of March 31, 2019	683		$	683	173			$	(10,284	)	$	5,839		$	15,970		$	(4,562	)	$	7,646		$	23	$	7,669
Net income		—		—		—			—			—			343			—			343			—		343
Other comprehensive income (loss)		—		—		—			—			—			—			(77	)		(77	)		—		(77	)
Purchases of treasury stock		—		—		2			(157	)		46			—			—			(111	)		—		(111	)
Stock issued under employee benefit plans and other		—		—		(2	)		119			21			(17	)		—			123			—		123
Dividends declared on common stock		—		—		—			—			—			(112	)		—			(112	)		—		(112	)
Change in noncontrolling interests		—		—		—			—			—			—			—			—			1		1
Balance as of June 30, 2019		683	$	683		173		$	(10,322	)	$	5,906		$	16,184		$	(4,639	)	$	7,812		$	24	$	7,836

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

Baxter International Inc.

Condensed Consolidated Statements of ~~Cash Flows~~Changes in Equity (unaudited)

(in millions)

Six months ended

June 30,

2018

2017

Cash flows from operations

Net income

$
732

$
537

Adjustments to reconcile income from continuing operations to net cash from operating activities:

Depreciation and amortization

387

378

Deferred income taxes

(51
)

(20
)

Stock compensation

54

46

Net periodic pension benefit and OPEB costs

21

62

Other

40

45

Changes in balance sheet items

Accounts and other current receivables, net

43

43

Inventories

(134
)

(38
)

Accounts payable and accrued liabilities

(109
)

(112
)

Business optimization items

(47
)

(79
)

Other

(84
)

(95
)

Cash flows from operations – continuing operations

852

767

Cash flows from operations – discontinued operations

—

(49
)

Cash flows from operations

852

718

Cash flows from investing activities

Capital expenditures

(311
)

(279
)

Acquisitions and investments, net of cash acquired

(228
)

(36
)

Divestitures and other investing activities, net

—

2

Cash flows from investing activities

(539
)

(313
)
Cash flows from financing activities

Issuance of debt

—

633

Payments of obligations

(1
)

—

Cash dividends on common stock

(173
)

(141
)

Proceeds from stock issued under employee benefit plans

170

200

Purchases of treasury stock

(781
)

(95
)

Other

(23
)

(31
)

Cash flows from financing activities

(808
)

566

Effect of foreign exchange rate changes on cash and equivalents

(42
)

45

(Decrease) increase in cash and equivalents

(537
)

1,016

Cash and equivalents at beginning of period

3,394

2,801

Cash and equivalents at end of period

$
2,857

$
3,817

	For the three and six months ended June 30, 2018
	Baxter International Inc. stockholders' equity
	Common stock shares		Common stock		Common stock shares in treasury			Common stock in treasury			Additional contributed capital			Retained earnings			Accumulated other comprehensive income (loss)			Total Baxter stockholders' equity			Noncontrolling interests			Total equity
Balance as of January 1, 2018	683		$	683		142		$	(7,981	)	$	5,940		$	14,483		$	(4,001	)	$	9,124		$	(8	)	$	9,116
Adoption of new accounting standards		—		—		—			—			—			(16	)		(3	)		(19	)		—			(19	)
Net income		—		—		—			—			—			389			—			389			—			389
Other comprehensive income (loss)		—		—		—			—			—			—			128			128			—			128
Purchases of treasury stock		—		—		8			(522	)		—			—			—			(522	)		—			(522	)
Stock issued under employee benefit plans and other		—		—		(3	)		149			(28	)		(36	)		—			85			—			85
Dividends declared on common stock		—		—		—			—			—			(86	)		—			(86	)		—			(86	)
Change in noncontrolling interests		—		—		—			—			—			—			—			—			2			2
Balance as of March 31, 2018	683		$	683	147			$	(8,354	)	$	5,912		$	14,734		$	(3,876	)	$	9,099		$	(6	)	$	9,093
Net income		—		—		—			—			—			343			—			343			—			343
Other comprehensive income (loss)		—		—		—			—			—			—			(323	)		(323	)		—			(323	)
Purchases of treasury stock		—		—		3			(259	)		—			—			—			(259	)		—			(259	)
Stock issued under employee benefit plans and other		—		—		(2	)		128			4			(9	)		—			123			—			123
Dividends declared on common stock		—		—		—			—			—			(102	)		—			(102	)		—			(102	)
Change in noncontrolling interests		—		—		—			—			—			—			—			—			(6	)		(6	)
Balance as of June 30, 2018		683	$	683		148		$	(8,485	)	$	5,916		$	14,966		$	(4,199	)	$	8,881		$	(12	)	$	8,869

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

Baxter International Inc.

Condensed Consolidated Statements of Cash Flows (unaudited)

(in millions)

	Six months ended
	June 30,
	2019			2018
Cash flows from operations
Net income	$	690		$	732
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		393			387
Deferred income taxes		(55	)		(51	)
Stock compensation		57			54
Net periodic pension benefit and other postretirement costs		7			21
Restructuring charges		77			33
Intangible asset impairment		31			—
Other		21			7
Changes in balance sheet items:
Accounts and other current receivables, net		(60	)		43
Inventories		(91	)		(134	)
Accounts payable and accrued liabilities		(308	)		(109	)
Restructuring payments		(60	)		(47	)
Other		(85	)		(84	)
Cash flows from operations – continuing operations		617			852
Cash flows from operations – discontinued operations		(6	)		—
Cash flows from operations		611			852
Cash flows from investing activities
Capital expenditures		(352	)		(311	)
Acquisitions and investments		(111	)		(228	)
Other investing activities, net		1			—
Cash flows from investing activities		(462	)		(539	)
Cash flows from financing activities
Issuances of debt		1,661			—
Cash dividends on common stock		(198	)		(173	)
Proceeds from stock issued under employee benefit plans		262			170
Purchases of treasury stock		(720	)		(781	)
Other financing activities, net		(37	)		(24	)
Cash flows from financing activities		968			(808	)
Effect of foreign exchange rate changes on cash and cash equivalents		(24	)		(42	)
Increase (decrease) in cash and cash equivalents		1,093			(537	)
Cash and cash equivalents at beginning of period		1,832			3,394
Cash and cash equivalents at end of period	$	2,925		$	2,857

Non-cash investing and financing activities
Decrease in liabilities for capital expenditures	$	47		$	20
Decrease in liability for treasury stock purchases	$	23		$	—

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

Baxter ~~International~~International Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

1. BASIS OF PRESENTATION

The unaudited interim condensed consolidated financial statements of Baxter International Inc. and its subsidiaries ~~(the company~~(we or ~~Baxter)~~our) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (GAAP) in the United States have been condensed or omitted. These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in ~~the company’s~~our Annual Report on Form 10-K for the year ended December 31, ~~2017 (2017~~2018 (2018 Annual Report).

In the opinion of management, the unaudited interim condensed consolidated financial statements reflect all adjustments necessary for a fair ~~statement~~presentation of the ~~interim periods.~~financial position, results of operations and cash flows for the periods presented. All such adjustments, unless otherwise noted herein, are of a normal, recurring nature. The results of operations for the current interim period are not necessarily indicative of the results of operations to be expected for the full year.

Certain reclassifications have been made to conform the prior period condensed consolidated statements to the current period presentation.

~~Accounting for Venezuelan Operations~~

Effective as of the end of the second quarter of 2017, the company no longer met the accounting criteria for control over its business in Venezuela and therefore deconsolidated its Venezuelan operations. As a result of deconsolidating the Venezuelan operations, the company recorded a pre-tax charge of $33 million in other (income) expense, net in the second quarter of 2017.

New ~~accounting standards~~Accounting Standards

Recently adopted accounting pronouncements

As of January 1, ~~2018, the company~~2019, we adopted Accounting Standards Update (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 actuarial gains/losses, and settlement and curtailment effects, are to be included separately and outside of any subtotal of operating income. This guidance impacted the presentation of the company’s consolidated statements of income with no significant impact on net income. The company elected to apply the practical expedient which allows it to reclassify amounts disclosed previously in the retirement and other benefits footnote as the basis for applying retrospective presentation for prior comparative periods2016-02, Leases (Topic 842). ~~The retrospective impact of adoption for the three and six months ended June 30, 2017 is shown in the following table.~~

Three months ended June 30, 2017

Six months ended June 30, 2017

As Previously Reported

Reclassification

As Reclassified

As Previously Reported

Reclassification

As Reclassified

Cost of sales

$
1,475

$
(2
)

$
1,473

$
2,908

$
(4
)

$
2,904

Gross margin

1,130

2

1,132

2,172

4

2,176

Marketing and administrative expenses

635

(5
)

630

1,205

(11
)

1,194

Research and development expenses

156

(1
)

155

284

(2
)

282

Operating income

339

8

347

683

17

700

Other (income) expense, net

20

8

28

22

17

39

As of January 1, 2018, the company adopted 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 recorded a net 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.

As of January 1, 2018, the company adopted ASU No. 2016-01, Financial Instruments: Recognition and Measurement of Financial Assets and Liabilities. The new standard amends certain aspects of accounting and disclosure requirements of financial instruments, including the requirement that equity investments with readily determinable fair values be measured at fair value with changes in fair value recognized in the results of operations. The adoption ofUnder this ~~standard did not have a material impact on the company’s condensed consolidated financial statements.~~

As of January 1, 2018, the company adopted 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. The company adopted 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 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 results in an acceleration of revenue recognition for certain contractual arrangements as compared to recognition under prior accounting literature. The new guidance also impacts the company’s arrangements subject to previous software revenue recognition guidance, as the company is required to recognize as revenue a significant portion of the contract consideration upon delivery of the software compared to the previous practice of recognizing the contract consideration ratably over time for certain arrangements. The adjustment upon adoption increased the company’s opening balance of retained earnings by approximately $48 million, net of tax, on January 1, 2018. Refer to Note 2 for further information regarding the company’s revenues.

~~Recently issued accounting standards not yet adopted~~

~~In February 2016, the Financial Accounting Standards Board (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 operating 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. In July 2018, the FASB issued an update to the leasing guidance to allow an additional transition option which would allow companies to adopt the standard as of the beginning of the year of adoption as opposed to the earliest comparative period presented. The company is in the process of implementing processes and tools to assist in cataloging and analyzing the company’s lease contracts. Additionally, the company is evaluating internal controls that may be impacted by ASU No. 2016-02. The company expects that the majority of lessee leases currently classified as operating will continue to be classified as such and that currently classified capital leases will be classified as finance leases. The company expects the adoption to materially increase assets and liabilities on the balance sheet.

~~2. REVENUES~~

Revenue is recognized when obligations under the terms of a contract with a customer are satisfied; generally this occurs with the transfer of control of the company’s products or services. Revenue is measured as the amount of consideration the company expects to receive in exchange for transferring goods or providing services. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in the contract. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Some of the company’s contracts have multiple performance obligations. For contracts with multiple performance obligations, the company allocates the contract’s transaction price to each performance obligation using its best estimate of the standalone selling price of each distinct good or service in the contract.

The majority of the company’s performance obligations are satisfied at a point in time. This includes sales of the company’s broad portfolio of essential healthcare products across its geographic segments 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. For a majority of these sales, the company’s performance obligation is satisfied upon delivery to the customer. Shipping and handling activities are considered to be fulfillment activities and are not considered to be a separate performance obligation.

To a lesser extent, in all the company’s segments, the company enters into other types of contracts including contract manufacturing arrangements, equipment leases, and certain subscription software and licensing arrangements. The company recognizes revenue for these arrangements over time or at a point in time depending on its evaluation of when the customer obtains control of the promised goods or service. Revenue is recognized over time when the company is creating or enhancing an asset that the customer controls as the asset is created or enhanced or the company’s performance does not create an asset with an alternative use and the company has an enforceable right to payment for performance completed.

On June 30, 2018, the company had $7.4 billion of transaction price allocated to remaining performance obligations related to executed contracts with an original duration of one year or more which are primarily included in the Americas segment. Some contracts in the United States included in this amount may contain index-dependent price increases, which are not known at this time. The company expects to recognize approximately 10% of this amount as revenue in 2018, 20% each in 2019, 2020, and 2021, and the remaining balance thereafter.

~~Significant Judgments~~

Revenues from product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration for reserves related to rebates, product returns, sales discounts and wholesaler chargebacks. These reserves are based on estimates of the amounts earned or to be claimed on the related sales. Management's 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 the company’s best estimates of the amount of consideration to which it is 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. Revenue recognized in the current period related to performance obligations satisfied in prior periods was not material.

The company’s contracts with customers sometimes 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 versus together may require significant judgment. Judgment is also required to determine the stand-alone selling price for each distinct performance obligation and whether there is a discount to be allocated based on the relative stand-alone selling price of the various products and services.

~~Contract Balances~~

The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), and customer advances and deposits (contract liabilities) on the condensed consolidated balance sheet. Net trade accounts receivable at June 30, 2018 and January 1, 2018 were $1.7 billion, respectively. Generally, for certain contract manufacturing and software arrangements, billing occurs subsequent to revenue recognition, resulting in contract assets. These assets are reported on the condensed consolidated balance sheet on an individual basis at the end of each reporting period. The contract asset balances at June 30, 2018 and January 1, 2018 were $79 million and $73 million, respectively. The contract assets as of June 30, 2018 are presented within accounts and other current receivables, net ($50 million) and other ($29 million) on the condensed consolidated balance sheet. The increase from January 1, 2018 to June 30, 2018 was due primarily to revenue recognition on contract manufacturing programs for which the company is not yet able to bill the customer, partially offset by the billing of contract assets recognized upon the adoption ofWe adopted Topic ~~606. The company had no contract liabilities as of June 30, 2018 and January 1, 2018, respectively.~~

~~Practical Expedients~~

The company applies a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include the company’s internal sales force compensation programs as the company has determined annual compensation is commensurate with annual sales activities. The company does not disclose the value of transaction price allocated to unsatisfied performance obligations for contracts with an original expected length of one year or less. The company has elected to use the practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component if it is expected, at contract inception, that the period between when the company transfers a promised good or service to a customer, and when the customer pays for that good or service, will be one year or less. Additionally, all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected from a customer are excluded from revenue.

~~The company adopted ASC 606~~842 using the modified retrospective method. ~~The impact~~We elected the following practical expedients when assessing the transition impact: i) not to ~~net sales~~reassess whether any expired or existing contracts as ~~a result~~ of the adoption date are or contain leases; ii) not to reassess the lease classification for any expired or existing leases as of the adoption date; and iii) not to reassess initial direct costs for any existing leases as of the adoption date. The adjustment to record operating lease right-of-use assets and operating lease liabilities was ~~an increase~~$502 million as of ~~$9 million and $4 million, respectively, for the three and six months ended June 30, 2018.~~January 1, 2019. The impact to ~~cost of goods sold was an increase of $5 million and $4 million, respectively, for the three and six months ended June 30, 2018.~~

~~3. 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). Baxter and Baxalta entered into several 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, an employee matters agreement, a long-term services agreement, and a shareholder’s and registration rights 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 (July 2018). 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 condensed consolidated statements of ~~income. In the three~~income was not material and ~~six months ended June 30, 2018, the company recognized approximately $2 million and $9 million, respectively, as a reduction~~there was no net impact to marketing and administrative expenses related to the TSA. In the three and six months ended June 30, 2017, the company recognized approximately $16 million and $36 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 the three and six months ended June 30, 2018, Baxter recognized approximately $7 million and $13 million in sales to Baxalta. In the three and six months ended June 30, 2017, Baxter recognized approximately $6 million and $12 million, respectively, in sales to Baxalta. In addition, in the three and six months ended June 30, 2018, Baxter recognized $36 million and $73 million, respectively, in cost of sales related to purchases from Baxalta pursuant to the MSA. In the three and six months ended June 30, 2017, Baxter recognized $50 million and $98 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.

Cash outflows of $49 million were reported in cash flows from operations — discontinued operations for the six-month period ending June 30, 2017. These related to non-assignable tenders whereby Baxter was the seller of Baxalta products, transactions related to importation services Baxter provides in certain countries, in addition to trade payables settled post local separation on Baxalta’s behalf.

~~4. SUPPLEMENTAL FINANCIAL INFORMATION~~

~~Net interest expense~~

Three months ended

Six months ended

June 30,

June 30,

(in millions)

2018

2017

2018

2017

Interest expense, net of capitalized interest

$
24

$
21

$
46

$
40

Interest income

(13
)

(8
)

(23
)

(13
)
Net interest expense

$
11

$
13

$
23

$
27

~~Other (income) expense, net~~

Three months ended

Six months ended

June 30,

June 30,

(in millions)

2018

2017

2018

2017

Foreign exchange

$
(18
)

$
(15
)

$
(33
)

$
(15
)
Venezuela deconsolidation

-

33

-

33

Pension and other postemployment benefit plans

(14
)

8

(26
)

17

All other

1

2

10

4

Other (income) expense, net

$
(31
)

$
28

$
(49
)

$
39

~~Inventories~~

June 30,

December 31,

(in millions)

2018

2017

Raw materials

$
371

$
347

Work in process

179

116

Finished goods

1,072

1,012

Inventories

$
1,622

$
1,475

~~Property, plant and equipment, net~~

June 30,

December 31,

(in millions)

2018

2017

Property, plant and equipment, at cost

$
10,233

$
10,148

Accumulated depreciation

(5,702
)

(5,560
)
Property, plant and equipment, net

$
4,531

$
4,588

In the first quarter of 2018, the estimated useful life of the company’s enterprise resource planning (ERP) software was extended from 2020 on a prospective basis based on the company’s commitment to upgrade, enhance and support its existing systems through 2028. This change in estimate resulted in a reduction of depreciation expense of $6 million and increase in net income of $5 million, or $0.01 per diluted share, for the three months ended June 30, 2018 and a reduction of depreciation expense of $12 million and increase in net income of $9 million, or $0.02 per diluted share, for the six months ended June 30, 2018.

~~5. 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.~~

Three months ended

Six months ended

June 30,

June 30,

(in millions)
2018

2017

2018

2017

Basic shares

535

544

537

542

Effect of dilutive securities

12

11

12

11

Diluted shares

547

555

549

553

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 4 million and 3 million equity awards for the three and six months ended June 30, 2018, respectively, and 6 million and 4 million equity awards for the three and six months ended June 30, 2017, respectively, because their inclusion would have had an anti-dilutive effect on diluted EPS.

~~Stock repurchases~~

In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of the company’s common stock. The Board of Directors increased this authority by an additional $1.5 billion in each of November 2016 and February 2018. During the first half of 2018, the company repurchased 11.5 million shares pursuant to one or more Rule 10b5-1 plans for $781 million in cash. During the first half of 2017, the company repurchased 1.8 million shares for $95 million in cash. The company had $1.8 billion remaining available under the authorization (as amended and after giving effect to stock repurchases) as of June 30, 2018.

~~6. ACQUISITIONS AND OTHER ARRANGEMENTS~~

~~Claris Injectables Limited~~

On July 27, 2017, Baxter acquired 100 percent of Claris Injectables Limited (Claris), a wholly owned subsidiary of Claris Lifesciences Limited, for total cash consideration of approximately $629 million, net of cash acquired. Through the acquisition, Baxter added capabilities in production of essential generic injectable medicines, such as anesthesia and analgesics, renal, anti-infectives and critical care in a variety of presentations including bags, vials and ampoules. 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 results of operations of Claris have been included in the company’s condensed consolidated statement of income since the date the business was acquired. The Claris acquisition contributed $33 million and $69 million, respectively, of net sales for the three and six months ended June 30, 2018. Acquisition and integration costs associated with the Claris acquisition were $7 million and $14 million, respectively for the three and six months ended June 30, 2018, and were primarily included within marketing and administrative expenses and cost of sales on the condensed consolidated statements of ~~income.~~cash flows.

