Baxter International Annual Report 2004

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FY2004 Annual Report · Baxter International

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Baxter International Inc. 2004 Annual Report

THE VALUE WITHIN

Manufacturing
presence in
28 countries

48,000
employees

Serving patients
and clinicians
in more than
110 countries

Expanding access
to healthcare

Improving
patient safety

Diversiﬁed
portfolio

Product
innovation

Biotechnology

THE VALUE WITHIN

Medical devices

Specialty
pharmaceuticals

Global reach
with local
commitment

Essential
therapies for
life-threatening
conditions

Strong
global brand

Dedicated to
meeting customer
and patient needs

MAKING
A DIFFERENCE
WORLDWIDE

The Value Within

Baxter’s strong technology platforms, extensive global presence, unparalleled manufacturing expertise,

and dedicated employees enable us to deliver signiﬁcant value to patients, healthcare providers,

governments, partners and to our communities worldwide. Through continuing innovation, investment

and collaboration, we are advancing new therapies, improving the safety and cost-effectiveness of

treatments, and operating in a more sustainable manner. In doing so, we will drive greater value for

our stakeholders.

Dear Baxter Shareholder:

It is with a sense of conﬁdence, and optimism toward our future,

A major element of our improving ﬁnancial condition is the successful

that I write my ﬁrst letter to you as Baxter’s chairman and CEO.

implementation of the restructuring program directed at reducing

2004 was a year that saw much change for our company, and also

overhead cost throughout the company. While difﬁcult, this has

meaningful progress on numerous fronts that has laid the ground-

been a necessary action that has not only reduced structural cost,

work for success and growth in the years ahead. I am honored to

but has resulted in reengineering administrative and business

have the opportunity to lead the company in our quest to further

processes that will beneﬁt the company going forward. All key

improve patient care, while at the same time delivering improved

project milestones associated with the restructuring were achieved

returns to our shareholders.

on schedule in 2004, and we look forward to the completion of

One of our primary goals in 2004 was to rebuild investor credibility.

this effort by the end of this year.

This is not only a matter of improved ﬁnancial performance,

The most important aspect of our improving ﬁnancial condition is

but more predictable and sustainable ﬁnancial performance as

the ability to begin accelerating investment in research and new

well. Over the past year we have made substantial progress in

product development. Product innovation has been a hallmark of

strengthening the balance sheet, generating strong cash ﬂows,

Baxter over many years. The most critical priority in 2005, and

and improving the quality of operating earnings while remediating

beyond, is to reinvigorate this tradition of innovation in our com-

past ﬁnancial issues. Every succeeding quarter in 2004 reﬂected

pany. New processes were put into place in 2004 that more

improvement in each of these areas.

effectively prioritized our research and development initiatives, and

also improved the discipline in managing R&D projects.

As indicated on the following pages of this report, Baxter possesses

In the midst of the aforementioned change, Baxter employees

world-class technology platforms in numerous areas including

have remained committed to meeting customer and patient needs

biologics and recombinant technologies; drug packaging, formula-

and have demonstrated a great ability to adapt and embrace the

tion and delivery systems; and medical plastics. We have effectively

changes that have occurred over the past year. One of the things

leveraged these capabilities in the past, and we are continuing

I enjoyed most in 2004 was the opportunity to visit numerous

to apply these technologies in new and expanded ways. We are

Baxter facilities and operations around the world. I have seen and

advancing more effective, convenient and safer therapies for chronic

heard ﬁrsthand the commitment of Baxter employees to making

diseases. We are increasing access to vital medical treatments

a meaningful difference in the lives of patients – a dedication that

throughout the world. We are integrating these technologies to help

runs throughout the organization. And I have witnessed personally

reduce the risk of error in the administration of medications. And,

the impact that our work is having on patients and our commu-

most importantly, we are using these platforms to improve the

nities around the world. I continue to be inspired by the connection

quality of life for patients around the world. We will selectively

Baxter employees have to the greater purpose of our business:

expand into new areas that build upon these core technologies

providing medically necessary products and services for people

in the future.

Signiﬁcant progress was also made in 2004 in building the senior

management team that will lead Baxter in the years ahead.

The following Corporate Vice Presidents were appointed in 2004:

John Greisch, Chief Financial Ofﬁcer; Joy Amundson, President,

BioScience; Bruce McGillivray, President, Renal; James Utts,

President, Europe; and Robert Davis, Treasurer. These key appoint-

with complex and life-threatening diseases. This is a truly noble

mission to which 48,000 Baxter employees around the world

are committed.

ments represent a blend of internal promotions and infusion of

Robert L. Parkinson, Jr.

leadership from outside the company. In addition, I would like to

recognize the impending retirement of David Drohan, President,

Medication Delivery, who has graciously agreed to stay on until his

successor has been identiﬁed. Dave has loyally served Baxter for

over 39 years and has been instrumental in helping to build Baxter

into the company it is today. We thank Dave for his dedicated

service over these many years.

Taking treatment to the next level
Advancing the science behind life-saving therapies

Pazhayannur Murali was diagnosed with hemophilia at age 4, which

Dr. Leonard Valentino, director of the hemophilia program at Rush

meant he lacked Factor VIII, a protein in blood plasma essential to

University Medical Center in Chicago, prescribed a new recombinant

clotting. Growing up in India in the 1960s and ’70s, his only treat-

Factor VIII concentrate for the surgery: ADVATE, Baxter’s next-gen-

ment was infusion of whole blood when he had an accident or major

eration recombinant Factor VIII. ADVATE, introduced in the United

trauma. He missed school frequently and had to cut down on sports.

States in July 2003, is the ﬁrst and only Factor VIII made without

Gradually, internal bleeds damaged all of his joints. At 19, Murali

any added human or animal plasma proteins such as albumin in

had an internal hip bleed that went undiagnosed for days. He became

the cell culture process, puriﬁcation or ﬁnal formulation, thereby

critically anemic and was hospitalized in Bombay, where he received,

eliminating the risk of infections from viruses and infectious prions

for the ﬁrst time, cryoprecipitate – a low-purity concentrate of several

that may be carried in these plasma protein additives.

plasma-based proteins, including Factor VIII. The bleed subsided

but he developed a “pseudo-tumor” that caused nerve damage in

his leg, paralyzing it for six months. Physical therapy enabled him

to regain 50 percent of his leg strength.

“Because of ADVATE’s higher potency, it can be infused at lower

volumes, and as such is good for continuous infusion,” Dr. Valentino

says. “We also wanted the safest possible product at a time when

he would be receiving very large doses of factor concentrate over a

Over the next 10 years, while earning degrees in microbiology

long period of time.”

and immunology from the University of Bombay, Murali received

cryoprecipitate on an as-needed basis – usually several times a

year – whenever he had a bleed. It wasn’t until he came to the United

States at the age of 29 that he began using Factor VIII concentrate –

highly puriﬁed Factor VIII derived from human plasma – to treat his

bleeding episodes.

ADVATE is the latest milestone in more than 40 years of leadership

for Baxter in providing the hemophilia community with increasingly

innovative clotting therapies. With each new development, Baxter

has reduced the potential risk associated with hemophilia treatment

and improved the lives of people with this disorder. Not coincidentally,

life expectancy for hemophilia patients has increased, from 11 years

In the early 1990s, Murali switched to recombinant Factor VIII, which

prior to the 1960s to more than 60 years today, with the advent of

is manufactured in cell culture rather than from plasma, reducing

better Factor VIII therapies, home infusion programs, prophylactic

the risk of infection from viruses that could be present in plasma.

treatment and improved patient education.

Murali used Baxter’s RECOMBINATE Factor VIII – the ﬁrst recombinant

Factor VIII on the market – for 10 years. Then, in October 2003,

he had to have surgery to remove the pseudo-tumor he had for

more than 20 years, as it had started to grow, causing more internal

bleeding and discomfort.

“Since my surgery, I have gone back to work full time and begun to

travel,” says Murali, a database administrator for a ﬁnance company

in the Chicago area. “Last December, I went back to India for the

ﬁrst time in four years to see my parents and other family. As some-

one who has lived through more than four decades with hemophilia,

I feel fortunate to have the life that I do.”

DEVELOPING NEXT-GENERATION TREATMENTS

Baxter continues to advance therapies for several chronic disorders. Baxter’s

viral-inactivation steps in the manufacturing process for an additional level

GAMMAGARD S/D immune globulin intravenous (IGIV) is a leading

of safety. In addition, Baxter is developing a recombinant Alpha-1 Proteinase

biologic for bolstering the immune systems of people with immune deﬁcien-
cies. In 2004, Baxter ﬁled for regulatory approval in the United States and

Inhibitor for people with alpha-1 antitrypsin deﬁciency, a form of hereditary
emphysema. The company’s current product, ARALAST, which was intro-

Europe of a next-generation, liquid IGIV that would not have to be recon-

duced in 2003, is derived from human plasma.

stituted prior to infusion by patients. It also will incorporate three dedicated

Legendary expertise
Extending Baxter’s leadership in sterile ﬂexible container technology

While surgery, drugs and other medical interventions are usually

The original product, called CLINOMEL, vaulted Baxter to leader-

front and center in treating patients, nutrition is an essential part of

ship in the multi-chamber bag market in Europe. In 2002, Baxter

a patient’s medical treatment. “Besides pain relief, nutrition is the

introduced a new version of the product, called OLICLINOMEL,

most important part of patient recovery,” says Ralf-Joachim Schulz,

featuring an olive oil-based lipid emulsion as opposed to a soy-based

M.D., a specialist in nutrition therapy at the Charité University

emulsion. Baxter is the only company to offer an olive oil emulsion

Hospital in Berlin. “It is important in stabilizing organ function and

in a triple-chamber bag.

the immune system. There can also be misdiagnoses of conditions

due to a patient’s metabolic state.”

“This is a signiﬁcant advancement,” says Schulz. “We believe the

body is able to absorb these fatty acids more readily and use them

Patients who do not have a functioning gastrointestinal tract, or for

more effectively.”

some other reason cannot take food orally, may need to be fed

intravenously, or “parenterally.” Unfortunately, amino acids, dextrose

and lipids – the primary ingredients in parenteral nutrition – cannot

be premixed at a factory and remain stable for any length of time.

Baxter’s leadership in multi-chamber bags for parenteral nutrition is

yet another example of the company’s legendary expertise in sterile

ﬂexible container systems. It started with the BLOOD PACK, the ﬁrst

ﬂexible, plastic blood-collection container that revolutionized blood

“The hospital pharmacy used to prepare individual solutions for each

collection and created the ﬁeld of blood-component therapy. That

patient,” Schulz says. “This complex and time-consuming process

technology led to the introduction in 1970 of the VIAFLEX container,

often delayed the start of treatment for up to two days.”

the ﬁrst ﬂexible plastic intravenous (IV) solution container, which

In 1998, Baxter introduced the ﬁrst “triple chamber bag” for parenteral

nutrition. This enabled clinicians to conveniently and cost-effectively

mix and administer parenteral nutrition solutions at the point of care.

The major components of the nutrition therapy are stored in different

chambers of the bag, separated by special seals. At the time of

administration, the clinician simply breaks the seals between cham-

bers, adds micronutrients and shakes gently to mix. The product has

been highly successful in Europe where, unlike in the United States,

set a new standard for IV therapy worldwide, and then a range of

ﬂexible container systems used in peritoneal dialysis. Today, Baxter

is extending this expertise to ﬁlms used in bioprocessing and unique

container systems for biologic drugs–for example, a ﬂexible plastic

container for albumin, a plasma-volume expander used to treat

patients with burns or in shock. Baxter ﬁled for regulatory clearance

of the ﬂexible albumin product in the United States at the end of

2004, and plans to ﬁle in Europe in early 2005.

automated compounding equipment for parenteral nutrition solutions

“This is an example of taking an existing platform we established in

is not often used.

“When we started using Baxter’s three-chamber system, we had

faster therapy start-ups, reduced patient days, and our costs

decreased dramatically,” Schulz says. “The work is done by nurses,

as opposed to the pharmacy, at the point of care.”

our drug delivery business and using it for biological drugs as opposed

to small molecule pharmaceuticals,” says Norbert Riedel, Baxter’s

chief scientiﬁc ofﬁcer. “It is a model project combining our expertise

in both biological proteins and medical plastics to create new products

that are truly unique and that few other companies can replicate.”

HISTORY OF FLEXIBLE CONTAINER INNOVATION

1948
Dr. Carl Walter,
co-founder of Fenwal
Laboratories, invents the
ﬁrst ﬂexible, plastic blood-
collection container.

1959
Baxter acquires Fenwal
Laboratories and reﬁnes
the BLOOD PACK
container technology
to create the ﬁrst closed
system that allows the
separation of whole blood
into components.

1970
Baxter introduces the
ﬁrst ﬂexible plastic con-
tainers for IV solutions.
The VIAFLEX container
revolutionizes the practice
of IV therapy worldwide.

2002
Baxter introduces the
ﬁrst triple-chamber
bag with an olive oil
lipid emulsion.

1998
Baxter introduces the
ﬁrst triple-chamber bag
for parenteral nutrition,
enabling clinicians to
mix and administer
parenteral nutrition at
the point of care.

1978
Baxter introduces
continuous ambulatory
peritoneal dialysis (CAPD),
the world’s ﬁrst portable
kidney-dialysis therapy,
made possible through
the use of a ﬂexible plastic
container system enabling
patients to administer
their own therapy.

Manufacturing new solutions to meet growing market needs
Drug delivery expertise helps biotechnology and pharmaceutical companies

Baxter’s leadership in partnering with pharmaceutical companies to

52 percent are biologics. Many of these “large molecule” drugs,

package their drugs for safe and convenient administration to patients

which are proteins or other modiﬁed cells, have more complex

dates back more than 20 years. That’s when Baxter began producing

manufacturing requirements.

premixed drugs in intravenous (IV) solution containers. Since then,

Baxter has manufactured more than a billion units of premixed drugs

in IV containers, in both liquid and frozen form, helping nine of the

top 10 pharmaceutical companies launch new products. Baxter’s

GALAXY technology – used to form, ﬁll and seal IV solutions in a sterile

environment – is the only commercially available aseptic ﬁlling process

for frozen premixed drugs in ﬂexible IV bags.

Today, Baxter’s expertise in drug delivery extends to contract manu-

facturing of injectable drugs in vials and syringes, lyophilized drugs

(drugs that are freeze-dried and need to be reconstituted before

they are administered), and biologics such as proteins and antibodies.

It also includes proprietary formulation technologies to help its

pharmaceutical customers develop new drugs with unique features,

such as immediate release for pulmonary delivery or controlled-

“Both traditional pharmaceutical companies and smaller biotechnology

companies may lack the necessary resources for manufacturing these

new compounds,” Tune says. “Our expertise and proven track record

in process development and manufacturing of proteins and antibodies

makes us a valuable resource for these customers.”

Sales in this part of Baxter’s business have nearly doubled in the

last three years, making it one of the fastest-growing areas of the

company. Contract manufacturing of pre-ﬁlled syringes, in particular,

has been a high-growth area, necessitating a signiﬁcant expansion

of Baxter’s manufacturing facility in Bloomington, Indiana. Already

the largest manufacturer of pre-ﬁlled syringes in North America,

the Bloomington facility will nearly double its capacity for pre-ﬁlled

syringes when the expansion is complete in 2005.

release, injectable delivery. The company has ongoing relationships

In 2005, Baxter expects to ﬁle for FDA approval of a pre-ﬁlled,

with the 15 largest biotechnology and pharmaceutical companies

co-polymer syringe called CLEARSHOT that will offer customers

in the world and last year alone, Baxter worked with more than 80

beneﬁts over traditional glass syringes. The syringe features a light,

different companies.

“Investment in manufacturing infrastructure may reduce resources

available for investment in research and development. By tapping

our manufacturing expertise, these companies can focus more on

their pipelines,” explains Joel Tune, general manager of BioPharma

Solutions for Baxter.

Another challenge is the large number of new biotech drugs expected

to come to market in the next few years, most of which are injectable.

Of the estimated 1,900 candidate drugs in development pipelines,

break-resistant material suitable for a broad range of molecules.

In addition, unlike glass syringes that Baxter purchases and ﬁlls for

its customers, the CLEARSHOT technology integrates molding,

aseptic ﬁlling and ﬁnishing into one controlled, in-line manufacturing

process – similar to the GALAXY technology for IV bags – providing

ﬂexibility of syringe supply with just-in-time manufacturing.

“The success of this business is largely attributable to the close

collaboration we have with our customers – pharmaceutical and

biotechnology companies around the world – and understanding how

our capabilities can best meet their needs,” Tune says. “The opportu-

nity we have to help bring new therapies to market is tremendous.”

MAKING NEW THERAPIES A REALITY

Another capability Baxter has added in recent years is proprietary formulation

With PROMAXX technology, a pharmaceutical or biotechnology com-

technology to help pharmaceutical and biotech companies bring to market

pound can be formulated into precisely sized microspheres, and delivered

drugs with challenging requirements. For example, Baxter’s NANOEDGE
technology may enable water-insoluble drugs to become soluble, and there-

by various routes of administration. In 2004 Baxter initiated a clinical
trial of a proprietary PROMAXX formulation of pure insulin, administered

fore, can lead to viable medications.

“Many new drugs can’t be developed further or tested because they are insol-
uble. Baxter is working with a number of pharmaceutical companies to help
bring promising therapies to market” says Tune.

with a simple dry powder inhaler. Baxter also applied and licensed the

technology to TEVA Pharmaceuticals for use in a sustained-release injectable

formulation of leuprolide acetate, in clinical development for the treatment

of prostate cancer.

Going the extra mile
Serving patients near and far

Located in the foothills of the Himalayan Mountains in northern India

“I observe and guide her through the solution-exchange procedure,

near the China border, Pithoragarh’s remote location and underde-

examine the catheter site, evaluate her physical condition and check

veloped infrastructure make it difﬁcult to reach from the outside world,

that she has enough solutions and related disposable products for

requiring hours of arduous journey through rugged terrain. That does

her treatment,” Singh says of his visits.

not stop Baxter clinical coordinator Dharampal Singh from visiting

home dialysis patient Bharati Chand every 40 days, to check on her

status and any product needs she may have. Depending on which

combination of buses and automobiles he takes, Singh makes the

trip from his base in Dehradun in 14 to 17 hours.

India is not the only country where Baxter goes to great lengths

to serve patients. In Taiwan last year, a typhoon wiped out peritoneal

dialysis (PD) supplies for some local hospitals and patients. In one

case, a Baxter account executive personally delivered PD solutions

to a patient’s home. In another, because of a road closure, Baxter

Chand, a 36-year-old mother of two, was diagnosed with end-stage

delivered a patient shipment by helicopter. At the end of 2004,

renal disease (ESRD) – irreversible kidney failure – in March 2004.

Baxter was serving more than 20,000 PD patients in Asia. That

She initially began hemodialysis (HD) treatment in which the patient

number has been growing close to 15 percent annually, making Asia

goes to a hospital or clinic several times a week to have his or her

the fastest-growing region in the world for Baxter’s PD products

blood pumped through an external ﬁlter to cleanse it of toxins, waste

and services. With local manufacturing in India, China, Singapore,

and excess water normally removed by healthy kidneys. The proce-

the Philippines and other Asian countries, Baxter has been able to

dure typically takes four to six hours.

drive down the cost of PD therapy, making it more affordable, while

“Accessing an HD clinic was even more of a challenge, as there is no

providing the service necessary to meet patient needs.

clinic in Pithoragarh. The closest one was in Haldwani, a good ﬁve

Baxter also is working to advance other therapies in developing

hours away,” Chand says.

After approximately 20 HD treatments, she switched to continuous

ambulatory peritoneal dialysis (CAPD), a home-based therapy pio-

neered by Baxter in the late 1970s. In CAPD, patients infuse dialysis

markets. For hemophilia patients, Baxter opened a ﬁrst-of-its-kind

hemophilia treatment center in a hospital in Taipei that provides

under one roof a full continuum of specialists and resources for

hemophilia patients.

solution into their peritoneal cavity through a catheter surgically

“We are committed to providing the same high level of service to

implanted in their abdomen. The peritoneal membrane serves as

patients no matter where they are located,” Singh says. “Looking

a ﬁlter that cleanses the blood. After the solution dwells in the patient’s

at the smile on my patient’s face makes it all worthwhile.”

abdomen for a period of time, used solution containing waste

products drains into an empty bag. Patients infuse fresh solution and

discard used solution several times a day. Baxter is the leading

provider of products and services for peritoneal dialysis worldwide.

“He is like an angel,” says Chand. “He is like a close friend or family

member who is always by my side whenever I need his help. Thanks

to CAPD, I am leading a near-normal life. I am here with my family

only because of Baxter’s products and services.”

HELPING PATIENTS EXPLORE NEW HORIZONS

Baxter routinely coordinates delivery of patients’ PD solutions when they

In 2004, a group of 26 patients, accompanied by their caregivers and a sup-

travel, using the company’s global network of manufacturing plants, ware-
houses, delivery and clinical support personnel to make sure patients receive
their therapy wherever their destination. The company also organizes trips

port team of three nurses and ﬁve Baxter employees (pictured at left), spent
ﬁve days visiting Korea’s many historic and cultural sites while performing
dialysis in their hotel rooms, where Baxter delivered their PD solutions in

for groups of PD patients at the country level. In Asia, for example, Baxter’s
country organizations in Singapore and Taiwan have organized overseas trips
to Australia, Hong Kong, Korea, New Zealand and Thailand.

advance of their arrival.

Helping to build a safety net for patients
Developing technologies and products to help ensure safe healthcare

Missouri Rehabilitation Center (MRC), a long-term, acute-care hospital

include their medical history and drug sensitivities. Wireless hand-

in Mt. Vernon, Missouri, specializes in treating patients with serious

held units allow medical staff to monitor patients and provide alerts

physical injuries, such as brain and spinal-cord injuries. The nature

to potential errors before they occur.

of these therapies requires a signiﬁcant amount of medications to be

administered to patients. This was one reason the American Society of

Health-System Pharmacists (ASHP) Foundation chose MRC to study,

document and publish the beneﬁts of implementing a medication-

management system to reduce medication errors in hospitals.

Reducing medical errors is one of the most important issues in

healthcare today. A 2000 report from the Institute of Medicine esti-

mated that medical errors in U.S. hospitals kill more people than

breast cancer or AIDS, claiming between 44,000 and 98,000 lives

and costing the healthcare system between $17 billion and $29

“The system helps safeguard against mistakes,” says Dennis Nicely,

chief executive ofﬁcer of MRC. “It veriﬁes that the medication scanned

is the right medication for the patient, and if not, tells the nurse that

it’s wrong before it is administered.”

Developing products that help improve patient safety is nothing new

for Baxter. It began with the company’s founding in 1931, when

Baxter introduced the ﬁrst commercially manufactured intravenous

(IV) solutions. Later came the ﬁrst ﬂexible, closed-system IV solutions,

eliminating ambient air that could carry potential contaminants.

billion a year. Errors involving the incorrect administration of medica-

Baxter’s COLLEAGUE infusion pump was the ﬁrst to offer automatic

tions, which are among the most serious errors, can occur at any

set-loading, reducing the potential for errors associated with manual

point, from the physician writing the prescription, during transcription

loading and unloading of IV tubing. In late 2004, Baxter received

and ﬁlling, or at the patient’s bedside – the last chance for errors

clearance from the FDA to market its wireless pump connectivity

to be caught prior to dispensing by a nurse.

