BAXTER INTERNATIONAL INC

As of January 1, 2019, we adopted Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842).  Under this 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.  We adopted Topic 842 using the modified retrospective method.  We elected the following practical expedients when assessing the transition impact: i) not to reassess whether any expired or existing contracts as 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 $502 million as of January 1, 2019. The impact to the condensed consolidated statements of income was not material and there was no net impact to the condensed consolidated statements of cash flows.

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 $1.7 billion as of March 31, 2019 and December 31, 2018.

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. Our contract asset balances totaled $73 million as of March 31, 2019, of which $34 million related to contract manufacturing services and $39 million related to software sales. 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 ($50 million as of March 31, 2019 and December 31, 2018) and other ($23 million and $30 million as of March 31, 2019 and December 31, 2018, respectively) in the accompanying condensed consolidated balance sheets. Contract liabilities as of March 31, 2019 and December 31, 2018 were not significant.

Our effective income tax rate was 11.3% and 11.2% for the three months ended March 31, 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 months ended March 31, 2019, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily attributable to excess tax benefits on stock compensation awards. For the three months ended March 31, 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 related to 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 and a reduction of a liability for an uncertain tax position as a result of a settlement with the related taxing authority.

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 quarter 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 three months ended March 31, 2019.

Other income, net was $25 million and $18 million in the first quarters of 2019 and 2018, respectively. The increase was primarily due to a benefit in the current-year period from fair value adjustments in marketable equity securities, an impairment of an investment in the prior-year period, and higher pension benefits in the current-year period. Partially offsetting the benefits were lower foreign exchange gains in the current-year period.    

Our effective income tax rate was 11.3% and 11.2% for the three months ended March 31, 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 months ended March 31, 2019, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily attributable to excess tax benefits on stock compensation awards. For the three months ended March 31, 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 related to the acquired operations of Claris, excess tax benefits on stock compensation awards, an adjustment of provisional amounts related to U.S. tax reform and a reduction in a liability for an uncertain tax position as a result of a settlement with the related taxing authority.