~~Baxter allocated $280 million~~As of January 1, 2019, we adopted ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities. The purpose of this ASU is to better align a company’s risk management activities and financial reporting for hedging relationships, simplify the ~~total consideration to acquired intangible assets.~~hedge accounting requirements, and improve the disclosures of hedging arrangements. The ~~acquired intangible assets include $140 million~~adoption of developed technology with a weighted-average useful life of eight years and $140 million of in-process research and development (IPR&D) with an indefinite useful life. For the IPR&D, additional R&D will be required to assess 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 would generate over its remaining useful life, discounted to present value. 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 within the 2017 Annual Report 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 provided to Baxter in the injectables market, and is included primarily in the Americas segment.

In the first quarter of 2018, Baxter and Claris Lifesciences Limited settled certain claims related to the acquired operations and terminated a development agreement with Dorizoe Lifesciences Limited. As a result, Baxter received $73 million in February 2018 and was released from an accrued liability to Claris Lifesciences Limited of $7 million. The total of $80 million is reflected as a benefit in the 2018 condensed consolidated statements of income.

~~RECOTHROM and PREVELEAK~~

On March 16, 2018, Baxter 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 company concluded that the acquired assets met the definition of a business and accounted for the transaction as a business combination using the acquisition method of accounting. The purchase price included an upfront payment of approximately $148 million in the first quarter of 2018. In the second quarter of 2018, the company adjusted the preliminary purchase price for an estimated $12 million post-closing payment that is expected to be paid in the third quarter of 2018. The measurement period

adjustments recorded as a result of the estimated post-closing payment included a $22 million increase to inventory, a $6 million reduction in other intangible assets and a $12 million increase in the total consideration transferred. These adjustments resulted in a $4 million decrease in goodwill. The measurement period adjustmentsthis standard did not have a material impact on our condensed consolidated financial statements.

As of January 1, 2019, we adopted ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (AOCI). As a result of the ~~company’s results~~enactment of ~~operations~~the U.S. Tax Cuts and Jobs Act of 2017 (the 2017 Tax Act), this guidance provides for a reclassification of certain tax effects from AOCI to retained earnings. The impact of the adoption of this standard was a $161 million increase to retained earnings.

2. ACQUISITIONS AND OTHER ARRANGEMENTS

In ~~addition,~~ the first quarter of 2019, we acquired the U.S. rights to multiple products for an aggregate purchase price ~~included new~~of $94 million. The purchase prices were capitalized as developed-technology intangible assets and assumed contingent payments in the future related to technology transfer milestones and net revenue royalty payments with an estimated fair value of $14 million as of the acquisition date. As of the acquisition date, the maximum aggregate amount payable for the technology transfer and net revenue royalties was $15 million and $143 million, respectively. The fair value of the potential contingent consideration payments were estimated by applying a probability-weighted expected payment model for technology transfer payments and a Monte Carlo simulation model for contingent royalty payments, which were then discounted to present value. The fair value measurements were based on Level 3 inputs.

~~The following table summarizes total consideration:~~

(in millions)

Cash

$
160

Contingent consideration

14

Total consideration

$
174

~~The following table summarizes the fair value of the assets acquired as of the acquisition date.~~

(in millions)

Assets acquired

Accounts receivable

$
2

Inventory

61

Goodwill

9

Other intangible assets

102

Total assets acquired

$
174

~~The valuation of the assets acquired~~ 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 the acquired business have been included in the company’s condensed consolidated statements of income since the date the business was acquired. ~~The RECOTHROM and PREVELEAK acquisitions contributed $17 million of net sales for the three and six months ended June 30, 2018.~~ ~~Acquisition and integration costs associated with the acquisition were $5 million for the three and six months ended June 30, 2018.~~

~~Baxter allocated $102 million of the total consideration to the RECOTHROM and PREVELEAK developed product rights with~~being amortized over a weighted-average useful life of 10 years. ~~The fair value of the intangible assets was determined using the income approach. The discount rates used~~Net sales related to measure the RECOTHROM and PREVELEAK intangible assets were 14% and 15%, respectively. The company considers the fair value of the 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 within the 2017 annual report for additional information regarding fair value measurements.

The goodwill, which is deductible for tax purposes, includes the value of potential future technologies as well as the overall strategic benefits provided to Baxter’s surgical portfolio of hemostats and sealants, and is includedthese products in the ~~Americas segment.~~

~~Celerity Pharmaceuticals, LLC~~first half of 2019 were not material.

In July 2019, we acquired the ~~first quarter of 2018, Baxter paid approximately $37 million and $35 million, respectively, to acquire the~~U.S. rights to ~~Bivalirudin and Dexmedetomidine from Celerity Pharmaceuticals, LLC (Celerity). Baxter capitalized the~~an additional product for $62 million. The purchase price ~~of Bivalirudin~~will be capitalized as ana developed-technology intangible asset ~~and is amortizing~~in the ~~asset over its estimated economic life of 12 years. The payment for Dexmedetomidine was based on tentative approval from the U.S. Food and Drug Administration (FDA)~~quarter ending September 30, 2019 and will be amortized over its estimated ~~economic~~useful life of 12 years. ~~Refer to Note 5 within the 2017 Annual Report for additional information regarding the company’s agreement with Celerity.~~

In the second quarter of 2017, Baxter paid approximately $10 million to acquire the rights to Clindamycin Saline from Celerity Pharmaceuticals, LLC (Celerity). Baxter capitalized the purchase price as an intangible asset and is amortizing the asset over the estimated economic life of 12 years.

123. SUPPLEMENTAL FINANCIAL INFORMATION

7.Interest Expense, Net

	Three months ended						Six months ended
	June 30,						June 30,
(in millions)	2019			2018			2019			2018
Interest expense, net of capitalized interest	$	28		$	24		$	53		$	46
Interest income		(8	)		(13	)		(15	)		(23	)
Interest expense, net	$	20		$	11		$	38		$	23

Other Income, Net

	Three months ended						Six months ended
	June 30,						June 30,
(in millions)	2019			2018			2019			2018
Foreign exchange gains, net	$	(17	)	$	(18	)	$	(22	)	$	(33	)
Pension and other postretirement benefits		(15	)		(14	)		(31	)		(26	)
Other		4			1			—			10
Other income, net	$	(28	)	$	(31	)	$	(53	)	$	(49	)

Inventories

	June 30,		December 31,
(in millions)	2019		2018
Raw materials	$	397	$	363
Work in process		197		203
Finished goods		1,163		1,087
Inventories	$	1,757	$	1,653

Property, Plant and Equipment, Net

	June 30,			December 31,
(in millions)	2019			2018
Property, plant and equipment, at cost	$	10,593		$	10,327
Accumulated depreciation		(6,052	)		(5,785	)
Property, plant and equipment, net	$	4,541		$	4,542

4. GOODWILL AND OTHER INTANGIBLE ASSETS, NET

Goodwill

The following is a reconciliation of goodwill by business segment.

(in millions)

Americas

EMEA

APAC

Total

Balance as of December 31, 2017

$
2,474

$
392

$
233

$
3,099

Additions

10

—

—

10

Currency translation adjustments

(100
)

(16
)

(9
)

(125
)
Balance as of June 30, 2018

$
2,384

$
376

$
224

$
2,984

(in millions)	Americas			EMEA			APAC			Total
Balance as of December 31, 2018	$	2,351		$	387		$	220		$	2,958
Adjustments		—			(4	)		—			(4	)
Currency translation adjustments		(13	)		(2	)		(1	)		(16	)
Balance as of June 30, 2019	$	2,338		$	381		$	219		$	2,938

As of June 30, ~~2018,~~2019, there were no ~~accumulated~~reductions in goodwill relating to impairment losses.

Other intangible assets, net

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

(in millions)	Developed technology, including patents			Other amortized intangible assets			Indefinite-lived intangible assets		Total			Developed technology, including patents			Other amortized intangible assets			Indefinite-lived intangible assets		Total
June 30, 2018
June 30, 2019
Gross other intangible assets	$	2,122		$	419		$	172	$	2,713		$	2,164		$	450		$	188	$	2,802
Accumulated amortization		(1,050	)		(236	)		—		(1,286	)		(1,171	)		(267	)		—		(1,438	)
Other intangible assets, net	$	1,072		$	183		$	172	$	1,427		$	993		$	183		$	188	$	1,364
December 31, 2017
December 31, 2018
Gross other intangible assets	$	2,002		$	435		$	172	$	2,609		$	2,115		$	451		$	188	$	2,754
Accumulated amortization		(1,010	)		(225	)		—		(1,235	)		(1,106	)		(250	)		—		(1,356	)
Other intangible assets, net	$	992		$	210		$	172	$	1,374		$	1,009		$	201		$	188	$	1,398

Intangible asset amortization expense was $45 million and $44 million ~~and $36 million in~~for the three months ended June 30, 2019 and 2018, respectively, and ~~2017, respectively,~~$88 million and $85 million ~~and $74 million in~~for the six months ended June 30, 2019 and 2018, ~~and 2017,~~ respectively.

~~8. 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 the remaining liability was $7 million as of June 30, 2018.

~~Business Optimization Charges~~

Beginning in the second half of 2015, the company initiated actions to transform its 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 June 30, 2018, the company has incurred cumulative pretax costs of $661 million related to these actions. The costs consisted primarily of employee termination, implementation costs and accelerated depreciation. The company expects to incur additional pretax costs of approximately $170 million and capital expenditures of $70 million through the completion of these initiatives. The costs will primarily include employee termination costs, implementation costs, and accelerated depreciation.

~~During the three and six months ended June 30, 2018 and 2017, the company recorded the following charges related to business optimization programs.~~

Three months ended

Six months ended

June 30,

June 30,

(in millions)

2018

2017

2018

2017

Restructuring charges, net

$
21

$
16

$
33

$
19

Costs to implement business optimization programs

25

16

50

37

Accelerated depreciation

1

3

2

8

Total business optimization charges

$
47

$
35

$
85

$
64

~~For segment reporting, business optimization charges are unallocated expenses.~~

~~During the three and six months ended June 30, 2018 and 2017, the company recorded the following restructuring charges.~~

Three months ended

June 30, 2018

(in millions)

COGS

SGA

R&D

Total

Employee termination costs

$
3

$
8

$
7

$
18

Contract termination costs

—

2

—

2

Asset impairments

—

1

—

1

Total restructuring charges

$
3

$
11

$
7

$
21

Three months ended

June 30, 2017

(in millions)

COGS

SGA

R&D

Total

Employee termination costs

$
4

$
3

$
—

$
7

Contract termination costs

—

4

—

4

Asset impairments

5

—

—

5

Total restructuring charges

$
9

$
7

$
—

$
16

Six months ended

June 30, 2018

(in millions)

COGS

SGA

R&D

Total

Employee termination costs

$
4

$
14

$
10

$
28

Contract termination costs

—

2

—

2

Asset impairments

1

2

—

3

Total restructuring charges

$
5

$
18

$
10

$
33

Six months ended

June 30, 2017

(in millions)

COGS

SGA

R&D

Total

Employee termination costs

$
14

$
9

$
—

$
23

Contract termination costs

—

5

—

5

Asset impairments

5

—

—

5

Reserve adjustments

(7
)

(5
)

(2
)

(14
)
Total restructuring charges

$
12

$
9

$
(2
)

$
19

Costs to implement business optimization programs for the three and six months ended June 30, 2018 were $25 million and $50 million, respectively, and consisted primarily of external consulting and transition costs as well as employee salary and related costs. These costs were included within cost of sales and marketing and administrative expense.

Costs to implement business optimization programs for the three and six months ended June 30, 2017 were $16 million and $37 million, respectively, and consisted primarily of external consulting and transition costs as well as employee salary related costs. These costs were included within cost of sales and marketing and administrative expense.

For the three and six months ended June 30, ~~2018,~~2019, we recognized a $31 million impairment charge related to a developed-technology intangible asset due to a decline in market expectations for the ~~company recognized accelerated depreciation, primarily associated with facilities to be closed,~~related product. The fair value of ~~$1 million~~the intangible asset was measured using a discounted cash flow approach and ~~$2 million, respectively. The costs were recorded~~the charge is classified within cost of sales in the accompanying condensed consolidated statements of income. We consider the fair value of the asset to be a Level 3 measurement due to the significant estimates and ~~marketing~~assumptions we used in establishing the estimated fair value.

5. FINANCING ARRANGEMENTS

Debt Issuance

In May 2019, we issued €750 million of 0.4% senior notes due in May 2024 and ~~administrative expense.~~€750 million of 1.3% senior notes due in May 2029. We have designated these debt instruments as net investment hedges of our European operations. Refer to Note 15 for additional information.

Short-term Debt

In the second quarter of 2019, we repaid $795 million of commercial paper and other short-term borrowings that were outstanding as of March 31, 2019. No commercial paper was outstanding as of June 30, 2019 or December 31, 2018.

6. LEASES

Lessee Activity

We have entered into operating and finance leases primarily for office, manufacturing and research and development (R&D) facilities, vehicles and equipment. Our leases have remaining terms from one to 25 years and some of those leases include options that provide us with the ability to extend the lease term for periods ranging from one to 12 years. Such options are included in the lease term when it is reasonably certain that the option will be exercised.

Certain lease contracts include other services, such as operations and maintenance. For all asset classes, we have elected to apply a practical expedient to account for other services within lease contracts as components of the lease. We also have elected to apply a practical expedient for short-term leases whereby we do not recognize a lease liability and right-of-use asset for leases with a term of less than 12 months.

We classify our leases as operating or finance at the lease commencement date. Finance leases are generally those leases for which we will pay substantially all of the underlying asset’s fair value or will use the asset for all or a major part of its economic life, including circumstances in which we will ultimately own the asset. All other leases are operating leases. For finance leases, we recognize interest expense using the effective interest method and we recognize

amortization expense on the right-of-use asset over the shorter of the lease term or the useful life of the asset. For operating leases, we recognize lease cost on a straight-line basis over the term of the lease.

Lease liabilities and right-of-use assets are recognized at the lease commencement date based on the present value of minimum lease payments over the lease term. We determine the present value of payments under a lease based on our incremental borrowing rate as of the lease commencement date. The incremental borrowing rate is equal to the rate of interest that we would have to pay to borrow on a collateralized basis over a similar term in an amount equal to the lease payments in a similar economic environment. For operating leases that commenced prior to our adoption of Topic 842, we measured the lease liabilities and right-of-use assets using our incremental borrowing rate as of January 1, 2019.

There were no material lease transactions that we entered into but have not yet commenced as of June 30, 2019.

~~For~~The components of lease cost for the three and six months ended June 30, 2017, the company recognized accelerated depreciation, primarily associated with facilities to be closed, of $3 million and $8 million, respectively. The costs were recorded within cost of sales, marketing and administrative expense and R&D expense.2019 were:

(in millions)	Three months ended June 30, 2019		Six months ended June 30, 2019
Operating lease cost	$	29	$	60
Finance lease cost
Amortization of right-of-use assets		1		2
Interest on lease liabilities		—		1
Variable lease cost		21		43
Lease cost	$	51	$	106

The following table ~~summarizes activity in the reserves~~contains supplemental cash flow information related to ~~the company’s business optimization initiatives.~~

(in millions)

Reserves as of December 31, 2017

$
112

Charges

30

Utilization

(47
)
CTA

(20
)
Reserves as of June 30, 2018

$
75

~~Substantially all of the company’s restructuring reserves as of June 30, 2018 relate to employee termination costs. The reserves are expected to be substantially utilized by the end of 2018.~~

~~9. DEBT, FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS~~

~~Debt Issuance~~

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

~~Securitization arrangement~~

~~The following is a summary of the activity relating to the company’s securitization arrangement in Japan.~~

Three months ended
June 30,

Six months ended
June 30,

(in millions)

2018

2017

2018

2017

Sold receivables at beginning of period

$
64

$
61

$
71

$
68

Proceeds from sales of receivables

67

67

129

129

Cash collections (remitted to the owners of the receivables)

(65
)

(66
)

(136
)

(137
)
Effect of currency exchange rate changes

(2
)

1

-

3

Sold receivables at end of period

$
64

$
63

$
64

$
63

The impacts on the condensed consolidated statements of income relating to the sale of receivables were immaterial for each period. Refer to the 2017 Annual Report for further information regarding the company’s securitization agreements.

~~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 that have experienced a deterioration in credit and economic conditions. As of June 30, 2018, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $133 million.

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. Governmental actions and customer-specific factors may also 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.

~~Derivatives and hedging activities~~

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.~~

All derivative instruments are recognized as either assets or liabilities at fair value in the condensed 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.

~~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.

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 other comprehensive income (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, net interest expense, and other (income) expense, net, and primarily relate to forecasted third-party sales denominated in foreign currencies, forecasted intercompany sales denominated in foreign currencies, and anticipated issuances of debt, respectively.

The notional amounts of foreign exchange contracts were $636 million and $660 million as of June 30, 2018 and December 31, 2017, respectively. There were no outstanding interest rate contracts designated as cash flow hedges as of June 30, 2018 and December 31, 2017. The maximum term over which the company has cash flow hedge contracts in place related to forecasted transactions as of June 30, 2018 is 15 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. For each derivative instrument that is designated and effective as a fair value hedge, the gain or loss on the derivative is recognized immediately to earnings, and offsets the loss or gain on the underlying hedged item. Fair value hedges are classified in net interest expense, as they hedge the interest rate risk associated with certain of the company’s fixed-rate debt.

There were no outstanding interest rate swap contracts designated as a fair value hedge as of June 30, 2018. The total notional amount of interest rate contracts designated as fair value hedges was $200 million as of December 31, 2017.

~~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 June 30, 2018, the company had an accumulated pre-tax unrealized translation loss in AOCI of $62 million related to the Euro-denominated senior notes.

~~Dedesignations~~

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 loss or income recognition of the underlying hedged items.

~~There were no hedge dedesignations in the first six months of 2018 or 2017 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 the first six months of 2018, the company terminated its interest rate fair value hedges and the cumulative fair value adjustment to the hedged item was insignificant. There were no fair value hedges terminated during the first six months of 2017.

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 change in fair value, which substantially offsets the change in book value of the hedged items, is recorded directly to other (income) expense, net. The terms of these instruments generally do not exceed one month.