To reduce the potential for medication errors at MRC, the hospital

implemented Baxter’s Patient Care System, a computer-based, wire-

less patient-information and medication-management system that

links medicines, drug-delivery systems and patient data at the bed-

side with the hospital’s information systems in the pharmacy and

elsewhere. The integration of these elements, which include electronic

hand-held devices, advanced bar-code technology, and Baxter’s

interface that enables hospitals to connect Baxter’s COLLEAGUE CX

infusion pump to its Patient Care System, allowing clinicians to more

closely monitor a patient throughout infusion of IV medications. In

addition to MRC, Northwestern Medical Center in Vermont and North

Adams Regional Hospital in Massachusetts have been using Baxter’s

Patient Care System to manage patient medication administration

and have seen beneﬁt in the enhanced ability to track and monitor

patients’ care. This system will be commercially available in 2005.

COLLEAGUE infusion pump technology, help ensure that the right

All of these products and technologies are part of Baxter’s Patient

patient receives the right medication in the right dose at the right

Care System. The ASHP study, when completed at the end of 2005,

time through the right route of administration – the so-called “ﬁve

will document how much this integrated system has affected the

rights” of patient safety.

safe delivery of medications at MRC.

Medications carry bar-coding to identify what they are and other key

“It is our duty as healthcare providers to use all available technologies

information on the drug. Patients wear bar-coded wristbands that

to ensure the safe and effective delivery of healthcare to patients,”

Nicely states.

BAXTER ENLIGHTENS BAR CODES

For years, printing readable bar codes on clear, plastic IV bags has been

proprietary technology for its IV bags that prints white spaces, rather than

a challenge because of the way bar codes are read. In 2003, Baxter intro-

black bars, onto the bag using high-resolution printing technology. The white

duced the ﬁrst truly readable bar code for clear, ﬂexible IV bags. Baxter’s
ENLIGHTENEDHRBC bar code was the ﬁrst to include such information
as lot number and expiration date, helping ensure that drugs subject to

recall or expired drugs will not be delivered to patients. Baxter developed

bars transmit the information to the scanner while the clear plastic serves
the purpose of the black bars by absorbing light from the scanner.

Extending a hand
Advancing the health of our communities

Barsequillo is located near Baxter’s manufacturing facility in Haina,

“We take very seriously the impact that our products have on patients

Dominican Republic, where approximately 1,500 employees manu-

and that our actions have in our own communities,” Lopez said.

facture blood bags, blood sets and other products used in transfusion

“We are gratiﬁed to see how our work has beneﬁted our own com-

therapies. Many of Barsequillo’s 5,000 residents live in wooden shacks

munity, and proud to be part of an organization where similar work

under poor hygienic conditions with very little access to medical care.

is being done by our colleagues throughout the world.”

Such conditions are common in the Dominican Republic, where a

large segment of its 8.6 million people – particularly in rural areas –

continues to live in poverty despite signiﬁcant economic growth in

the country.

The December 26, 2004, underwater earthquake and tsunami

that rocked southern Asia left in its wake a death toll estimated at

200,000 people and billions of dollars in damages. Baxter responded

to the disaster on many fronts. The company donated more than

“We have employees from that community, with families in that com-

100,000 units of intravenous (IV) solutions and other needed prod-

munity,” says Luis Lopez, manager of human resources at Baxter’s

ucts to affected areas. Baxter’s Alathur facility in India also served

Haina facility. “Many of these people might never see a doctor.”

as a central collection and distribution point for emergency supplies,

At the Haina plant, as in all Baxter facilities worldwide, employees

take the needs of their communities very seriously, donating time and

money to a range of worthy causes. Employees in Haina came up

with the concept of “medical journeys” – free clinics held twice a year

in poor communities where there is little or no access to healthcare.

while Baxter India employees donated a day’s pay, matched by

the company, and provided other assistance. In Thailand, Baxter

employees volunteered at local blood banks and donated 5,000

blood bags to the Thai Red Cross. Companywide, Baxter established

a disaster-relief fund in which it matched employee contributions

two-for-one, raising more than $500,000 for the American Red Cross

At one such medical journey on November 27, 2004, 25 general

International Response Fund and UNICEF to provide aid in the region.

practitioners, pediatricians, gynecologists and other specialists

In addition, The Baxter International Foundation pledged $1 million

volunteered their time to provide care at no cost to approximately

in grants to help victims of the tsunami.

1,500 people in a Barsequillo public school. Patients ranged from

infants to elderly. About 100 Baxter employees participated in the

event, many conducting talks with patients on nutrition, domestic

violence, cancer prevention and other health-related topics. Baxter

also provided free medicines that were prescribed and dispensed to

patients on-site.

In 2004, The Baxter International Foundation, the company’s phil-

anthropic arm, provided grants to more than 50 organizations in

17 countries, totaling approximately $2 million. Its primary focus is

on organizations and programs that serve to increase access to

healthcare, particularly for the disadvantaged and underserved, in

communities where Baxter employees live and work.

PROVIDING URGENTLY NEEDED SUPPLIES

Baxter also extends a helping hand to communities through product dona-

approximately $120 million worth of products to nearly 100 countries,

tions. Baxter’s primary partner for donating products is AmeriCares, an
international disaster relief and humanitarian aid organization that solicits
donations of medical products and other supplies from the private sector

and coordinates their delivery to where they are needed most. Since Baxter
began working with AmeriCares in 1987, the company has donated

including more than $7.5 million in 2004. Baxter’s products aided relief
efforts in nearly 40 countries in 2004, from Albania to Zimbabwe.

“Baxter’s ongoing commitment to providing urgently needed supplies has
saved thousands of lives,” says Curtis R. Welling, AmeriCares president and
chief executive ofﬁcer.

Financial
Highlights

Financial Section
Table of Contents

Management’s Discussion and Analysis

Management’s Responsibility for Consolidated Financial Statements

Management’s Report on Internal Control over Financial Reporting

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets

Consolidated Statements of Income

Consolidated Statements of Cash Flows

Consolidated Statements of Stockholders’ Equity and Comprehensive Income

Notes to Consolidated Financial Statements

Directors and Ofﬁcers

Company Information

Five-Year Summary of Selected Financial Data

* Returns include dividends.

This annual report contains forward-looking statements that may involve risks and uncertainties. Please see page 38 for more details.

0.015.161010001600253517

MANAGEMENT’S DISCUSSION AND ANALYSIS

INTRODUCTION

The purpose of this section of the Annual Report is to help investors and other users assess the financial condition and the results of
operations of Baxter International Inc. (Baxter or the company). Except for the section relating to discontinued operations (see Note 2 to the
consolidated financial statements), the discussion relates to continuing operations only.

COMPANY AND INDUSTRY OVERVIEW

Business Segments and Products
Baxter is a global diversified medical products and services company with expertise in medical devices, pharmaceuticals and biotechnology
that assists health-care professionals and their patients with the treatment of complex medical conditions including hemophilia, immune dis-
orders, infectious diseases, kidney disease, trauma and other conditions. The company operates in three segments: Medication Delivery,
which provides a range of intravenous solutions and specialty products that are used in combination for fluid replenishment, general
anesthesia, nutrition therapy, pain management, antibiotic therapy and chemotherapy; BioScience, which develops biopharmaceuticals,
biosurgery products, vaccines and blood collection, processing and storage products and technologies for transfusion therapies; and
Renal, which develops products and provides services to treat end-stage kidney disease.

Sales and Operations Outside the United States
The company generates approximately 50% of its revenues outside the United States, selling its products and services in over 100 countries.
Baxter’s principal international markets are Europe, Japan, Canada, Asia and Latin America. The company maintains manufacturing and dis-
tribution facilities in many locations outside the United States. These global operations provide for extensive resources, and generally lower
tax rates, and give Baxter the ability to react quickly to local market changes and challenges. While health-care cost containment continues to
be a focus around the world, with the aging population and the availability of new and better medical treatments, demand for health-care
products and services continues to be strong worldwide, particularly in developing markets, and is expected to grow over the long-term. The
company’s strategies emphasize global expansion and technological innovation to advance medical care worldwide.

There are foreign currency fluctuation and other risks associated with operating on a global basis, such as price and currency exchange
controls, import restrictions, expropriation and other governmental action, as well as volatile economic, social and political conditions in
certain countries, particularly in developing countries. Management expects these risks to continue. 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 utilizes derivative and nonderivative financial instruments to further reduce the net exposure to currency fluctuations.
Management will continue to hedge foreign currency risks where appropriate, and seek opportunities where appropriate to limit potential
unfavorable impacts of operating in countries with weakened economic conditions.

Government Regulation
The company’s products and services are subject to substantial regulation by the Food and Drug Administration (FDA) in the United States,
as well as other governmental agencies around the world. The company must obtain specific approval from the FDA and non-United States
regulatory authorities before it can market most of its products. The process of obtaining such approvals can be lengthy and costly, and
requires the company to demonstrate product safety and efficacy. There can be no assurance that any new products that the company
develops will be approved in a timely or cost-effective manner. Further, the company’s products, facilities and operations are subject to
continued review by the FDA and other regulatory authorities. The company is subject to possible administrative and legal actions by these
regulatory agencies. These actions may include product recalls, product seizures, injunctions to halt manufacture and distribution, and other
civil and criminal sanctions. From time to time, the company has instituted voluntary compliance actions, such as removing products from
the market that were found to not meet acceptable standards. These actions could adversely impact the company’s future results of
operations. This regulatory environment is expected to continue in the future.

Competition and Customers
The company’s primary markets are highly competitive. There has been consolidation in the company’s customer base and by its
competitors, which has resulted in pricing and market share pressures. The company has experienced increases in its labor and material
costs, which are partly influenced by general inflationary trends and foreign exchange rates. Competitive market conditions have minimized
inflation’s impact on the selling prices of the company’s products and services. Although no single company competes with Baxter in all of
its businesses, Baxter faces substantial competition in each of
its segments, generally from global and domestic health-care and
pharmaceutical companies of all sizes. Competition is focused on price, cost-effectiveness, service, product performance, and technological
innovation. Competitive pressure in these areas is expected to continue. This competitive environment requires substantial investments in
research and development (R&D), and manufacturing and other facilities.

MANAGEMENT’S DISCUSSION AND ANALYSIS

The trend toward managed care and economically motivated customers has also resulted in continued pressure on product pricing. A
substantial portion of Baxter’s products are sold through contracts, both within and outside the United States. Many of these contracts,
which are often with group purchasing organizations (GPOs), have terms of more than one year and place limits on price increases. These
contracts may specify minimum quantities of a particular product or categories of products to be purchased by the customer. As a result of
the above-mentioned consolidation, transactions with customers are larger and more complex.

Each of Baxter’s segments operates in a competitive marketplace. Within the BioScience segment, the competitive environment for plasma-
derived products has changed over the last few years due to the entry of foreign competitors into the United States market. This has
resulted in reduced pricing, significantly impacting the company’s gross margin, and these pressures, while stabilizing, could reoccur in the
future. The market for recombinant products remains competitive, and this environment is expected to continue with the potential expansion
of manufacturing capacity by competitors. Within the Medication Delivery segment, increased pricing pressure is expected from generic
competition for injectable drugs, and from GPOs in the United States. Specifically, management believes it is likely that additional
competitors may enter the market with a generic propofol, an anesthetic agent, which could result in a loss of market share and price
erosion. The company has experienced reduced pricing principally due to its renegotiated long-term agreements with Premier Purchasing
Partners L.P. (Premier), a large GPO. Within the Renal segment, competitors are continuing to expand their peritoneal dialysis products
manufacturing capacity and sales and marketing channels on a global basis.

Management intends to manage the challenges resulting from these competitive pressures by capitalizing on the breadth and depth of
Baxter’s product lines and its relationships with customers, continuing to explore business development opportunities for partnering, in-
licensing, and acquisitions, reducing the company’s cost structure, executing and prioritizing the R&D pipeline, evaluating the business
portfolio and assessing alternatives (including, where appropriate, restructuring or divesting under-performing businesses), and by
continuing to upgrade its facilities.

RESULTS OF CONTINUING OPERATIONS

Net Sales

years ended December 31 (in millions)

2004

2003

2002

2004

Medication Delivery
BioScience
Renal

Total net sales

$4,047
3,504
1,958

$9,509

$3,827
3,269
1,808

$8,904

$3,311
3,096
1,692

$8,099

6%
7%
8%

2003

16%
6%
7%

10%

Percent change

years ended December 31 (in millions)

2004

2003

2002

2004

United States
International

Total net sales

$4,460
5,049

$9,509

$4,279
4,625

$8,904

$3,974
4,125

$8,099

4%
9%

2003

8%
12%

10%

Percent change

Foreign exchange benefited sales growth by 4 percentage points in 2004 and by 5 percentage points in 2003, primarily because the United
States Dollar weakened relative to the Euro and Japanese Yen. These fluctuations favorably impacted sales growth for all three segments.

Medication Delivery Net sales for the Medication Delivery segment increased 6% in 2004 and 16% in 2003 (including 3 percentage
points in 2004 and 4 percentage points in 2003 relating to the favorable impact of foreign exchange).

The following is a summary of sales by significant product line.

years ended December 31 (in millions)

2004

2003

2002

IV Therapies
Drug Delivery
Infusion Systems
Anesthesia
Other

Total net sales

$1,154
789
846
827
431

$4,047

$1,100
699
803
808
417

$3,827

$ 982
580
751
568
430

$3,311

Percent change

2004

5%
13%
5%
2%
3%

2003

12%
20%
7%
42%
(3%)

16%

MANAGEMENT’S DISCUSSION AND ANALYSIS

IV Therapies
This product line principally consists of intravenous solutions and nutritional products. Because approximately two-thirds of IV Therapies’ sales
are generated outside the United States, sales growth in this product line particularly benefited from the weakened United States
Dollar in 2004 and 2003. Sales growth was lower in 2004 as compared to 2003 because of reduced pricing included in renegotiated
long-term contracts with certain GPOs, principally Premier. Also, sales volume growth in 2004 was impacted by domestic wholesaler inventory
reduction actions and lower sales of nutritional products used with automated compounding equipment.

Drug Delivery
This product line primarily consists of drugs and contract services, principally for pharmaceutical and biotechnology customers. Increased
sales of certain generic and branded pre-mixed drugs, as well as increased contract services revenues, fueled sales growth in 2004 and
2003. Sales growth was lower in 2004 as compared to 2003 partly due to several new product launches during 2003, as well as the
impact of the renegotiated GPO contracts. This was partially offset by the impact of a $45 million one-time order in 2004 by the United
States Government related to its biodefense program. Management expects sales in 2005 to be relatively consistent with 2004, with 2005
sales growth impacted by increased generic competition and the one-time 2004 order.

Infusion Systems
Sales growth in electronic infusion pumps and related tubing sets in 2004 and 2003 was primarily driven by higher sales of devices.
Increased device volume in the United States and Canada was partially offset by reduced pricing in 2004. The growth in volume in the
United States in 2004 was partially due to the timing of GPO contract awards, as certain customers delayed capital purchases in the prior
year in anticipation of a new contract award. The reduced pricing was also due to the renegotiated GPO contracts, which contributed to
lower sales growth in this product line in 2004 relative to 2003.

Anesthesia
Sales growth in anesthesia products in 2004 reflected stable pricing and volume growth, with volume growth partially impacted by
wholesaler inventory reduction actions in the United States with respect to SUPRANE (Desflurane, USP), an inhaled anesthetic agent. Sales
growth in 2003 was almost entirely driven by the December 2002 acquisition of the majority of the assets of ESI Lederle (ESI), a division of
Wyeth. ESI was a leading manufacturer and distributor of injectable drugs used in the United States hospital market. Refer to Note 3 for
further information regarding this acquisition. Sales in 2003 relating to ESI totaled $228 million. As noted above, management believes that
it is possible that additional competitors may enter the market in 2005 with a generic propofol, which could unfavorably impact market
share and pricing for this product.

Other
This category primarily includes oncology products and other hospital-distributed products. The sales growth in 2004 was primarily related
to the benefit of the weakened United States Dollar, as a large portion of the sales in this category are generated outside the United States.
This growth was partially offset by the company’s continued exit of certain lower-margin distribution businesses outside the United States,
which also impacted growth during 2003.

BioScience Sales in the BioScience segment increased 7% in 2004 and 6% in 2003 (including 4 percentage points in 2004 and 7 per-
centage points in 2003 relating to the favorable impact of foreign exchange).

The following is a summary of sales by significant product line.

years ended December 31 (in millions)

2004

2003

2002

Recombinants
Plasma Proteins
Antibody Therapy
Transfusion Therapies
Other

Total net sales

$1,329
1,037
336
550
252

$3,504

$1,123
1,005
311
553
277

$3,269

$ 999
1,008
318
548
223

$3,096

Percent change

2004

18%
3%
8%
(1%)
(9%)

2003

13%
—
(2%)
1%
24%

Recombinants
The primary driver of sales growth in the BioScience segment in both 2004 and 2003 was increased sales volume of recombinant Factor
VIII products. Pricing increases also fueled sales growth. Factor VIII products are used in the treatment of hemophilia A, which is a bleeding
disorder caused by a deficiency in blood clotting Factor VIII. Sales growth in 2004 was primarily fueled by the continued launch of the

MANAGEMENT’S DISCUSSION AND ANALYSIS

advanced recombinant therapy, ADVATE (Antihemophilic Factor (Recombinant), Plasma/Albumin-Free Method) rAHF-PFM, which received
regulatory approval in the United States in July 2003 and in Europe in March 2004. ADVATE is the first and only Factor VIII product made
without any added human or animal proteins in the cell culture, purification or final formulation process, thereby eliminating the risk of
infections caused by viruses that could potentially be contained in these proteins. Sales growth in 2003 was also favorably impacted by the
United States launch of ADVATE, as well as continued strong demand for RECOMBINATE Antihemophilic Factor (rAHF). Partially offsetting the
growth in sales volume in 2003 was the impact of reductions in wholesaler inventory levels of recombinant products in the United States.
Sales growth in 2004 benefited from the impact of the inventory reductions in 2003. In addition, sales growth in 2003 was unfavorably
impacted by the entry or re-entry into the marketplace by certain competitors. Management expects sales volumes of ADVATE will continue
to grow in 2005 as the launch of this new product continues, and as pricing of recombinant Factor VIII products remains stable.

Plasma Proteins
The growth in sales of plasma-based products (excluding antibody therapies) in 2004 was primarily due to foreign exchange, increased
sales volume of FEIBA, an anti-inhibitor coagulant complex, along with improved pricing of this product, partially offset by reduced pricing
due to competitive pressures in other product lines. Increased sales volume of the company’s plasma-based sealant, TISSEEL, also
contributed to the segment’s growth rate, particularly in 2004. Sales of plasma-based products in both 2004 and 2003 were unfavorably
impacted by the continuing shift in the market from plasma-based to recombinant hemophilia products. Management expects these trends
to continue in 2005. As discussed further below, as a result of these competitive pressures, the company’s 2004 and 2003 restructuring
actions included the closure of plasma collection centers and a plasma fractionation plant, in order to improve the profitability of the
business. Due to this throughput reduction, coupled with lower sales to third parties as a result of management’s plans to exit certain lower-
margin contracts, sales in this product line are expected to decline in 2005.

Antibody Therapy
Higher sales of IVIG (intravenous immunoglobulin), which is used in the treatment of immune deficiencies, fueled sales growth in 2004,
primarily due to improved pricing in North America. Competitive pricing pressures impacted sales growth in 2003. With the above-mentioned
closures of plasma collection centers and lower plasma fractionation levels, IVIG sales volume is expected to decline in 2005 (with fewer units
available for sale), but pricing is expected to increase, partially due to an anticipated change in the geographic mix of IVIG sales. The
introduction of a liquid formulation of IVIG is also expected to fuel sales growth in the future, partly due to more favorable pricing and higher
yields generated from the liquid formulation process.

Transfusion Therapies
Sales of transfusion therapies products, which are products and systems for use in the collection and preparation of blood and blood
components, have been unfavorably impacted by consolidation in the plasma industry. Sales growth in the future is expected to be fueled by
continued penetration in the United States of ALYX, the new system for the automated collection of red blood cells and plasma.

Other
Other BioScience products primarily consist of vaccines and non-plasma-based sealant products. Sales of vaccines tend to fluctuate
from period to period as they are impacted by the timing of government tenders. Sales of smallpox and NeisVac-C (for the prevention of
meningitis C) vaccines were lower in 2004 due to the timing of these tenders. Sales of smallpox vaccines were also lower in 2003 as
compared to 2002, as 2002 sales benefited from the sale of crude bulk vaccine to Acambis, Inc. (Acambis) in conjunction with its contract
with the United States Government. The company’s non-plasma-based sealants are relatively new products, and their sales growth
contributed to the segment’s growth rate in both 2004 and 2003, and continued growth is expected in the future.

Renal Sales in the Renal segment increased 8% in 2004 and 7% in 2003 (including 4 percentage points in both 2004 and 2003 relating
to the favorable impact of foreign exchange). Sales growth in the Renal segment particularly benefited from the weakened dollar during the
three-year period ended December 31, 2004 because approximately three-quarters of this segment’s revenues are generated outside the
United States.

The following is a summary of sales by significant product line.

years ended December 31 (in millions)

2004

2003

2002

2004

2003

Percent change

PD Therapy
HD Therapy
Other

Total net sales

$1,445
499
14

$1,958

$1,344
447
17

$1,808

$1,262
413
17

$1,692

8%
12%
(17%)

6%
8%
(2%)

MANAGEMENT’S DISCUSSION AND ANALYSIS

PD Therapy
Peritoneal dialysis, or PD Therapy, is a dialysis treatment method for end-stage renal disease. PD Therapy, which is used primarily at home,
uses the peritoneal membrane, or abdominal lining, as a natural filter to remove waste from the bloodstream. In addition to the favorable
impact of foreign exchange, the sales growth in both periods was primarily driven by an increased number of patients, principally in Europe,
Asia and Japan. Changes in the pricing of the segment’s PD Therapy products were not a significant factor. Increased penetration of PD
Therapy products continues to be strong in emerging markets, where many people with end-stage renal disease are currently under-treated.

HD Therapy
Hemodialysis, or HD Therapy, is another form of end-stage renal disease dialysis therapy, which is generally performed in a hospital or
outpatient center. HD Therapy works by removing wastes and fluid from the blood by using a machine and a filter, also known as a dialyzer.
Sales of HD Therapy products were particularly strong in 2004 as a result of strong sales of dialyzers in the United States due, in particular,
to the launch of the single-use EXELTRA dialyzer. Growth was also partially driven by increased service revenues from the Renal Therapy
Services (RTS) business outside the United States. RTS revenues from continuing operations are expected to decline in 2005 due to
planned divestitures. As further discussed below and in Note 2, the company divested the majority of its RTS dialysis clinics (and these
divested operations are reported in the consolidated financial statements as discontinued operations).

Gross Margin and Expense Ratios

years ended December 31 (as a percent of sales)

Gross margin
Marketing and administrative expenses

2004

2003

2002

41.2%
20.6%

44.4%
20.3%

46.7%
19.3%

Gross Margin
2004 vs. 2003 The decline in gross margin in 2004 was primarily driven by changes in product mix, pricing pressures, hedging losses
and increased costs relating to the company’s employee benefit plans. In the BioScience segment, the gross margin declined in 2004
primarily due to lower margins in the segment’s plasma-based products and vaccines businesses, partially offset by stronger sales of
higher-margin recombinant products. In the Medication Delivery segment, the pricing declines associated with the renegotiated contracts
with Premier and other GPOs impacted the margin decline. In the Renal segment, the margin declined in 2004 due to higher sales of
lower-margin hemodialysis products, and a change in geographic mix. In addition, while 2004 sales benefited from foreign exchange,
principally the strengthened Euro, the gross margin rate was unfavorably impacted by the company’s foreign currency hedging activities.
Increased inventory reserves (relating to the BioScience segment) and foreign currency hedge adjustments, together totaling $45 million
(included in the second quarter 2004 special charges, discussed in Note 4), accounted for almost 1 point of the decline during 2004. Also,
costs associated with the company’s employee pension and other postemployment benefit (OPEB) plans increased in 2004. These factors
were partially offset by cost savings relating to the company’s 2003 and 2004 restructuring programs, which are further discussed below.

