2. SEPARATION OF BAXALTA INCORPORATED

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

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

For a portion of Baxalta’s operations, the legal transfer of Baxalta’s assets and liabilities did not occur with the separation of Baxalta on July 1, 2015 due to the time required to transfer marketing authorizations and other regulatory requirements in certain countries. Under the terms of the International Commercial Operations Agreement (ICOA), Baxalta is subject to the risks and entitled to the benefits generated by these operations and assets until legal transfer; therefore, the net economic benefit and any cash collected by these entities by Baxter are transferred to Baxalta. As of September 30, 2017, all countries have been separated.

Following is a summary of the operating results of Baxalta, which have been reflected as discontinued operations for the three and nine months ended September 30, 2017 and 2016. The assets and liabilities have been classified as held for disposition as of December 31, 2016. All assets and liabilities have been transferred as of September 30, 2017.

	Three months ended September 30,					Nine months ended September 30,
(in millions)	2017		2016			2017			2016
Major classes of line items constituting income from discontinued operations before income taxes
Net sales	$	1	$	24		$	7		$	144
Cost of sales		—		(20	)		(5	)		(135	)
Marketing and administrative expenses		—		—			(1	)		(20	)
Income (loss) from discontinued operations before income taxes		1		4			1			(11	)
Gain on disposal of discontinued operations		2		—			2			17
Income tax expense		—		1			—			10
Income (loss) from discontinued operations, net of tax	$	3	$	3		$	3		$	(4	)

	December 31,
(in millions)	2016
Carrying amounts of major classes of assets included as part of discontinued operations
Accounts and other current receivables, net	$	48
Property, plant, and equipment, net		1
Other		1
Total assets of the disposal group	$	50

Carrying amounts of major classes of liabilities included as part of discontinued operations
Accounts payable and accrued liabilities	$	3
Total liabilities of the disposal group	$	3

As of December 31, 2016, Baxter recorded a liability of $47 million for its obligation to transfer these net assets to Baxalta.

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. 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 and nine months ended September 30, 2017, the company recognized approximately $11 million and $47 million, respectively, as a reduction to marketing and administrative expenses related to the TSA. In the three and nine months ended September 30, 2016, the company recognized approximately $26 million and $79 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 nine months ended September 30, 2017, Baxter recognized approximately $6 million and $18 million, respectively, in sales to Baxalta. In the three and nine months ended September 30, 2016, Baxter recognized approximately $6 million and $31 million, respectively, in sales to Baxalta. In addition, in the three and nine months ended September 30, 2017, Baxter recognized $35 million and $133 million, respectively, in cost of sales related to purchases from Baxalta pursuant to the MSA. In the three and nine months ended September 30, 2016, Baxter recognized $47 million and $139 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 $20 million and inflows of $3 million were reported in cash flows from operations – discontinued operations for the nine-month periods ending September 30, 2017 and 2016, respectively. These relate to non-assignable tenders whereby Baxter remains the seller of Baxalta products, transactions related to importation services Baxter provides in certain countries, in addition to trade payables settled post local separation on Baxalta’s behalf.