~~The total notional amount of undesignated derivative instruments was $655 million as of June 30, 2018 and $885 million as of December 31, 2017.~~

~~Gains and Losses on Hedging Activities~~

~~The following tables summarize the income statement locations and gains and losses on the company’s derivative instruments for the three months ended June 30, 2018 and 2017.~~

Gain (loss) recognized in OCI

Location of gain (loss)

Gain (loss) reclassified from AOCI
into income

(in millions)

2018

2017

in income statement

2018

2017

Cash flow hedges

Foreign exchange contracts

$
7

$
(5
)

Cost of sales

$
(6
)

$
(3
)
Interest Rate contracts

—

(3
)

Net interest expense

—

—

Net investment hedge

38

$
(31
)

Other (income) expense, net

—

—

Total

$
45

$
(39
)

$
(6
)

$
(3
)

Gain (loss) recognized in income

(in millions)

Location of gain (loss) in income statement

2018

2017

Fair value hedges

Interest rate contracts

Net interest expense

$
—

$
1

Undesignated derivative instruments

Foreign exchange contracts

Other (income) expense, net

$
6

$
(4
)

~~The following tables summarize the income statement locations and gains and losses on the company’s derivative instruments~~leases for the six months ended June 30, ~~2018 and 2017.~~2019:

Gain (loss) recognized in OCI

Location of gain (loss)

Gain (loss) reclassified from AOCI
into income

(in millions)

2018

2017

in income statement

2018

2017

Cash flow hedges

Foreign exchange contracts

$
(2
)

$
(13
)

Cost of sales

$
(10
)

$
(1
)
Interest Rate contracts

—

(3
)

Net interest expense

—

—

Net investment hedge

17

$
(31
)

Other (income) expense, net

—

—

Total

$
15

$
(47
)

$
(10
)

$
(1
)

(in millions)	Six months ended June 30, 2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	60
Operating cash flows from finance leases		3
Financing cash flows from finance leases		1

Right-of-use operating lease assets obtained in exchange for lease obligations		140

Gain (loss) recognized in income

(in millions)

Location of gain (loss) in income statement

2018

2017

Fair value hedges

Interest rate contracts

Net interest expense

$
(4
)

$
—

Undesignated derivative instruments

Foreign exchange contracts

Other (income) expense, net

$
(11
)

$
(4
)

For the company’s fair value hedges, equal and offsetting gains of zero and $4 million were recognized in net interest expense in the second quarter and first half of 2018, respectively and an equal and offsetting loss of $1 million was recognized in net interest expense in the second quarter of 2017. IneffectivenessSupplemental balance sheet information related to ~~the company’s cash flow and fair value hedges for all periods presented were not material.~~

As of June 30, 2018, $2 million of deferred, net after-tax losses 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 values of derivative instruments reported in the condensed consolidated balance sheet~~leases as of June 30, ~~2018.~~2019 includes:

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

Foreign exchange contracts

Prepaid expenses and other

$
17

Accounts payable and
accrued liabilities

$
2

Total derivative instruments designated as hedges

$
17

$
2

Undesignated derivative instruments

Foreign exchange contracts

Prepaid expenses and other

$
—

Accounts payable
and
accrued liabilities

$
1

Total derivative instruments

$
17

$
3

(in millions)	June 30, 2019
Operating leases
Operating lease right-of-use assets	$	588

Accounts payable and accrued liabilities	$	98
Operating lease liabilities		490
Total operating lease liabilities	$	588

Finance leases
Property, plant and equipment, at cost	$	81
Accumulated depreciation		(27	)
Property, plant and equipment, net	$	54

Current maturities of long-term debt and finance lease obligations	$	1
Long-term debt and finance lease obligations		58
Total finance lease liabilities	$	59

Lease term and discount rates as of June 30, 2019 were:

	June 30, 2019
Weighted-average remaining lease term (years)
Operating leases		10
Finance leases		15
Weighted-average discount rate
Operating leases		2.8	%
Finance leases		10.3	%

Maturities of operating and finance lease liabilities as of June 30, 2019 were:

(in millions)	Finance Leases			Operating Leases
2019	$	4		$	59
2020		8			99
2021		8			83
2022		8			70
2023		6			59
Thereafter		82			297
Total minimum lease payments		116			667
Less: imputed interest		(57	)		(79	)
Present value of lease liabilities	$	59		$	588

~~The following table summarizes the classification and fair values of derivative instruments reported in the condensed consolidated balance sheet~~Future minimum lease payments as of December 31, ~~2017.~~2018, as disclosed in our 2018 Annual Report, were:

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

(in millions)	Capital Leases			Operating Leases
2019	$	8		$	122
2020		7			93
2021		7			86
2022		8			71
2023		6			64
Thereafter		88			210
Total minimum lease payments		124		$	646
Less: imputed interest		(62	)
Present value of lease liabilities	$	62

Lessor Activity

~~While the company’s derivatives~~We lease medical equipment, such as renal dialysis equipment and infusion pumps, to customers primarily in conjunction with arrangements to provide consumable medical products such as dialysis therapies, intravenous (IV) fluids and inhaled anesthetics. Certain of our equipment leases are all subject to master netting arrangements, the company presents its assets and liabilities related to derivative instruments on a gross basis within the condensed 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~~classified as ~~if they were presented on a net basis, allowing for the right of offset by counterparty.~~

June 30, 2018

December 31, 2017

(in millions)

Asset

Liability

Asset

Liability

Gross amounts recognized in the consolidated balance sheet

$
17

$
3

$
19

$
4

Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet

(3
)

(3
)

(4
)

(4
)
Total

$
14

$
—

$
15

$
—

~~Fair value measurements~~

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

Basis of fair value measurement

(in millions)

Balance as of
June 30, 2018

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

$
17

$
—

$
17

$
—

Marketable equity securities

13

6

7

—

Total assets

$
30

$
6

$
24

$
—

Liabilities

Foreign currency hedges

$
3

$
—

$
3

$
—

Contingent payments related to acquisitions

23

—

—

23

Total liabilities

$
26

$
—

$
3

$
23

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

—

Marketable equity 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

As of June 30, 2018, cash and equivalents of $2.9 billion included money market funds of approximately $1.2 billion, and as of December 31, 2017, cash and equivalents of $3.4 billion included money market funds of approximately $0.7 billion. Money market funds are considered Level 2 in the fair value hierarchy.

value these instruments are discounted cash flow and Black-Scholes models. The key inputs are considered observable and vary depending on the type of derivative, and include contractual terms, interest rate yield curves, foreign exchange rates and volatility.

Contingent payments related to acquisitions consist of milestone payments and sales-based payments, and are valued using discounted cash flow techniques. The fair value of 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 change in the liability for contingent payments related to Baxter’s acquisitions, which use significant unobservable inputs (Level 3) in the fair value measurement, were primarily driven by new contingent liabilities recognized as a result of the RECOTHROM and PREVELEAK acquisitions of approximately $14 million in the first half of 2018.

Equity investments not measured at fair value and excluded from the above table are comprised of other equity investments without readily determinable fair values of $36 million at June 30, 2018 and $43 million at December 31, 2017. These amounts are included in Other assets.

~~The following table provides information relating to the company’s investments in marketable equity securities.~~

(in millions)

Amortized cost

Unrealized gains

Unrealized losses

Fair value

June 30, 2018

$
11

$
3

$
1

$
13

December 31, 2017

$
8

$
—

$
—

$
8

~~In the first quarter of 2017, the company recorded an other-than-temporary impairment charge related to a marketable equity security of $4 million within other (income) expense, net.~~

~~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 condensed 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 condensed consolidated balance sheetssales-type leases and the ~~approximate fair values as of June 30, 2018 and December 31, 2017.~~

Book values

Approximate fair values

(in millions)

2018

2017

2018

2017

Liabilities

Current maturities of long-term debt and lease obligations

$
3

$
3

$
3

$
3

Long-term debt and lease obligations

3,495

3,509

3,479

3,595

remainder are operating leases. The ~~following tables summarize the bases used to measure the approximate fair value of the financial instruments as of June 30, 2018 and December 31, 2017.~~

Basis of fair value measurement

(in millions)

Balance as of
June 30,
2018

Quoted prices in
active markets for
identical assets
(Level 1)

Significant other
observable inputs
(Level 2)

Significant
unobservable inputs
(Level 3)

Liabilities

Current maturities of long-term debt and lease obligations

$
3

$
—

$
3

$
—

Long-term debt and lease obligations

3,479

—

3,479

—

Total liabilities

$
3,482

$
—

$
3,482

$
—

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)

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

$
—

~~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~~related contracts, including the proportion of fixed versus variable payments and ~~yield curves commensurate with~~any options to shorten or extend the ~~company’s credit risk. The carrying values of the other financial instruments approximate~~lease term, vary by customer. We allocate revenue between equipment leases and medical products based on their ~~fair values due to the short-term maturities of most of these assets and liabilities.~~

~~10. RETIREMENT AND OTHER BENEFIT PROGRAMS~~standalone selling prices.

The ~~following is a summary~~components of ~~net periodic benefit cost relating to the company’s pension and other postemployment benefit (OPEB) plans.~~

Three months ended

Six months ended

June 30,

June 30,

(in millions)

2018

2017

2018

2017

Pension benefits

Service cost

$
25

$
23

$
47

$
45

Interest cost

45

45

91

90

Expected return on plan assets

(79
)

(73
)

(157
)

(145
)
Amortization of net losses and other deferred amounts

24

41

48

81

Net periodic pension benefit cost

$
15

$
36

$
29

$
71

OPEB

Service cost

$
—

$
—

$
—

$
—

Interest cost

2

2

4

4

Amortization of net loss and prior service credit

(6
)

(7
)

(12
)

(13
)
Net periodic OPEB cost

$
(4
)

$
(5
)

$
(8
)

$
(9
)

~~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 benefitslease revenue 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 projected benefit obligation (PBO) with an offsetting adjustment against AOCI upon the effective date of the changes.

~~11. ACCUMULATED OTHER COMPREHENSIVE INCOME~~

Comprehensive income includes all changes in shareholders’ equity that do not arise from transactions with shareholders, 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. As a result of recent changes in accounting guidance related to available-for-sale equity securities, the unrealized gains and losses associated with these assets are no longer recognized in AOCI beginning January 1, 2018. The following table is a net-of-tax summary of the changes in AOCI by component for the six months ended June 30, 2018 and 2017.

(in millions)

CTA

Pension and
other employee
benefits

Hedging
activities

Available-
for-sale
securities

Total

Gains (losses)

Balance as of December 31, 2017

$
(3,013
)

$
(981
)

$
(10
)

$
3

$
(4,001
)
Adoption of new accounting standard

—

—

—

(3
)

(3
)
Other comprehensive income before reclassifications

(282
)

51

(1
)

—

(232
)
Amounts reclassified from AOCI (a)

—

30

7

—

37

Net other comprehensive income (loss)

(282
)

81

6

—

(195
)
Balance as of June 30, 2018

$
(3,295
)

$
(900
)

$
(4
)

$
—

$
(4,199
)

(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 before reclassifications

320

(8
)

(11
)

—

301

Amounts reclassified from AOCI (a)

29

46

1

3

79

Net other comprehensive income (loss)

349

38

(10
)

3

380

Balance as of June 30, 2017

$
(3,089
)

$
(1,084
)

$
(7
)

$
4

$
(4,176
)

~~(a)~~

~~See table below for details about these reclassifications.~~

~~The following is a summary of the amounts reclassified from AOCI to net income during~~ the three and six months ended June 30, ~~2018 and 2017.~~2019 were:

Amounts reclassified from AOCI (a)

(in millions)

Three months ended
June 30, 2018

Six months ended June 30, 2018

Location of impact in income statement
Amortization of pension and other employee benefits items

Actuarial losses and other (b)

$
(18
)

$
(36
)

Other (income) expense, net

(18
)

(36
)

Total before tax

3

6

Income tax expense

$
(15
)

$
(30
)

Net of tax
Losses on hedging activities

Foreign exchange contracts

$
(6
)

$
(10
)

Cost of sales

(6
)

(10
)

Total before tax

2

3

Income tax expense

$
(4
)

$
(7
)

Net of tax
Total reclassification for the period

$
(19
)

$
(37
)

Total net of tax

(in millions)	Three months ended June 30, 2019		Six months ended June 30, 2019
Sales-type lease revenue	$	5	$	11
Operating lease revenue		15		30
Variable lease revenue		21		42
Total lease revenue	$	41	$	83

Amounts reclassified from AOCI (a)

(in millions)

Three months ended
June 30, 2017

Six months ended
June 30, 2017

Location of impact in income statement
Translation adjustments

Loss on Venezuela deconsolidation

$
(29
)

$
(29
)

Other (income) expense, net

(29
)

(29
)

Total before tax

—

—

Income tax expense

$
(29
)

$
(29
)

Net of tax
Amortization of pension and other employee benefits items

Actuarial losses and other (b)

$
(34
)

$
(68
)

Other (income) expense, net

(34
)

(68
)

Total before tax

11

22

Income tax benefit

$
(23
)

$
(46
)

Net of tax
Losses on hedging activities

Foreign exchange contracts

$
(3
)

$
(1
)

Cost of sales

(3
)

(1
)

Total before tax

1

—

Income tax benefit

$
(2
)

$
(1
)

Net of tax
Available-for-sale-securities

Other-than-temporary impairment of equity securities

$
—

$
(4
)

Other (income) expense, net

—

(4
)

Total before tax

—

1

Income tax benefit

$
—

$
(3
)

Net of tax
Total reclassification for the period

$
(54
)

$
(79
)

Total net of tax

~~(a)~~

~~Amounts in parentheses indicate reductions to net income.~~

~~(b)~~

~~These AOCI components are included in the computation~~The components of our net investment in sales-type leases as of ~~net periodic benefit cost disclosed in Note 10.~~

~~Refer to Note 9 for additional information regarding hedging activity and Note 10 for additional information regarding the amortization of pension and other employee benefits items.~~

~~12. INCOME TAXES~~

~~Effective tax rate~~

~~The company’s effective income tax rate for continuing operations was 15.1% and 13.7% in the second quarters of 2018 and 2017, respectively, and 13.1% and 15.3% in the six months ended~~ June 30, 2018 and 2017, respectively. The company’s effective income tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes, and foreign taxes that are different than the U.S. federal statutory rate. In addition, the effective tax rate can be impacted each period by discrete factors and events.

The effective income tax rate for continuing operations increased during the three months ended June 30, 2018 primarily driven by the revaluation of Swedish net deferred tax assets due to legislation reducing the Swedish income tax rate. The effective income tax rate for continuing operations during the six months ended June 30, 2018 was impacted by benefits recorded relating to settlement of a 2008 through 2010 transfer pricing Competent Authority proceeding between the U.S. and Germany, the reversal of a valuation allowance as a result of continued profit improvements, receipt of tax free income from the settlement of Claris contingent matters (as described in Note 6), and adjustments of state income tax provisional amounts related to the 2017 Tax Act toll charge. In addition, windfall benefits realized from stock option exercises and vesting of RSUs associated with the company’s stock compensation programs favorably impacted the effective tax rate by approximately 3.5 percentage points. Partially offsetting the foregoing benefits was interest on the reserve for uncertain tax benefits (UTPs), the revaluation of Swedish net deferred tax assets, and some miscellaneous transfer pricing UTP accruals.2019 were:

(in millions)	June 30, 2019
Minimum lease payments	$	86
Unguaranteed residual values		11
Net investment in leases	$	97

~~13. LEGAL PROCEEDINGS~~Our net investment in sales-type leases is classified as follows in the accompanying condensed consolidated balance sheets:

~~Baxter is~~

(in millions)	June 30, 2019
Accounts and other current receivables, net	$	36
Other non-current assets		61
Total	$	97

Maturities of sales-type and operating leases as of June 30, 2019 were:

(in millions)	Sales-type Leases			Operating Leases
2019	$	17		$	24
2020		30			48
2021		24			48
2022		15			30
2023		8			16
Thereafter		2			7
Total minimum lease payments		96		$	173
Less: imputed interest		(10	)
Present value of minimum lease payments	$	86

7. COMMITMENTS AND CONTINGENCIES

We are involved in product liability, patent, commercial, and other legal matters that arise in the normal course of ~~the company’s~~our business. ~~The company records~~We record 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 ~~recorded.~~accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. As of June 30, ~~2018~~2019 and December 31, ~~2017, the company’s~~2018, our total recorded reserves, including the environmental matters discussed below, with respect to legal matters were ~~$34~~$49 million and ~~$41~~$43 million, respectively, and there were no related receivables.

~~Baxter has~~We have established reserves for certain of the matters discussed below. ~~The company is~~We are 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~~our liability ~~of the company~~ in connection with these claims cannot be estimated and the resolution thereof in any reporting period could have a significant impact on ~~the company’s~~our 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~~our consolidated financial position. While ~~the company believes~~we believe that ~~it has~~we have valid defenses in the matters set forth below, litigation is inherently uncertain, excessive verdicts do occur, and ~~the company~~we may incur material judgments or enter into material settlements of claims.

In addition to the matters described below, ~~the company remains~~we remain 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~~our operations and monetary sanctions, including significant civil or criminal penalties. With respect to intellectual property, ~~the company~~we may be exposed to significant litigation concerning the scope of ~~the company’s~~our 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~~We are involved as a potentially responsible party (PRP) for environmental clean-up costs at ~~seven~~six 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~~we are involved in an ongoing voluntary environmental remediation associated with historic operations at ~~the company’s~~our Irvine, California, United States facility. As of June 30, ~~2018~~2019 and December 31, ~~2017,~~2018, our environmental reserves, ~~of approximately~~which are measured on an undiscounted basis, were $20 million and ~~$21~~$19 million, ~~respectively, were established to address these specific estimated potential liabilities. Such reserves are undiscounted and do not include anticipated recoveries, if any, from insurance companies.~~respectively. 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~~our financial position or results of operations.

General ~~litigation~~

On July 31, 2015, 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. 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.Litigation

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. ~~On July 5, 2018, the court granted the company’s~~We filed a motion to dismiss the consolidated complaint ~~(which had been previously filed~~ in February ~~2017)~~2017. The court granted our motion to dismiss the consolidated complaint without ~~prejudice.~~prejudice in July 2018. The plaintiffs ~~have until August 9, 2018 to file~~filed an amended complaint oron September 6, 2018. We filed a motion to ~~have~~dismiss the ~~court enter a final judgement (which they can appeal).~~ amended complaint on November 9, 2018.

In April 2017, ~~the company~~we became aware of a criminal investigation by the U.S. Department of Justice (DOJ), Antitrust Division and a federal grand jury in the United States District Court for the Eastern District of Pennsylvania. ~~The company~~We 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)~~us) and communications with competitors regarding the same. ~~The company is cooperating with~~On November 30, 2018, the DOJ notified us that it had closed the investigation. The New York Attorney General has also requested that ~~Baxter~~we provide information regarding business practices in the IV saline industry. ~~The company is~~We are cooperating with the New York Attorney General.

Other

As previously disclosed, in 2008 we recalled our heparin sodium injection products in the United States. Following the recall, more than 1,000 lawsuits alleging that plaintiffs suffered various reactions to a heparin contaminant, in some cases resulting in fatalities, were filed. In January 2019, the last of these cases was settled. In the first half of 2019, following the resolution of an insurance dispute, we received cash proceeds of $35 million for our allocation of the insurance proceeds under a settlement and cost-sharing agreement related to the defense of the heparin product liability cases. We recognized a $33 million gain in connection with the resolution of the dispute with the insurer that is classified within other operating income, net on the condensed consolidated statement of income for the six months ended June 30, 2019.

In September 2017, Hurricane Maria caused damage to certain of our assets in Puerto Rico and disrupted operations. As previously disclosed, we realized $42 million of insurance recoveries in 2018 related to the damages and losses from that hurricane. In July 2019, an additional $40 million of claims were approved by our insurers and will be recognized in the quarter ending September 30, 2019.

In December 2016, ~~the company~~we received a civil investigative demand from the Commercial Litigation Branch of the ~~United States Department of Justice (DOJ)~~U.S. DOJ primarily relating to contingent discount arrangements for, and other promotion of, ~~the company’s~~our TISSEEL and ARTISS products. In April 2018, the DOJ filed a notice of its decision not to intervene and an underlying qui tam complaint (U.S. ex rel. Andrew Capp v. Baxter) was unsealed in the United States District Court for the District of Columbia. The attorney for the relator/plaintiff voluntarily dismissed the qui tam complaint on June 16, 2018. The complaint which is now fully resolved, related to contingent discount arrangements for, and other promotion of, ~~the company’s~~our TISSEEL, ARTISS and VERITAS products.

~~14. SEGMENT INFORMATION~~8. STOCKHOLDERS’ EQUITY

Cash Dividends

Cash dividends declared per common share for the three and six months ended June 30, 2019 were $0.22 and $0.41, respectively. Cash dividends declared per common share for the three and six months ended June 30, 2018 were $0.19 and $0.35, respectively.

Stock Repurchase Programs

In ~~2017, Baxter announced~~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 and by an additional $2.0 billion in November 2018. During the first half of 2019, we repurchased 9.5 million shares under this authority pursuant to Rule 10b5-1 plans and otherwise. During the first half of 2018, we repurchased 11.5 million shares pursuant to Rule 10b5-1 plans. We had $1.4 billion remaining available under the authorization as of June 30, 2019.