2003 vs. 2002 The decline in the gross margin during 2003 was primarily related to the BioScience segment, partially offset by increases
in the Medication Delivery segment. Sales of the BioScience segment’s plasma-based products were impacted by increased competition
and related pricing pressures, which unfavorably affected the gross margin. Also, sales of higher-margin smallpox vaccines were lower in
2003 as compared to 2002, as 2002 sales benefited from the sale of crude bulk vaccine to Acambis in conjunction with its contract with
the United States Government. The increase in the gross margin in the Medication Delivery segment in 2003 was principally due to strong
sales of higher-margin anesthesia and drug delivery products, as well as incremental higher-margin sales related to the December 2002
acquisition of ESI. The product mix within Medication Delivery was also favorably impacted by reduced sales in certain lower-margin
distribution businesses in countries outside the United States, as a result of management’s decision to slowly withdraw from these
businesses. As in 2004, while 2003 sales benefited from the strengthened Euro, the gross margin rate was unfavorably impacted by the
company’s foreign currency hedging activities. Also, employee pension and OPEB plan costs increased in 2003.

Marketing and Administrative Expenses
2004 vs. 2003 Marketing and administrative expenses as a percent of sales increased during 2004. Increased receivable reserves totaling
$55 million (as discussed in Note 4) increased the expense ratio by approximately 1 point. Expenses also increased because of foreign
exchange, higher employee pension and OPEB plan costs, and the impact of reduced costs in the prior year due to a change in the employee
vacation policy. Partially offsetting these increases were the benefits of the company’s restructuring programs.

2003 vs. 2002 Marketing and administrative expenses as a percentage of sales increased during 2003 primarily due to increased
investments in sales and marketing programs in conjunction with the launch of new products, such as ADVATE and ALYX, the impact of the
strengthening Euro, higher employee benefit plan costs, and to drive overall sales growth. The increase in the expense ratio in 2003 was

MANAGEMENT’S DISCUSSION AND ANALYSIS

due to the impact of $60 million in favorable adjustments recorded in 2002, primarily related to favorable insurance recoveries.
Partially offsetting these increases were the benefits of the company’s restructuring programs, which were initiated at the end of the
second quarter of 2003.

Employee Benefit Plan Expenses
Pension and OPEB plan expenses increased $59 million in 2004 and $76 million in 2003, as detailed in Note 9, and contributed to the
company’s lower gross margin ratio and higher expense ratio in both 2004 and 2003. The increased expenses were partially due to a
change in assumptions. For the company’s domestic plans, which represent over three-quarters of the company’s total pension assets and
obligations, the discount rate decreased from 6.75% to 6% in 2004, and from 7.5% to 6.75% in 2003, and the expected return on assets
decreased from 11% to 10% in 2003. The increased expenses were also due to changes in demographics and investment returns, which
increased actuarial loss amortization expense. The $76 million increase in pension and OPEB plan expenses in 2003 was partially offset by
reduced expenses of $16 million as a result of a change in the company’s employee vacation policy.

Pension and OPEB plan expenses are expected to further increase in 2005, by approximately $65 million, primarily due to changes in
pension assumptions and higher actuarial loss amortization expense. For the domestic plans, the discount rate will be reduced from 6% to
5.75% and the expected return on plan assets will be lowered from 10% to 8.5%. The discount rate assumption change is due to reductions
in market interest rates used to determine the appropriate pension and OPEB discount rate. The change in the expected return on assets
assumption is principally a result of anticipated changes in the company’s pension trust asset allocation. Refer to the Critical Accounting
Policies section below for a discussion of how the pension and OPEB plan assumptions are developed, and how they impact the company’s
net expense.

Research and Development

years ended December 31 (in millions)

Research and development expenses
as a percent of sales

2004

$517
5.4%

2003

$553
6.2%

2002

$501
6.2%

Percent change

2004

(7%)

2003

10%

The company’s in-process R&D (IPR&D) charges in 2002, which are discussed in Note 3, are reported separately in the consolidated income
statements and are not included in the R&D amounts above.

R&D expenses declined in 2004, with increased spending on certain projects across the three segments more than offset by restructuring-
related cost savings and the termination of certain programs (such as the recombinant hemoglobin protein project, which was terminated in
the second quarter of 2003). In 2004, R&D activities resulted in the expanded approval of ADVATE in Europe. The company also filed for
approval of ADVATE in Japan. Other significant R&D activities in 2004 include filing for approval in the United States and Europe with respect
to the company’s next-generation liquid IVIG product, and filing for approval
in the United States for the expanded use of the company’s
ALYX system for the automated collection of red blood cells and plasma.

The increase in R&D expenses in 2003 was primarily due to increased investments in the Medication Delivery segment. Recent acquisitions,
principally the late 2002 acquisitions of ESI and Epic Therapeutics, Inc. (Epic), a business specializing in the formulation of drugs for
injection or inhalation, contributed 4 points to the 2003 R&D growth rate. Also contributing to the growth rate in 2003 was increased
spending relating to a number of other projects across the three segments.

Management’s strategy is to focus investments on key R&D initiatives, which management believes will maximize the company’s resources
and generate the most significant return on the company’s investment.

IPR&D Charges The IPR&D charges in 2002 primarily included $51 million relating to the acquisition of Fusion Medical Technologies, Inc.
(Fusion), a business that developed and commercialized proprietary products used to control bleeding during surgery, which is included in
the BioScience segment, $52 million relating to the acquisition of Epic and $56 million relating to the acquisition of ESI.

The nature of the acquired R&D projects, timing of projected material net cash inflows, assumptions used in the valuation, risks associated
with the projects, and other key information, such as post-acquisition terminations and delays of certain projects, are described in Note 3.
There can be no assurance that these R&D efforts will be successful. As with all R&D projects, delays in the development, introduction or
marketing of a product can result either in such product being marketed at a time when its cost and performance characteristics might not
be competitive in the marketplace or in a shortening of its commercial life. If a product is not completed on time, the expected return on the
company’s investments could be significantly and unfavorably impacted.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Special Charges
Restructuring Charges The company recorded restructuring charges totaling $543 million in 2004, $337 million in 2003 and $26 million
in 2002. The net-of-tax impact of the charges was $394 million ($0.64 per diluted share) in 2004, $202 million ($0.33 per diluted share) in
2003 and $15 million ($0.02 per diluted share) in 2002. The following is a summary of these charges.

2004 Restructuring Charge
During the second quarter of 2004, the company recorded a $543 million restructuring charge principally associated with management’s
decision to implement actions to reduce the company’s overall cost structure and to drive sustainable improvements in financial
performance. The charge is primarily for severance and costs associated with the closing of facilities and the exiting of contracts.

These actions include the elimination of over 4,000 positions, or 8% of the global workforce, as management reorganizes and streamlines the
company. Approximately 50% of the positions being eliminated are in the United States. Approximately three quarters of the estimated savings
impact general and administrative expenses, with the remainder primarily impacting cost of sales. The eliminations impact all three of the
company’s segments, along with the corporate headquarters and functions. Baxter is also further reducing plasma production, closing
additional plasma collection centers, and exiting certain other facilities and activities. During the second half of 2004, $92 million of the
reserve for cash costs was utilized. Approximately $150 million is expected to be expended in 2005, and the remainder of approximately
$105 million in 2006. The cash expenditures are being funded with cash generated from operations. Approximately 60% of the targeted
positions have been eliminated as of December 31, 2004. The program is proceeding on plan. Refer to Note 4 for additional information.

Management estimates that these additional initiatives yielded savings of approximately $0.05 per diluted share in the second half of 2004,
and anticipates that the initiatives will yield savings of approximately $0.20 to $0.25 per diluted share in 2005 (assuming a constant diluted
share count), incremental savings of $0.15 to $0.20 per diluted share as compared to 2004. Once fully implemented in 2006, management
anticipates total annual savings will be approximately $0.30 to $0.35 per diluted share (assuming a constant diluted share count).

2003 Restructuring Charge
During the second quarter of 2003, the company recorded a $337 million restructuring charge principally associated with management’s
decision to close certain facilities and reduce headcount on a global basis. Management undertook these actions in order to position the
company more competitively and to enhance profitability. The company closed 26 plasma collection centers in the United States, as well
as a plasma fractionation facility located in Rochester, Michigan. In addition, the company consolidated and integrated several facilities,
including facilities in Maryland; Frankfurt, Germany; Issoire, France; and Mirandola, Italy. Management discontinued Baxter’s recombinant
hemoglobin protein program because it did not meet expected clinical milestones. Also included in the restructuring charge were costs
related to other reductions in the company’s workforce.

During 2004 and 2003, $91 million and $69 million, respectively, of the reserve for cash costs was utilized. Virtually all of the 3,200
targeted positions have been eliminated as of December 31, 2004. The remaining severance and other costs are expected to be paid
in 2005. The cash expenditures are being funded with cash generated from operations. Refer to Note 4 for additional information.

Management estimates that, as expected, cost savings totaled approximately $0.15 per diluted share in 2004. The program is substantially
complete, and management does not expect incremental cost savings in 2005. Cost savings in 2003 (since the June 2003 announcement
date) totaled approximately $0.05 per diluted share. As mentioned above, these benefits are offset by increased employee benefit costs.

2002 R&D Prioritization Charge
During the fourth quarter of 2002, the company recorded a charge of $26 million to prioritize the company’s investments in certain of
the company’s R&D programs across the three segments. This charge resulted from management’s comprehensive assessment of the
company’s R&D pipeline with the goal of having a focused and balanced strategic portfolio, which maximizes the company’s resources and
generates the most significant return on the company’s investment. Approximately 150 R&D positions were eliminated. Cash payments
relating to the charge totaled $1 million in 2004, $10 million in 2003 and $2 million in 2002. Management expects that the reserve will be
fully utilized, with the remaining reserve pertaining to certain lease payments, which continue through early 2005. Total cash expenditures
for this plan are being funded with cash generated from operations. Refer to Note 4 for further information.

Impairment Charges The company recorded a $289 million impairment charge in the fourth quarter of 2004 relating to its PreFluCel
influenza vaccine, recombinant erythropoietin drug (EPOMAX) for the treatment of anemia, and Thousand Oaks, California Suite D manu-
facturing assets. The net-of-tax impact of the impairment charges was $245 million ($0.40 per diluted share). Refer to Note 4 for further
information.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Other Special Charges The company recorded other special charges totaling $115 million in the second quarter of 2004. The net-of-tax
impact was $20 million ($0.03 per diluted share). These special charges related to accounts and other receivable reserves, the valuation of
inventory, intangible assets and fixed assets, foreign currency hedges and tax adjustments. By line item, cost of goods sold increased
$45 million, marketing and administrative expenses increased $55 million, other expense increased $15 million, and income tax expense
decreased $95 million. Refer to Note 4 for a discussion of the individual charges.

Net Interest Expense
Net interest expense increased $12 million, or 14%, in 2004, due to higher interest rates and lower capitalized interest, partially offset by a
lower average net debt level. Net interest expense increased $36 million, or 71%, in 2003, due to a higher average net debt level as well as
higher interest rates. Net interest expense is expected to increase by approximately $30 million to $40 million in 2005 due to higher expected
interest rates and the settlement of the company’s net investment hedges, as further discussed below.

Other Expense, Net
Refer to Note 10 for a table which details the components of other expense, net for the three years ended December 31, 2004.

The increase in other expense, net in 2004 primarily related to lower equity method income and lower gains on divestitures. Partially offsetting
these items were $11 million in costs recorded in 2003 related to the redemption of convertible bonds and lower asset impairment charges in
2004 compared to 2003. Equity method income and divestiture gains were lower in 2004 principally because Baxter divested its equity
method investment in Acambis in late 2003, recognizing a gain of $36 million.

The decrease in other expense, net in 2003 primarily related to higher equity method income relating to Acambis, the gain on the divestiture
of this investment, and lower asset impairment charges, partially offset by the convertible bond redemption costs recorded in 2003.

Pre-Tax Income
Refer to Note 13 for a summary of financial results by segment. Certain balance sheet and income and expense items are maintained at the
company’s corporate level and are not allocated to the segments. They primarily include certain foreign currency fluctuations, the majority
of the foreign currency and interest rate hedging activities, net interest expense, income and expense related to certain non-strategic
investments, corporate headquarters costs, certain employee benefit costs, certain nonrecurring gains and losses and certain special
charges (such as IPR&D, restructuring and certain asset impairments). Included in Note 13 is a table that reconciles financial results for the
segments to the consolidated company’s results. The following is a summary of significant factors impacting the segments’ financial results.

Medication Delivery Pre-tax income increased 4% in 2004 and 21% in 2003. The growth in pre-tax income in 2004 was primarily the
result of sales growth, the close management of costs, restructuring-related benefits, and foreign exchange (as noted above, the majority of
foreign currency hedging activities for all segments are recorded at the corporate level, and are not included in segment results). As noted
above, these factors were partially offset by the gross margin impact of reduced pricing in the renegotiated long-term contracts with GPOs.

The growth in pre-tax income in 2003 was primarily the result of sales growth, a favorable change in sales mix, the close management of
costs, acquisitions, the leveraging of expenses in conjunction with recent acquisitions, and foreign exchange. Favorably impacting the sales
mix in 2003 were higher-margin sales related to the December 2002 acquisition of ESI, as well as reduced sales in certain lower-margin
distribution businesses in certain countries outside the United States, as a result of management’s decision to slowly withdraw from these
businesses. These factors were partially offset by increased R&D spending, which was primarily related to the fourth quarter 2002
acquisitions of ESI and Epic.

BioScience Pre-tax income decreased 1% in 2004 and increased 9% in 2003. The decrease in pre-tax income in 2004 was primarily due
to increased inventory reserves and an asset impairment charge (recorded as special charges in 2004, as discussed in Note 4) and lower
margins in the segment’s plasma-based products and vaccines businesses. In addition, as discussed above, equity method income was
lower in 2004 as compared to 2003 due to the divestiture of the company’s investment in Acambis in late 2003. These factors were
partially offset by lower R&D spending as a result of the recent prioritization initiatives (including the termination of the recombinant
hemoglobin protein project in mid-2003), stronger sales of higher-margin recombinant products, the close management of costs,
restructuring-related benefits, and foreign exchange.

The increase in pre-tax income in 2003 was primarily due to increased income from the investment in Acambis, lower R&D spending, the
close management of costs, and foreign exchange, partially offset by lower gross margins, and increased sales and marketing costs
associated with the launch of new products. As discussed above, the lower gross margin in 2003 was primarily related to competitive
pricing pressures in the plasma-based products business. The impact of the lower plasma-based products margins was partially offset by
the effect of increased sales of recombinant products, which have a higher gross margin.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Renal Pre-tax income increased 14% in 2004 and decreased 6% in 2003. The increase in pre-tax income in 2004 was primarily due to
solid sales growth, foreign exchange, the close management of costs, and restructuring-related benefits. These factors were partially offset
by the impact of higher sales of lower-margin hemodialysis products, and a change in geographic mix.

The decrease in pre-tax income in 2003 was primarily due to lower gross profits, increased sales and marketing costs associated with the
launch of new products and increased R&D spending, partially offset by foreign exchange.

Income Taxes
The effective income tax rate relating to continuing operations was 11% in 2004, 20% in 2003 and 26% in 2002. The changes in the
effective income tax rate each year were due to varying tax rates applicable to the restructuring and other special charges, favorable
settlements in certain jurisdictions around the world, and the one-time tax cost in 2003 of nondeductible foreign dividends paid as the
company converted to a new tax structure in certain regions. As discussed in Note 4, as a result of the completion of tax audits in the second
quarter of 2004, $55 million of reserves for matters previously under review were reversed into income during 2004. These items decreased
the effective income tax rate by approximately 13 points in 2004, 6 points in 2003 and 1 point in 2002. Management anticipates that the
effective income tax rate will be approximately 25% in 2005. Refer to Note 11 for further information regarding the company’s income taxes.

The American Jobs Creation Act of 2004
In October 2004, the American Jobs Creation Act of 2004 (the Act) was enacted. The Act includes numerous provisions, including the
creation of a temporary incentive for United States multinationals to repatriate accumulated income earned abroad. The temporary tax
deduction of 85% of certain repatriated foreign earnings is subject to a number of limitations. Detailed final guidance necessary to
implement the Act has not yet been issued by the Internal Revenue Service. Management is analyzing the provisions of the Act and has not
yet determined the effects, if any, on the company’s plans or its consolidated financial statements. Management has not determined when it
will complete its evaluation. Refer to Note 11 for further information regarding the company’s foreign unremitted earnings.

Income From Continuing Operations Before the Cumulative Effect of Accounting Changes and Related per Diluted Share Amounts
Income from continuing operations, before the cumulative effect of accounting changes, was $383 million in 2004, $907 million in 2003
and $1.03 billion in 2002. Net earnings per diluted share from continuing operations, before the cumulative effect of accounting changes,
was $0.62 in 2004, $1.50 in 2003 and $1.66 in 2002. The significant factors and events causing the net declines from 2003 to 2004 and
from 2002 to 2003 are discussed above.

Income (Loss) From Discontinued Operations
In 2002, management decided to divest certain businesses, principally the majority of the services businesses included in the Renal seg-
ment, and recorded a $294 million pre-tax charge ($229 million on an after-tax basis). Management’s decision was based on an evaluation
of the company’s business strategy and the economic conditions in certain geographic markets. Refer to Note 2 for further information.

During 2003, the company sold RMS Lifeline, Inc., RMS Disease Management, Inc., and the Medication Delivery segment’s offsite pharmacy
admixture products and services business. During 2004 and 2003, the company divested the RTS centers. At December 31, 2004, the
divestiture plan is substantially complete.

During 2004, discontinued operations generated income of $5 million. The income was principally related to tax and other adjustments, as
the company completed divestitures. Discontinued operations generated net-of-tax losses of $24 million in 2003 and $26 million in 2002.

Changes in Accounting Principles
During 2003, the company adopted Statement of Financial Accounting Standards (FASB) No. 150, “Accounting for Certain Financial Instru-
ments with Characteristics of both Liabilities and Equity,” and Financial Accounting Standards Board Interpretation No. 46, “Consolidation of
Variable Interest Entities” (FIN No. 46). Upon adoption, Baxter recorded charges to earnings for the cumulative effect of these changes in
accounting principles totaling $17 million (net of income tax benefit of $5 million). Refer to Note 1 for further information.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with generally accepted accounting principles (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
significant accounting policies is included in Note 1. Certain of the company’s accounting policies are considered critical because these
policies are the most important to the depiction of the company’s financial statements and require significant, difficult or complex judgments
by management, often requiring the use of estimates about the effects of matters that are inherently uncertain. Actual results that differ
from management’s estimates could have an unfavorable effect on the company’s results of operations and financial position. The company
applies estimation methodologies consistently from year to year. Other than changes required due to the issuance of new accounting
pronouncements, there have been no significant changes in the company’s application of its critical accounting policies during 2004. The

MANAGEMENT’S DISCUSSION AND ANALYSIS

company’s critical accounting policies have been reviewed with the Audit Committee of the Board of Directors. The following is a summary
of accounting policies that management considers critical to the company’s consolidated financial statements.

Revenue Recognition and Related Provisions and Allowances
The company’s policy is to recognize revenues from product sales and services when earned, as defined by GAAP. Specifically, revenue is
recognized when persuasive evidence of an arrangement exists, delivery has occurred (or services have been rendered), the price is fixed
or determinable, and collectibility is reasonably assured.

The company enters into certain arrangements in which it commits to provide multiple elements (i.e., deliverables) to its customers. In
accordance principally with Emerging Issues Task Force No. 00-21, “Revenue Arrangements with Multiple Deliverables,” when the criteria
are met, total revenue for these arrangements is allocated among the deliverables based on the estimated fair values of the individual
deliverables. Fair values are generally determined based on sales of the individual deliverables to other third parties. It is not possible to
determine how reported amounts would change if different fair values were used.

Provisions for discounts, rebates to customers, and returns are provided for at the time the related sales are recorded, and are reflected
as a reduction of sales. These estimates are reviewed periodically and, if necessary, revised, with any revisions recognized immediately
as adjustments to sales. Management periodically and systematically evaluates the collectibility of accounts receivable and determines the
appropriate reserve for doubtful accounts. In determining the amount of the reserve, management considers historical credit losses, the
past due status of receivables, payment history and other customer-specific information, and any other relevant factors or considerations.

The company also provides for the estimated costs that may be incurred under its warranty programs when the cost is both probable
and reasonably estimable, which is at the time the related revenue is recognized. The cost is determined based upon actual company
experience for the same or similar products as well as any other relevant information. Estimates of future costs under the company’s
warranty programs could change based on developments in the future. Management is not able to estimate the probability or amount of any
future developments that could impact the reserves, but believes presently established reserves are adequate.

Stock-Based Compensation
The company has elected to apply the intrinsic value method in accounting for its stock-based compensation plans. In accordance with this
method, no expense is generally recognized for the company’s stock option and employee stock purchase plans. Included in Note 1 are
disclosures of pro forma net income and earnings per share as if the company had accounted for its employee stock option and stock
purchase plans based on the fair value method. That is, the pro forma disclosures assume Baxter had expensed the cost of stock options
and employee stock purchase subscriptions in its income statement. The fair value method requires management to make assumptions,
including estimated option and purchase plan lives and the future volatility of Baxter’s stock price. The use of different assumptions would
result in different pro forma amounts of net income and earnings per share. Management is not able to estimate the probability of actual
results differing from expected results, but believes the company’s assumptions are appropriate.

Refer to the discussion below regarding the newly issued stock compensation accounting rules, which will become effective during 2005.

Pension and OPEB Plans
The company provides pension and OPEB benefits to certain of its employees. These employee benefit expenses are reported in the same
line items in the consolidated income statement as the applicable employee’s compensation expense. The valuation of the funded status and
net expense for the plans are calculated using actuarial assumptions. These assumptions are reviewed annually, and revised if appropriate.
The significant assumptions include the following:

(cid:127)
(cid:127)
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(cid:127)
(cid:127)

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

Selecting assumptions involves an analysis of both short-term and long-term historical trends and known economic and market conditions at
the time of the valuation (also called the measurement date). The use of different assumptions would result in different measures of the
funded status and net expense. Actual results in the future could differ from expected results. Management is not able to estimate the
probability of actual results differing from expected results, but believes its assumptions are appropriate.

The company’s assumptions are listed in Note 9. The most critical assumptions relate to the plans covering United States and Puerto Rican
employees, because these plans are the most significant to the company’s consolidated financial statements.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Discount Rate Assumption
For the United States and Puerto Rico plans, as of the 2004 measurement date, the company used a discount rate of 5.75% for both the
pension and OPEB plans, versus the 6% discount rate used in the prior year. This assumption will be used in calculating the expense for
these plans in 2005. The lower discount rate assumption will result in increased expense in 2005.

In estimating the discount rate assumption, the company uses the Moody’s Aa corporate bond index, and adjusts for differences in duration
between the bonds in the index and Baxter’s pension and OPEB plan liabilities (incorporating expected reinvestment rates, which are
extrapolated from the measurement-date yield curve). In finalizing the assumption in 2004, the company also examined the projected cash
flows and durations of its pension and OPEB plan liabilities, and matched them to a yield curve generated by a large population of Aa-rated
corporate bonds.