In December 2018, we entered into a ~~change~~$300 million accelerated share repurchase agreement (ASR Agreement) with an investment bank. We funded the ASR Agreement with available cash. The ASR Agreement was executed pursuant to the 2012 Repurchase Authorization described above. 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 on May 7, 2019.

9. ACCUMULATED OTHER COMPREHENSIVE INCOME

Comprehensive income includes all changes in ~~its commercial structure~~stockholders’ equity that do not arise from transactions with shareholders, and consists of net income, currency translation adjustments (CTA), pension and other postretirement employee benefit (OPEB) plans, unrealized gains and losses on cash flow hedges and prior to ~~improve performance, optimize costs, increase speed in the decision-making process~~2018, unrealized gains and ~~drive improved accountability across the company.~~losses on available-for-sale equity securities. As a result of changes in accounting guidance related to available-for-sale equity securities, the ~~company now reports its financial~~unrealized gains and losses associated with these assets are no longer recognized in AOCI beginning January 1, 2018. The following table is a net-of-tax summary of the changes in AOCI by component for the six months ended June 30, 2019 and 2018.

(in millions)	CTA			Pension and OPEB plans			Hedging activities			Total
Gains (losses)
Balance as of December 31, 2018	$	(3,474	)	$	(949	)	$	(1	)	$	(4,424	)
Adoption of new accounting standard		9			(169	)		(1	)		(161	)
Other comprehensive income before reclassifications		(48	)		8			(26	)		(66	)
Amounts reclassified from AOCI (a)		—			13			(1	)		12
Net other comprehensive income (loss)		(48	)		21			(27	)		(54	)
Balance as of June 30, 2019	$	(3,513	)	$	(1,097	)	$	(29	)	$	(4,639	)

(in millions)	CTA			Pension and OPEB plans			Hedging activities			Available- for-sale- equity securities			Total
Gains (losses)
Balance as of December 31, 2017	$	(3,013	)	$	(981	)	$	(10	)	$	3		$	(4,001	)
Adoption of new accounting standard		—			—			—			(3	)		(3	)
Other comprehensive income before reclassifications		(282	)		51			(1	)		—			(232	)
Amounts reclassified from AOCI (a)		—			30			7			—			37
Net other comprehensive income (loss)		(282	)		81			6			—			(195	)
Balance as of June 30, 2018	$	(3,295	)	$	(900	)	$	(4	)	$	—		$	(4,199	)

(a)	See table below for details about these reclassifications.

The following is a summary of the amounts reclassified from AOCI to net income during the three and six months ended June 30, 2019 and 2018.

	Amounts reclassified from AOCI (a)
(in millions)	Three months ended June 30, 2019			Six months ended June 30, 2019			Location of impact in income statement
Amortization of pension and OPEB items
Amortization of net losses and prior service costs or credits	$	(7	)	$	(15	)	Other income, net
		(7	)		(15	)	Total before tax
		1			2		Income tax expense
	$	(6	)	$	(13	)	Net of tax
Gains on hedging activities
Foreign exchange contracts	$	1		$	1		Cost of sales
		1			1		Total before tax
		—			—		Income tax expense
	$	1		$	1		Net of tax
Total reclassifications for the period	$	(5	)	$	(12	)	Total net of tax

	Amounts reclassified from AOCI (a)
(in millions)	Three months ended June 30, 2018			Six months ended June 30, 2018			Location of impact in income statement
Amortization of pension and OPEB items
Amortization of net losses and prior service costs or credits	$	(18	)	$	(36	)	Other income, net
		(18	)		(36	)	Total before tax
		3			6		Income tax expense
	$	(15	)	$	(30	)	Net of tax
Losses on hedging activities
Foreign exchange contracts	$	(6	)	$	(10	)	Cost of sales
		(6	)		(10	)	Total before tax
		2			3		Income tax expense
	$	(4	)	$	(7	)	Net of tax
Total reclassifications for the period	$	(19	)	$	(37	)	Total net of tax

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

Refer to Note 12 for additional information regarding the amortization of pension and OPEB items and Note 15 for additional information regarding hedging activity.

10. REVENUES

Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in the contract. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Some of our contracts have multiple performance obligations. For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. Our global payment terms are typically between 30-90 days.

The majority of our performance obligations are satisfied at a point in time. This includes sales of our broad portfolio of essential healthcare products across our geographic segments 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. For a majority of these sales, our performance obligation is satisfied upon delivery to the customer. Shipping and handling activities are considered to be fulfillment activities and are not considered to be a separate performance obligation.

To a lesser extent, in all of our segments, we enter into other types of contracts including contract manufacturing arrangements, equipment leases, and certain subscription software and licensing arrangements. We recognize revenue for these arrangements over time or at a point in time depending on our evaluation of when the customer obtains control of the promised goods or services. Revenue is recognized over time when we are creating or enhancing an asset that the customer controls as the asset is created or enhanced or our performance does not create an asset with an alternative use and we have an enforceable right to payment for performance completed.

On June 30, 2019, we had $8.9billion of transaction price allocated to remaining performance obligations related to executed contracts with an original duration of one year or more, which are primarily included in the Americas segment. Some contracts in the United States included in this amount contain index-dependent price increases, which are not known at this time. We expect to recognize approximately 10% of this amount as revenue over the remainder of 2019, 20% in each year between 2020 and 2022, 10% in each of 2023 and 2024, and the remaining balance thereafter.

Significant Judgments

Revenues from product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration for reserves related to rebates, product returns, sales discounts and wholesaler chargebacks. These reserves are based on estimates of the amounts earned or to be claimed on the related sales and are included in accounts and other current receivables, net and accounts payable and accrued liabilities on the condensed consolidated balance sheets. Management's 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 using the expected value method. 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. Revenue recognized during the three and six months ended June 30, 2019 and 2018 related to performance obligations satisfied in prior periods was not material.

Contract Balances

The timing of revenue recognition, billings and cash collections results in the recognition of trade accounts receivable, unbilled receivables, contract assets and customer advances and deposits (contract liabilities) on our condensed consolidated balance sheets. Net trade accounts receivable were $1.8 billion and $1.7 billion as of June 30, 2019 and December 31, 2018, respectively.

For contract manufacturing arrangements, revenue is primarily recognized throughout the production cycle, which typically lasts up to 90 days, resulting in the recognition of contract assets until the related services are completed and the customers are billed. Additionally, for arrangements containing a performance obligation to deliver software that can be used with medical devices, we recognize revenue upon delivery of the software, which results in the recognition of contract assets when customers are billed over time, generally over one to five years. For certain bundled contracts, total contract revenue is allocated between equipment and consumable medical products. In conjunction with these arrangements, a contract asset is created, which represents the difference between the amount of equipment revenue recognized upon sale and the amount of consideration received from the customer. The contract asset is reclassified as accounts receivable as consumable medical products are provided and billed, generally over one to seven years. Our contract asset balances totaled $89 million as of June 30, 2019, of which $37 million related to contract manufacturing services, $40 million related to software sales and $12 million related to bundled equipment and consumable medical products contracts. Our contract asset balances totaled $80 million as of December 31, 2018, of which $33 million related to contract manufacturing services and $47 million related to software sales. Contract assets are presented within accounts and other receivables, net ($57 million and $50 million as of June 30, 2019 and December 31, 2018, respectively) and other non-current assets ($32 million and $30 million as of June 30, 2019 and December 31, 2018, respectively) in the accompanying condensed consolidated balance sheets. Contract liabilities as of June 30, 2019 and December 31, 2018 were not significant.

Disaggregation of Net Sales

The following tables disaggregate our net sales from contracts with customers by Global Business Unit (GBU) between the U.S. and international:

	Three months ended June 30,
	2019						2018
(in millions)	U.S.		International		Total		U.S.		International		Total
Renal Care ¹	$	196	$	714	$	910	$	204	$	727	$	931
Medication Delivery ²		441		248		689		426		255		681
Pharmaceuticals ³		235		304		539		262		275		537
Clinical Nutrition ⁴		79		136		215		80		141		221
Advanced Surgery ⁵		143		89		232		118		86		204
Acute Therapies ⁶		44		89		133		42		87		129
Other ⁷		55		67		122		78		61		139
Total Baxter	$	1,193	$	1,647	$	2,840	$	1,210	$	1,632	$	2,842

	Six months ended June 30,
	2019						2018
(in millions)	U.S.		International		Total		U.S.		International		Total
Renal Care ¹	$	388	$	1,373	$	1,761	$	400	$	1,399	$	1,799
Medication Delivery ²		847		476		1,323		862		495		1,357
Pharmaceuticals ³		467		581		1,048		505		528		1,033
Clinical Nutrition ⁴		156		264		420		163		281		444
Advanced Surgery ⁵		263		167		430		217		169		386
Acute Therapies ⁶		92		169		261		88		170		258
Other ⁷		100		129		229		122		120		242
Total Baxter	$	2,313	$	3,159	$	5,472	$	2,357	$	3,162	$	5,519

Renal Care includes sales of our peritoneal dialysis (PD), hemodialysis (HD) and additional dialysis therapies and services.

Medication Delivery includes sales of our 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.

11. BUSINESS OPTIMIZATION CHARGES

Beginning in the second half of 2015, we have undertaken actions to transform our 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 June 30, 2019, we have incurred cumulative pre-tax costs of $899 million related to these actions. The costs consisted primarily of employee termination, implementation costs and accelerated depreciation. We currently expect to incur additional pre-tax costs of approximately $70 million through the completion of these initiatives under our current program. These costs will primarily include employee termination costs, implementation costs, and accelerated depreciation.

During the three and six months ended June 30, 2019 and 2018, we recorded the following charges related to business optimization programs.

	Three months ended				Six months ended
	June 30,				June 30,
(in millions)	2019		2018		2019		2018
Restructuring charges	$	52	$	21	$	77	$	33
Costs to implement business optimization programs		12		25		22		50
Accelerated depreciation		1		1		4		2
Total business optimization charges	$	65	$	47	$	103	$	85

For segment reporting, business optimization charges are unallocated expenses.

Costs to implement business optimization programs for the three and six months ended June 30, 2019 and 2018, respectively, consisted primarily of external consulting and transition costs, including employee compensation and related costs. The costs were generally included within cost of sales, selling, general and administrative (SG&A) expense and R&D expense.

For the three and six months ended June 30, 2019 and 2018, respectively, we recognized accelerated depreciation, primarily associated with facilities to be closed. The costs were recorded within cost of sales and SG&A expense.

During the three and six months ended June 30, 2019 and 2018, we recorded the following restructuring charges.


	Three months ended June 30, 2019
(in millions)	COGS		SG&A		R&D		Total
Employee termination costs	$	6	$	26	$	17	$	49
Contract termination and other costs		1		—		—		1
Asset impairments		1		—		1		2
Total restructuring charges	$	8	$	26	$	18	$	52


	Three months ended June 30, 2018
(in millions)	COGS		SG&A		R&D		Total
Employee termination costs	$	3	$	8	$	7	$	18
Contract termination costs		—		2		—		2
Asset impairments		—		1		—		1
Total restructuring charges	$	3	$	11	$	7	$	21


	Six months ended June 30, 2019
(in millions)	COGS		SG&A		R&D		Total
Employee termination costs	$	6	$	25	$	26	$	57
Contract termination and other costs		8		—		—		8
Asset impairments		10		1		1		12
Total restructuring charges	$	24	$	26	$	27	$	77


	Six months ended June 30, 2018
(in millions)	COGS		SG&A		R&D		Total
Employee termination costs	$	4	$	14	$	10	$	28
Contract termination costs		—		2		—		2
Asset impairments		1		2		—		3
Total restructuring charges	$	5	$	18	$	10	$	33

The following table summarizes activity in the reserves related to our restructuring initiatives.

(in millions)
Reserve as of December 31, 2018	$	101
Charges		78
Reserve adjustments		(13	)
Utilization		(60	)
Currency translation		2
Reserve as of June 30, 2019	$	108

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

Substantially all of our restructuring reserves as of June 30, 2019 relate to employee termination costs, with the remaining reserves attributable to contract termination costs. The reserves are expected to be substantially utilized by the end of 2020.

12. PENSION AND OTHER POSTRETIREMENT BENEFIT PROGRAMS

The following is a summary of net periodic benefit cost relating to our pension and OPEB plans.

	Three months ended						Six months ended
	June 30,						June 30,
(in millions)	2019			2018			2019			2018
Pension benefits
Service cost	$	19		$	25		$	38		$	47
Interest cost		43			45			90			91
Expected return on plan assets		(67	)		(79	)		(140	)		(157	)
Amortization of net losses and prior service costs		14			24			29			48
Net periodic pension benefit cost	$	9		$	15		$	17		$	29
OPEB
Interest cost	$	2		$	2		$	4		$	4
Amortization of net loss and prior service credit		(7	)		(6	)		(14	)		(12	)
Net periodic OPEB cost	$	(5	)	$	(4	)	$	(10	)	$	(8	)

13. INCOME TAXES

Our effective income tax rate was 5.5% and 15.1% for the three months ended June 30, 2019 and 2018, respectively, and 8.5% and 13.1% for the six months ended June 30, 2019 and 2018, respectively. 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 three and six months ended June 30, 2019, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily attributable to a tax benefit from the resolution of an uncertain tax position (UTP) as a result of a favorable ruling from the related taxing authority and excess tax benefits on stock compensation awards. For the three months ended June 30, 2018, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily driven by excess tax benefits on stock compensation awards, partially offset by the revaluation of Swedish net deferred tax assets due to legislation reducing the Swedish income tax rate. For the six months ended June 30, 2018, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily attributable to nontaxable income from the settlement of certain claims with the seller of the acquired operations of Claris Injectables Limited, excess tax benefits on stock compensation awards, an adjustment of provisional amounts related to U.S. tax reform, a reduction of a liability for a UTP as a result of a settlement with the related taxing authority and the reversal of a valuation allowance as a result of continued profit improvements. Partially offsetting the foregoing benefits was interest on the reserve for UTPs, the revaluation of Swedish net deferred tax assets and transfer pricing-related income tax accruals.

14. EARNINGS PER SHARE

The numerator for both basic and diluted earnings per share (EPS) is net income. 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.

	Three months ended				Six months ended
	June 30,				June 30,
(in millions)	2019		2018		2019		2018
Basic shares		510		535		511		537
Effect of dilutive securities		9		12		9		12
Diluted shares		519		547		520		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 4 million equity awards each for the three and six months ended June 30, 2019, respectively, and 4 million and 3 million equity awards for the three and six months ended June 30, 2018, respectively, because their inclusion would have had an anti-dilutive effect on diluted EPS.

15. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

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.

We are 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 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 instruments to further reduce the net exposure to foreign exchange risk. Gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and equity volatility resulting from changes in foreign exchange rates. Financial market and currency volatility may limit our ability to cost-effectively hedge these exposures.

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 a mix of fixed- and floating-rate debt that we believe is appropriate.

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 do not hold any instruments for trading purposes and none of our outstanding derivative instruments contain credit-risk-related contingent features.

All derivative instruments are recognized as either assets or liabilities at fair value in the condensed consolidated balance sheets and are classified as short-term or long-term based on the scheduled maturity of the instrument. We designate certain of our hedging instruments as cash flow, fair value, or net investment hedges.

Cash Flow Hedges

We 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. We periodically use treasury rate locks to hedge the risk to earnings associated with movements in interest rates relating to anticipated issuances of debt.

For each derivative instrument that is designated and effective as a cash flow hedge, the gain or loss on the derivative is recorded in 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 other comprehensive income (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 interest expense, net, and are primarily related to forecasted third-party sales denominated in foreign currencies, forecasted intercompany sales denominated in foreign currencies, and anticipated issuances of debt, respectively.

The notional amounts of foreign exchange contracts designated as cash flow hedges were $629 million and $775 million as of June 30, 2019 and December 31, 2018, respectively. The total notional amounts of interest rate contracts designated as cash flow hedges were $300 million and $150 million as of June 30, 2019 and December 31, 2018, respectively. The maximum term over which we have cash flow hedge contracts in place related to forecasted transactions at June 30, 2019 is 18 months for foreign exchange contracts and 30 years for interest rate contracts.

Fair Value Hedges

We periodically use interest rate swaps to convert a portion of our fixed-rate debt into variable-rate debt. These instruments hedge our earnings from changes in the fair value of debt due to fluctuations in the designated benchmark interest rate. For each derivative instrument that is designated and effective as a fair value hedge, the gain or loss on the derivative is recognized immediately to earnings, and offsets the loss or gain on the underlying hedged item. Fair value hedges are classified in interest expense, net, as they hedge the interest rate risk associated with certain of our fixed-rate debt.

There were no outstanding interest rate swap contracts designated as fair value hedges as of June 30, 2019 and December 31, 2018.

Net Investment Hedges

In May 2017, we issued €600 million of senior notes due May 2025. In May 2019, we issued €750 million of senior notes due May 2024 and €750 million of senior notes due May 2029. We have designated these debt obligations as hedges of our net investment in our 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 June 30, 2019, we had an accumulated pre-tax unrealized translation loss in AOCI of $69 million related to the Euro-denominated senior notes.

In May 2019, we entered into forward contracts designated as net investment hedges to reduce exposure to changes in currency rates on €1.2 billion of our net investment in our European operations. Those hedges were entered into in advance of the issuance of our senior notes mentioned above, were settled in the second quarter of 2019 and resulted in an insignificant loss.

Dedesignations

If it is determined that a derivative or nonderivative hedging instrument is no longer highly effective as a hedge, we discontinue hedge accounting prospectively. If we remove 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 loss or income recognition of the underlying hedged items.

There were no hedge dedesignations in the first six months of 2019 or 2018 resulting from changes in our assessment of the probability that the hedged forecasted transactions would occur.

If we terminate 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. There were no fair value hedges terminated during the first six months of 2019 and 2018.

If we terminate a net investment hedge, any gain or loss recognized in AOCI is not reclassified to earnings until we sell, liquidate, or deconsolidate the foreign investments that were being hedged. In the second quarter of 2019, we dedesignated €1.2 billion of forward contracts designated as a net investment hedge of our European operations.

Undesignated Derivative Instruments

We use forward contracts to hedge earnings from the effects of foreign exchange relating to certain of our 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 $494 million as of June 30, 2019 and $485 million as of December 31, 2018.

Gains and Losses on Derivative Instruments

The following tables summarize the income statement locations and gains and losses on our derivative instruments for the three months ended June 30, 2019 and 2018.

	Gain (loss) recognized in OCI					Location of gain (loss)	Gain (loss) reclassified from AOCI into income
(in millions)	2019			2018		in income statement	2019		2018
Cash flow hedges
Interest rate contracts	$	(23	)	$	—	Interest expense, net	$	—	$	—
Foreign exchange contracts		9			7	Cost of sales		1		(6	)
Net investment hedges		(36	)		38	Other income, net		—		—
Total	$	(50	)	$	45		$	1	$	(6	)

		Gain (loss) recognized in income
(in millions)	Location of gain (loss) in income statement	2019		2018
Undesignated derivative instruments
Foreign exchange contracts	Other income, net	$	3	$	6

The following tables summarize the income statement locations and gains and losses on our derivative instruments for the six months ended June 30, 2019 and 2018.

	Gain (loss) recognized in OCI						Location of gain (loss)	Gain (loss) reclassified from AOCI into income
(in millions)	2019			2018			in income statement	2019		2018
Cash flow hedges
Interest rate contracts	$	(34	)	$	—		Interest expense, net	$	—	$	—
Foreign exchange contracts		—			(2	)	Cost of sales		1		(10	)
Net investment hedges		(22	)		17		Other income, net		—		—
Total	$	(56	)	$	15			$	1	$	(10	)

		Gain (loss) recognized in income
(in millions)	Location of gain (loss) in income statement	2019			2018
Fair value hedges
Interest rate contracts	Interest expense, net	$	—		$	(4	)
Undesignated derivative instruments
Foreign exchange contracts	Other income, net	$	(6	)	$	(11	)

For our fair value hedges, an equal and offsetting gain of $4 million was recognized in interest expense, net as an adjustment to the underlying hedged item, fixed-rate debt, in the second quarter and first half of 2018.

As of June 30, 2019, $13 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 values of derivative instruments reported in the condensed consolidated balance sheet as of June 30, 2019.

	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 non-current assets	$	—	Other non-current liabilities	$	37
Foreign exchange contracts	Prepaid expenses and other		20	Accounts payable and accrued liabilities		1
Foreign exchange contracts	Other non-current assets		1	Other non-current liabilities		—
Total derivative instruments designated as hedges			21			38
Undesignated derivative instruments
Foreign exchange contracts	Prepaid expenses and other		—	Accounts payable and accrued liabilities		—
Total derivative instruments		$	21		$	38

The following table summarizes the classification and fair values of derivative instruments reported in the condensed consolidated balance sheet as of December 31, 2018.

	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 non-current assets	$	—	Other non-current liabilities	$	3
Foreign exchange contracts	Prepaid expenses and other		22	Accounts payable and accrued liabilities		1
Foreign exchange contracts	Other non-current assets		1	Other non-current liabilities		—
Total derivative instruments designated as hedges			23			4
Undesignated derivative instruments
Foreign exchange contracts	Prepaid expenses and other		—	Accounts payable and accrued liabilities		1
Total derivative instruments		$	23		$	5

While some of our derivatives are subject to master netting arrangements, we present our assets and liabilities related to derivative instruments on a gross basis within the condensed consolidated balance sheets. Additionally, we are not required to post collateral for any of our outstanding derivatives.

The following table provides information on our derivative positions as if they were presented on a net basis, allowing for the right of offset by counterparty.

	June 30, 2019						December 31, 2018
(in millions)	Asset			Liability			Asset			Liability
Gross amounts recognized in the consolidated balance sheet	$	21		$	38		$	23		$	5
Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet		(1	)		(1	)		(5	)		(5	)
Total	$	20		$	37		$	18		$	—

The following table presents the amounts recorded on the condensed consolidated balance sheet related to fair value hedges:

Carrying amount of hedged item

Cumulative amount of fair value hedging adjustment included in the carrying amount of the hedged item ^(a)

(in millions)

Balance as of

June 30, 2019

Balance as of

December 31, 2018

Balance as of

June 30, 2019

Balance as of

December 31, 2018

Long-term debt

103

(a) These fair value hedges were terminated prior to December 31, 2018.

16. FAIR VALUE MEASUREMENTS

The following tables summarize our financial instruments that are measured at fair value on a recurring basis.

			Basis of fair value measurement
(in millions)	Balance as of June 30, 2019		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets
Foreign exchange contracts	$	21	$	—	$	21	$	—
Marketable equity securities		4		4		—		—
Total	$	25	$	4	$	21	$	—
Liabilities
Foreign exchange contracts	$	1	$	—	$	1	$	—
Interest rate contracts		37		—		37		—
Contingent payments related to acquisitions		27		—		—		27
Total	$	65	$	—	$	38	$	27

			Basis of fair value measurement
(in millions)	Balance as of December 31, 2018		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets
Foreign exchange contracts	$	23	$	—	$	23	$	—
Marketable equity securities		3		3		—		—
Total	$	26	$	3	$	23	$	—
Liabilities
Foreign exchange contracts	$	2	$	—	$	2	$	—
Interest rate contracts		3		—		3		—
Contingent payments related to acquisitions		32		—		—		32
Total	$	37	$	—	$	5	$	32

As of June 30, 2019 and December 31, 2018, cash and cash equivalents of $2.9 billion and $1.8 billion, respectively, included money market funds of approximately $1.5 billion and $169 million, respectively, which are considered Level 2 in the fair value hierarchy.

For assets that are measured using quoted prices in active markets, the fair value is the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The majority of the derivatives entered into by us are valued using internal valuation techniques as no quoted market prices exist for such instruments. The principal techniques used to value these instruments are discounted cash flow and Black-Scholes models. The key inputs, which are considered observable and vary depending on the type of derivative, include contractual terms, interest rate yield curves, foreign exchange rates and volatility.

Contingent payments related to acquisitions, which consist of milestone payments and sales-based payments, are valued using discounted cash flow techniques. The fair value of milestone payments reflects management’s expectations of probability of payment, and increases as the probability of payment increases or the expected 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 increases or the expected 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.

	Three months ended June 30,					Six months ended June 30,
(in millions)	2019			2018		2019			2018
Fair value at beginning of period	$	31		$	23	$	32		$	9
Additions		—			—		—			14
Change in fair value recognized in earnings		(4	)		—		(4	)		—
Payments		—			—		(1	)		—
Fair value at end of period	$	27		$	23	$	27		$	23

Equity investments not measured at fair value are comprised of other equity investments without readily determinable fair values and were $39 million at June 30, 2019 and $41 million at December 31, 2018. These amounts are included in Other non-current assets.

Fair Values of Financial Instruments Not Measured at Fair Value

In addition to the financial instruments that we are required to recognize at fair value in the condensed consolidated balance sheets, we have certain financial instruments that are recognized at amortized cost or some basis other than fair value. For these financial instruments, the following table provides the values recognized in the condensed consolidated balance sheets and the estimated fair values as of June 30, 2019 and December 31, 2018.

	Book values				Fair values^(a)
(in millions)	2019		2018		2019		2018
Liabilities
Short-term debt	$	2	$	2	$	2	$	2
Current maturities of long-term debt and finance lease obligations		2		2		2		2
Long-term debt and finance lease obligations		5,157		3,473		5,440		3,460

(a)	These fair value amounts are classified as Level 2 within the fair value hierarchy as they are estimated based on observable inputs.

The carrying value of short-term debt approximates its ~~new~~fair value due to the short-term maturities of the obligations. The estimated fair values of current and long-term debt were computed by multiplying price by the notional amount of the respective debt instruments. Price is calculated using the stated terms of the respective debt instrument and yield curves commensurate with our credit risk. The carrying values of other financial instruments approximate their fair values due to the short-term maturities of most of those assets and liabilities.

17. SEGMENT INFORMATION

We manage our business based on three geographical segments: Americas (North and South America), EMEA (Europe, Middle East and Africa) and APAC (Asia Pacific). ~~Segment results for the first half of 2017 have been recast to conform to the current year presentation.~~

~~The company’s~~Our 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~~We use operating income on a segment basis to make resource allocation decisions and assess the ongoing performance of ~~the company’s~~our 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~~R&D costs, certain ~~Global Business Unit (GBU)~~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, acquisition and integration ~~and separation-related~~ costs, intangible asset amortization and asset impairments). ~~The company’s~~Our chief operating decision maker does not receive any asset information by operating segment and, accordingly, ~~the company does~~we do not report asset information by operating segment.

Financial information for ~~the company’s~~our segments is as follows.

	Three months ended				Six months ended				Three months ended				Six months ended
	June 30,				June 30,				June 30,				June 30,
(in millions)	2018		2017		2018		2017		2019		2018		2019		2018
Net sales
Net sales:
Americas	$	1,525	$	1,433	$	2,967	$	2,806	$	1,520	$	1,525	$	2,928	$	2,967
EMEA		758		666		1,482		1,297		744		758		1,449		1,482
APAC		559		506		1,070		977		576		559		1,095		1,070
Total net sales	$	2,842	$	2,605	$	5,519	$	5,080	$	2,840	$	2,842	$	5,472	$	5,519
Operating Income
Operating Income:
Americas	$	619	$	555	$	1,185	$	1,088	$	584	$	619	$	1,121	$	1,185
EMEA		162		141		313		268		162		162		307		313
APAC		131		121		248		237		137		131		258		248
Total segment operating income	$	912	$	817	$	1,746	$	1,593	$	883	$	912	$	1,686	$	1,746

The following is a reconciliation of segment

operating income to income ~~from continuing operations~~ before income taxes per the condensed consolidated statements of income.

	Three months ended						Six months ended						Three months ended						Six months ended
	June 30,						June 30,						June 30,						June 30,
(in millions)	2018			2017			2018			2017			2019			2018			2019			2018
Total segment operating income	$	912		$	817		$	1,746		$	1,593		$	883		$	912		$	1,686		$	1,746
Corporate and other		(528	)		(470	)		(930	)		(893	)		(528	)		(528	)		(947	)		(930	)
Total operating income		384			347			816			700			355			384			739			816
Net interest expense		11			13			23			27			20			11			38			23
Other (income) expense, net		(31	)		28			(49	)		39
Income from continuing operations before income taxes	$	404		$	306		$	842		$	634
Other income, net														(28	)		(31	)		(53	)		(49	)
Income before income taxes													$	363		$	404		$	754		$	842

Refer to Note 10 for additional information on Net Sales ~~by GBU~~

~~The following table represents net sales~~ by GBU.

Three months ended

Six months ended

June 30,

June 30,

(in millions)

2018

2017

2018

2017

Renal Care ¹

$
931

$
854

$
1,799

$
1,643

Medication Delivery ²

681

683

1,357

1,347

Pharmaceuticals ³

537

450

1,033

877

Clinical Nutrition ⁴

221

216

444

428

Advanced Surgery ⁵

204

178

386

346

Acute Therapies ⁶

129

112

258

218

Other ⁷

139

112

242

221

Total Baxter

$
2,842

$
2,605

$
5,519

$
5,080

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

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

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

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

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

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

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

Item 2.

Management’s ~~Discussio~~nDiscussion and Analysis of Financial Condition and Results of Operations

Refer to ~~the company’s~~our Annual Report on Form 10-K for the year ended December 31, ~~2017 (2017~~2018 (2018 Annual Report) for management’s discussion and analysis of ~~the~~our financial condition and results of ~~operations of the company.~~operations. The following is management’s discussion and analysis of ~~the~~our financial condition and results of ~~operations of the company for the three and six months ended June 30, 2018.~~

~~RESULTS OF OPERATIONS~~

~~Baxter’s income from continuing~~ operations for the three and six months ended June 30, ~~2018~~2019 and 2018.

RESULTS OF OPERATIONS

Our net income for the three and six months ended June 30, 2019 totaled $343 million, or $0.66 per diluted share, and $690 million, or $1.33 per diluted share, compared to $343 million, or $0.63 per diluted share, and $732 million, or $1.33 per diluted share, ~~compared to $264 million, or $0.48 per diluted share, and $537 million, or $0.97 per diluted share,~~ for the three and six months ended June 30, ~~2017. Income from continuing operations~~2018. Net income for the three and six months ended June 30, 2019 included special items which decreased net income by $121 million and $173 million, respectively, or $0.23 and $0.33 per diluted share, respectively, as further discussed below. Net income for the three and six months ended June 30, 2018 included special items which decreased net income ~~from continuing operations~~ by $78 million and $77 million, respectively, or $0.14 per diluted share, respectively, as further discussed below. Income from continuing operations for the three and six months ended June 30, 2017 included special items which decreased income from continuing operations by $84 million and $129 million, respectively, or $0.15 and $0.23 per diluted share, respectively, as further discussed below.

Special Items

The following table provides a summary of ~~the company’s~~our special items and the related impact by line item on ~~the company’s~~our results ~~of continuing operations~~ for the three and six months ended June 30, ~~2018~~2019 and ~~2017.~~2018.

Three months ended June 30,

Six months ended June 30,

(in millions)

2018

2017

2018

2017

Gross Margin

Intangible asset amortization expense

$
(44
)

$
(36
)

$
(85
)

$
(74
)
Business optimization items ¹

(3
)

(14
)

(9
)

(30
)
Acquisition and integration expenses ⁴

(6
)

—

(9
)

—

Litigation ⁶

—

—

(8
)

—

Product-related items ⁸

—

4

—

4

Separation-related costs ²

—

(1
)

—

(1
)
Total Special Items

$
(53
)

$
(47
)

$
(111
)

$
(101
)
Impact on Gross Margin Ratio

(1.9 pts)

(1.8 pts)

(2.0 pts)

(2.0 pts)

Marketing and Administrative Expenses

Business optimization items ¹

$
34

$
20

$
63

$
35

Separation-related costs ²

—

7

—

14

Acquisition and integration expenses ⁴

6

5

10

5

Historical reserve adjustments ³

—

—

—

(12
)
Litigation ⁶

—

—

2

—

Total Special Items

$
40

$
32

$
75

$
42

Impact on Marketing and Administrative Expense Ratio

1.4 pts

1.2 pts

1.3 pts

0.8 pts

Research and Development Expenses

Business optimization items ¹

$
10

$
1

$
13

$
(1
)
Total Special Items

$
10

$
1

$
13

$
(1
)
Claris Settlement

Claris settlement ⁵

$
—

$
—

$
(80
)

$
—

Total Special Items

$
—

$
—

$
(80
)

$
—

Other (Income) Expense, Net

Venezuela deconsolidation⁷

$
—

$
33

$
—

$
33

Total Special Items

$
—

$
33

$
—

$
33

Income Tax Expense

Impact of special items⁹

$
(25
)

$
(29
)

$
(42
)

$
(46
)
Total Special Items

$
(25
)

$
(29
)

$
(42
)

$
(46
)
Impact on Effective Tax Rate

(1.9 pts)

(3.2 pts)

(2.7 pts)

(2.4 pts)

	Three months ended June 30,						Six months ended June 30,
(in millions)	2019			2018			2019			2018
Gross Margin
Intangible asset amortization expense	$	(45	)	$	(44	)	$	(88	)	$	(85	)
Intangible asset impairment ¹		(31	)		—			(31	)		—
Business optimization items ²		(10	)		(3	)		(29	)		(9	)
Acquisition and integration expenses³		(12	)		(6	)		(17	)		(9	)
Litigation ⁴		—			—			—			(8	)
European medical devices regulation ⁵		(6	)		—			(10	)		—
Total Special Items	$	(104	)	$	(53	)	$	(175	)	$	(111	)
Impact on Gross Margin Ratio	(3.7 pts)			(1.9 pts)			(3.2 pts)			(2.0 pts)

Selling, General and Administrative (SG&A) Expenses
Business optimization items ²	$	32		$	34		$	40		$	63
Acquisition and integration expenses³		—			6			5			10
Litigation ⁴		—			—			—			2
Total Special Items	$	32		$	40		$	45		$	75
Impact on SG&A Ratio	1.1 pts			1.4 pts			0.8 pts			1.3 pts

Research and Development (R&D) Expenses
Business optimization items ²	$	23		$	10		$	34		$	13
Acquisition and integration expenses³		2			—			6			—
Total Special Items	$	25		$	10		$	40		$	13
Impact on R&D Ratio	0.8 pts			0.3 pts			0.7 pts			0.2 pts

Other Operating Income, net
Acquisition and integration expenses³	$	(4	)	$	—		$	(4	)	$	—
Insurance recovery from legacy product-related matter ⁶		—			—			(33	)		—
Claris settlement ⁷		—			—			—			(80	)
Total Special Items	$	(4	)	$	—		$	(37	)	$	(80	)

Income Tax Expense
Tax effects of special items and impact of U.S. Tax Reform⁸	$	(36	)	$	(25	)	$	(50	)	$	(42	)
Total Special Items	$	(36	)	$	(25	)	$	(50	)	$	(42	)
Impact on Effective Tax Rate	(5.3 pts)			(1.9 pts)			(3.2 pts)			(2.7 pts)

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

~~The company’s~~Our results in ~~the second quarter of 2018~~2019 included a ~~charge of $47~~$31 million asset impairment related to ~~business optimization initiatives. This included~~ a charge of $21 million related to restructuring activities, $25 million of costs to implement business optimization programs which primarily included external consulting and project employee costs, and $1 million of accelerated depreciation associated with facilities to be closed. The $21 million of restructuring included $18 million of employee termination costs, $2 million related to contract termination and other costs and $1 million related to asset impairments.developed-technology intangible asset.

The company’s results in the first half of 2018 included a charge of $85 million related to business optimization initiatives. This included a charge of $33 million related to restructuring activities, $50 million of costs to implement business optimization programs which primarily included external consulting and project employee costs, and $2 million of accelerated depreciation associated with facilities to be closed. The $33 million of restructuring included $28 million of employee termination costs, $2 million related to contract termination and other costs and $3 million related to asset impairments.

The company's results in the second quarter of 2017 included a charge of $35 million related to business optimization initiatives. This included a charge of $16 million related to restructuring activities, $16 million of costs to implement business optimization programs which primarily included external consulting and project employee costs, and $3 million of accelerated depreciation associated with facilities to be closed. The $16 million of restructuring included $7 million of employee termination costs, $4 million related to contract termination costs, and $5 million of asset impairment charges primarily related to facility closures.

The company's results in the first half of 2017 included a net charge of $64 million related to business optimization initiatives. This included a net charge of $19 million related to restructuring activities, $37 million of costs to implement business optimization programs which primarily included external consulting and project employee costs, and $8 million of accelerated depreciation associated with facilities to be closed. The $19 million of net restructuring included $9 million of employee termination costs, $5 million related to contract termination costs, and $5 million of asset impairment charges primarily related to facility closures.

~~The company's~~In 2019 and 2018, our results were impacted by costs associated with our execution of programs to optimize our organization and cost structure on a global basis. These actions included streamlining our international operations, rationalizing our manufacturing facilities, reducing our general and administrative infrastructure, re-aligning certain R&D activities and cancelling certain R&D programs. Our results in ~~2017~~2019 included ~~costs incurred related to the Baxalta separation totaling $8~~business optimization charges of $65 million in the second quarter and ~~$15~~$103 million in the first half. Our results in 2018 included business optimization charges of $47 million in the second quarter and $85 million in the first half. Refer to Note 11 within Item 1 for more information.

³	~~The company's~~Our results in 2019 included $10 million in the second quarter and $24 million in the first half of ~~2017 included a benefit of $12 million related to an adjustment to the company's historical rebates and discounts reserve.~~

⁴

~~The company’s results in 2018 include~~ acquisition and integration ~~costs~~expenses. This included integration expenses related to ~~the company’s~~our acquisitions of Claris Injectables Limited (Claris) and the RECOTHROM and PREVELEAK products in prior periods, as well as the 2019 acquisitions of 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 $12 million in the second quarter and $19 million in the first ~~half. The company’s results in 2017 include~~half of acquisition and integration ~~costs of $5 million~~expenses related to ~~the company’s acquisition~~our acquisitions of Claris ~~Injectables Limited (Claris).~~and the RECOTHROM and PREVELEAK products.

⁵⁴	~~The company’s~~Our results in the first ~~quarter~~half of ~~2018 includes a benefit of $80 million for the February 2018 settlement of certain claims related to the acquired operations of Claris.~~

⁶	~~The company’s results in~~ 2018 included a charge of $10 million related to certain product litigation.

⁷⁵

~~The company’s~~Our results in ~~2017~~2019 included ~~a charge~~costs of ~~$33~~$6 million in the second quarter and $10 million in the first half related to updating our quality systems and product labeling to comply with the ~~deconsolidation~~new medical device reporting regulation and other requirements of ~~its Venezuelan operations.~~the European Union’s regulations for medical devices that will become effective in 2020.

⁸⁶

~~The company’s~~Our results in the ~~second quarter~~first half of ~~2017 include~~2019 included a benefit of $4$33 million ~~related~~for our allocation of insurance proceeds received pursuant to ~~an adjustment to historical product reserves.~~a settlement and cost-sharing arrangement for a legacy product-related matter.

^9 7	Our results in the first half of 2018 included a benefit of $80 million for the settlement of certain claims related to the acquired operations of Claris.

⁸

Reflected in this item is the income tax impact of the special items identified in this ~~table as well as~~table. Additionally, our results in the first half of 2018 included a tax benefit of $8 million ~~from the first quarter of 2018,~~ related to ~~an update~~updates to the estimated impact of U.S. ~~federal~~Federal tax reform previously made ~~by the company.~~in 2017. The tax effect of each adjustment is based on the jurisdiction in which the adjustment is incurred and the tax laws in effect for each such jurisdiction.