Changes in the discount rate assumption each year reflect changes in market interest rates, and thus there is little discretion in selecting
this assumption.

In order to understand the impact of changes in discount rates on expense, management performs a sensitivity analysis. Holding all other
assumptions constant, for each 50 basis point (i.e., one-half of one percent) increase in the discount rate, global pension and OPEB plan
pre-tax expenses would decrease by approximately $25 million. For each 50 basis point decrease in the discount rate, global pension and
OPEB plan pre-tax expenses would increase by approximately $26 million.

Return on Plan Assets Assumption
As of the 2004 measurement date, the company is using a long-term rate of return of 8.5% for the pension plans covering United States
and Puerto Rican employees, versus the 10% used in the prior year (this assumption is not applicable to the company’s OPEB plans because
they are not funded). The 8.5% assumption will be used in calculating net pension expense for 2005. The lower expected asset return
assumption will result in increased expense in 2005.

The reduction in the expected asset return assumption is primarily due to anticipated changes in the company’s pension trust asset
allocation. That is, the company plans to reduce the equity securities weighting in the overall asset portfolio over time, increasing the
portion of the portfolio invested in fixed-income securities. Based on historical and projected analyses, fixed-income securities generate
lower returns over time than equity securities. The lower return associated with fixed-income securities is offset by generally lower risk and
other benefits relating to investing in these securities. Refer to Note 9 for the company’s targeted asset allocation ranges and actual asset
allocations at December 31, 2004 and December 31, 2003, as well as a summary of the company’s policies and procedures relating to the
pension plan assets.

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

In order to understand the impact of changes in the expected asset return assumption on net expense, management performs a sensitivity
analysis. Holding all other assumptions constant, for each 50 basis point increase (decrease) in the asset return assumption, global pre-tax
pension expenses would decrease (increase) by approximately $10 million.

Other Assumptions
The assumptions relating to employee compensation increases and future health-care costs are based on historical experience, market
trends, and anticipated future management actions.

Projected 2005 Pension and OPEB Plan Expense
Total expense for the company’s pension and OPEB plans is expected to increase by approximately $65 million, from $150 million in 2004
to approximately $215 million in 2005.

The expected $65 million increase is principally due to changes in assumptions, demographics and investment returns, partially offset by
higher expected investment returns relating to the company’s planned funding of its plans during the 2005 measurement period. In addition,
pension and OPEB plan expense fluctuates each year based on the normal operation of the plans.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Amortization of Gains and Losses and Changes in Assumptions As disclosed in Note 9, the company’s benefit plans had a net unrecog-
nized loss of $1.57 billion as of the 2004 measurement date. Gains and losses resulting from actual experience differing from assumptions
are determined on each measurement date, and are subject to recognition in the consolidated income statement. These calculated gains
and losses are also impacted by any changes in assumptions during the year. If the net accumulated gain or loss exceeds 10% of the
greater of plan assets or liabilities, a portion of the net unrecognized gain or loss is amortized to income or expense over the remaining
service lives of employees participating in the plans, beginning in the following year. Amortization of the net unrecognized loss, which is a
component of total pension and OPEB plan expense, increased $44 million in 2004 and $28 million in 2003. The increased loss amor-
tization component of total pension and OPEB plan expense was partly impacted by changes in the discount rate and investment return
assumptions. Overall, these changes in assumptions increased total pension and OPEB plan expense by approximately $33 million in 2004
and by approximately $34 million in 2003. It should be noted that changes in assumptions do not directly impact the company’s cash flows
as funding requirements are pursuant to government regulations, which use different formulas and assumptions than GAAP (refer to the
Funding of Pension and OPEB Plans section below). The company may or may not change the assumptions as of the 2005 measurement
date. Those determinations will be based on market conditions and future expectations as of the future date.

Legal Contingencies
Baxter is currently involved in certain legal proceedings, lawsuits and other claims, which are discussed in Note 12. Management assesses
the likelihood of any adverse judgments or outcomes for these matters, as well as potential ranges of reasonably possible losses, and has
established reserves in accordance with GAAP for certain of these legal proceedings. Management also records any insurance recoveries that
are probable of occurring. At December 31, 2004, total legal liabilities were $168 million and total insurance receivables were $106 million.

The loss estimates are developed in consultation with outside counsel and are based upon analyses of potential results. There is a
possibility that resolution of these matters could result in an additional
loss in excess of presently established liabilities. Also, there is a
possibility that resolution of certain of the company’s legal contingencies for which there is no liability could result in a loss. Management is
not able to estimate the amount of such loss or additional loss (or range of loss or additional loss). With respect to the recording of any
insurance recoveries, after completing the assessment and accounting for the company’s legal contingencies, management separately and
independently analyzes its insurance coverage and records any insurance recoveries that are probable of occurring at the gross amount
that is expected to be collected. In performing the assessment, management reviews all available information,
including historical
company-specific and market collection experience for similar claims, current facts and circumstances pertaining to the particular
insurance claim, the financial viability of the applicable insurance company or companies, and other relevant information. Management also
consults with and obtains the opinion of external legal counsel in forming its conclusion.

It is possible that future results of operations or net cash flows could be materially affected if actual outcomes are significantly different than
management’s assumptions or estimates related to these matters. Management believes that, while such a future charge could have a
material adverse impact on the company’s net income and cash flows in the period in which it is recorded or paid, no such charge would
have a material adverse effect on Baxter’s consolidated financial position.

Inventories
The company values its inventories at the lower of cost, determined using the first-in, first-out method, or market value. Market value
for raw materials is based on replacement costs. Market value for work in progress and finished goods is based on net realizable value.
Management reviews inventories on hand at least quarterly and records provisions for estimated excess, slow-moving and obsolete
inventory, as well as inventory with a carrying value in excess of net realizable value. The regular and systematic inventory valuation reviews
include a current assessment of future product demand, anticipated release of new products into the market (either by the company or its
competitors), historical experience and product expiration. Uncertain timing of product approvals, variability in product launch strategies,
product recalls and variation in product utilization all impact the estimates related to inventory valuation. Additional inventory provisions may
be required if future demand or market conditions are less favorable than the company has estimated. Management is not able to estimate
the probability of actual results differing from expected results, but believes its estimates are appropriate.

Tax Audits and Valuation Reserves
In the normal course of business, the company is regularly audited by federal, state and foreign tax authorities, and is periodically
challenged regarding the amount of taxes due. These challenges include questions regarding the timing and amount of deductions and the
allocation of income among various tax jurisdictions. Management believes the company’s tax positions comply with applicable tax law and
the company intends to defend its positions. In evaluating the exposure associated with various tax filing positions, the company
records reserves for uncertain tax positions, and management believes these reserves are adequate. The company’s effective tax rate
in a given period could be impacted if the company prevailed in matters for which reserves have been established, or was required to pay
amounts in excess of established reserves.

MANAGEMENT’S DISCUSSION AND ANALYSIS

The company maintains valuation allowances unless it is more likely than not that all or a portion of the deferred tax asset will be realized.
Changes in valuation allowances are included in the company’s tax provision in the period of change. In determining whether a valuation
allowance is warranted, management evaluates factors such as prior earnings history, expected future earnings, carry-back and carry-
forward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset.

Impairment of Assets
Goodwill is subject to annual impairment reviews, and whenever indicators of impairment exist. Intangible assets other than goodwill and
other long-lived assets (such as fixed assets) are reviewed for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Refer to Note 1 for further information. The company’s impairment review is based on
a cash flow approach that requires significant management judgment with respect to future volume, revenue and expense growth rates,
changes in working capital use, foreign exchange rates, the selection of an appropriate discount rate and other assumptions and estimates.
The estimates and assumptions used are consistent with the company’s business plans. The use of alternative estimates and assumptions
could increase or decrease the estimated fair value of the asset, and potentially result in different impacts to the company’s results of oper-
ations. Actual results may differ from management’s estimates.

Hedging Activities
As further discussed in Note 6 and in the Financial
Instrument Market Risk section below, the company uses derivative instruments to
hedge certain risks. As Baxter operates on a global basis, there is a risk to earnings associated with foreign exchange relating to the
company’s firm commitments and forecasted transactions denominated in foreign currencies. Compliance with FASB No. 133, “Accounting
for Derivative Instruments and Hedging Activities” and its amendments, and the company’s hedging policies requires management to make
judgments regarding the probability of anticipated hedged transactions. In making these estimates and assessments of probability,
management analyzes historical trends and expected future cash flows and plans. The estimates and assumptions used are consistent with
the company’s business plans. If management were to make different assessments of probability or make the assessments during a
different fiscal period, the company’s results of operations for a given period would be different.

Equity Units
Certain financial
instruments used by the company are complex and accounting for them requires management to make estimates and
judgments that affect the reported amounts of liabilities, stockholders’ equity, net income and earnings per diluted share. If management
had made different estimates and judgments, amounts reported in the company’s consolidated financial statements would be different.

Specifically, in December 2002 the company issued equity units, which are financial instruments that bear characteristics of both debt and
equity. Each equity unit contains a senior note and a purchase contract that obligates the holder to purchase common stock from Baxter at
a future date. Refer to Note 5 for further discussion of these financial instruments.

The proceeds obtained from the issuance of the equity units were allocated to the senior notes and the purchase contracts on a relative fair
value basis, with $1.25 billion allocated to the senior notes and $0 allocated to the purchase contracts. The estimated fair values were
determined by management based on several valuation techniques, including a review of the prices of similar securities trading in the
market, the Black-Scholes model, present value calculations, as well as consultation with outside advisers. With respect to the related
underwriting costs, management allocated to the senior notes the amount of fees typically charged in the marketplace for a similar issuance
on a stand-alone basis ($7.5 million), with the remaining underwriting costs ($30 million) allocated to the purchase contracts. This method
was determined to be the most appropriate and objective as, unlike for the purchase contracts, the costs of issuing the senior notes
on a stand-alone basis are readily available and known in the marketplace. The costs allocated to the senior notes are being amortized
through February 2006, which is the date holders have a contingent right to put the notes to Baxter. The costs allocated to the purchase
contracts were charged to additional contributed capital on the issuance date. Had the company allocated more (less) of the underwriting
costs to the senior notes, Baxter’s results of operations would be lower (higher) in future periods.

The senior notes contain certain features, such as a remarketing provision (where the holders of the senior notes can elect to participate
in a resale of the notes to new investors), and contingent put and call options. Management reviewed applicable GAAP and determined that
no separate accounting for these features as stand-alone derivatives was required. In arriving at this determination, management made
estimates of the probability of certain of the contingencies occurring. Had management made different judgments, the accounting treatment
would be different. Management has not quantified this potential impact.

With respect to the calculation of earnings per diluted share, the purchase contracts require the holder to settle the contracts in cash,
which requires use of the treasury stock method for these contracts. Only in the event of a failed remarketing of the senior notes in
February 2006 does the contract holder have the option to surrender the senior note in satisfaction of the purchase contract, triggering use
of the if-converted method. Since management believes the likelihood of a failed remarketing is remote, use of the treasury stock method is

MANAGEMENT’S DISCUSSION AND ANALYSIS

appropriate. Had management determined that the if-converted method was appropriate, the impact would be more dilutive than with use of
the treasury stock method.

As disclosed in Note 5, Baxter is making quarterly contract adjustment payments to the purchase contract holders at a rate of 3.4%. The
present value of these payments was charged to additional contributed capital and is included in other liabilities, and payments to the
holders are allocated between the liability and interest expense based on a constant rate calculation over the life of the contracts.
Management used a 3.75% discount rate to calculate this liability. Because, in the event of Baxter’s insolvency, the contract adjustment
liability would be settled only after the senior notes have been repaid, the discount rate used to calculate the liability must be higher than the
3.6% coupon rate on the senior notes. The discount rate was estimated by management based on the inherently higher risk associated with
the purchase contract liability, in consultation with outside advisers. Had management selected a higher (lower) discount rate, the
company’s net interest expense would be higher (lower) in future periods.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows from Operations
Continuing operations Cash flows from continuing operations decreased in 2004 and increased in 2003. The decrease in cash flows in
2004 was principally due to lower earnings (before non-cash items), increased payments related to the restructuring programs, higher
contributions to the company’s primary pension trust relating to the United States and Puerto Rico plans, and reduced cash flows relating to
accounts receivable, partially offset by improved inventory management. In 2003, higher earnings (before non-cash items) and improved
cash flows relating to accounts receivable and inventories were partially offset by increased payments relating to the 2003 restructuring
program and higher contributions to the pension trusts.

Accounts Receivable
Cash flows relating to accounts receivable decreased in 2004. Days sales outstanding increased from 50.7 days at December 31, 2003 to
55.3 days at December 31, 2004. Cash flows from the company’s securitization arrangements decreased by over $150 million during
2004, partially offset by increased cash flows relating to the factoring of receivables.

In 2003, with increased focus on working capital efficiency, the company improved its accounts receivable collections (days sales
outstanding improved from 52.7 days at December 31, 2002 to 50.7 days at December 31, 2003). The company’s receivable
securitization arrangements did not impact cash flows during 2003. Cash flows in 2002 benefited $57 million from the company’s
receivable securitization arrangements.

Inventories
The following is a summary of inventories at December 31, 2004 and 2003, as well as inventory turns for each of the three years ended
December 31, 2004, by segment.

(in millions, except inventory turn data)

BioScience
Medication Delivery
Renal

Total company

Inventories

Inventory turns

2004

2003

$1,332
587
216

$2,135

$1,378
528
198

$2,104

2004

1.57
4.40
4.19

2.66

2003

1.53
4.52
4.15

2.55

2002

1.65
4.60
4.23

2.71

Inventories increased by $31 million from December 31, 2003 to December 31, 2004, including the impact of foreign exchange, which
increased inventories approximately $100 million during the year. The reduction in BioScience inventories was principally related to the
planned reduction in plasma inventories, offset by the impact of foreign exchange. Overall, total company inventory turns increased as
management continues to focus on working capital efficiency.

Liabilities, Including Restructuring Payments and Contributions to the Pension Trusts
As noted above, significant reasons for the decline in cash flows from continuing operations during 2004 were increased payments related
to restructuring programs and increased contributions to the company’s pension trusts. Restructuring payments increased $116 million,
from $79 million to $195 million. Contributions to Baxter’s pension trusts increased $9 million, from $86 million to $95 million.

Payments relating to the 2003 restructuring program and contributions to the company’s pension trusts also increased in 2003. Restructuring
payments increased $77 million, from $2 million to $79 million. Contributions to the pension trusts totaled $86 million in 2003 as compared
to no contributions in 2002.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Discontinued operations Cash flows relating to discontinued operations increased $7 million during 2004, from $1 million in 2003 to $8
million in 2004, with the increased cash flows primarily relating to divestiture proceeds. As discussed in Note 2 and above, the company
has substantially completed the divesture plan.

Cash flows from discontinued operations increased $59 million in 2003. The increase was primarily due to management’s 2002 decision to
exit the majority of the RTS business, and thus reduce significant further investments, due to the economic and currency volatility in Latin
America, where RTS primarily operated.

Cash Flows from Investing Activities

Capital Expenditures
Capital expenditures decreased in 2004 by $234 million, from $792 million in 2003 to $558 million in 2004. Capital expenditures decreased
$60 million in 2003, from $852 million in 2002 to $792 million in 2003. The company has reduced its level of investments in capital
expenditures as certain significant long-term projects are completed, and as management more efficiently manages capital spending.
Construction in progress decreased 32% in 2004 and 6% in 2003. However, the company continues to invest in various multi-year capital
projects across its three segments, including ongoing projects to upgrade facilities or increase manufacturing capacity for drug delivery,
plasma-based (including antibody therapy) and other products. One of the significant drug delivery projects includes the expansion of the
company’s manufacturing facility in Bloomington, Indiana. One of the significant plasma-based products projects includes the upgrade of the
company’s manufacturing facility in Los Angeles, California.

Capital expenditures are made at a level sufficient to support the strategic and operating needs of the businesses. Management expects to
spend approximately $550 million to $600 million in capital expenditures in 2005. Management expects that the total of depreciation and
amortization expense in 2005 will be relatively consistent with 2004.

Acquisitions and Investments in and Advances to Affiliates
Net cash outflows relating to acquisitions and investments in and advances to affiliates decreased by $164 million in 2004, from $184
million in 2003 to $20 million in 2004. The 2004 outflows include additional payments relating to the 2003 acquisition of certain assets of
Alpha Therapeutic Corporation (Alpha), which are included in the BioScience segment.

The total outflows in 2003 included a $71 million net payment relating to the acquisition of Alpha, and the funding of a five-year $50 million
loan to Cerus Corporation, a minority investment holding which is included in the BioScience segment. The 2003 payments also included
an $11 million common stock investment in Acambis, which was divested later in 2003, a $26 million additional purchase price payment
relating to the December 2002 acquisition of ESI, and an $11 million payment for an icodextrin manufacturing facility in England, which is
included in the Renal segment.

In 2002, net cash outflows relating to acquisitions related primarily to acquisitions and investments in the Medication Delivery segment, with
$308 million relating to the acquisition of ESI, $59 million relating to the acquisition of Epic, $43 million relating to the July 2002 acquisition
of Wockhardt Life Sciences Limited, an Indian manufacturer and distributor of intravenous fluids, and $24 million relating to the January
2002 acquisition of Autros Healthcare Solutions Inc., a developer of automated patient information and medication management systems
designed to reduce medication errors. As further discussed in Note 3, in May 2002, the company acquired Fusion in a non-cash transaction,
with the purchase price paid in Baxter common stock.

Divestitures and Other
Net cash flows relating to divestitures and other totaled $26 million in 2004, and primarily related to the sale of a building and the return of
collateral.

The cash inflows relating to divestitures and other in 2003 primarily consisted of the net cash proceeds relating to the company’s divestiture
of its investment in Acambis. The cash inflows relating to divestitures and other in 2002 primarily consisted of $41 million relating to the
sales of certain land and facilities, $15 million relating to the transfer of assets to Edwards Lifesciences Corporation, as further discussed in
Note 2, and a final cash receipt related to a prior year divestiture in the Medication Delivery segment. These cash inflows in 2002 were
partially offset by a payment made to extinguish the company’s liability relating to certain put rights.

Cash Flows from Financing Activities

Debt Issuances, Net of Redemptions and Other Payments of Debt
Debt issuances, net of redemptions and other payments of financing obligations totaled to a net outflow in all three years. The net outflows
totaled $378 million in 2004, $440 million in 2003 and $1.59 billion in 2002. Included in the outflows in 2004 was a $40 million payment to

MANAGEMENT’S DISCUSSION AND ANALYSIS

exit one of the company’s cross-currency swap agreements. Refer to the discussion below regarding these swaps and management’s
strategy for the future.

In March 2003, the company issued $600 million of term debt, maturing in March 2015 and bearing a 4.625% coupon rate. In June 2003,
the company redeemed $800 million, or substantially all, of its convertible debentures, as the holders exercised their rights to put the
debentures to the company. In December 2002, the company issued equity units and received net proceeds of $1.21 billion. Refer to the
Critical Accounting Policies section above as well as Note 5 for a description of the equity units. In April 2002, the company issued $500
million of term debt, maturing in May 2007 and bearing a 5.25% coupon rate. The net proceeds of these issuances in 2004, 2003 and
2002 were used for various purposes, principally to fund acquisitions, settle certain equity forward agreements (as further discussed in
Note 6), retire existing debt, fund capital expenditures and for general corporate purposes.

Other Financing Activities
Common stock cash dividends increased by $15 million in 2004 due to a higher level of common shares outstanding. In November 2004,
the board of directors declared an annual dividend on the company’s common stock of $0.582 per share. The dividend, which was payable
on January 5, 2005 to stockholders of record as of December 10, 2004, is a continuation of the current annual rate. As in prior years, the
dividend will be funded with cash generated from operations. Cash received for stock issued under employee benefit plans increased by
$76 million in 2004 primarily due to a higher level of stock option exercises and purchases under the company’s employee stock purchase
plans, coupled with a higher average stock option exercise price. There were no common stock issuances in 2004. In September 2003, the
company issued 22 million shares of common stock and received net proceeds of $644 million. The net proceeds were used to settle
equity forward agreements, to fund the company’s acquisition of Alpha, and for other general corporate purposes. In 2004, the company
paid $18 million to repurchase stock from Shared Investment Plan participants. Refer to Note 5 for further information regarding the Shared
Investment Plan. In 2003, the company purchased 15 million shares of common stock for $714 million from counterparty financial
institutions in conjunction with the settlement of equity forward agreements.

Common stock cash dividends decreased in 2003 by $3 million due to a lower level of common shares outstanding. Cash received for
stock issued under employee benefit plans decreased in 2003 by $75 million primarily due to a lower level of stock option exercises,
partially offset by a higher level of employee stock subscription purchases. Other issuances of common stock increased by $230 million in
2003. As further described in Note 8, the company issued 14.95 million shares of common stock in 2002 and received net proceeds of
$414 million. The net proceeds from these issuances were principally used to fund acquisitions, retire a portion of the company’s debt,
settle the company’s equity forward agreements, and for other general corporate purposes. Stock repurchases in both 2003 and 2002
principally related to the company’s decision to exit all of its equity forward agreements.

issue between 35.0 and 43.4
Refer to Note 5 regarding the company’s equity units. As discussed, in February 2006, the company will
million shares of Baxter common stock for $1.25 billion. Management has not yet determined how the company will use the $1.25 billion
proceeds that will be received upon settlement of the purchase contracts included in the equity units. The company may use the proceeds
to pay down existing debt, fund pension plans, make acquisitions, and/or for other corporate purposes.

Credit Facilities, Access to Capital and Net Investment Hedges

Credit Facilities
The company had $1.11 billion of cash and equivalents at December 31, 2004. The company also maintains two revolving credit facilities,
which totaled $1.44 billion at December 31, 2004. One of the facilities totals $640 million and matures in October 2007, and the other
facility totals $800 million and matures in September 2009. The facilities enable the company to borrow funds on an unsecured basis
at variable interest rates. The company has never drawn on these facilities. Management believes these credit facilities are adequate to
support ongoing operational requirements. The credit facilities contain certain covenants, including a maximum net-debt-to-capital ratio and a
minimum interest coverage ratio. At December 31, 2004, as in prior periods, the company was in compliance with all financial covenants.
The company’s net-debt-to-capital ratio, as defined below, of 33.5% at December 31, 2004 was well below the credit facilities’ net-debt-
to-capital covenant. Similarly, the company’s actual interest coverage ratio of 4.4 to 1 in the fourth quarter of 2004 was well in excess of
the minimum interest coverage ratio covenant. The net-debt-to-capital ratio, which is calculated in accordance with the company’s primary
credit agreements, and is not a measure defined by GAAP, is calculated as net debt (short-term and long-term debt and lease obligations,
less cash and equivalents) divided by capital (the total of net debt and stockholders’ equity). The net-debt-to-capital ratio at December 31,
2004 and the corresponding covenant in the company’s credit agreements give 70% equity credit to the company’s equity units. The mini-
mum interest coverage ratio is a four-quarter rolling calculation of the total of income from continuing operations before income taxes plus
interest expense (before interest income), divided by interest expense (before interest income). Baxter also maintains certain other credit
arrangements, as described in Note 5.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Access to Capital
Management intends to fund short-term and long-term obligations as they mature through cash on hand, future cash flows from operations,
by issuing additional debt, or by issuing common stock. As of December 31, 2004, the company can issue up to $399 million of securities,
including debt, common stock and other securities, under an effective shelf registration statement filed with the Securities and Exchange
Commission.