NET SALES

	Three months ended																Three months ended
	June 30,				Percent change												June 30,				Percent change
(in millions)	2018		2017		At actual currency rates			At constant currency rates			U.S. Cyclophosphamide			Acquisitions			2019		2018		At actual currency rates			At constant currency rates			U.S. cyclophosphamide⁽¹⁾
United States	$	1,210	$	1,131		7	%		7	%		(1	)%		4	%	$	1,193	$	1,210		(1	)%		(1	)%		(1	)%
International		1,632		1,474		11	%		4	%		0	%		1	%		1,647		1,632		1	%		8	%		0	%
Total net sales	$	2,842	$	2,605		9	%		5	%		0	%		2	%	$	2,840	$	2,842		(0	)%		4	%		0	%


	Six months ended																Six months ended
	June 30,				Percent change												June 30,				Percent change
(in millions)	2018		2017		At actual currency rates			At constant currency rates			U.S. Cyclophosphamide			Acquisitions			2019		2018		At actual currency rates			At constant currency rates			U.S. cyclophosphamide⁽¹⁾
United States	$	2,357	$	2,234		6	%		6	%		0	%		3	%	$	2,313	$	2,357		(2	)%		(2	)%		(1	)%
International		3,162		2,846		11	%		4	%		0	%		1	%		3,159		3,162	(0		)%		7	%		0	%
Total net sales	$	5,519	$	5,080		9	%		5	%		0	%		2	%	$	5,472	$	5,519		(1	)%		3	%		0	%

(1)	The amounts reflect the impact of U.S. cyclophosphamide net sales on constant currency sales growth for the current period.

Foreign currency ~~favorably~~unfavorably impacted net sales by 4 percentage points during the second quarter and first half of ~~2018,~~2019, respectively, compared to the prior ~~periods~~period principally due to the ~~weakening~~strengthening of the U.S. ~~dollar~~Dollar relative to the Euro, Australian Dollar, British Pound, Chinese Yuan, Colombian Peso and ~~Chinese Yuan.~~Brazilian Real.

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

~~The company is presenting~~We have disclosed the impact of generic competition for U.S. cyclophosphamide on our net sales to enhance comparability between periods and better identify operating trends.

On July 27, 2017, Baxter completed the acquisition of Claris, a wholly owned subsidiary of Claris Lifesciences Limited, for total cash consideration of $629 million, net of cash acquired. In the three and six months ended June 30, 2018, consolidated Baxter results include $33 million and $69 million, respectively, of net sales related to the Claris acquisition.

On March 19, 2018, Baxter 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 includes an upfront payment of approximately $148 million, a post-closing payment estimated at $12 million and potential contingent payments in the future. In the three months ended June 30, 2018, consolidated Baxter results include $17 million of net sales of RECOTHROM and PREVELEAK.

Global Business Unit Net Sales Reporting

~~The company’s~~Our global business units (GBUs) include the following:

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

•

Renal Care includes sales of our peritoneal dialysis (PD), hemodialysis (HD) and additional dialysis therapies and services.

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

•

Medication Delivery includes sales of our intravenous (IV) therapies, infusion pumps, administration sets and drug reconstitution devices.

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

•

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 the company’s parenteral nutrition (PN) therapies.~~

•

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.

~~Advanced Surgery~~ ~~includes sales of the company’s 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).

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

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

•

Other primarily includes sales of contract manufacturing services from our pharmaceutical partnering business.

The following is a summary of net sales by GBU.


	Three months ended June 30,				Percent change												Three months ended June 30,				Percent change
(in millions)	2018		2017		At actual currency rates			At constant currency rates			U.S. Cyclophosphamide			Acquisitions			2019		2018		At actual currency rates			At constant currency rates			U.S. cyclophosphamide⁽¹⁾
Renal Care	$	931	$	854		9	%		4	%		0	%		0	%	$	910	$	931		(2	)%		3	%		0	%
Medication Delivery		681		683		0	%		(2	)%		0	%		0	%		689		681		1	%		4	%		0	%
Pharmaceuticals		537		450		19	%		16	%		(3	)%		8	%		539		537		0	%		4	%		(2	)%
Clinical Nutrition		221		216		2	%		(3	)%		0	%		0	%		215		221		(3	)%		2	%		0	%
Advanced Surgery		204		178		15	%		12	%		0	%		10	%		232		204		14	%		17	%		0	%
Acute Therapies		129		112		15	%		10	%		0	%		0	%		133		129		3	%		8	%		0	%
Other		139		112		24	%		20	%		0	%		0	%		122		139		(12	)%		(9	)%		0	%
Total Baxter	$	2,842	$	2,605		9	%		5	%		0	%		2	%	$	2,840	$	2,842	(0		)%		4	%		0	%


	Six months ended June 30,				Percent change												Six months ended June 30,				Percent change
(in millions)	2018		2017		At actual currency rates			At constant currency rates			U.S. Cyclophosphamide			Acquisitions			2019		2018		At actual currency rates			At constant currency rates			U.S. cyclophosphamide⁽¹⁾
Renal Care	$	1,799	$	1,643		9	%		4	%		0	%		0	%	$	1,761	$	1,799		(2	)%		3	%		0	%
Medication Delivery		1,357		1,347		1	%		(1	)%		0	%		0	%		1,323		1,357		(3	)%	(0		)%		0	%
Pharmaceuticals		1,033		877		18	%		14	%		(2	)%		8	%		1,048		1,033		1	%		5	%		(2	)%
Clinical Nutrition		444		428		4	%		(2	)%		0	%		0	%		420		444		(5	)%		(1	)%		0	%
Advanced Surgery		386		346		12	%		8	%		0	%		5	%		430		386		11	%		15	%		0	%
Acute Therapies		258		218		18	%		12	%		0	%		0	%		261		258		1	%		6	%		0	%
Other		242		221		10	%		4	%		0	%		0	%		229		242		(5	)%		(2	)%		0	%
Total Baxter	$	5,519	$	5,080		9	%		5	%		0	%		2	%	$	5,472	$	5,519		(1	)%		3	%		0	%

(1)

The amounts reflect the impact of U.S. cyclophosphamide net sales on constant currency sales growth for the current period.

On a constant currency basis, Renal Care net sales increased 9% during the second quarter and first half of ~~2018, respectively. Excluding the impact of foreign~~2019, driven by global patient growth in PD partially offset by lower U.S. in-center HD sales.

On a constant currency basis, Medication Delivery net sales increased 4%during the second quarter and were flat during the first half of 2019. The increase in the second quarter of 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. The increase in the second quarter was offset by a decline in the first quarter compared to the prior year due to higher sales in 2018 of our large volume parenterals (LVPs) as customer demand increased due to industry-wide supply challenges.

On a constant currency basis, Pharmaceuticals net sales increased during the second quarter and first half of ~~2018, respectively, driven by global~~2019. The increase in 2019 was due to growth in ~~the PD business as well as~~international pharmacy compounding sales and increased sales ~~internationally in the HD business.~~of our generic injectables. Partially offsetting those increases were reduced sales of U.S. cyclophosphamide and BREVIBLOC due to increased generic competition.

~~Medication Delivery~~On a constant currency basis, Clinical Nutrition net sales ~~were flat~~increased during the second quarter and ~~increased 1%~~decreased during the first half of ~~2018. Excluding~~2019. The increase in the ~~impact~~second quarter was due to the launch of ~~foreign~~new products. The decrease in the first half of 2019 was due to lower U.S. sales of our PN therapies and related products.

On a constant currency basis, Advanced Surgery net sales ~~decreased 2% and 1%, respectively,~~increased during the second quarter and first half of ~~2018. Net~~2019, primarily driven by higher sales were negatively impacted by lower growth than anticipated in the U.S. for the company’s large volume parenterals (LVPs) and supply constraints associated with the company’s small volume parenterals (SVPs) as a result of ~~Hurricane Maria. The company expects~~a temporary supply ~~levels for SVPs to continue to improve throughout the remainder~~disruption of ~~the year.~~a competitor.

~~Pharmaceuticals~~On a constant currency basis, Acute Therapies net sales increased ~~19% and 18%, respectively,~~ during the second quarter and first half of ~~2018. Excluding~~2019 due to higher global demand for our CRRT systems to treat acute kidney injuries, including the ~~impact~~launch of ~~foreign~~PrisMax in several countries across Europe and Asia.

On a constant currency basis, Other net sales increased 16% and 14% in the second quarter and first half of 2018, respectively. The increase in 2018 was a result of strength in the company’s U.S. injectables business, which benefited from increased sales of BREVIBLOC due to competitive supply constraints. Beginning in the back half of 2018, the company expects sales of BREVIBLOC to be negatively impacted due to an improved competitor supply and additional competition entering the market. Strength in the company’s other premixed injectables and the international hospital pharmacy compounding business also contributed to growth in the second quarter and first half of 2018. Partially offsetting the increase was a reduction in net sales for TransDerm Scop in the first quarter of 2018 due to a temporary supply disruption for an alternative product in the prior year and a reduction in U.S. sales due to the impact of Hurricane Maria in the first quarter of 2018. The acquisition of Claris in 2017 also contributed $33 million and $69 million, respectively, of net sales in the second quarter and first half of 2018. Sales of U.S. cyclophosphamide decreased ~~from $50 million in~~

~~the second quarter of 2017 to $45million in the second quarter of 2018 and from $96 million in the first half of 2017 to $87million in the first half of 2018. The company continues to expect sales of U.S. cyclophosphamide to decrease over the remainder of 2018 due to the entry of competitors into the market.~~

~~Clinical Nutrition net sales increased 2% and 4%, respectively,~~ during the second quarter and first half of ~~2018. Excluding the impact of foreign currency, net~~2019 in comparison to strong sales decreased 3% and 2%, respectively, during the second quarter and first half of 2018. Results were driven by improved volumes internationally for the company’s nutritional therapies offset by the impact of Hurricane Maria as customers in the U.S. have not yet returned to their historical purchasing patterns that preceded the hurricane.

Advanced Surgery net sales increased 15% and 12%, respectively, during the second quarter and first half of 2018. Excluding the impact of foreign currency, net sales increased 12% and 8% in the second quarter and first half of 2018, respectively, primarily driven by the acquisition of RECOTHROM and PREVELEAK from Mallinckrodt, which contributed $17 million of net sales in the second quarter of 2018, and improved sales internationally for the company’s core hemostats and sealants.

Acute Therapies net sales increased 15% and 18%, respectively, during the second quarter and first half of 2018. Excluding the impact of foreign currency, net sales increased 10% and 12% in the second quarter and first half of 2018, respectively, due to higher demand for the company’s CRRT systems and a benefit from an intense flu season in the first quarter.

Other net sales increased 24% and 10%, respectively, during the second quarter and first half of 2018. Excluding the impact of foreign currency, net sales increased 20% and 4% in the second quarter and first half 2018, respectively, due to the timing of certain items compared to the prior-year period and favorable performance in the ~~company’s contract manufacturing businesses.~~ prior year.

Gross Margin and Expense Ratios

Three months ended

Six months ended

June 30,

June 30,

(as a percentage of net sales)

2018

2017

Change

2018

2017

Change
Gross margin

43.6
%

43.5
%

0.1 pts

42.6
%

42.8
%

(0.2 pts)
Marketing and administrative expenses

24.0
%

24.2
%

(0.2 pts)

23.6
%

23.5
%

0.1 pts

	Three months ended June 30,
	2019		% of net sales			2018		% of net sales			$ change			% change
Gross margin	$	1,159		40.8	%	$	1,239		43.6	%	$	(80	)		(6.5	)%
SG&A	$	642		22.6	%	$	681		24.0	%	$	(39	)		(5.7	)%
R&D	$	166		5.8	%	$	174		6.1	%	$	(8	)		(4.6	)%


	Six months ended June 30,
	2019		% of net sales			2018		% of net sales			$ change			% change
Gross margin	$	2,239		40.9	%	$	2,353		42.6	%	$	(114	)		(4.8	)%
SG&A	$	1,242		22.7	%	$	1,303		23.6	%	$	(61	)		(4.7	)%
R&D	$	295		5.4	%	$	314		5.7	%	$	(19	)		(6.1	)%

Gross Margin

The special items identified above had an unfavorable impact of approximately ~~1.9~~3.7 and ~~2.0~~3.2 percentage points on the gross margin ratio in the second quarter and first half of ~~2018,~~2019, respectively. The unfavorable impact was ~~1.8~~1.9 and 2.0 percentage points in the second quarter and first half of ~~2017,~~2018, respectively. Refer to the Special Items caption above for additional detail.

Excluding the impact of the special items, the gross margin ratio ~~increased~~decreased in the second quarter ~~but decreased in the~~and first half of ~~2018 from~~2019 compared to the prior ~~year. Contributing~~year due to ~~the variance was operational expansion offset by the negative impact of foreign exchange rates~~an unfavorable product mix as well as inventory write-downs and incremental ~~supply chain~~ costs relating to improvements at a dialyzer facility in the ~~company absorbed~~U.S. that experienced manufacturing issues during the ~~first half of 2018. In addition, the impact of lost sales due to Hurricane Maria in the first~~second quarter of ~~2018 contributed to the reduction in the gross margin ratio in the first half of 2018.~~2019.

~~Marketing and Administrative Expenses~~SG&A

The special items identified above had an unfavorable impact of approximately ~~1.4~~1.1 and ~~1.3~~0.8 percentage points on the ~~marketing and administrative expense~~SG&A expenses ratio in the second quarter and first half of ~~2018,~~2019, respectively. The unfavorable impact was ~~1.2~~1.4 and ~~0.8~~1.3 percentage points in the second quarter and first half of ~~2017,~~2018, respectively. Refer to the Special Items caption above for additional detail.

Excluding the impact of the special items, the ~~marketing and administrative~~SG&A expenses ratio decreased in the second quarter and first half of ~~2018 declined~~2019 primarily due to ~~the~~favorable foreign currency translation and actions ~~taken by the company~~we took to ~~rebase its~~restructure our cost ~~structure~~position and focus on expense ~~management. These savings were~~management, partially offset by ~~decreased benefits to~~ the ~~marketing and administrative expenses ratio from lower~~absence of transition service income ~~(approximately 50 basis points in the three and six months ended June 30, 2018)~~that we earned following our spinoff of Baxalta Incorporated (Baxalta), as the agreement ~~with Baxalta~~ for ~~these~~those services ~~continues to wind down, and increased freight expenses~~terminated as the company works to ensure adequate product availability to meet customer needs (approximately 10 and 25 basis points in the three and six months ended June 30, 2018, respectively). In addition, the change in the estimated useful life of the company’s ERP systems contributed to the reduction in the marketing and administrative expense ratio in the second quarter and first half of 2018 (approximately 20 basis points in the three and six months ended June 30, 2018).

~~Research and Development~~July 1, 2018.

Three months ended
June 30,

Percent

Six months ended
June 30,

Percent

(in millions)

2018

2017

change

2018

2017

change

Research and development expenses

$
174

$
155

12
%

$
314

$
282

11
%
As a percentage of net sales

6.1
%

6.0
%

5.7
%

5.6
%

R&D

The special items identified above had an unfavorable impact of approximately ~~$10 million~~0.8 and ~~$13 million~~0.7 percentage points on the R&D expenses ratio in the second quarter and first half of 2019, respectively. The unfavorable impact was 0.3 and 0.2 percentage points in the second quarter and first half of 2018, respectively. Refer to the Special Items caption above for additional detail.

Excluding the impact of the special items, ~~research and development~~R&D expenses ~~increased~~decreased in the second quarter and first half of ~~2018~~2019 as a result of ~~foreign exchange rates. Expenses in the periods were also impacted by~~ the timing of ~~certain~~ project-related ~~expenditures.~~expenditures compared to the prior year, actions we took to restructure our cost position and focus on expense management, and favorable foreign currency translation.

Business Optimization Items

Beginning in the second half of 2015, ~~the company initiated~~we have undertaken actions to transform ~~its~~our cost structure and enhance operational efficiency. These efforts include restructuring the organization, optimizing ~~the~~our manufacturing footprint, R&D operations and supply chain network, employing disciplined cost management, and centralizing and streamlining certain support functions. Through June 30, ~~2018, the company has~~2019, we have incurred ~~pretax~~cumulative pre-tax costs of ~~$661~~$899 million related to these actions. The costs consisted primarily of employee termination costs, implementation costs, and accelerated depreciation. ~~The company expects~~We currently expect to incur additional ~~pretax~~pre-tax costs of approximately ~~$170 million and capital expenditures of~~ $70 million related to these initiatives, ~~by the end of 2018. These costs will~~ primarily ~~include~~related to employee termination costs and implementation ~~costs, and accelerated depreciation. These~~costs. The reductions in our cost base from these actions in the aggregate are expected to provide ~~future~~cumulative annual ~~pretax~~pre-tax savings of approximately $1.2 ~~billion.~~billion once the remaining actions are complete. The savings from these actions will impact cost of sales, ~~marketing and administrative~~SG&A expenses, and ~~research and development~~R&D expenses. Approximately 8090 percent of the expected annual ~~pretax~~pre-tax savings are expected to be realized by the end of ~~2018,~~2019, with the remainder by the end of ~~2020.~~2023.

~~Refer~~Other Operating Income, Net

Other operating income, net was $4 million and $37 million in the second quarter and first half of 2019, respectively, and $80 million in the first half of 2018. In the second quarter of 2019, we recognized a benefit of $4 million related to ~~Note 8~~the change in ~~Item 1 for additional information regarding~~ the ~~company’s business optimization initiatives.~~estimated fair value of contingent consideration liabilities. In the first half of 2019, we recognized a $33 million gain 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 the prior period, we settled certain claims with the seller related to the acquired operations of Claris, which resulted in a gain of $80 million.

~~Net~~ Interest Expense, Net

~~Net interest~~Interest expense, net was $20 million and $38 million in the second quarter and first half of 2019, respectively, and $11 million and $23 million in the second quarter and first half of 2018, ~~respectively,~~respectively. The increase in the second quarter and ~~$13~~first half of 2019 was primarily driven by higher average debt outstanding and lower interest income as a result of lower average cash and cash equivalents balances.

Other Income, Net

Other income, net was $28 million and ~~$27~~$53 million in the second quarter and first half of ~~2017, respectively. The decrease in the second quarter~~2019, respectively, and ~~first half of 2018 was primarily driven by higher interest income earned in the quarter as a result of favorable interest rates.~~

~~Other (Income) Expense, Net~~

~~Other (income) expense, net was income of~~ $31 million and $49 million in the second quarter and first half of 2018, ~~respectively,~~respectively. The decrease in the second quarter of 2019 compared to the prior year was primarily due to fair value declines in marketable equity securities in the current year. The increase in the first half of 2019 compared to the prior year was primarily due to the impairment of an investment in the prior-year period and ~~expense of $28 million~~higher pension benefits in the current-year period, partially offset by lower foreign exchange gains in the current-year period.

Income Taxes

Our effective income tax rate was 5.5% and ~~$39 million~~15.1% in the second quarter and ~~first half of 2017, respectively. The change was a result of a net pension benefit of $14 million~~8.5% and $26 million, respectively, in the second quarter and first half of 2018, as compared to a net pension expense of $8 million and $17 million, respectively, in the second quarter and first half of 2017. The benefit in the current year was primarily driven by reduced amortization expense as a result of the changes in the company’s U.S. pension plans that were announced in January 2018. Refer to Note 10 within Item 1 for additional information regarding the U.S. pension changes. Additionally, in the second quarter and first half of 2018, the company recognized higher income from foreign currency fluctuations principally related to intercompany receivables, payables and monetary assets denominated in a foreign currency, compared to the prior year periods. Special items during the periods presented included the $33 million loss on the deconsolidation of the company’s Venezuelan subsidiary in the second quarter of 2017.