The company’s ability to generate cash flows from operations, issue debt, enter into other financing arrangements and attract long-term
capital on acceptable terms could be adversely affected in the event there is a material decline in the demand for the company’s products,
deterioration in the company’s key financial ratios or credit ratings, or other significantly unfavorable changes in conditions. Management
believes the company has sufficient financial flexibility in the future to issue debt, enter into other financing arrangements, and attract long-
term capital on acceptable terms to support the company’s growth objectives.

Credit Ratings
The company’s credit ratings at December 31, 2004 were as follows.

Ratings

Senior debt
Short-term debt

Outlook

Standard & Poor’s

Fitch

Moody’s

A-
A2
Negative

BBB+
F2
Stable

Baa1
P2
Negative

The company’s credit ratings and outlooks were downgraded during 2004. At December 31, 2003, the ratings were A by Standard &
Poor’s, A by Fitch and A3 by Moody’s on senior debt, and A1 by Standard & Poor’s, F1 by Fitch and P2 by Moody’s on short-term debt (with
a negative outlook from Moody’s and Standard & Poor’s and a stable outlook from Fitch).

The rating agency downgrades in 2004 and any future downgrades of Baxter’s credit ratings may unfavorably impact the financing costs
related to the company’s credit arrangements and future debt issuances. Management believes that the actual and anticipated impact of the
recent downgrades and changes in outlook are not material. Management believes that the impact of reasonably possible future changes in
credit ratings or outlook would also not be material.

Any future credit rating downgrades or changes in outlook would not affect the company’s ability to draw on its credit facilities, and would
not result in an acceleration of the scheduled maturities of any of the company’s outstanding debt.

Certain specified rating agency downgrades, if they occur in the future, could require the company to post collateral for, or immediately
settle certain of its arrangements. These arrangements principally pertain to the company’s foreign currency and interest rate derivatives,
which Baxter uses for hedging purposes. For risk-management purposes, certain of the company’s counterparty financial institutions require
that collateral could be required to be posted or that the arrangement could be terminated under specified circumstances. The terms of the
arrangements vary, but generally, the collateral or termination trigger is dependent upon the mark-to-market liability (if any) with the financial
institution and the company’s credit ratings. No collateral was required to be posted at December 31, 2004. It is not possible to know with
certainty what each of these variables will be in the future. However, if Baxter’s credit rating on its senior unsecured debt declined to Baa2
or BBB (i.e., a one-rating or two-rating downgrade, depending upon the rating agency), no arrangement would be terminated, and the
amount of collateral that could currently be required (holding the mark-to-market liability balance of outstanding derivative instruments as of
December 31, 2004 constant) would total approximately $100 million. In addition, in the event of certain specified downgrades (Baa3 or
BBB-, depending on the rating agency), the company would no longer be able to securitize new receivables under certain of its securitization
arrangements. However, any downgrade of credit ratings would not impact previously securitized receivables.

Net Investment Hedges
As discussed in Note 6, the company has historically used cross-currency swaps to hedge the net assets of certain of its foreign operations
using a combination of foreign currency denominated debt and cross-currency swaps. The swaps have served as effective hedges for
accounting purposes and have reduced volatility in the company’s stockholders’ equity balance and net-debt-to-capital ratio (as any increase
or decrease in the fair value of the swaps relating to changes in spot currency exchange rates is offset by the change in value of the hedged
net assets of the foreign operations relating to changes in spot currency exchange rates).

Because the United States Dollar has weakened relative to the hedged currency, the hedged net assets have increased in value over time,
while the cross-currency swaps have decreased in value over time. At December 31, 2004, as presented in the following table, the com-
pany had a pre-tax net liability of $1.17 billion relating to cross-currency swap agreements. Of this total, $356 million was short-term, and
$816 million was long-term.

MANAGEMENT’S DISCUSSION AND ANALYSIS

The company reevaluated its net investment hedge strategy in the fourth quarter of 2004 and decided to reduce the use of these
instruments as a risk-management tool. Management intends to settle the swaps that mature in 2005 using cash flows from operations.

In addition, in order to reduce financial risk and uncertainty through the maturity (or cash settlement) dates of the cross-currency swaps,
the company executed offsetting or mirror cross-currency swaps relating to approximately 58% of the existing portfolio. As of the date of
execution, these mirror swaps effectively fixed the net amount that the company will ultimately pay to settle the cross-currency swap
agreements subject to this strategy. After execution, as the market value of the fixed portion of the original portfolio decreases, the market
value of the mirror swaps increases by an approximately offsetting amount, and vice versa. The mirror swaps will be settled when the
offsetting existing swaps are settled. The following is a summary, by maturity date, of the mark-to-market liability position of the original
cross-currency swaps portfolio, the offsetting mirror swaps net asset position, and the net mark-to-market position as of December 31, 2004
(in millions).

Maturity date

2005
2007
2008
2009

Total

Swaps liability

Mirror swaps net asset

Net liability position

$ 465
64
309
458

$1,296

$(109)
(4)
(11)
—

$(124)

$ 356
60
298
458

$1,172

The mirror swaps net asset of $124 million consists of a $129 million asset net of a $5 million liability. Approximately $631 million of the
total swaps liability of $1.30 billion as of December 31, 2004 has been fixed by the mirror swaps.

For the mirrored swaps, the company will no longer realize the favorable interest rate differential between the two currencies, and this will
result in increased net interest expense in the future. The amount of increased net interest expense will vary based on floating interest rates
and foreign exchange rates, and the timing of the company’s settlements. Based on interest rates at December 31, 2004, the increase in
net interest expense is estimated to be approximately $20 million on an annual basis.

In accordance with FASB No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” when the cross-
currency swaps are settled, the cash flows will be reported within the financing section of the consolidated statement of cash flows. When
the mirror swaps are settled, the cash flows will be reported in the operating section of the consolidated statement of cash flows.

Contractual Obligations
As of December 31, 2004, the company has contractual obligations (excluding accounts payable, accrued liabilities, deferred income taxes
and contingent liabilities) payable or maturing in the following periods.

(in millions)

Short-term debt
Long-term debt and lease obligations, including current maturities
Operating leases
Other long-term liabilities2
Purchase obligations3

Contractual cash obligations

Total

$ 207
4,080
588
1,086
551

$6,512

Less than

one year

$207
154
135
—
346

$842

One to

three years

$ —
1,711
198
275
138

$2,322

Three to

five years

$ —
1,4231
147
791
38

$2,399

More than

five years

$ —
792
108
20
29

$949

1 Includes $1.25 billion 3.6% notes maturing in 2008. The holders of the notes have contingent put rights in 2006, as further discussed in Note 5.

2 The primary components of Other Long-Term Liabilities in the company’s consolidated balance sheet are liabilities relating to pension and OPEB plans, cross-
currency swaps, foreign currency hedges and litigation. Management projected the timing of the future cash payments based on contractual maturity dates (where
applicable), and estimates of the timing of payments (for liabilities with no contractual maturity dates).

As disclosed in Note 9, estimated cash funding relating to the company’s primary pension and OPEB plans in the United States and Puerto Rico totals $122 million
in 2005 (and is included in accrued liabilities in the consolidated balance sheet). Because the timing of funding relating to these plans beyond 2005 is uncertain,
and is dependent on future movements in interest rates and investment returns, changes in laws and regulations, and other variables, pension and OPEB plan cash
outflows beyond 2005 (approximately $1.1 billion) have not been included in the table above.

Future cash payments related to cross-currency swaps (the long-term portion) in the table above of $836 million are based on contractual maturity dates. Refer to
the discussion above for further information regarding the cross-currency swaps and management’s reassessment of its net investment hedge strategy.

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

MANAGEMENT’S DISCUSSION AND ANALYSIS

Off-Balance Sheet Arrangements and Contingencies
Baxter periodically enters into off-balance sheet financing arrangements where economical and consistent with the company’s business
strategy. In addition, certain contingencies arise in the normal course of business, which are not recorded in the consolidated balance
sheet in accordance with GAAP (such as contingent purchase price payments relating to acquisitions). Also, upon resolution of uncertainties,
the company may incur charges in excess of presently established liabilities for certain matters (such as legal contingencies). The following
is a summary of significant off-balance sheet arrangements and significant contingencies.

Synthetic Leases
Certain of the company’s operating leases are commonly referred to as synthetic leases. As discussed in Note 1, upon the company’s
adoption of FIN No. 46, three of the lessors (representing the majority of the company’s synthetic leases) were consolidated and therefore,
the leased assets and related liabilities are now included in Baxter’s consolidated financial statements. The synthetic leases that were not
impacted by FIN No. 46 continue to be accounted for as third-party operating leases.

The synthetic leases include contingent obligations in the form of residual value guarantees. Upon termination or expiration of these leases,
at Baxter’s option, Baxter must purchase the leased property, arrange for the sale of the leased property, or renew the lease. If the prop-
erty is sold for an amount less than the lessor’s investment in the leased property, the company is responsible to pay the lessor the differ-
ence between the sales price and an agreed-upon percentage of the amount financed by the lessor. Refer to Note 5 for further information.

Receivable Securitizations
Where economical, the company securitizes an undivided interest in certain pools of receivables. Refer to Note 6 for a description of these
arrangements. The securitization arrangements include limited recourse provisions, which are not material to the consolidated financial
statements. Neither the buyers of the receivables nor the investors in these transactions have recourse to assets other than the transferred
receivables.

A subordinated interest in each securitized portfolio is generally retained by the company. The subordinated interests retained in the
transferred receivables are carried as assets in Baxter’s consolidated balance sheet, and totaled $97 million at December 31, 2004.
Credit losses on these retained interests have historically been immaterial as a result of the securitized assets needing to meet certain
eligibility criteria, as further discussed in Note 6.

Shared Investment Plan
In order to align management and shareholder interests, in 1999 the company sold shares of Baxter stock to senior managers. As part
of this shared investment plan, the company has guaranteed repayment of participants’ third-party loans. Baxter’s maximum potential
obligation relating to the guarantee was $95 million as of December 31, 2004. Refer to Note 5 for further information.

Potential Additional Purchase Price Payments Relating to Acquisitions
As further discussed in Note 3, the company has contingent liabilities to pay additional purchase price relating to certain business
acquisitions. In accordance with GAAP, contingent purchase price payments relating to acquisitions are recorded when the contingencies
are resolved. The contingent consideration, if paid, will be recorded as an additional element of the cost of the acquired company or as
compensation, as appropriate. Based on management’s projections, any additional payments relating to the achievement of post-acquisition
sales or profit levels will be completely funded by the net cash flows relating to such sales or profits.

Joint Development and Commercialization Arrangements
In the normal course of business, Baxter enters into joint development and commercialization arrangements with third parties, sometimes
with investees of the company. The arrangements are varied but generally provide that Baxter will receive certain rights to manufacture,
market or distribute a specified technology or product under development by the third party, in exchange for payments by Baxter. At
December 31, 2004, the unfunded milestone payments under these arrangements totaled less than $150 million, and the majority of them
were contingent upon the third parties’ achievement of contractually specified milestones.

Credit Commitments
As also discussed in Note 5, as part of its financing program, the company had commitments to extend credit. The company’s total credit
commitment at December 31, 2004 was $139 million, of which $128 million was drawn and outstanding.

Cash Collateral Requirements
Certain specified rating agency downgrades, if they occur in the future, could require the company to post collateral or immediately
instruments, or could cause the company to no longer be able to securitize new receivables under certain of its
settle certain financial
securitization arrangements. Refer to the Credit Ratings section above for further information.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Indemnifications
During the normal course of business, Baxter makes certain indemnities, commitments and guarantees under which the company may be
required to make payments related to specific transactions. These include: (i) intellectual property indemnities to customers in connection
with the use, sales or license of products and services; (ii) indemnities to customers in connection with losses incurred while performing
services on their premises; (iii) indemnities to vendors and service providers pertaining to claims based on negligence or willful misconduct;
and (iv) indemnities involving the representations and warranties in certain contracts. In addition, under Baxter’s Restated Certificate of
Incorporation, the company is committed to its directors and officers for providing for payments upon the occurrence of certain prescribed
events. The majority of these indemnities, commitments and guarantees do not provide for any limitation on the maximum potential for
future payments that the company could be obligated to make. To help address these risks, the company maintains various insurance
coverages. Based on historical experience and evaluation of the agreements, management does not believe that any significant payments
related to its indemnifications will result, and therefore the company has not recorded any associated liabilities.

Legal Contingencies
Refer to Note 12 for a discussion of the company’s legal contingencies. Upon resolution of any of these uncertainties, the company
may incur charges in excess of presently established liabilities. While such a future charge could have a material adverse effect on the
company’s net income or cash flows in the period in which it is recorded or paid, based on the advice of counsel, management believes
that the outcome of these actions, individually or in the aggregate, will not have a material adverse effect on the company’s consolidated
financial position.

Funding of Pension and OPEB Plans
The company’s funding policy for its defined benefit pension plans is to contribute amounts sufficient to meet legal funding requirements,
plus any additional amounts that management may determine to be appropriate considering the funded status of the plans, tax deductibility,
the cash flows generated by the company, and other factors. Management expects to fund approximately $100 million to its primary plans
in the United States and Puerto Rico in 2005. Management expects that Baxter will have cash outflows of approximately $22 million in 2005
relating to its OPEB plans. With respect to the pension plan covering United States employees, the United States Congress has been
considering various changes to the pension plan funding rules, which could affect future required cash contributions. Management’s ex-
pected future contributions and benefit payments disclosed in this report are based on current laws and regulations, and do not reflect any
potential future legislative changes.

Insurance Coverage
In view of business conditions in the insurance industry, the company’s liability insurance coverage, including product liability insurance, with
respect to insured occurrences after April 30, 2003, is significantly less than the coverage available for insured occurrences prior to that
date. These reductions in insurance coverage available to the company reflect current trends in the liability insurance area generally, and
are not unique to the company. The company will continue to pursue higher coverage levels and lower self-insured retentions in the future,
when reasonably available. It is possible that the company’s net income and cash flows could be adversely affected in the future as a result
of any losses sustained in the future.

Stock Repurchase Programs
As authorized by the board of directors, from time to time the company repurchases its stock on the open market to optimize its capital
structure depending upon its cash flows, net debt level and current market conditions. As of December 31, 2004, $243 million was available
under the board of directors’ October 2002 authorization. No open-market repurchases were made in 2004 or 2003. As discussed in Note 6,
in 2003 and 2002 the company repurchased its stock from counterparty financial institutions in conjunction with the settlement of its equity
forward agreements. In 2004, all of the stock repurchases were from Shared Investment Plan participants in private transactions. Refer to
Note 5 for information regarding the Shared Investment Plan. Total stock repurchases (including those associated with the settlement of
equity forward agreements and the Shared Investment Plan) were $18 million in 2004, $714 million in 2003, and $1.17 billion in 2002.

FINANCIAL INSTRUMENT MARKET RISK

The company operates on a global basis, and is exposed to the risk that its earnings, cash flows and stockholders’ 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 management’s judgment of the appropriate trade-off between risk, opportunity and costs. Refer to Note 6
for further information regarding the company’s financial instruments and hedging strategies.

Currency Risk
The company is primarily exposed to foreign exchange risk with respect to firm commitments, forecasted transactions and net assets
denominated in the Euro, Japanese Yen, British Pound and Swiss Franc. The company manages its foreign currency exposures on a

MANAGEMENT’S DISCUSSION AND ANALYSIS

consolidated basis, which allows the company to net exposures and take advantage of any natural offsets. In addition, the company uses
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 earnings and stockholders’ equity volatility relating to foreign
exchange.

The company uses forward and option contracts to hedge the foreign exchange risk to earnings relating to firm commitments and
forecasted transactions denominated in foreign currencies. The company enters into forward agreements to hedge certain intercompany
and third party receivables, payables and debt denominated in foreign currencies. The company also hedges certain of its net investments
in international affiliates, using a combination of debt denominated in foreign currencies and cross-currency swap agreements.

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

Foreign exchange forward and option contracts A sensitivity analysis of changes in the fair value of foreign exchange forward and
option contracts outstanding at December 31, 2004, while not predictive in nature, indicated that if the United States Dollar uniformly
fluctuated unfavorably by 10% against all currencies, on a net-of-tax basis, the net liability balance of $63 million with respect to those
contracts would increase by $78 million. A similar analysis performed with respect to forward and option contracts outstanding at
December 31, 2003 indicated that, on a net-of-tax basis, the net asset balance of $100 million would increase by $139 million.

Cross-currency swap agreements With respect to the company’s cross-currency swap agreements (including the outstanding mirror
swaps), if the United States Dollar uniformly weakened by 10%, on a net-of-tax basis, the net liability balance of $743 million with respect to
those contracts outstanding at December 31, 2004 would increase by $119 million. A similar analysis performed with respect to the cross-
currency swap agreements outstanding at December 31, 2003 indicated that, on a net-of-tax basis, the net liability balance of $598 million
would increase by $261 million. Any increase or decrease in the fair value of cross-currency swap agreements designated as hedges of the
net assets of foreign operations relating to changes in spot currency exchange rates is offset by the change in the value of the hedged net
assets relating to changes in spot currency exchange rates. With respect to the portion of the cross-currency swap portfolio that is no
longer designated as a net investment hedge, but is fixed via the mirror swaps, as discussed above, as the fair value of this fixed portion
of the portfolio decreases, the fair value of the mirror swaps increases by an approximately offsetting amount, and vice versa.

The sensitivity analysis model recalculates the fair value of the foreign currency forward, option and cross-currency swap contracts
outstanding at December 31 of each year by replacing the actual exchange rates at December 31, 2004 and 2003, respectively, with
exchange rates that are 10% unfavorable to the actual exchange rates for each applicable currency. All other factors are held constant.
These sensitivity analyses disregard the possibility that currency exchange rates can move in opposite directions and that gains from one
currency may or may not be offset by losses from another currency. The analyses also disregard the offsetting change in value of the
underlying hedged transactions and balances.

Interest Rate and Other Risks
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 management 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 also uses forward-starting interest rate swaps and treasury rate locks to hedge the risk to earnings
associated with fluctuations in interest rates relating to anticipated issuances of term debt.

As part of its risk-management program, the company performs sensitivity analyses to assess potential gains and losses in earnings relating
to hypothetical movements in interest rates. A 25 basis-point increase in interest rates (approximately 10% of the company’s weighted-
average interest rate during 2004) affecting the company’s financial instruments, including debt obligations and related derivatives, would
have an immaterial effect on the company’s 2004 and 2003 earnings and on the fair value of the company’s fixed-rate debt as of the end of
each fiscal year.

As discussed in Note 6, the fair values of the company’s long-term litigation liabilities and related insurance receivables were computed by
discounting the expected cash flows based on currently available information. A 10% movement in the assumed discount rate would have an
immaterial effect on the fair values of those assets and liabilities.

MANAGEMENT’S DISCUSSION AND ANALYSIS

With respect to the company’s investments in affiliates, management believes any reasonably possible near-term losses in earnings, cash
flows and fair values would not be material to the company’s consolidated financial position.

NEW ACCOUNTING STANDARD

In December 2004, the Financial Accounting Standards Board revised and reissued FASB No. 123, “Share-Based Payment” (FASB No.
123-R), which requires companies to expense the value of employee stock options and similar awards. The new rules become effective July
1, 2005 and provide for one of three transition elections, including prospective application, partial restatement (back to January 1, 2005)
and full restatement (back to January 1, 1995). The company plans to adopt the new standard on July 1, 2005 and has not yet decided
which transition option the company will use. Management is also in the process of analyzing the other provisions of FASB No. 123-R. The
pro forma effect of expensing employee stock options and similar awards under existing rules is presented in Note 1. Management has not
yet determined the impact of the new rules on the company’s future consolidated financial statements.

FORWARD-LOOKING INFORMATION

The matters discussed in this Annual Report that are not historical facts include forward-looking statements. These statements are based on
the company’s current expectations and involve numerous risks and uncertainties. Some of these risks and uncertainties are factors that
affect all international businesses, while some are specific to the company and the health-care arenas in which it operates. Many factors
could affect the company’s actual results, causing results to differ, possibly materially, from those expressed in any such forward-looking
statements. These factors include, but are not limited to:

(cid:127)
(cid:127)
(cid:127)
(cid:127)

(cid:127)
(cid:127)
(cid:127)
(cid:127)
(cid:127)

(cid:127)
(cid:127)
(cid:127)
(cid:127)
(cid:127)
(cid:127)
(cid:127)
(cid:127)
(cid:127)
(cid:127)
(cid:127)
(cid:127)
(cid:127)

the company’s ability to realize in a timely manner the anticipated benefits of restructuring initiatives;
the effect of economic conditions;
the impact of geographic and/or product mix on the company’s sales;
actions of regulatory bodies and other government authorities, including the FDA and foreign counterparts that could delay, limit
or suspend product sales and distribution;
product quality and/or patient safety concerns, leading to product recalls, withdrawals, launch delays or declining sales;
product development risks;
interest rates;
technological advances in the medical field;
demand for and market acceptance risks for new and existing products, such as ADVATE (Antihemophilic Factor (Recombinant),
Plasma/Albumin-Free Method) rAHF-PFM, and other technologies;
the impact of competitive products and pricing, including generic competition, drug reimportation and disruptive technologies;
inventory reductions or fluctuations in buying patterns by wholesalers or distributors;
foreign currency exchange rates;
the availability of acceptable raw materials and component supply;
global regulatory, trade and tax policies;
regulatory, legal or other developments relating to the company’s A, AF and AX series dialyzers;
the ability to obtain adequate insurance coverage at reasonable cost;
ability to enforce patents;
patents of third parties preventing or restricting the company’s manufacture, sale or use of affected products or technology;
reimbursement policies of government agencies and private payers;
internal and external factors that could impact commercialization;
results of product testing;
other factors described elsewhere in this report or in the company’s other filings with the Securities and Exchange Commission.

Currency fluctuations are also a significant variable for global companies, especially fluctuations in local currencies where hedging
opportunities are not economic or not available. If the United States Dollar strengthens significantly against foreign currencies, the
company’s ability to realize projected growth rates in its sales and net earnings outside the United States, as reported in United States
Dollars, could be negatively impacted.

Management believes that its expectations with respect to forward-looking statements are based upon reasonable assumptions within the
bounds of its knowledge of the company’s business and operations, but there can be no assurance that the actual results or performance of
the company will conform to any future results or performance expressed or implied by such forward-looking statements. The company
does not undertake any obligation to update any forward-looking statements as a result of new information, future events, changed
assumptions or otherwise, and all forward-looking statements speak only as of the time when made.

MANAGEMENT’S RESPONSIBILITY FOR CONSOLIDATED FINANCIAL STATEMENTS

Management is responsible for the preparation of the company’s consolidated financial statements and related information appearing in this
report. Management believes that the consolidated financial statements fairly reflect the form and substance of transactions and that the
financial statements reasonably present the company’s financial position and results of operations in conformity with generally accepted
accounting principles. Management also has included in the company’s consolidated financial statements amounts that are based on esti-
mates and judgments, which it believes are reasonable under the circumstances.

The independent registered public accounting firm audits the company’s consolidated financial statements in accordance with the standards
of the Public Company Accounting Oversight Board and provides an opinion on whether the consolidated financial statements present fairly,
in all material respects, the financial position, results of operations and cash flows of the company.

The Board of Directors of the company has an Audit Committee composed of non-management Directors. The committee meets
periodically with financial management, the internal auditors and the independent registered public accounting firm to review accounting,
control, auditing and financial reporting matters.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in
Exchange Act Rules 13a-15(f) and 15d-15(f). The company’s internal control over financial reporting is a process designed under the super-
vision of the principal executive and financial officers, and effected by the board of directors and management, to provide reasonable assur-
ance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accord-
ance with generally accepted accounting principles in the United States of America. Because of its inherent limitations, such as human
judgment, errors or mistakes, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.

We performed an assessment of the effectiveness of the company’s internal control over financial reporting as of December 31, 2004
based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. The objective of this assessment is to determine whether the company’s internal control over financial reporting was effective
as of December 31, 2004.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a mate-
rial misstatement of the annual or interim financial statements will not be prevented or detected. Management is not permitted to conclude
that the company’s internal control over financial reporting is effective if there are one or more material weaknesses in internal control over
financial reporting. As of December 31, 2004, the company did not maintain effective controls over the accounting for income taxes, includ-
ing the determination of income taxes payable and deferred income tax assets and liabilities and the related income tax provisions. Specifi-
cally, current income taxes payable were not reconciled to expected tax payments due, and the company did not adequately review the dif-
ference between the income tax basis and financial reporting basis of assets and liabilities and reconcile the difference to recorded deferred
income tax assets and liabilities. This control deficiency results in more than a remote likelihood that a material misstatement of annual or
interim financial statements would not be prevented or detected. Further, it resulted in the restatement of the company’s consolidated finan-
cial statements for 2003, 2002 and 2001 and of the company’s interim financial statements for the first, second and third quarters of
2004. Accordingly, management determined that this control deficiency constitutes a material weakness. Because of this material weak-
ness, we have concluded that the company did not maintain effective internal control over financial reporting as of December 31, 2004,
based on criteria in Internal Control—Integrated Framework.

Our management’s assessment of the effectiveness of the company’s internal control over financial reporting as of December 31, 2004 has
been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm as stated in their report, which appears on
pages 40 and 41 and which expressed an unqualified opinion on management’s assessment and an adverse opinion on the effectiveness of
the company’s internal control over financial reporting as of December 31, 2004.

Robert L. Parkinson, Jr.
Chairman of the Board and
Chief Executive Officer

John J. Greisch
Corporate Vice President and
Chief Financial Officer

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Baxter International Inc.:

We have completed an integrated audit of Baxter International Inc.’s 2004 consolidated financial statements and of its internal control over
financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, cash flows and stock-
holders’ equity and comprehensive income present fairly, in all material respects, the financial position of Baxter International Inc. and its
subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the
period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. These finan-
cial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial state-
ments based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Account-
ing Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evi-
dence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant esti-
mates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable
basis for our opinion.

As discussed in Note 1 to the consolidated financial statements, effective July 1, 2003, the company adopted Statement of Financial
Accounting Standards (SFAS) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” and
Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities.”

Internal control over financial reporting

Also, we have audited management’s assessment, included in Management’s Report on Internal Control over Financial Reporting appearing
on page 39, that Baxter International Inc. did not maintain effective internal control over financial reporting as of December 31, 2004, be-
cause of the effect of the company not maintaining effective controls over the accounting for income taxes including the determination of
income taxes payable and deferred income tax assets and liabilities and the related income tax provisions, based on criteria established in
Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The
company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effec-
tiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effec-
tiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Over-
sight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether ef-
fective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting
includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circum-
stances. We believe that our audit provides a reasonable basis for our opinions.

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

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

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a mate-
rial misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been
identified and included in management’s assessment. As of December 31, 2004, the company did not maintain effective controls over the

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

accounting for income taxes including the determination of income taxes payable and deferred income tax assets and liabilities and the re-
lated income tax provisions. Specifically, current income taxes payable were not reconciled to expected tax payments due, and the com-
pany did not adequately review the difference between the income tax basis and financial reporting basis of assets and liabilities and recon-
cile the difference to recorded deferred income tax assets and liabilities. This control deficiency results in more than a remote likelihood that
a material misstatement of annual or interim financial statements would not be prevented or detected. Further, it resulted in the restatement
of the company’s consolidated financial statements for 2003, 2002 and 2001 and of the company’s interim financial statements for the
first, second and third quarter of 2004. Accordingly, management determined that this control deficiency constitutes a material weakness.
This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2004 con-
solidated financial statements, and our opinion regarding the effectiveness of the company’s internal control over financial reporting does
not affect our opinion on those consolidated financial statements.

In our opinion, management’s assessment that Baxter International Inc. did not maintain effective internal control over financial reporting as
of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework
issued by the COSO. Also, in our opinion, because of the effect of the material weakness described above on the achievement of the
objectives of the control criteria, Baxter International Inc. has not maintained effective internal control over financial reporting as of Decem-
ber 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the COSO.

PricewaterhouseCoopers LLP
Chicago, Illinois
March 14, 2005

CONSOLIDATED BALANCE SHEETS

as of December 31 (in millions, except share information)

Current Assets

Cash and equivalents
Accounts and other current receivables
Inventories
Short-term deferred income taxes
Prepaid expenses and other

Total current assets

Property, Plant and Equipment, Net

Other Assets

Current Liabilities

Goodwill
Other intangible assets
Other

Total other assets

Total assets

Short-term debt
Current maturities of long-term debt and lease obligations
Accounts payable and accrued liabilities
Income taxes payable

Total current liabilities

Long-Term Debt and Lease Obligations

Other Long-Term Liabilities

Commitments and Contingencies

Stockholders’ Equity

Common stock, $1 par value, authorized 2,000,000,000 shares, issued

648,414,492 shares in 2004 and 648,574,109 shares in 2003
Common stock in treasury, at cost, 30,489,183 shares in 2004 and

37,273,424 shares in 2003

Additional contributed capital
Retained earnings
Accumulated other comprehensive loss

Total stockholders’ equity

2004

$ 1,109
2,091
2,135
297
387

6,019

4,369

1,648
547
1,564

3,759

2003

925
1,914
2,104
140
277

5,360

4,592

1,599
611
1,545

3,755

$14,147

$13,707

207
154
3,531
394

4,286

3,933

2,223

150
3
3,107
438

3,698

4,421

2,206

648

649

(1,511)
3,597
2,259
(1,288)

3,705

(1,863)
3,786
2,230
(1,420)

3,382

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

Total liabilities and stockholders’ equity

$14,147

$13,707

CONSOLIDATED STATEMENTS OF INCOME

years ended December 31 (in millions, except per share data)

Operations

Net sales
Costs and expenses

Cost of goods sold
Marketing and administrative expenses
Research and development expenses
In-process R&D (IPR&D) charges
Restructuring charges
Impairment charges
Net interest expense
Other expense, net

Total costs and expenses

Income from continuing operations before income taxes and

cumulative effect of accounting changes

Income tax expense

Income from continuing operations before cumulative

effect of accounting changes

Income (loss) from discontinued operations, including exit
charge in 2002 of $229, net of income tax benefit

Income before cumulative effect of accounting changes
Cumulative effect of accounting changes, net of income tax

benefit

Net income

Per Share Data

Earnings per basic common share

Continuing operations, before cumulative effect of

accounting changes
Discontinued operations
Cumulative effect of accounting changes

Net income

Earnings per diluted common share

Continuing operations, before cumulative effect of

accounting changes
Discontinued operations
Cumulative effect of accounting changes

Net income

Weighted average number of common shares

outstanding
Basic
Diluted

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

2004

2003

2002

$9,509

$8,904

$8,099

5,594
1,960
517
—
543
289
99
77

9,079

430
47

383

388

—

4,951
1,805
553
—
337
—
87
42

7,775

1,129
222

4,314
1,566
501
163
26
—
51
92

6,713

1,386
360

907

1,026

(24)

883

(17)

(255)

771

—

$ 388

$ 866

$ 771

$ 0.62
0.01
—

$ 0.63

$ 0.62
0.01
—

$ 0.63

$ 1.51
(0.04)
(0.03)

$ 1.71
(0.43)
—

$ 1.44

$ 1.28

$ 1.50
(0.04)
(0.03)

$ 1.66
(0.41)
—

$ 1.43

$ 1.25

614
618

599
606

600
618

CONSOLIDATED STATEMENTS OF CASH FLOWS

years ended December 31 (in millions) (brackets denote cash outflows)

2004

2003

2002

Cash Flows from Operations

Income from continuing operations before cumulative

effect of accounting changes

$ 383

$ 907

$ 1,026

Adjustments

Depreciation and amortization
Deferred income taxes
Impairments, special charges and asset dispositions
IPR&D charges
Restructuring charges
Other
Changes in balance sheet items

Accounts and other current receivables
Inventories
Accounts payable and accrued liabilities
Restructuring payments
Other

601
(119)
404
—
543
26

(188)
28
(235)
(195)
124

547
106
(14)
—
337
14

24
(148)
(159)
(79)
(110)

440
72
26
163
26
40

(261)
(269)
34
(2)
(40)

Cash flows from continuing operations

1,372

1,425

1,255

Cash flows from discontinued operations

(58)

Cash flows from operations

1,380

1,426

1,197

Cash Flows from Investing Activities

Cash Flows from Financing Activities

Capital expenditures (including additions to the pool of
equipment placed with or leased to customers of
$77 in 2004, $113 in 2003 and $118 in 2002)
Acquisitions (net of cash received) and investments in

and advances to affiliates

Divestitures and other

Cash flows from investing activities

Issuances of debt
Redemptions of financing obligations
Increase (decrease) in debt with maturities of three

months or less, net

Common stock cash dividends
Proceeds from stock issued under employee benefit

plans

Other issuances of stock
Purchases of treasury stock

Cash flows from financing activities

Effect of Foreign Exchange Rate Changes on Cash and Equivalents

Increase (Decrease) in Cash and Equivalents

Cash and Equivalents at Beginning of Year

Cash and Equivalents at End of Year

Supplemental schedule of noncash investing activities
Fair value of assets acquired, net of liabilities assumed
Common stock issued at fair value

Net cash paid

Other supplemental information
Interest paid, net of portion capitalized
Income taxes paid

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

(558)

(792)

(852)

(20)
26

(552)

600
(627)

(351)
(361)

181
—
(18)

(576)

(68)

184

925

(184)
87

(889)

696
(1,477)

341
(346)

105
644
(714)

(751)

(30)

(244)

1,169

(492)
34

(1,310)

2,412
(633)

(185)
(349)

180
414
(1,169)

670

587

582

$1,109

$ 925

$ 1,169

20
—

$ 184
—

$ 184

$ 652
160

$ 492

$ 114
$ 173

$ 142
$ 130

$
83
$ 312

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

as of and for the years ended December 31 (in millions)

Amount

2004

2003

2002

649
—
—
(1)

648

37
1
(8)

649
—
—
(1)

648

(1,863)
(18)
370

(1,511)

627
22
—
—

649

27
15
(5)

Common Stock
Beginning of year
Common stock issued
Common stock issued for acquisitions
Other

End of year

Common Stock in Treasury
Beginning of year
Purchases of common stock
Common stock issued under employee benefit plans

End of year

Additional Contributed Capital
Beginning of year
Common stock issued
Common stock issued for acquisitions
Equity units issued
Common stock issued under employee benefit plans

End of year

Retained Earnings
Beginning of year
Net income
Common stock cash dividends
Change to equity method of accounting for a minority investment
Distribution of Edwards Lifesciences Corporation common stock to

stockholders

End of year

Accumulated Other Comprehensive Loss
Beginning of year
Other comprehensive income (loss)

End of year

Total stockholders’ equity

Comprehensive Income (Loss)
Net income

Currency translation adjustments
Unrealized net loss on hedges of net investments in foreign

operations, net of tax benefit of $134 in 2004, $232 in 2003, and
$223 in 2002

Unrealized net gain (loss) on other hedging activities, net of tax

expense (benefit) of $21 in 2004, ($54) in 2003 and ($67) in 2002

Unrealized net gain (loss) on marketable equity securities, net of tax
expense (benefit) of $1 in 2004, $1 in 2003 and ($5) in 2002

Additional minimum pension liability, net of tax benefit of $30 in 2004,

$86 in 2003 and $287 in 2002

Other comprehensive income (loss)

Total comprehensive income (loss)

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

3,786
—
—
—
(189)

3,597

2,230
388
(359)
—

—

2,259

(1,420)
132

(1,288)

$ 3,705

388

303

(171)

(48)

132

609
15
3
—

627

10
23
(6)

$ 627
22
—
—

649

(1,326)
(714)
177

(1,863)

3,236
622
—
—
(72)

3,786

1,740
866
(356)
(14)

(6)

2,230

(1,264)
(156)

(1,420)

$ 3,382

$ 866

502

(384)

(106)

(170)

(156)

$ 609
15
3
—

627

(328)
(1,169)
171

(1,326)

2,828
399
157
(157)
9

3,236

1,151
771
(346)
—

164

1,740

(422)
(842)

(1,264)

$ 3,013

$ 771

167

(370)

(114)

(8)

(517)

(842)

520

$ 710

(71)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Inc.

(Baxter or

International

the company)

Nature of Operations
Baxter
is a global
diversified medical products and services company with expertise in
medical devices, pharmaceuticals and biotechnology that assists
health-care professionals and their patients with the treatment of
complex medical
immune
disorders, infectious diseases, cancer, kidney disease, trauma and
other conditions. The company’s products and services are
described in Note 13.

hemophilia,

conditions,

including

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

Basis of Consolidation
The consolidated financial statements include the accounts of
Baxter and its majority-owned subsidiaries, any minority-owned
subsidiaries that Baxter controls, and variable interest entities
(VIEs) in which Baxter is the primary beneficiary, after elimination of
intercompany transactions. A primary beneficiary in a VIE has a
controlling financial interest through means other than voting rights.
Baxter consolidates certain VIEs (or special-purpose entities) relating
to its synthetic leases because of Baxter’s residual value guarantees
relating to these leases. Refer to Note 5 and the changes in
accounting principles discussion below for further information.

In the first quarter of 2003, a charge of $14 million was recorded
directly to retained earnings in conjunction with the change from the
cost method to the equity method of accounting for a minority
investment in Acambis, Inc. (Acambis). The change in method was
due to Baxter’s increase in its common stock ownership of
Acambis, which resulted in Baxter having the ability to exercise
significant influence over Acambis’ operating and financial policies.

Changes in Accounting Principles
On July 1, 2003, the company adopted Statement of Financial
Accounting Standards (FASB) No. 150, “Accounting for Certain
Financial
Instruments with Characteristics of both Liabilities and
Equity” (FASB No. 150), and Financial Accounting Standards Board
Interpretation (FIN) No. 46,
“Consolidation of Variable Interest
Entities” (FIN No. 46), and recorded cumulative effect net-of-tax
charges to earnings totaling $17 million.

FASB No. 150
FASB No. 150 requires that certain financial
instruments, which
previously had been classified as equity, be classified as liabilities.
FASB No. 150 applied to the company’s equity forward agreements
outstanding on that date. As a result, on July 1, 2003, the company

recognized a $571 million liability relating to these agreements
(representing the net present value of the redemption amounts
reduced stockholders’ equity by $561 million
on that date),
(representing the value of the underlying shares at the contract
inception dates), and recorded the difference of $10 million as a
cumulative effect of a change in accounting principle. Other than for
the impact of adoption, FASB No. 150 did not have a material
impact on the company’s consolidated financial statements. The
company settled the equity forward agreements, which are further
discussed in Note 6, during the third quarter of 2003.

FIN No. 46
FIN No. 46 defines VIEs and requires that a VIE be consolidated if
certain conditions are met. Upon adoption of this new standard,
Baxter consolidated three VIEs related to certain leases. The leases
principally relate to an office building in California and plasma collec-
tion centers in various locations throughout the United States. The
consolidation of the VIEs on July 1, 2003 resulted in an increase in
property and equipment of $160 million and a net increase in debt
and other liabilities of $167 million. The difference of $7 million (net
of income tax benefit of $5 million) was recorded as a cumulative
effect of a change in accounting principle. Other than for the impact
of adoption, FIN No. 46 did not have a material impact on the com-
pany’s consolidated financial statements.

In December 2003,
the Financial Accounting Standards Board
revised and reissued FIN No. 46 (FIN No. 46-R). Baxter adopted FIN
No. 46-R on March 31, 2004, and adoption of the revised standard
did not have a material
impact on the company’s consolidated
financial statements.

Revenue Recognition
The company recognizes revenues from product sales and services
when earned, as defined by GAAP. Specifically,
revenue is
recognized when persuasive evidence of an arrangement exists,
delivery has occurred (or services have been rendered), the price is
fixed or determinable, and collectibility is reasonably assured. For
product sales, revenue is not recognized until title and risk of loss
have transferred to the customer.
In certain circumstances the
company enters into arrangements in which it commits to provide
multiple elements to its customers. In these cases, total revenue is
allocated among the elements based on the estimated fair values of
the individual elements. Fair values are generally determined based
on sales of the individual elements to other third parties. Provisions
for discounts, rebates to customers, and returns are provided for at
the time the related sales are recorded, and are reflected as a
reduction of sales.

Stock Compensation Plans
The company measures stock-based compensation cost using the
intrinsic value method of accounting. Generally, no expense is
recognized for the company’s employee stock option and purchase
plans. Expense is recognized relating to restricted stock grants and
certain modifications to stock options.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Under the fair value method, expense would be recognized for
the company’s employee stock option and purchase plans. The
following table shows net income and earnings per share (EPS) had
the company applied the fair value method of accounting for
stock-based compensation.

years ended December 31 (in millions,

except per share data)

2004

2003

2002

Net income, as reported
Add: Stock-based employee

compensation expense included
in reported net income, net of tax

Deduct: Total stock-based

employee compensation expense
determined under the fair value
method, net of tax

$ 388

$ 866

$ 771

(96)

(157)

(159)

Pro forma net income

$ 305

$ 710

$ 614

Earnings per basic share

As reported
Pro forma

Earnings per diluted share

As reported
Pro forma

$0.63
$0.50

$0.63
$0.49

$1.44
$1.18

$1.43
$1.18

$1.28
$1.03

$1.25
$1.01

The pro forma compensation expense for stock options and
employee stock purchase subscriptions
above was
calculated using the Black-Scholes model. The weighted-average
assumptions used in calculating the pro forma expense and the
weighted-average fair values of the grants and subscriptions in each
year were as follows.

shown

Employee stock option plans

Dividend yield
Expected volatility
Risk-free interest rate
Expected life (in years)
Fair values

Employee stock purchase plans

Dividend yield
Expected volatility
Risk-free interest rate
Expected life (in years)
Fair values

2004

2003

2002

2%
39%
3.0%
5.5
$9.82

2%
26%
1.8%
1
$9.94

2%
38%
3.4%
6
$9.19

2%
55%
1.2%
1
$7.83

2%
37%
4.1%
6
$15.61

2%
38%
1.8%
1
$12.41

See discussion below regarding the required future adoption of new
stock compensation accounting rules.

Foreign Currency Translation
For foreign operations in highly inflationary economies, translation
gains and losses are included in other income or expense. For
foreign operations, currency translation adjustments
all other

are included in accumulated other comprehensive income (AOCI),
which is a component of stockholders’ equity.

Allowance for Doubtful Accounts
In the normal course of business, the company provides credit to
customers in the health-care industry, performs credit evaluations of
these customers and maintains reserves for potential credit losses.
In determining the amount of the allowance for doubtful accounts,
management considers, among other
things, historical credit
losses, the past due status of receivables, payment history and
other customer-specific information. Receivables are written off
when management determines they are uncollectible. Credit losses,
when realized, have been within the range of management’s
allowance for doubtful accounts. The allowance for doubtful
accounts was $147 million at December 31, 2004 and $84 million
at December 31, 2003. The increase in the allowance in 2004 was
primarily due to certain special charges, as discussed in Note 4.

Receivable Securitizations
When the company sells receivables in a securitization arrangement,
the historical carrying value of the sold receivables is allocated
between the portion sold and the portion retained by Baxter based
on their relative fair values. The fair values of the retained interests
are estimated based on the present values of expected future cash
flows. The difference between the net cash proceeds received and
the value of the receivables sold is recognized immediately as a
gain or loss. The retained interests are subject
to impairment
reviews and are classified in current or noncurrent receivables,
as appropriate.

Product Warranties
The company provides for the estimated costs relating to product
warranties at the time the related revenue is recognized. The cost is
determined based upon actual company experience for the same or
similar products as well as any other relevant information.

as of and for the years ended December 31 (in millions)

Beginning of year
New warranties and adjustments to existing

warranties

Payments in cash or in kind

End of year

Inventories

2004

$ 53

27
(23)

2003

$ 53

29
(29)

$ 57

$ 53

as of December 31 (in millions)

2004

2003

Raw materials
Work in process
Finished products

Total inventories

$ 456
754
925

$ 568
731
805

$2,135

$2,104

Inventories are stated at the lower of cost (first-in, first-out method)
or market value. Market value for raw materials is based on

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

replacement costs, and market value for work in process and
finished goods is based on net realizable value. The inventory
amounts above are stated net of reserves for excess and obsolete
inventory, which totaled $142 million at December 31, 2004 and
$124 million at December 31, 2003.

Property, Plant and Equipment, Net

as of December 31 (in millions)

2004

2003

Land
Buildings and leasehold improvements
Machinery and equipment
Equipment with customers
Construction in progress

173
1,670
4,792
705
651

$ 172
1,558
4,443
663
955

IPR&D
Amounts allocated to IPR&D are determined using the income
approach, which measures the value of an asset by the present
value of
its future economic benefits. Estimated cash flows are
discounted to their present values at rates of return that reflect the
risks associated with the particular projects. The status of
development, stage of completion, nature and timing of remaining
efforts for completion, risks and uncertainties, and other key factors
may vary by individual project. The valuations incorporate the stage
of completion for each individual project. Projected revenue and cost
assumptions are determined considering the company’s historical
experience and industry trends and averages. No value is assigned
to any IPR&D project unless it is probable as of the acquisition date
that the project will be further developed.

Total property, plant and equipment, at cost
Accumulated depreciation and amortization

7,991
(3,622)

7,791
(3,199)

Impairment Reviews

Property, plant and equipment, net (PP&E)

$ 4,369

$ 4,592

lives of

Depreciation and amortization are calculated using the straight-line
method over the estimated useful
the related assets,
which range from 20 to 50 years for buildings and improvements
and from 3 to 15 years for machinery and equipment. Leasehold
improvements are amortized over the life of the related facility lease
or the asset, whichever is shorter. Straight-line and accelerated
methods of depreciation are used for
income tax purposes.
Depreciation expense was $481 million in 2004, $446 million in
2003 and $360 million in 2002. Repairs and maintenance expense
was $193 million in 2004, $182 million in 2003 and $167 million in
2002.