~~Income Taxes~~

~~The company’s effective income tax rate for continuing operations was 15.1% and 13.7% in the second quarter and~~ 13.1% ~~and 15.3%~~ for the first half of 2019 and 2018, ~~and 2017,~~ respectively. ~~The company’s~~Our effective income tax rate ~~differs~~can differ from the 21% U.S. ~~federal~~Federal statutory rate ~~each year~~ due to ~~certain operations that are subject to~~a number of factors, including foreign rate differences, tax incentives, ~~state~~increases or decreases in valuation allowances and ~~local taxes,~~liabilities for uncertain tax positions and ~~foreign taxes that are different than~~excess tax benefits on stock compensation awards. For the ~~U.S. federal statutory rate. In addition, the effective tax rate can be impacted each period by discrete factors~~three and ~~events.~~

~~The effective income tax rate for continuing operations during the~~ six months ended June 30, ~~2018 decreased~~2019, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily attributable to a tax benefit from the ~~six~~resolution of an uncertain tax position (UTP) as a result of a favorable ruling from the related taxing authority and excess tax benefits on stock compensation awards. For the three months ended June 30, ~~2017, due, in part, to benefits recordedrelating to settlement of a 2008 through 2010 transfer pricing Competent Authority proceeding~~2018, the difference between our effective income tax rate and the U.S. and Germany, the reversal of a valuation allowance as a result of continued profit improvements, receipt of tax free income from the settlement of Claris contingent matters, and adjustments of state income tax provisional amounts related to the 2017 Tax Act toll charge. Partially offsetting the foregoing benefitsFederal statutory rate was ~~interest on the reserve for uncertain~~primarily driven by excess tax benefits ~~(UTPs), a charge during the second quarter due to~~on stock compensation awards, partially offset by the revaluation of Swedish net deferred tax assets due to legislation reducing the Swedish income tax rate, and some miscellaneous transfer pricing UTP accruals. In addition, windfall benefits realized from stock option exercises and vesting of RSUs associated with the company’s stock compensation programs had a lower favorable impact on the effective tax rate in 2018 compared to 2017.

The 2017 Tax Act lowered the U.S. Federal rate from 35% to 21% and generally exempts foreign income from U.S. taxation. The benefit from the reduction of the U.S. Federal rate on U.S. income and the ability to repatriate foreign earnings exempt from U.S. Federal tax was almost wholly offset by additional tax charges related to the 2017 Tax Act. These charges included the disallowance of salary deductions in excess of $1 million for certain highly paid executives, including stock compensation, as well as lost tax benefits from the allocations of certain U.S. expenses to exempt foreign income. At this time, the company’s first half 2018 provision does not include any tax charge related to either the Global Intangible Low Taxed Income (GILTI) and Base Erosion Anti-Abuse Tax (BEAT) provisions as the company does not believe that it is subject to either.

Other than the foregoing state tax toll charge adjustment, the company continues to refine its 2017 Tax Act provisional amounts; additionally, the company continues to evaluate the potential impact of the 2017 Tax Act’s GILTI and BEAT provisions, including any related tax accounting elections. The company expects to complete its provisional accounting within the one-year measurement period.

~~Income from Continuing Operations and Earnings per Diluted Share~~

~~Income from continuing operations was $343 million and $264 million for the three months ended June 30, 2018 and 2017, respectively, and $732 million and $537 million for~~rate. For the six months ended June 30, 2018, the difference between our effective income tax rate and ~~2017, respectively. Income~~the U.S. Federal statutory rate was primarily attributable to nontaxable income from ~~continuing~~the settlement of certain claims with the seller of the acquired operations ~~per diluted share~~of Claris, excess tax benefits on stock compensation awards, an adjustment of provisional amounts related to U.S. tax reform, a reduction of a liability for a UTP as a result of a settlement with the related taxing authority and the reversal of a valuation allowance as a result of continued profit improvements. Partially offsetting the foregoing benefits was ~~$0.63~~interest on the reserve for UTPs, the revaluation of Swedish net deferred tax assets and $0.48 for the three months ended June 30, 2018 and 2017, respectively, and $1.33 and $0.97 for the six months ended June 30, 2018 and 2017, respectively. The significant factors and events contributing to the changes are discussed above.

~~Income from Discontinued Operations~~

~~Discontinued operations were insignificant for both periods presented. Refer to Note 3 within Item 1 for additional information regarding the separation of Baxalta.~~transfer pricing-related income tax accruals.

Segment Results

~~The company uses~~We use operating income on a segment basis to make resource allocation decisions and assess the ongoing performance of ~~the company’s~~our segments. The following is a summary of significant factors impacting ~~the~~our reportable segments’ financial results.

	Net sales								Operating income												Net sales								Operating income (loss)
	Three months ended				Six months ended				Three months ended						Six months ended						Three months ended				Six months ended				Three months ended						Six months ended
	June 30,				June 30,				June 30,						June 30,						June 30,				June 30,				June 30,						June 30,
(in millions)	2018		2017		2018		2017		2018			2017			2018			2017			2019		2018		2019		2018		2019			2018			2019			2018
Americas	$	1,525	$	1,433	$	2,967	$	2,806	$	619		$	555		$	1,185		$	1,088		$	1,520	$	1,525	$	2,928	$	2,967	$	584		$	619		$	1,121		$	1,185
EMEA		758		666		1,482		1,297		162			141			313			268			744		758		1,449		1,482		162			162			307			313
APAC		559		506		1,070		977		131			121			248			237			576		559		1,095		1,070		137			131			258			248
Corporate and other		—		—		—		—		(528	)		(470	)		(930	)		(893	)		—		—		—		—		(528	)		(528	)		(947	)		(930	)
Total	$	2,842	$	2,605	$	5,519	$	5,080	$	384		$	347		$	816		$	700		$	2,840	$	2,842	$	5,472	$	5,519	$	355		$	384		$	739		$	816

Americas

Segment operating income was $584 million and $1,121 million, respectively, in the second quarter and first half of 2019 and $619 million and $1,185 million, respectively, in the second quarter and first half of 2018. The decrease in the second quarter of 2019 was primarily driven by lower sales and gross margin in Pharmaceuticals. Lower sales and gross margin in Medication Delivery and Clinical Nutrition in the first quarter of 2019 contributed to the decrease in the first half of ~~2018~~2019. Partially offsetting the decreases in the second quarter and ~~$555~~first half of 2019 was favorable performance in Advanced Surgery primarily due to a temporary supply disruption of a competitor.

EMEA

Segment operating income was $162 million and ~~$1,088~~$307 million, respectively, in the second quarter and first half ~~2017. The increase in 2018 was primarily driven by increased net sales~~of 2019 and ~~gross margin as a result of the Claris and RECOTHROM and PREVELEAK acquisitions and higher sales of~~

BREVIBLOC due to its use as a substitute product during a market shortage. Also, driving performance during the quarter and first half of 2018 was improved performance in Renal Care, driven primarily by PD growth. Negatively impacting performance in the first half of 2018 was the impact of Hurricane Maria.

~~EMEA~~

~~Segment operating income was~~ $162 million and $313 million, respectively, in the second quarter and first half of 2018. The decrease in the first half of ~~2018~~2019 was primarily driven by unfavorable foreign exchange rates partially offset by increased sales and ~~$141~~gross margin in Renal Care and Pharmaceuticals.

APAC

Segment operating income was $137 million and ~~$268~~$258 million, respectively, in the second quarter and first half ~~2017. The increase in 2018 was primarily driven by higher net sales across multiple GBUs, primarily in Western Europe,~~of 2019 and ~~improved margins primarily as a result of product mix.~~

~~APAC~~

~~Segment operating income was~~ $131 million and $248 million, respectively, in the second quarter and ~~the~~ first half of ~~2018 and $121 million and $237 million, respectively, in the second quarter and first half 2017.~~2018. Results in ~~2018~~2019 were ~~primarily~~ driven by higher sales ~~across multiple GBUs,~~and gross margin, primarily from China and ~~Australia.~~Australia, in Renal Care and Pharmaceuticals.

Corporate and ~~other~~Other

Certain ~~income~~items are maintained at Corporate and ~~expense amounts~~ are not allocated to a segment. ~~These amounts~~They primarily include certain foreign currency hedging activities, corporate headquarters costs, certain R&D costs, certain GBU support costs, stock compensation ~~expense, non-strategic investments and related income and~~ expense, certain employee benefit plan costs as well as certain gains, losses, and other charges (such as business optimization, acquisition and integration costs, intangible asset amortization and asset impairments). The operating loss in the second quarter of 2019 was consistent with the prior-year period as higher business optimization charges and an impairment of a developed-technology intangible asset were offset by lower SG&A and R&D expenses. The operating loss in the first half of 2019 increased over the prior-year period due to an impairment of a developed-technology intangible asset, higher business optimization charges and the benefit from the Claris settlement in the prior year, partially offset by a benefit for our allocation of insurance proceeds received pursuant to a settlement and cost-sharing arrangement for a legacy product-related matter in the current year and lower SG&A and R&D expenses.

LIQUIDITY AND CAPITAL RESOURCES

The following table is a summary of the statement of cash flows for the ~~six month~~six-month periods ended June 30, ~~2018~~2019 and ~~2017.~~2018.

	Six months ended						Six months ended
	June 30,						June 30,
(in millions)	2018			2017			2019			2018
Cash flows from operations - continuing operations	$	852		$	767		$	617		$	852
Cash flows from investing activities		(539	)		(313	)		(462	)		(539	)
Cash flows from financing activities		(808	)		566			968			(808	)

Cash Flows from Operations — Continuing Operations

~~Operating cash flows from continuing operations increased during~~In the first half of ~~2018~~2019, cash provided by operating activities was $617 million, as compared to ~~the prior year period. The increase was driven~~cash provided by ~~the factors discussed below.~~

~~Net Income~~

Net income, as adjusted for certain non-cash items, such as depreciation and amortization, net periodic pension benefit and OPEB costs, stock compensation, deferred income taxes and other items increased in the six months ended June 30, 2018 compared to 2017.

~~Accounts Receivable~~

~~Cash flows relating to accounts receivable were flat compared to the prior year. Days sales outstanding decreased from 53.4 days to 52.7 days period over period.~~

~~Inventories~~

~~Cash flows relating to inventories had a larger negative impact on cash flows in the first half~~operating activities of 2018 as compared to the prior year period. The following is a summary of inventories as of June 30, 2018 and December 31, 2017, as well as annualized inventory turns for the first half of 2018 and 2017.

Inventories

Annualized inventory
turns for the six

June 30,

December 31,

months ended June 30,

(in millions, except inventory turn data)

2018

2017

2018

2017

Total company

$
1,622

$
1,475

3.8

3.7

~~Other~~

The changes in accounts payable and accrued liabilities were a $109 million outflow in the first half of 2018 compared to a $112 million outflow in the first half of 2017. The changes were primarily driven by the timing of supplier payments. Days payable outstanding increased to 56.2 days in the first half of 2018 compared to 51.6 days in the prior year.

Payments related to the execution of the company’s business optimization initiatives decreased from $79 million in the first half of 2017 to $47 million in the first half of 2018. Refer to Note 8 within Item 1 for further information regarding the company’s business optimization initiatives.

~~Changes in other balance sheet items include outflows of $84 million and $95~~$852 million in the first half of 2018, ~~and 2017, respectively.~~a decrease of $235 million. The ~~change~~decrease was primarily ~~driven~~due to the Claris settlement received in 2018 and the timing of customer and vendor payments, partially offset by an insurance recovery received in 2019 from a ~~higher pension contribution in the first half of 2017.~~legacy product-related matter.

Cash Flows from Investing Activities ~~— Continuing Operations~~

~~Capital Expenditures~~

~~Capital~~In the first half of 2019, cash used for investing activities included payments for acquisitions of $111 million, primarily related to the U.S. rights to multiple products we acquired, and capital expenditures ~~were $311 million and $279 million in~~of $352 million. In the first half of 2018, ~~and 2017, respectively. The company’s capital expenditures in 2018 were driven by targeted investments in projects to support production of PD and IV solutions.~~

~~Acquisitions and Investments~~

~~Cash outflows relating to~~cash used for investing activities included payments for acquisitions ~~and investments~~ of $228 million, ~~in the first half of 2018 were~~ primarily ~~driven by the $148 million acquisition of~~related to RECOTHROM and PREVELEAK ~~from Mallinckrodt~~ and ~~the acquisition of~~ two ~~products~~molecules from Celerity ~~for $72~~Pharmaceuticals, LLC, and capital expenditures of $311 million. ~~Cash outflows relating to acquisitions and investments of $36 million in the first half of 2017 were driven primarily by the acquisition of the rights to Clindamycin Saline from Celerity.~~

~~Divestitures and Other Investing Activities~~

~~Cash inflows from divestitures and other investing activities in the first half of 2018 and 2017 were not significant.~~

Cash Flows from Financing Activities

~~Debt Issuances, Net~~In the first half of ~~Payments~~2019, cash generated from financing activities included the net proceeds from the issuance of ~~Obligations~~

~~Cash flows related to debt~~€750 million of senior notes due in 2024 and ~~other financing obligations~~€750 million of senior notes due in 2029 along with stock issued under employee benefit plans of $262 million, partially offset by payments for stock repurchases of $720 million and dividend payments of $198 million. In the first half of 2018, ~~were insignificant. Net~~ cash ~~inflows related to debt~~used for financing activities included payments for stock repurchases of $781 million and ~~other financing obligations totaled $633 million for the first half of 2017 primarily due to the issuance of~~ ~~€600~~ ~~million of senior notes at a fixed coupon rate of 1.30% due in May 2025.~~

~~Other Financing Activities~~

~~Cash~~ dividend payments ~~totaled~~of $173 million, ~~and $141 million in~~partially offset by the first half of 2018 and 2017, respectively. The increase in cash dividend payments was primarily due to an increase in the quarterly dividend rate from $0.13 to $0.16 per share for quarterly dividends declared between May 2017 and May 2018. In addition, the company increased the quarterly dividend rate from $0.16 to $0.19 per share for quarterly dividends declared beginning May 2018.

~~Proceeds~~proceeds from stock issued under employee benefit plans ~~decreased from $200 million in the first half~~ of ~~2017 to~~ $170 ~~million in the first half of 2018, primarily due to decreased option exercises in the first half of 2018.~~million.

As authorized by the Board of Directors, ~~the company repurchases its~~we repurchase our stock depending upon ~~the company’s~~our cash flows, net debt ~~level~~levels and market conditions. In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of ~~the company’s~~our common stock. The Board of Directors increased this authority by an additional $1.5 billion in each of November 2016 and February 2018 and by an additional ~~$1.5~~$2.0 billion in ~~February~~November 2018. ~~The company~~We paid ~~$781~~$720 million in cash to repurchase approximately ~~11.5~~9.5 million shares under this authority pursuant to Rule 10b5-1 plans and otherwise in the first half of ~~2018~~2019 and had ~~$1.8~~$1.4 billion remaining available under this authorization ~~(as amended and after giving effect to stock repurchases)~~ as of June 30, ~~2018.~~2019.

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 on May 7, 2019.

Credit Facilities and Access to Capital and Credit Ratings

Credit Facilities

As of June 30, ~~2018, the company’s~~2019, our U.S. dollar-denominated revolving credit facility and Euro-denominated senior revolving credit facility had a maximum capacity of $1.5 billion and approximately €200 million, respectively. There were no amounts outstanding under our credit facilities at June 30, 2019 or December 31, 2018, respectively. As of June 30, ~~2018, the company was~~2019, 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 each institution’s respective commitment.

Access to Capital and Credit Ratings

~~The company intends~~We intend to fund short-term and long-term obligations as they mature through cash on hand, future cash flows from operations or by issuing additional debt. ~~The company~~We had $2.9 billion of cash and cash equivalents as of June 30, ~~2018,~~2019, with adequate cash available to meet operating requirements in each jurisdiction in which ~~the company operates. The company invests its~~we operate. We invest our excess cash in ~~certificates of deposit and~~ money market funds and ~~diversifies~~diversify the concentration of cash among different financial institutions.

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

~~The company continues to do business with foreign governments in certain countries, including Greece, Spain, Portugal~~ Between February and ~~Italy, which have experienced a deterioration in credit~~July 2019, Standard & Poor’s, Fitch, and ~~economic conditions. As of June 30, 2018, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $133 million.~~

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

~~Credit Ratings~~

~~The company’s~~Moody’s reaffirmed our investment grade credit ratings ~~at June 30,~~that we disclosed in our 2018 ~~were as follows.~~Annual Report.

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

~~In the first quarter of 2018, Moody’s upgraded Baxter’s senior unsecured debt ratings from Baa2 to Baa1, and Fitch upgraded Baxter’s senior unsecured debt ratings from BBB+ to A-.~~

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 ~~the company’s~~our significant accounting policies is included in Note 1 to ~~the company’s~~our consolidated financial statements in ~~the 2017~~our 2018 Annual Report. Certain of ~~the company’s~~

our accounting policies are considered critical, as these policies are the most important to the depiction of ~~the company’s~~our financial statements and require significant, difficult or complex judgments, often employing the use of estimates about the effects of matters that are inherently uncertain. Such policies are summarized in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in ~~the 2017~~our 2018 Annual Report. ~~Excluding the paragraph below, there~~There have been no significant changes in the ~~company’s~~ application of ~~its~~our critical accounting policies during the first half of ~~2018.~~2019.

~~Revenue Recognition~~RECENT ACCOUNTING PRONOUNCEMENTS

~~The company’s revenues from product sales are recorded~~In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASU) 2016-13, Financial Instruments - Credit Losses, which requires the measurement of expected credit losses for financial instruments held at the ~~net sales price (transaction price), which includes estimates of variable consideration for reserves related to rebates, product returns, sales discounts and wholesaler chargebacks~~. ~~These reserves are~~reporting date based on ~~estimates of the amounts earned or to be claimed on the related sales. Management's estimates take into consideration~~ historical experience, current ~~contractual~~conditions and ~~statutory requirements, specific known market events~~reasonable forecasts. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and ~~trends, industry data, and forecasted customer buying and payment patterns. Overall, these reserves reflect~~other commitments to extend credit held by a reporting entity at each reporting date. The standard is effective for our financial statements beginning in 2020. We are currently evaluating the ~~company’s best estimates~~impact of the ~~amount~~adoption of ~~consideration to which~~this ASU, but it is ~~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.~~

The company’s 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 may require significant judgment.

~~The company does not expect the new standard related to revenue recognition~~expected to have a material ~~impact~~effect on ~~its~~our condensed consolidated financial statements.

In August 2018, the FASB issued ASC 2018-15, Intangibles-Goodwill and Other-Internal-Use Software, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The standard is effective for our financial statements ~~as compared~~beginning in 2020. We are currently evaluating the impact of the adoption of this ASU, but it is not expected to ~~historical revenue recognition guidelines. Refer to Notes 1 and 2 within Item 1 for further information.~~have a material effect on our condensed consolidated financial statements.

LEGAL CONTINGENCIES

Refer to Note 137 within Item 1 for a discussion of ~~the company’s~~our legal contingencies. Upon resolution of any of these uncertainties, ~~the company~~we may incur charges in excess of presently established liabilities. While ~~the~~our liability ~~of the company~~ in connection with certain claims cannot be estimated with any certainty, and although the resolution in any reporting period of one or more of these matters could have a significant impact on ~~the company’s~~our 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~~our consolidated financial position. While ~~the company believes~~we believe that ~~it has~~we have valid defenses in these matters, litigation is inherently uncertain, excessive verdicts do occur, and ~~the company~~we may in the future incur material judgments or enter into material settlements of claims.