Other Long-Term Assets

as of December 31 (in millions)

2004

2003

Deferred income taxes
Insurance receivables
Other long-term receivables
Investments in affiliates
Other

$ 865
66
358
20
255

$ 756
105
400
45
239

Other long-term assets

$1,564

$1,545

Acquisitions
Acquisitions are accounted for under the purchase method. Results
of operations of acquired companies are included in the company’s
results of operations as of the respective acquisition dates. The
purchase price of each acquisition is allocated to the net assets
acquired based on estimates of their fair values at the date of the
acquisition. A portion of the purchase price for certain acquisitions
is allocated to in-process research and development (IPR&D) and
immediately expensed. Any purchase price in excess of these net
assets is recorded as goodwill. Contingent purchase price payments
are recorded when the contingencies are resolved. The contingent
consideration, if paid, is recorded as an additional element of the
cost of the acquired company or as compensation, as appropriate.

to at

least annual

Goodwill
is no longer amortized, but
Effective January 1, 2002, goodwill
is subject
impairment reviews, or whenever
indicators of impairment exist. An impairment would occur if the
carrying amount of a reporting unit exceeds the fair value of that
reporting unit. The company’s reporting units are the same as its
reportable segments: Medication Delivery, BioScience and Renal. An
impairment charge would be recorded for the difference between
the
estimated
future cash flows, which represents the estimated fair value of the
reporting unit.

carrying value

present

value

and

the

Other Long-Lived Assets
The company reviews the carrying amounts of long-lived assets
impairment whenever events or
other than goodwill for potential
changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Examples include a significant
decrease in market price, significant adverse change in the extent
or manner in which an asset is being used, and a significant adverse
change in legal or business climate. In evaluating recoverability,
management compares the carrying amounts of the assets with the
estimated undiscounted future cash flows. In the event impairment
exists, an impairment charge would be recorded as the amount by
which the carrying amount of the asset exceeds the fair value.
Depending on the asset and the availability of information, fair value
may be determined by reference to estimated selling values of
assets in similar condition, or by using a discounted cash flow
model.
the
impaired asset would be reassessed and revised if necessary.

the remaining amortization period for

In addition,

Earnings Per Share
The numerator for both basic and diluted 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 employee stock options, employee stock purchase
subscriptions and the purchase contracts in the company’s equity

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

units is reflected in the denominator for diluted EPS using the
treasury stock method. Prior to the adoption of FASB No. 150, the
dilutive effect of equity forward agreements was reflected in diluted
EPS using the reverse treasury stock method. The following is a
reconciliation of basic shares to diluted shares.

years ended December 31 (in millions)

Basic

2004

614

2003

599

2002

600

Effect of dilutive securities
Employee stock options
Equity forward agreements
Employee stock purchase subscriptions

Diluted

3
—
1

1
5
1

11
6
1

618

606

618

Accumulated Other Comprehensive Income (AOCI)
Comprehensive income includes all changes in stockholders’ equity
that do not arise from transactions with stockholders, and consists
of net income, currency translation adjustments (CTA), unrealized
gains and losses on certain hedging activities, unrealized gains
and losses on unrestricted available-for-sale marketable equity
securities and additional minimum pension liabilities. The net-of-tax
components of AOCI, a component of stockholders’ equity, were
as follows.

as of December 31 (in millions)

2004

2003

CTA
Hedges of net investments in foreign

operations

Other hedging activities
Marketable equity securities
Additional minimum pension liabilities

222

(81)

(684)
(91)
—
(735)

(513)
(138)
(1)
(687)

Total AOCI

$(1,288)

$(1,420)

Derivatives and Hedging Activities
All derivative instruments subject to FASB No. 133, “Accounting For
Derivative Instruments and Hedging Activities” and its amendments
are recognized in the consolidated balance sheets at fair value.

For each derivative instrument that is designated and effective as a
cash flow hedge, the gain or loss on the derivative is recognized in
earnings with the underlying hedged item. Cash flow hedges are
principally classified in cost of goods sold, and they primarily relate
to intercompany sales denominated in foreign currencies.

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 gain or loss on the under-
lying 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.

the gain or loss is recorded in AOCI, with any hedge ineffectiveness
recorded immediately in net interest expense. As for CTA, upon sale
the amount
or liquidation of an investment
attributable to that entity and accumulated in AOCI would be
removed from AOCI and reported as part of the gain or loss in the
period during which the sale or liquidation of the investment occurs.

in a foreign entity,

Changes in the fair value of derivative instruments not designated as
hedges are reported directly to earnings. Undesignated derivative
instruments are recorded in other income or expense or net interest
expense. The company does not hold any instruments for trading
purposes.

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.
the company removes the
designation for cash flow hedges 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
flow hedges are
relating to terminations of effective cash
deferred and recognized consistent with the income or
loss
recognition of the underlying hedged items.

Derivatives are classified in the consolidated balance sheets in other
assets or other liabilities, as applicable, and are classified as short-
term or long-term based on the scheduled maturity of the instrument.

Derivatives are principally classified in the operating section of the
consolidated statements of cash flows, in the same category as
the related consolidated balance sheet account. Cross-currency
swap agreements that include a financing element at inception are
classified in the financing section of the consolidated statements of
cash flows when settled. Cross-currency swap agreements that
did not include a financing element at inception are classified in the
operating section.

Equity Units
In December 2002, the company issued equity units, which are
described in Note 5. The proceeds from the issuance of the equity
units were allocated entirely to the senior notes using a relative fair
value basis calculation. The issuance costs were allocated on a
residual basis, with an amount allocated to the senior notes based
on market data (and amortized to the February 2006 put date), and
the remainder allocated to the purchase contracts (and charged
directly to additional contributed capital on the issuance date).

Cash and Equivalents
Cash and equivalents include cash, certificates of deposit and mar-
ketable securities with an original maturity of three months or less.

For each derivative or nonderivative instrument that is designated
and effective as a hedge of a net investment in a foreign operation,

Shipping and Handling Costs
In general, shipping costs, which are costs incurred to physically
move product from Baxter’s premises to the customer’s premises,

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

are classified as marketing and administrative expenses. Handling
costs, which are costs incurred to store, move and prepare products
for shipment, are classified as cost of goods sold. Approximately
$214 million in 2004, $213 million in 2003 and $206 million in 2002
of costs were classified in marketing and administrative expenses.

Income Taxes
Deferred taxes are recognized for
the future tax effects of
temporary differences between financial and income tax reporting
based upon enacted tax laws and rates. Deferred tax assets are
reduced by a valuation allowance unless it is more likely than not
that the assets will be realized.

Reclassifications
Certain reclassifications have been made to conform the 2003 and
2002 consolidated financial statements and notes to the 2004
presentation.

including prospective application, partial

New Accounting Standard
In December 2004,
the Financial Accounting Standards Board
revised and reissued FASB No. 123, “Share-Based Payment” (FASB
No. 123-R), which requires companies to expense the value of
employee stock options and similar awards. The new rules become
three transition
effective July 1, 2005 and provide for one of
elections,
restatement
(back to January 1, 2005) and full restatement (back to January 1,
1995). The company plans to adopt the new standard on July 1,
2005 and has not yet decided which transition option the company
will use. Management is also in the process of analyzing the other
provisions of FASB No. 123-R. The pro forma effect of expensing
employee stock options and similar awards under existing rules
is presented above. Management has not yet determined the
impact of
the new rules on the company’s future consolidated
financial statements.

NOTE 2

DISCONTINUED OPERATIONS

Divestitures
During the fourth quarter of 2002, the company recorded a $294
million pre-tax charge ($229 million on an after-tax basis) principally
associated with management’s decision to divest the majority of the
services businesses included in the Renal segment. The Renal seg-
ment’s services portfolio consists of Renal Therapy Services (RTS),
which operates dialysis clinics in partnership with local physicians in
international markets, RMS Disease Management,
Inc., a renal-
disease management organization, and RMS Lifeline, Inc., a pro-
vider of management services to renal access care centers. The
charge principally pertained to the majority of RTS, and most of
these centers were located in Latin America and Europe. Manage-
ment’s decision was based on an evaluation of the company’s busi-
ness strategy and the economic conditions in certain geographic
markets. Also included in the pre-tax charge were $16 million of

costs associated with exiting the Medication Delivery segment’s off-
site pharmacy admixture products and services business.

Included in the total pre-tax charge was $269 million for non-cash
costs, which consisted of write-downs of the following assets due to
impairment, with the impairment losses estimated based on market
data (in millions):

Goodwill and other intangible assets
Property and equipment
Other assets
CTA losses (included in stockholders’ equity) related to the

assets

Total

$ 96
66
12

$269

The book values of goodwill and other intangible assets (which princi-
pally consisted of management contracts) were completely written
off as their fair values were estimated to be zero based on manage-
ment’s assessment of the value of the businesses. Because the dis-
continued operations consisted of recent acquisitions or businesses
that had not been fully integrated into their respective segments, the
book value of the acquired goodwill was written off. The property and
equipment was written down from $70 million to $4 million.

Also included in the pre-tax charge was $25 million for cash costs,
principally relating to severance and other employee-related costs
associated with the elimination of approximately 75 positions, as
well as legal and contractual commitment costs.

The company’s consolidated statements of income and cash flows
reflect the results of operations and cash flows of these businesses
as discontinued operations. The assets and liabilities of the dis-
continued businesses are immaterial to the company’s consolidated
balance sheets. Net revenues relating to the discontinued busi-
nesses were $24 million in 2004, $171 million in 2003 and $274
million in 2002. During 2004, discontinued operations generated
income of $5 million (including a tax benefit of $31 million). The
income was principally related to tax and other adjustments,
as the company completed divestitures. Discontinued operations
generated losses of $24 million in 2003 and $26 million in 2002.
These losses were net of income tax benefits of $8 million in 2003
and $10 million in 2002.

During 2003, the company sold RMS Lifeline, Inc., RMS Disease
Management, Inc., and the Medication Delivery segment’s offsite
pharmacy admixture products and services business. During 2004
and 2003, the company divested the RTS centers.

During 2004 and 2003, $4 million and $9 million, respectively, of
the reserve for cash costs was utilized. During 2003, as the final
form of certain of the divestitures became known, approximately
the reserve for cash costs was reversed and
$8 million of

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

reported within discontinued operations in the consolidated income
statements. The remaining reserve for cash costs of $4 million
is expected to be utilized in 2005.

Spin-Off of Edwards Lifesciences Corporation
On March 31, 2000, Baxter stockholders of record on March 29,
2000 received all of the outstanding stock of Edwards Lifesciences
Corporation (Edwards), the company’s cardiovascular business, in a
tax-free spin-off. The distribution of Edwards stock in 2000 totaled
$961 million, and was charged directly to retained earnings. The
cardiovascular business in Japan was not legally transferred to
Edwards in 2000 due to Japanese regulatory requirements and
business culture considerations.
In October 2002, Baxter and
Edwards consummated an agreement whereby Edwards purchased
the Japanese assets from Baxter. The 2002 transaction resulted in
a net credit of $164 million directly to retained earnings (reduced by
$6 million in 2003 based on the resolution of certain matters), and a
net cash inflow of $15 million. These transactions had no impact on
the company’s results of operations.

NOTE 3

ACQUISITIONS, INTANGIBLE ASSETS AND IPR&D

Significant Acquisitions
The following is a summary of the company’s significant acquisitions
during the three years ended December 31, 2004, along with
the allocation of the purchase price. With the exception of IPR&D
charges, which are recorded at the corporate level, the results of
operations and assets and liabilities,
including goodwill, are
included in the indicated segments.

the company acquired the majority of

In December 2002,
the
assets of ESI Lederle (ESI), a division of Wyeth. ESI was a leading
manufacturer and distributor of injectable drugs used in the United
States hospital market, and offered a complete range of sterile
injectable manufacturing capabilities, including ampules and vials.
ESI primarily manufactured injectable generic drugs, which now
strength,
leverages
manufacturing processes, customer relationships, and research and
development. The other
intangible assets consist primarily of
developed technology, which is being amortized on a straight-line
is
basis over an estimated useful
deductible for tax purposes. The IPR&D charge pertained principally
to generic anesthesia and critical care drugs.

life of 15 years. The goodwill

expertise,

injectable

Baxter’s

channel

collagen-

expertise

In May 2002, the company acquired Fusion Medical Technologies,
Inc. (Fusion). The acquisition of Fusion, a business that developed
and commercialized proprietary products used to control bleeding
during surgery, expands the company’s portfolio of
innovative
therapeutic solutions for biosurgery and tissue regeneration.
Fusion’s
and gelatin-based products
complements Baxter’s fibrin-based technologies. With the combina-
tion, the company can now offer surgeons a broader array of
solutions to seal
tissue, enhance wound healing and manage
hemostasis, including active bleeding. The purchase price was paid
in 2,806,660 shares of Baxter common stock. The other intangible
assets consist of developed technology and are being amortized on
a straight-line basis over an estimated useful life of 20 years. The
is not deductible for tax purposes. The IPR&D charge
goodwill
pertained to a product used to control bleeding during surgery.

(in millions)

Acquisition date

Purchase price

Segment

Purchase Price Allocation

Current assets
PP&E
IPR&D (expensed at acquisition date)
Goodwill
Other assets

Total assets acquired

Current liabilities
Other liabilities

Total liabilities assumed

Net assets acquired

ESI

December
2002

$334

Medication
Delivery

Fusion

May
2002

$161

BioScience

$ 33
107
56
82
78

356

22
—

$ 9
5
51
26
107

198

7
30

$334

$161

IPR&D Charges
In addition to the IPR&D charges relating to ESI and Fusion, the total
IPR&D charge in 2002 of $163 million included a $52 million charge
relating to the November 2002 acquisition of Epic Therapeutics, Inc.
(Epic) and other insignificant IPR&D charges. Epic, which is included
in the Medication Delivery segment, was acquired for $59 million,
and was a drug delivery company specializing in the formulation
of drugs for injection or inhalation. Epic’s IPR&D charge principally
pertained to controlled-release protein therapeutics using the
proprietary PROMAXX microsphere technology.

With respect to the valuation of the Epic IPR&D, material net cash
inflows were forecasted to commence between 2003 and 2005, a
discount rate of 20% was used, and assumed additional research
and development
the
initial product introduction totaled approximately $16 million. Ap-
proximately $8 million in 2004, $6 million in 2003 and $1 million in
2002 (subsequent
to the acquisition date) of R&D costs
were expensed relating to these projects.

(R&D) expenditures prior to the date of

With respect to the valuation of the ESI
IPR&D, material net cash
inflows were forecasted to commence in 2004, a discount rate of
16% was used, and assumed additional R&D expenditures prior to

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

the date of the initial product introductions totaled approximately
$17 million. Approximately $2 million in 2004 and $3 million in
2003 of R&D costs were expensed relating to these projects.

With respect to the valuation of the Fusion IPR&D, material net cash
inflows were forecasted to commence between 2003 and 2004, a
discount rate of 28% was used, and assumed additional R&D
expenditures prior to the date of the initial product introduction
totaled $3 million. Approximately $2 million in 2004, $1 million in
2003 and $2 million in 2002 (subsequent to the acquisition date)
of R&D costs were expensed relating to this project.

In conjunction with the company’s restructuring programs and man-
agement’s R&D prioritization decisions, certain of the R&D projects
acquired in these recent acquisitions have been terminated.
The in-process values assigned at
the acquisition date to ESI
projects that were subsequently terminated totaled $8 million. Other
projects have been delayed, or the related spending has been
reduced and the timetables extended, as compared to the original
projections. The cash inflow projections made at acquisition date for
ongoing R&D projects acquired through the Epic, ESI and Fusion
acquisitions have either been delayed, or the actual inflows are less
than originally projected partially as a result of the company’s recent
restructuring and prioritization actions.

The products currently under development are at various stages of
development, and substantial further research and development,
pre-clinical testing and clinical trials will be required to determine
their technical feasibility and commercial viability. There can be no
assurance such efforts will be successful. Delays in the develop-
ment, introduction or marketing of the products under development
can result either in such products being marketed at a time when
their cost and performance characteristics will not be competitive in
the marketplace or in a shortening of their commercial lives. If the
products are not completed on schedule, the expected return on
the company’s investments can be significantly and unfavorably
impacted.

Contingent Purchase Price Payments
Baxter could be required to make additional purchase price
payments relating to prior acquisitions. Such additional payments
are contingent on the achievement of certain post-acquisition events,
or sales or profits levels. Based on management’s projections, any
additional payments relating to the achievement of post-acquisition
sales or profit levels will be completely funded by the net cash
flows relating to such sales or profits. Contingent purchase price
payments are recorded when the contingencies are resolved,
as the outcomes of the contingencies are not determinable beyond
a reasonable doubt on the acquisition date.

Autros
With respect to the January 2002 $24 million acquisition of the
majority of the assets of Autros Healthcare Solutions Inc. (Autros), a

developer of automated patient information and medication manage-
ment systems, the company could make additional purchase price
payments of up to $26 million, primarily based on the sales and prof-
its generated from existing and future products through early 2006.
As of December 31, 2004, no additional purchase price
payments have been made relating to the assets acquired from
Autros, which are included in the Medication Delivery segment.

Elanex
With respect to the October 2001 $38 million acquisition of certain
assets from Elanex Pharma Group (Elanex) relating to the propri-
etary recombinant erythropoietin therapeutic for treating anemia in
dialysis patients,
the purchase agreement provided that Baxter
could make additional payments of up to $40 million, contingent on
the receipt of specified regulatory approvals of the product under
development, and payments of up to $180 million, contingent on the
achievement of specified sales levels in the future relating to the
product under development. As discussed in Note 4, during 2004
management decided to no longer fund this R&D project beyond the
currently ongoing clinical trials. Therefore, no additional purchase
price payments are anticipated at this time.

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

(in millions)

Delivery BioScience

Renal

Total

Medication

Balance at December 31, 2002

ESI
Alpha
Other

Balance at December 31, 2003

Other

$ 785
27
—
48

860
35

$ 517 $ 143 $ 1,445
27
—
34
—
93
25

—
34
20

571 168 1,599
49
2

Balance at December 31, 2004

$895

$583 $170 $1,648

The increase in ESI goodwill
in 2003 primarily related to an
additional purchase price payment which was contractually due
based on the finalization of the acquisition-date balance sheet. The
Alpha goodwill
in 2003 pertains to the October 2003 $71 million
acquisition of certain assets from Alpha Therapeutic Corporation.

The Other category in the table above principally relates to foreign
currency fluctuations. It also includes goodwill relating to individually
insignificant acquisitions, and certain immaterial
impairments of
goodwill.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Other Intangible Assets
Intangible assets with finite useful lives are amortized on a straight-
Intangible assets
lives.
line basis over
with indefinite useful
lives are not material to the company. The
following is a summary of the company’s intangible assets subject
to amortization.

their estimated useful

(in millions, except

Developed

Manufacturing,

technology,

distribution

including

and other

amortization period data)

patents

contracts

Other

Total

December 31, 2004
Gross intangible assets
Accumulated amortization

Net intangible assets

Weighted-average amortization

$804
333

$471

$28
14

$14

$80
25

$55

$912
372

$540

period (in years)

December 31, 2003
Gross intangible assets
Accumulated amortization

Net intangible assets

Weighted-average amortization

$ 802
279

$ 523

$ 39
14

$ 25

$ 74
18

$ 56

$ 915
311

$ 604

period (in years)

The amortization expense for these intangible assets was $63
million in 2004, $53 million in 2003 and $41 million in 2002. At
December 31, 2004, the anticipated annual amortization expense
for these intangible assets is $55 million in 2005, $54 million in
2006, $45 million in 2007, $40 million in 2008, and $39 million in
2009. The expected decline in amortization from 2004 to 2005 is
primarily due to the asset impairment charges recorded in 2004.

NOTE 4

SPECIAL CHARGES

costs associated with the closing of facilities and the exiting of
contracts.

estimated

savings

general

impact

and

Included in the 2004 charge was $196 million relating to asset
impairments, almost all of which was to write down PP&E, based on
market data for the assets. Also included in the 2004 charge was
$347 million for cash costs, principally pertaining to severance and
other employee-related costs. Approximately 60% of the targeted
positions have been eliminated as of December 31, 2004.

2003 Restructuring Charge
During the second quarter of 2003, the company recorded a $337
million restructuring charge principally associated with manage-
ment’s decision to close certain facilities and reduce headcount on a
global basis. Management undertook these actions in order to
position the company more competitively and to enhance profit-
ability. The company closed 26 plasma collection centers in the
United States, as well as a plasma fractionation facility located in
Rochester, Michigan.
the company consolidated
and integrated several
including facilities in Maryland;
Frankfurt, Germany; Issoire, France; and Mirandola, Italy. Manage-
ment discontinued Baxter’s
hemoglobin protein
program because it did not meet expected clinical milestones.
Also included in the charge were costs related to other reductions
in the company’s workforce.

In addition,
facilities,

recombinant

Restructuring Charges
The company recorded restructuring charges totaling $543 million
in 2004, $337 million in 2003 and $26 million in 2002. The net-of-
tax impact of the charges was $394 million ($0.64 per diluted
share) in 2004, $202 million ($0.33 per diluted share) in 2003 and
$15 million ($0.02 per diluted share) in 2002. The following is a
summary of these charges.

2004 Restructuring Charge
During the second quarter of 2004, the company recorded a $543
million restructuring charge principally associated with manage-
ment’s decision to implement actions to reduce the company’s
overall cost structure and to drive sustainable improvements in
financial performance. The charge is primarily for severance and

Included in the 2003 charge was $128 million relating to asset
impairments, principally to write down PP&E, goodwill and other
intangible assets. The impairment loss relating to the PP&E was
based on market data for the assets. The impairment loss relating
to goodwill and other intangible assets was based on management’s
assessment of the value of the related businesses. Also included in
the 2003 charge was $209 million for cash costs, principally
pertaining to severance and other employee-related costs associated
with the elimination of approximately 3,200 positions worldwide.
Virtually all of the targeted positions have been eliminated as of
December 31, 2004, and the program is substantially complete,
except for remaining severance and other cash payments to be
made in the future.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Restructuring Reserves
The following summarizes activity in the company’s restructuring
reserves through December 31, 2004.

launching this product, management performed an impairment
review of the assets in this program, and recorded a $197 million
impairment charge.

(in millions)

2003 Restructuring Charge
Charge
Utilization

Reserve at December 31, 2003
Utilization

Contractual

Employee-

costs

and

other

costs

Total

$ 160
(63)

$ 49
(6)

$ 209
(69)

97
(74)

43
(17)

140
(91)

Erythropoietin (EPOMAX)
In December 2004, management decided not
to fund, beyond
the currently ongoing clinical trials, further development of tech-
nology acquired in 2001 for the development of a recombinant
erythropoietin drug (EPOMAX)
for the treatment of anemia. Due
to the resulting uncertainty of successful commercialization of
this product, management performed an impairment review of the
intangible and fixed assets in this program, and recorded a
$42 million impairment charge.

Reserve at December 31, 2004

$ 23

$ 26

$ 49

2004 Restructuring Charge
Charge
Utilization

$212
(60)

$135
(32)

$347
(92)

Reserve at December 31, 2004

$152

$103

$255

With respect to the 2003 restructuring charge, the majority of the
severance and other costs are expected to be paid in early 2005.
With respect to the 2004 restructuring charge, approximately $150
million is expected to be paid in 2005, and the remainder in 2006.

2002 R&D Prioritization Charge
During the fourth quarter of 2002, the company recorded a charge
of $26 million to prioritize the company’s investments in certain of
the company’s R&D programs across the three segments. This
charge resulted from management’s comprehensive assessment of
the company’s R&D pipeline with the goal of having a focused and
balanced strategic portfolio, which maximizes the company’s
resources and generates the most significant
return on the
company’s investment. The charge included $14 million for cash
costs, primarily relating to employee severance, and $12 million
of asset
to write down certain PP&E and
other assets. Approximately 150 R&D positions were eliminated.
Cash payments totaled $1 million in 2004, $10 million in 2003
and $2 million in 2002. Management expects that the reserve will
be fully utilized, with the remaining reserve pertaining to certain
lease payments, which continue through early 2005.

impairment charges,

Impairment Charges
The company recorded a $289 million charge in the fourth quarter
of 2004 relating to the following asset impairments. The net-of-tax
impact was $245 million ($0.40 per diluted share).