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, at which time FDA issued a related Form-483 (Claris 483). In July 2018, FDA issued a Warning Letter based on observations identified in the 2017 inspection (Claris Warning Letter).¹ The Claris Warning Letter includes a number of observations across a variety of areas. ~~The company is preparing its~~We submitted our response to the Claris Warning Letter in August 2018 and iswe are continuing to implement corrective and preventive actions, which have included product recalls that are financially immaterial to ~~the company,~~us, to address FDA’s observations as set forth in the Claris 483 or the Claris Warning Letter and other items identified in connection with integrating Claris into ~~the company’s~~our quality systems. We had a Regulatory Meeting with FDA on November 6, 2018 and we continue to cooperate with FDA in connection with the resolution of these matters.

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 contains 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 483 or the Claris Warning Letter. We responded to the Show Cause Notice and are cooperating with the regulatory authorities.

In June 2013, ~~the company~~we received a Warning Letter from FDA regarding operations and processes at ~~its~~our North Cove, North Carolina and Jayuya, Puerto Rico facilities. ~~The company~~We attended Regulatory Meetings with ~~the~~ FDA regarding one or both of these facilities in October 2014, November 2015, July 2017, April 2018 and ~~April~~October 2018. The Warning Letter addresses observations related to Current Good Manufacturing Practice violations at the two facilities.

As previously disclosed, 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 the 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 July 2019, the deferred prosecution agreement expired and, based on Baxter’s fulfillment of the terms of the agreement, the court dismissed the criminal information previously filed in the case with prejudice.

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

FORWARD-LOOKING INFORMATION

This quarterly report includes forward-looking statements. Use of the words “may,” “will,” “would,” “could,” “should,” “believes,” “estimates,” “projects,” “potential,” “expects,” “plans,” “seeks,” “intends,” “evaluates,” “pursues,” “anticipates,” “continues,” “designs,” “impacts,” “affects,” “forecasts,” “target,” “outlook,” “initiative,” “objective,” “designed,” “priorities,” “goal,” or the negative of those words or other similar expressions is intended to identify forward-looking statements that represent our current judgment about possible future events. These forward-looking statements may include statements with respect to accounting estimates and assumptions, litigation-related matters including outcomes, future regulatory filings and ~~the company’s~~our R&D pipeline (including estimates regarding ~~the company’s~~our ability to ~~have new product approved out of its Baxter Ahmedabad facility~~obtain approval for distribution in the

U.S.) of new products manufactured at our Baxter Ahmedabad facility), 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, ~~the company’s~~our exposure to financial market volatility and foreign currency and interest rate risks, potential tax liability associated with the separation of ~~the company’s~~our biopharmaceuticals and medical products businesses (including the 2016 disposition of ~~the company’s~~our formerly retained shares in Baxalta (Retained Shares)), the impact of competition, future sales growth, business development activities (including the recent acquisitions of Claris Injectables and two surgical products from Mallinckrodt plc) ~~and Hurricane Maria related~~, the effects of product recalls or production disruptions, business optimization initiatives, cost saving initiatives, future capital and R&D expenditures, future debt issuances, manufacturing expansion, the sufficiency of ~~the company’s~~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 ~~the company’s~~our experience and perception of historical trends, current conditions, and expected future developments as well as other factors that ~~the company believes~~we believe are appropriate in the circumstances. While these statements represent ~~the company’s~~our current judgment on what the future may hold, and ~~the company believes~~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:

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

•

failure to achieve our long-term financial improvement goals;

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

•

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

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

•

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

product quality or patient safety issues, leading to product recalls, withdrawals, launch delays, warning letters (including the recently issued Claris Warning Letter), import bans, sanctions, seizures, litigation, or declining sales;

•

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

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

•

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

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

•

product quality or patient safety issues, leading to product recalls, withdrawals, launch delays, warning letters (including the Claris Warning Letter), import bans, sanctions, seizures, litigation, or declining sales;

~~breaches or failures of the company’s information technology systems, including by cyberattack;~~

•

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

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 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;

•

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

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

•

breaches or failures of our information technology systems or products, including by cyber-attack, unauthorized access or theft;

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 the company’s business, including new or amended laws, rules and regulations (such as the European Union’s General Data Protection Regulation which became effective in May 2018 for example);

•

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

~~global regulatory, trade and tax policies;~~

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

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

•

proposed regulatory changes of the U.S. Department of Health and Human Services in kidney health policy (AAKHI) 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;

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

•

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

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

•

future actions of third parties, including third-party payers, the impact of healthcare reform and the 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 and the European Union’s General Data Protection Regulation which became effective in May 2018 for example);

the impact of any future tax liability with respect to the separation and distribution, including with respect to transactions with Baxalta regarding its separation and distribution and the Retained Shares;

•

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

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

•

global regulatory, trade and tax policies;

~~the impact of global economic conditions (including potential trade wars) on the company and its customers and suppliers, including foreign governments in countries in which the company operates;~~

•

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;

~~fluctuations in foreign exchange and interest rates;~~

•

the impact of any goodwill impairments on our operating results;

~~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;~~

•

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

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

•

the impact of global economic conditions (including potential trade wars) on us and our customers and suppliers, including foreign governments in countries in which we operate;

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

•

fluctuations in foreign exchange and interest rates;

~~the outcome of pending or future litigation;~~

•

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;

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

•

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 report and other filings with the Securities and Exchange Commission, including those factors described in Item 1A of the company’s Annual Report on Form 10-K for the year ended December 31, 2017, all of which are available on the company’s website.
•
the outcome of pending or future litigation;

•

the adequacy of our cash flows from operations to meet our ongoing cash obligations and fund our investment program; and

•

other factors identified elsewhere in this report and other filings with the Securities and Exchange Commission, including those factors described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, all of which are available on our website.

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

Item 3.

Quantitative and Qualitative D~~isclosures~~Disclosures About Market Risk

Currency Risk

~~The company is~~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 and ~~New Zealand Dollar. The company manages its~~Swedish Krona. We manage our foreign currency exposures on a consolidated basis, which allows ~~the company~~us to net exposures and take advantage of any natural offsets. In addition, ~~the company uses~~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. Financial market and currency volatility may limit ~~the company’s~~our ability to cost-effectively hedge these exposures.

~~The company~~We may use options, forwards and cross-currency swaps to hedge the foreign exchange risk to earnings relating to forecasted transactions denominated in foreign currencies and recognized assets and liabilities. The maximum term over which ~~the company has~~we have cash flow hedge contracts in place related to foreign exchange risk on forecasted transactions as of June 30, ~~2018~~2019 is 1518 months. ~~The company~~We also ~~enters~~enter into derivative instruments to hedge foreign exchange risk on certain intercompany and third-party receivables and payables and debt denominated in foreign currencies.

As part of ~~its~~our risk-management program, ~~the company performs~~we perform sensitivity analyses to assess potential changes in the fair value of ~~its~~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 option and forward contracts outstanding atas of June 30, ~~2018,~~2019, while not predictive in nature, indicated that if the U.S. Dollar uniformly weakened by 10% against all currencies, on a net-of-tax basis, the net asset balance of ~~$11~~$15 million with respect to those contracts would decrease by ~~$21~~$26 million, resulting in a net liability position.

The sensitivity analysis model recalculates the fair value of the foreign exchange option and forward contracts outstanding at June 30, ~~2018~~2019 by replacing the actual exchange rates at June 30, ~~2018~~2019 with exchange rates that are 10% weaker compared to the actual exchange rates for each applicable currency. All other factors are held constant. ~~The~~These sensitivity ~~analysis disregards~~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 ~~analysis~~analyses also ~~disregards~~disregard the offsetting change in value of the underlying hedged transactions and balances.

~~The company’s~~Our operations in Argentina are reported using highly inflationary accounting effective July 1, ~~2018 and its functional currency is the U.S. dollar.~~2018. Changes in the value of the Argentine ~~peso versus the U.S. dollar~~Peso applied to our peso-denominated net monetary asset positions are recorded in income at the time of the change. As of June 30, ~~2018, the company’s~~2019, our net monetary assets denominated in Argentine ~~pesos~~Pesos are not significant.

Interest Rate and Other Risks

Refer to the caption “Interest Rate and Other Risks” in the “Financial Instrument Market Risk” section of the ~~2017~~2018 Annual Report. There were no significant changes during the quarter ended June 30, ~~2018.~~2019.

Item 4.

Controls and ~~Procedures~~Procedures

Evaluation of Disclosure Controls and Procedures

~~Baxter~~We carried out an evaluation, under the supervision and with the participation of ~~its~~our Disclosure Committee and management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of ~~Baxter’s~~our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of June 30, ~~2018.~~2019. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that ~~the company’s~~our disclosure controls and procedures were effective as of June 30, ~~2018.~~2019.

Changes in Internal Control over Financial Reporting

We are currently implementing an upgrade to our enterprise resource planning (ERP) software. In connection with the ERP upgrade, we are updating the processes that constitute our internal control over financial reporting, as necessary. This normal course of business ERP upgrade is being implemented to remain current with the latest release of the software.

In 2017, related to ~~its~~our overall business optimization initiatives, ~~the company~~we began implementation of a business transformation project within the finance, human resources, purchasing and information technology functions which will further centralize and standardize business processes and systems across the company. ~~The company is~~We are transitioning some processes to ~~its~~our shared services centers while others ~~are moving~~have moved to outsourced providers. This multi-year initiative ~~will be~~is being conducted in phases and ~~include~~includes modifications to the design and operation of controls over financial reporting.

With the exception of the above, there have been no changes in ~~Baxter’s~~our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, ~~2018~~2019 that have materially affected, or are reasonably likely to materially affect, ~~Baxter’s~~our internal control over financial reporting.

Review by Independent Registered Public ~~Accounting~~Accounting Firm

A review of the interim condensed consolidated financial ~~information~~statements included in this Quarterly Report on Form 10-Q for the three and six months ended June 30, ~~2018~~2019 and ~~2017~~2018 has been performed by PricewaterhouseCoopers LLP, ~~the company’s~~our independent registered public accounting firm. Its report on the interim condensed consolidated financial information follows. This report is not considered a report within the meaning of Sections 7 and 11 of the Securities Act of 1933 and, therefore, the independent accountants’ liability under Section 11 does not extend to it.

Report of Independent Registered Public Accounting Firm

To theBoard of Directors and ~~Shareholders~~Stockholders of Baxter International Inc.

Results of Review of Interim Financial Statements

We have reviewed the ~~accompanying~~ condensed consolidatedbalance sheet ofBaxter International Inc. and its subsidiaries(the “Company”) as ofJune 30, ~~2018,~~2019, and the related condensed consolidated statements of income, ~~and of~~ comprehensive income and changes in equity for the three-month and six-month periods ended June 30, 2019 and 2018 and ~~2017 and~~ the related condensed consolidated statements of cash flows for the six-month periods ended June 30, ~~2018~~2019 and ~~2017,~~ 2018,including the related notes, appearing under Part I, Item 1 of this Quarterly Report on Form 10-Q (collectively referred to as the “interim financialstatements”).Based on our reviews, we are not aware of any material modifications that should be made to the ~~accompanying~~ interim financial statements referred to aboveforthem to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, ~~2017,~~2018 and the related consolidated statements of income, of comprehensive income, ~~of cash flows, and of~~ changes in equity and cash flows for the year then ended (not presented herein), and in our report dated February ~~23,~~21, 2019, which included a paragraph describing a change in the manner of accounting for certain pension and postretirement net periodic benefit costs in the 2018 financial statements, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the ~~accompanying~~condensed consolidated balance sheet ~~information~~ as of December 31, ~~2017,~~2018, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

These interim financial statements arethe responsibility of the Company’s management.We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ~~(“PCAOB”)~~(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 review in accordance with the standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

/s/PricewaterhouseCoopers LLP

Chicago, Illinois

~~August 6, 2018~~July 30, 2019

PART II. OTHER ~~INFORMATION~~INFORMATION

Item 1.

Legal Proceedings

The information in Part I, Item 1, Note 147 is incorporated herein by reference.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

The following table includes information about ~~the company’s~~our common stock repurchases during the three-month period ended June 30, ~~2018.~~2019.

Issuer Purchases of Equity Securities	Issuer Purchases of Equity Securities									Issuer Purchases of Equity Securities

Period		Total number of shares purchased ⁽¹⁾		Average price paid per share		Total number of shares purchased as part of publicly announced program⁽¹⁾		Approximate dollar value of shares that may yet be purchased under the program⁽¹⁾			Total number of shares purchased ⁽¹⁾		Average price paid per share		Total number of shares purchased as part of publicly announced program⁽¹⁾		Approximate dollar value of shares that may yet be purchased under the program⁽¹⁾
April 1, 2018 through April 30, 2018			1,803,900	$	65.81		1,803,900
May 1, 2018 through May 31, 2018			1,993,700	$	70.53		1,993,700
June 1, 2018 through June 30, 2018			—	$	—		—
April 1, 2019 through April 30, 2019												749,300	$	80.68		749,300
May 1, 2019 through May 31, 2019⁽²⁾												1,254,787	$	76.59		1,254,787
June 1, 2019 through June 30, 2019												—	$	—		—
Total			3,797,600	$	68.29		3,797,600	$	1,837,825,592			2,004,087	$	78.12		2,004,087	$	1,447,516,465

(1)

In July 2012, ~~the company~~we announced that ~~its board~~our Board of ~~directors~~Directors authorized ~~the company~~us to repurchase up to $2.0 billion of ~~its~~our common stock on the open market or in private transactions. The ~~board~~Board of ~~directors~~Directors increased this authority by an additional $1.5 billion in each of November 2016 and February 2018 and by an additional $2.0 billion in November 2018. During the second quarter of ~~2018, the company~~2019, we repurchased ~~3.8~~1.4 million shares under this authority pursuant to Rule 10b5-1 plans ~~for $259 million under this program. $1.8~~and otherwise. We had $1.4 billion ~~remained available~~remaining under this program (as amended and after giving effect to stock repurchases) as of June 30, ~~2018.~~2019. This program does not have an expiration date.

(2)

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. The ASR Agreement was executed pursuant to the 2012 Repurchase Authorization described above. 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 on May 7, 2019.

Item 6.

E~~xhibits~~Exhibits

Exhibit Index:

Exhibit Number		Description

4.2		Twelfth Supplemental Indenture, dated as of May 15, 2019, between Baxter International Inc. (the “Company”) and The Bank of New York Mellon Trust Company, N.A., as Trustee (including form of 0.400% Senior Note due 2024 and form of 1.300% Senior Note due 2029) (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K, filed May 15, 2019).
15*		Letter Re Unaudited Interim Financial Information

31.1*		Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as ~~amended~~amended..

31.2*		Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.

32.1*		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of ~~2002~~.2002.

32.2*		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of ~~2002~~.2002.

101.INS*		XBRL Instance Document

101.SCH*		XBRL Taxonomy Extension Schema Document

101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB*		XBRL Taxonomy Extension Label Linkbase Document

101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document

*	Filed herewith.

~~Signature~~Signature

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

		BAXTER INTERNATIONAL INC.
		(Registrant)

Date: ~~August 6, 2018~~July 30, 2019	By:	/s/ James K. Saccaro
		James K. Saccaro
		Executive Vice President and Chief Financial Officer
		(duly authorized officer and principal financial officer)

	Three months ended June 30, 2017							Six months ended June 30, 2017
	As Previously Reported		Reclassification			As Reclassified		As Previously Reported		Reclassification			As Reclassified

Cost of sales	$	1,475	$	(2	)	$	1,473	$	2,908	$	(4	)	$	2,904
Gross margin		1,130		2			1,132		2,172		4			2,176
Marketing and administrative expenses		635		(5	)		630		1,205		(11	)		1,194
Research and development expenses		156		(1	)		155		284		(2	)		282
Operating income		339		8			347		683		17			700
Other (income) expense, net		20		8			28		22		17			39

(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

(in millions)
Cash	$	160
Contingent consideration		14
Total consideration	$	174

(in millions)
Assets acquired
Accounts receivable	$	2
Inventory		61
Goodwill		9
Other intangible assets		102
Total assets acquired	$	174

	Three months ended
	June 30, 2017
(in millions)	COGS		SGA		R&D		Total
Employee termination costs	$	4	$	3	$	—	$	7
Contract termination costs		—		4		—		4
Asset impairments		5		—		—		5
Total restructuring charges	$	9	$	7	$	—	$	16

(in millions)
Reserves as of December 31, 2017	$	112
Charges		30
Utilization		(47	)
CTA		(20	)
Reserves as of June 30, 2018	$	75

			Basis of fair value measurement
(in millions)	Balance as of June 30, 2018		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	$	17	$	—	$	17	$	—
Marketable equity securities		13		6		7		—
Total assets	$	30	$	6	$	24	$	—
Liabilities
Foreign currency hedges	$	3	$	—	$	3	$	—
Contingent payments related to acquisitions		23		—		—		23
Total liabilities	$	26	$	—	$	3	$	23

			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		—
Marketable equity 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

(in millions)	Amortized cost		Unrealized gains		Unrealized losses		Fair value
June 30, 2018	$	11	$	3	$	1	$	13
December 31, 2017	$	8	$	—	$	—	$	8

	Book values				Approximate fair values
(in millions)	2018		2017		2018		2017
Liabilities
Current maturities of long-term debt and lease obligations	$	3	$	3	$	3	$	3
Long-term debt and lease obligations		3,495		3,509		3,479		3,595

			Basis of fair value measurement
(in millions)	Balance as of June 30, 2018		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Liabilities
Current maturities of long-term debt and lease obligations	$	3	$	—	$	3	$	—
Long-term debt and lease obligations		3,479		—		3,479		—
Total liabilities	$	3,482	$	—	$	3,482	$	—

			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)
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	$	—

(in millions)	CTA			Pension and other employee benefits			Hedging activities			Available- for-sale securities			Total
Gains (losses)
Balance as of December 31, 2017	$	(3,013	)	$	(981	)	$	(10	)	$	3		$	(4,001	)
Adoption of new accounting standard		—			—			—			(3	)		(3	)
Other comprehensive income before reclassifications		(282	)		51			(1	)		—			(232	)
Amounts reclassified from AOCI (a)		—			30			7			—			37
Net other comprehensive income (loss)		(282	)		81			6			—			(195	)
Balance as of June 30, 2018	$	(3,295	)	$	(900	)	$	(4	)	$	—		$	(4,199	)

	Amounts reclassified from AOCI (a)
(in millions)	Three months ended June 30, 2017			Six months ended June 30, 2017			Location of impact in income statement
Translation adjustments
Loss on Venezuela deconsolidation	$	(29	)	$	(29	)	Other (income) expense, net
		(29	)		(29	)	Total before tax
		—			—		Income tax expense
	$	(29	)	$	(29	)	Net of tax
Amortization of pension and other employee benefits items
Actuarial losses and other (b)	$	(34	)	$	(68	)	Other (income) expense, net
		(34	)		(68	)	Total before tax
		11			22		Income tax benefit
	$	(23	)	$	(46	)	Net of tax
Losses on hedging activities
Foreign exchange contracts	$	(3	)	$	(1	)	Cost of sales
		(3	)		(1	)	Total before tax
		1			—		Income tax benefit
	$	(2	)	$	(1	)	Net of tax
Available-for-sale-securities
Other-than-temporary impairment of equity securities	$	—		$	(4	)	Other (income) expense, net
		—			(4	)	Total before tax
		—			1		Income tax benefit
	$	—		$	(3	)	Net of tax
Total reclassification for the period	$	(54	)	$	(79	)	Total net of tax

	Three months ended June 30,						Percent			Six months ended June 30,						Percent
(in millions)	2018			2017			change			2018			2017			change
Research and development expenses	$	174		$	155			12	%	$	314		$	282			11	%
As a percentage of net sales		6.1	%		6.0	%					5.7	%		5.6	%

	Inventories				Annualized inventory turns for the six
	June 30,		December 31,		months ended June 30,
(in millions, except inventory turn data)	2018		2017		2018		2017
Total company	$	1,622	$	1,475		3.8		3.7