PreFluCel Influenza Vaccine
In December 2004, the company suspended enrollment in the Phase
II/III clinical study in Europe of its PreFluCel influenza vaccine, due to
a higher than expected rate of mild fever and associated symptoms
in the clinical trial participants. As a result of the expected delays in

Thousand Oaks Suite D
As a result of manufacturing process improvements at the compa-
ny’s Neuchâtel, Switzerland facility, and the existing manufacturing
capacity available at Thousand Oaks, California, where the
company’s RECOMBINATE Antihemophilic Factor (rAHF) product is
produced,
the
additional capacity of the “Suite D” facility at Thousand Oaks is
not needed. Therefore, management has decided to keep Suite D
fully decommissioned for the foreseeable future. As a result of this
the
decision, management performed an impairment review of
Suite D manufacturing assets, and recorded a $50 million
impairment charge.

in December 2004 management decided that

With respect to these charges, the impairment losses relating to the
PP&E were based on market data for the assets.

Other Special Charges
The company recorded other special charges totaling $115 million
in the second quarter of 2004. The net-of-tax impact was $20
million ($0.03 per diluted share). By line item, cost of goods sold
increased $45 million, marketing and administrative expenses
increased $55 million, other expense increased $15 million,
and income tax expense decreased $95 million.

Accounts and Other Receivable Reserves
The company established a reserve due to the uncertain collectibility
of a loan from Cerus Corporation (Cerus). Baxter owns approx-
imately 1% of
the common stock of Cerus. This reserve was
determined based on Cerus’ current financial position at the time
of the charge (in February 2005, Cerus and the company settled
the loan in an amount approximating the company’s reserved
receivable). Also, based on the lengthening age of accounts
receivables and more current market data in certain markets, the
company increased the allowance for doubtful accounts. In addition,
certain Shared Investment Plan participants defaulted on their loans,
which were due and payable in May 2004, requiring the company to
make payments to the bank under its guarantee arrangement. Refer
to Note 5 for further information regarding the Shared Investment
Plan. While the company has not forgiven any of these loans and

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

is pursuing repayment of the defaulted amounts, a reserve was re-
corded for potential
the
company paid to the bank under the loan guarantee as a result of
the defaulted loans. These adjustments, which were recorded in
marketing and administrative expenses, totaled $55 million.

losses, representing the amount

that

Inventories
Based upon second quarter 2004 restructuring decisions in the
BioScience segment, which will reduce inventory production in an
effort to focus on more profitable sales in the plasma market, the
company expects that future sales in this market will be less than
previously expected. As a result, the company increased inventory
reserves (a charge to cost of goods sold) by $28 million.

Hedges
As discussed in Note 6, the company uses forward contracts to
hedge the risk to earnings relating to anticipated intercompany
sales denominated in foreign currencies (cash flow hedges). Based
on a second quarter 2004 analysis, intercompany sales from the
United States to Europe (denominated in Euros) are expected to
be lower than originally projected. In particular, due to the strong
Factor
European
(Recombinant),
the
Plasma/Albumin-Free Method)
company’s advanced recombinant therapy (which is manufactured
in Europe), the second quarter 2004 forecasts of intercompany
sales of RECOMBINATE Antihemophilic Factor (rAHF) from the United
States into Europe were reduced. Because it was probable that
these originally forecasted sales would no longer occur, the related
deferred hedge loss was recorded as a $17 million charge to cost
of goods sold.

(Antihemophilic

rAHF-PFM,

ADVATE

launch

sales

Pathogen Inactivation Program Assets
As a result of lower than expected sales from the company’s Patho-
gen Inactivation programs, strategic decisions announced in the
second quarter of 2004 by Cerus, along with an assessment of
future market potential for these products, the company performed
an impairment review of
its fixed assets in this program and
recorded a $15 million impairment charge, which was classified as
other expense.

Income Taxes
The income tax benefit relating to the above-mentioned charges
totaled $40 million. In addition, as a result of the completion of tax
audits in the second quarter of 2004, $55 million of reserves for
matters previously under review were reversed into income in
the quarter.

NOTE 5

DEBT, CREDIT FACILITIES, AND COMMITMENTS AND

CONTINGENCIES

Debt Outstanding

as of December 31 (in millions)

interest rate1

20042

20032

Effective

Commercial paper
Variable-rate loan due 2005
5.75% notes due 2006
Variable-rate loan due 2007
7.125% notes due 2007
1.02% notes due 2007
5.25% notes due 2007
Variable-rate loan due 2008
7.25% notes due 2008
9.5% notes due 2008
3.6% notes due 2008
4.625% notes due 2015
6.625% debentures due 2028
Other

1.4% $ — $ 351
148
153
0.6%
824
884
5.9%
107
111
0.7%
55
55
7.2%
130
134
1.0%
501
498
5.6%
41
40
2.2%
29
29
7.3%
9.5%
82
81
4.0% 1,250 1,250
580
588
4.8%
174
158
6.8%
152
106

Total debt and capital lease obligations
Current portion

Long-term portion

4,087 4,424
(3)

(154)

$3,933 $4,421

1 Excludes the effect of related interest rate swaps, as applicable.

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

instruments, as applicable.

In addition, as further discussed below, the company has short-term
debt totaling $207 million at December 31, 2004 and $150 million
at December 31, 2003.

Equity Units
In December 2002, the company issued equity units for $1.25 bil-
lion in an underwritten public offering. Each equity unit consists of
senior notes ($1.25 billion in total) that mature in February 2008
and a purchase contract. The purchase contracts obligate the hold-
ers to purchase between 35.0 and 43.4 million shares (based upon
a specified exchange ratio) of Baxter common stock in February
2006 for $1.25 billion. Prior to the February 2006 purchase date,
the purchase contracts will not have a dilutive effect on diluted EPS
except when the market price of Baxter stock exceeds $35.69.

Baxter is making quarterly interest payments to the holders of the
notes initially at an annual rate of 3.6% and quarterly purchase con-
tract payments to the holders of the purchase contracts at a rate of
3.4% per year.

Between November 2005 and February 2006, the notes will be
remarketed and the interest rate will be reset. If the notes are not
remarketed by February 16, 2006, the holders will have the right to
put the notes to Baxter. If the notes are put to Baxter, Baxter would
likely use the $1.25 billion proceeds received from the settlement of

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

the purchase contracts to satisfy the $1.25 billion principal plus
accrued interest obligation to the note holders. If the notes are
remarketed, as is expected, the company may use the proceeds
from the settlement of the purchase contracts to pay down existing
debt, fund pension plans, make acquisitions, and/or for other gen-
eral corporate purposes.

The present value of the purchase contract payments of $127
million was charged to additional contributed capital on the issuance
date and is included in other liabilities. The purchase contract
payments are allocated between this liability and interest expense
based on a constant rate calculation over the life of the instruments.
Equity unit underwriting costs totaling $37.5 million were allocated
between the notes ($7.5 million) and the purchase contracts ($30
million), with the amount allocated to the purchase contracts
charged to additional contributed capital on the issuance date.

Other Significant Debt Issuances and Redemptions
In March 2003, the company issued $600 million of term debt,
which matures in March 2015 and bears a 4.625% coupon rate. In
April 2002, the company issued $500 million of term debt, which
matures in May 2007 and bears a 5.25% coupon rate. In May
2001, the company issued $800 million of convertible debentures,
these
which bore a 1.25% coupon rate. Substantially all of
debentures were put to the company by the holders in June 2003.
The net proceeds of
issuances were used to fund
acquisitions, settle certain equity forward agreements (as further
discussed in Note 6), retire existing debt, fund capital expenditures
and for general corporate purposes.

the debt

Future Minimum Lease Payments and Debt Maturities

as of and for the years ended December 31 (in millions)

leases1

leases

Debt maturities

Operating

and capital

2005
2006
2007
2008
2009
Thereafter

Total obligations and commitments
Interest on capital leases, discounts and
premiums, and adjustments relating to
hedging instruments

Total long-term debt and lease obligations

1 Excludes discontinued operations.

$135
105
93
80
67
108

588

$ 154
903
808
1,4162
7
792

4,080

$4,087

2 Includes $1.25 billion 3.6% notes maturing in 2008. As discussed above,

holders of the notes have contingent put rights in 2006.

Credit Facilities
The company maintains two primary revolving credit facilities, which
totaled $1.44 billion at December 31, 2004. One of the facilities
totals $640 million and matures in October 2007, and the other fa-

cility totals $800 million and matures in September 2009. The
facilities enable the company to borrow funds in United States
Dollars, Euros or Swiss Francs on an unsecured basis at variable
interest rates and contain various covenants, including a maximum
net-debt-to-capital ratio and a minimum interest coverage ratio.
There were no borrowings outstanding under
the company’s
primary credit facilities at December 31, 2004 or 2003, and the
company was in compliance with all covenants at both balance
sheet dates. Baxter also maintains other credit arrangements,
which totaled $609 million at December 31, 2004 and $1.08
billion at December 31, 2003. Borrowings outstanding under these
facilities totaled $207 million at December 31, 2004 and $150
million at December 31, 2003.

Commercial paper and short-term debt totaling $391 million at
December 31, 2003 have been classified with long-term debt as
they were supported by the long-term credit facilities.

Cash Collateral Requirements
As discussed further in Note 6, the company uses foreign currency
and interest-rate derivative instruments for hedging purposes. For
risk-management purposes, certain of the company’s counterparty
financial
institutions require that collateral could be required to be
posted or that the arrangement could be terminated under specified
circumstances. The terms of the arrangements vary, but generally,
the collateral or termination trigger is dependent upon the mark-to-
market liability (if any) with the financial institution and the company’s
credit ratings. No early termination clauses were triggered during
the three-year period ended December 31, 2004, and no collateral
was posted pursuant
to these arrangements at December 31,
2004.

Leases
The company leases certain facilities and equipment under capital
and operating leases expiring at various dates. The leases generally
provide for the company to pay taxes, maintenance, insurance and
certain other operating costs of the leased property. Most of the
operating leases contain renewal options. Operating lease rent ex-
pense was $149 million in 2004, $152 million in 2003 and
$138 million in 2002.

Synthetic Leases
Certain of the company’s operating leases are commonly referred
to as synthetic leases. An unrelated third party funded the costs of
acquisition or construction of property and leased the property to
Baxter. The third party maintains a specified percentage of equity
throughout the term of the lease. Baxter has entered into these
arrangements where economical and consistent with the company’s
business strategy, principally relating to an office building in
California and plasma collection centers in various locations
throughout the United States. No Baxter employee or member of
the board of directors has any financial interest with regard to these
synthetic lease arrangements or with the VIEs (also referred to as
special-purpose entities) used in certain of these arrangements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Prior to the adoption of FIN No. 46, all of the company’s synthetic
leases were considered operating leases for accounting purposes
and none of the special-purpose entities were consolidated. As
discussed in Note 1, effective July 1, 2003 the company adopted
FIN No. 46 and was required to consolidate certain of the synthetic
lease entities.

The synthetic leases (whether or not consolidated) have contingent
obligations in the form of residual value guarantees. Upon termination
or expiration of these leases, at Baxter’s option, the company must
purchase the leased property, arrange for the sale of the leased
property, or renew the lease. If the property is sold for an amount
less than the lessor’s investment in the leased property, the company
is required to pay the lessor the difference between the sales price
and an agreed-upon percentage of the amount financed by the lessor.
The residual value guarantees relating to entities not consolidated
pursuant to FIN No. 46 totaled $35 million at December 31, 2004. Of
this amount, approximately $10 million is related to the Thousand Oaks
Suite D facility, and was reserved in conjunction with the fourth
quarter 2004 impairment charges (as further discussed in Note 4).
The remainder of the guaranteed amount is not included as future
minimum lease payments in the table above as management believes
the fair values of
the properties equal or exceed the lessor’s
investments in the leased properties at December 31, 2004. One of
the agreements requires that the company collateralize the outstanding
lease balance in December 2007. The potential cash collateral
obligation, which is not included in the minimum lease payments
above, totals less than $10 million. The lease agreements contain cer-
tain covenants,
including a minimum interest coverage ratio, and
Baxter was in compliance with all covenants at December 31, 2004.

Other Commitments and Contingencies

Shared Investment Plan
In order to align management and shareholder interests, in 1999
the company sold 6.1 million shares of the company’s stock to
142 of Baxter’s senior managers for $198 million in cash. The
participants used five-year full-recourse personal bank loans to
purchase the stock at the May 3, 1999 closing price of $31.81.
Baxter guaranteed repayment to the banks in the event a participant
in the plan defaulted on his or her obligations, which were due on
May 6, 2004.

In May 2003, management announced that, in order to continue to
align management and shareholder interests and to balance both
the short- and long-term needs of Baxter, the board of directors
authorized the company to provide a new three-year guarantee at
the May 6, 2004 loan due date for the non-executive officer employ-
ees who remain in the plan, should they elect to extend their loans.
The amount under the company’s loan guarantee at December 31,
2004 relating to the 70 eligible employees who extended their loans
was $95 million. In accordance with FIN No. 45, “Guarantor’s Ac-
counting and Disclosure Requirements for Guarantees, Including In-

direct Guarantees of Indebtedness of Others” (which was effective
for
guarantees
the company
issued or modified after December 31, 2002),
recorded a $5 million liability for the fair value of these guarantees.
As with the guarantee issued in 1999, the company may take ac-
tions relating to participants and their assets to obtain full
reimbursement for any amounts the company pays to the banks
pursuant to the loan guarantee.

With respect to the participants who were either not eligible or did not
elect to extend their loans on the May 6, 2004 due date, the majority
paid their principal and interest obligations in full, and the company
structured new repayment schedules with certain participants.

Joint Development and Commercialization Arrangements
In the normal course of business, Baxter enters into joint
development and commercialization arrangements with third parties,
sometimes with investees of the company. The arrangements are
varied but generally provide that Baxter will receive certain rights to
manufacture, market or distribute a specified technology or product
under development by the third party, in exchange for payments by
Baxter. At December 31, 2004, the unfunded milestone payments
under these arrangements totaled less than $150 million, and the
majority of them were contingent upon the third parties’ achievement
of contractually specified milestones.

Credit Commitments
As part of its financing program, the company had commitments
to extend credit. The company’s total credit commitment was $139
million at December 31, 2004 and $144 million at December 31,
2003, of which $128 million was drawn and outstanding at
December 31, 2004 and $129 million was drawn and outstanding
at December 31, 2003.

Receivable Securitizations
Refer to Note 6 for a discussion of limited recourse provisions
related to the company’s receivable securitization arrangements.

Potential Additional Purchase Price Payments Relating to Acquisitions
Refer to Note 3 for a discussion of contingent purchase price
payments relating to acquisitions.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Restated Certificate of Incorporation, the company is committed to
its directors and officers for providing for payments upon the occur-
these
rence of certain prescribed events. The majority of
indemnities, commitments and guarantees do not provide for any
limitation on the maximum potential for future payments that the
company could be obligated to make. To help address these risks,
the company maintains various insurance coverages. Based on
historical experience and evaluation of the agreements, manage-
ment does not believe that any significant payments related to its
indemnifications will result, and therefore the company has not
recorded any associated liabilities.

Legal Contingencies
Refer
contingencies.

to Note 12 for a discussion of

the company’s legal

NOTE 6

FINANCIAL INSTRUMENTS AND RISK MANAGEMENT

Receivable Securitizations
Where economical, the company has entered into agreements with
various financial
institutions in which undivided interests in certain
pools of receivables are sold. The securitized receivables principally
consist of hardware lease receivables originated in the United
States, and trade receivables originated in Europe and Japan. The
securitization programs require that the underlying receivables meet
certain eligibility criteria, including concentration and aging limits.

The company continues to service the receivables. Servicing assets
or liabilities are not recognized because the company receives
adequate compensation to service the sold receivables.

The securitization arrangements include limited recourse provisions,
which are not material. Neither the buyers of the receivables nor the
investors in these transactions have recourse to assets other than
the transferred receivables.

A subordinated interest in each securitized portfolio is generally
retained by the company. The amount of the retained interests and
the costs of certain of the securitization arrangements vary with
the company’s credit rating and other factors. Under one of the
agreements the company is required to maintain compliance with
various covenants,
including a maximum net-debt-to-capital ratio
and a minimum interest coverage ratio. The company was in
compliance with all covenants at December 31, 2004. Another
arrangement requires that
in
the event of a specified unfavorable change in credit rating. The
maximum potential cash collateral, which was not required as of
December 31, 2004, totals less than $20 million. In addition, in
the event of certain specified downgrades (Baa3 or BBB-,
depending on the rating agency), the company would no longer
its
be able to securitize new receivables under certain of

the company post cash collateral

securitization arrangements. However, any downgrade of credit
ratings would not impact previously securitized receivables.

The fair values of the retained interests are estimated taking into
consideration both historical experience and current projections
with respect to the transferred assets’ future credit losses. The key
assumptions used when estimating the fair values of the retained
interests include the discount
rate (which generally averages
approximately 4%),
the expected weighted-average life (which
averages approximately 5 years for lease receivables and 5 to 7
months for trade receivables) and anticipated credit losses (which
are expected to be immaterial as a result of meeting the eligibility
criteria mentioned above). The subordinated interests retained in the
transferred receivables are carried in Baxter’s consolidated balance
sheets, and totaled $97 million at December 31, 2004 and
$70 million at December 31, 2003. An immediate 10% and 20%
adverse change in these assumptions would reduce the fair value
of the retained interests at December 31, 2004 by approximately
$1 million and $2 million, respectively. These sensitivity analyses
are hypothetical and should be used with caution. Changes in fair
value based on a 10% or 20% variation in assumptions generally
cannot be extrapolated because the relationship of the change in
each assumption to the change in fair value may not be linear.

As detailed below, the securitization arrangements resulted in a net
cash outflow of $162 million in 2004, had no impact on net cash
flows in 2003, and resulted in a net cash inflow of $57 million in
2002. A summary of the securitization activity is as follows.

as of and for the years ended December 31

(in millions)

2004

2003

2002

Sold receivables at beginning of

year

742

$ 721

$ 683

Proceeds from sales of

receivables

Cash collections (remitted to the
owners of the receivables)

Foreign exchange

1,395

1,712

2,152

(1,557)
14

(1,712)
21

(2,095)
(19)

Sold receivables at end of year

594

$ 742

$ 721

Credit losses, net of recoveries, relating to the retained interests,
cash flows received on retained interests and the net gains relating
to the sales of receivables were immaterial for each year.

Concentrations of Risk
The company invests excess cash in certificates of deposit or money
market accounts and, where appropriate, diversifies the concen-
tration 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Foreign Currency and Interest Rate Risk Management
The company operates on a global basis, and is exposed to the
risk that its earnings, cash flows and stockholders’ equity could be
adversely impacted by foreign exchange and movements in
interest rates. The company’s hedging policy manages these risks
based on management’s judgment of
the appropriate trade-off
between risk, opportunity and costs.

The company is primarily exposed to foreign currency risk related
to firm commitments,
forecasted transactions and net assets
denominated in the Euro, Japanese Yen, British Pound and Swiss
Franc. 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 exposure to foreign exchange. Gains and losses on the hedging
instruments offset losses and gains on the hedged transactions to
reduce the earnings and stockholders’ equity volatility resulting from
foreign exchange.

As of December 31, 2004, $52 million of deferred net after-tax
losses on derivative instruments included in AOCI are expected to
be recognized in earnings during the next twelve months, coinciding
with when the hedged items are expected to impact earnings.

During the three years ended December 31, 2004, certain foreign
currency derivatives were no longer classified as hedges and
were discontinued primarily due to changes in the company’s
anticipated net exposures. This was partially as a result of changes
to intercompany product flow forecasts, as well as recent business
acquisitions and divestitures, whereby the company gained natural
offsets to previously existing currency exposures.
the
net-of-tax amounts reclassified to earnings relating to discontinued
hedges, which are included in the table above, was a $10 million
loss in 2004 (refer to description in Note 4) and a $24 million gain
in 2002. The discontinued hedges were not significant in 2003.

In total,

The maximum term over which the company has cash flow hedges
in place as of December 31, 2004 is three years.

fixed and floating rate debt

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
that management believes is
of
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.

Cash Flow Hedges
The company uses forward and option contracts to hedge the
foreign exchange risk to earnings relating to firm commitments
and forecasted transactions denominated in foreign currencies. The
company periodically uses forward-starting interest rate swaps and
treasury rate locks to hedge the risk to earnings associated with
movements in interest rates relating to anticipated issuances of
debt. Certain other firm commitments and forecasted transactions
are also periodically hedged with forward and option contracts.

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

as of and for the years ended December 31

(in millions)

2004

2003

2002

AOCI (loss) balance at beginning of

year

$(138)

$ (32)

$ 82

Net loss in fair value of derivatives

during the year

(47)

(152)

(10)

Net loss (gain) reclassified to
earnings during the year

(104)

AOCI (loss) balance at end of year

$ (91)

$(138)

$ (32)

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 fluctuations in interest rates. No portion
of the change in fair value of the company’s fair value hedges was
ineffective or excluded from the assessment of hedge effectiveness
during the three years ended December 31, 2004.

Hedges of Net Investments in Foreign Operations
The company has historically hedged the net assets of certain of
its foreign operations through a combination of foreign currency
denominated debt and cross-currency swaps. The swaps have
served as effective hedges for accounting purposes and have
reduced volatility in the company’s stockholders’ equity balance
and net-debt-to-capital ratio. Any increase or decrease in the fair
value of the swaps relating to changes in spot foreign exchange
rates is offset by the change in value of the hedged net assets of the
foreign operations relating to changes in spot foreign exchange
rates. The net after-tax losses related to derivative and nonderivative
totaled
net
$171 million in 2004, $384 million in 2003 and $370 million in
2002.

investment hedge instruments recorded in AOCI

Because the United States Dollar has weakened relative to the
hedged currency, the hedged net assets have increased in value
over time, while the cross-currency swaps have decreased in value
over time. At December 31, 2004, as presented in the following
table, the company had a pre-tax net liability of $1.17 billion relating
to cross-currency swap agreements. Of this total, $356 million was
short-term, and $816 million was long-term.

Management reevaluated its net investment hedge strategy in the
fourth quarter of 2004 and decided to reduce the use of these

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

instruments as a risk-management tool. Management intends to settle
the swaps that mature in 2005 using cash flows from operations.

instruments, which substantially offsets the change in book value of
the hedged items, is recorded directly to earnings.

In addition, in order to reduce financial risk and uncertainty through the
maturity (or cash settlement) dates of the cross-currency swaps, the
company executed offsetting or mirror cross-currency swaps relating
to approximately 58% of the existing portfolio. As of the date of
execution, these mirror swaps effectively fixed the net amount that the
company will ultimately pay to settle the cross-currency swap agree-
ments subject to this strategy. After execution, as the market value of
the fixed portion of the original portfolio decreases, the market value of
the mirror swaps increases by an approximately offsetting amount, and
vice versa. The mirror swaps will be settled when the offsetting existing
swaps are settled. The following is a summary, by maturity date, of the
mark-to-market liability position of the original cross-currency swaps
portfolio, the offsetting mirror swaps net asset position, and the net
mark-to-market position as of December 31, 2004 (in millions).

Maturity date

Swaps liability

Mirror swaps net asset

Net liability position

2005
2007
2008
2009

Total

$ 465
64
309
458

$1,296

$(109)
(4)
(11)
—

$(124)

$ 356
60
298
458

$1,172

The mirror swaps net asset of $124 million consists of a $129
million asset net of a $5 million liability. Approximately $631 million
of the total swaps liability of $1.30 billion as of December 31, 2004
has been fixed by the mirror swaps.

For the mirrored swaps, the company will no longer realize the
favorable interest rate differential between the two currencies, and
this will result in increased net interest expense in the future. The
amount of increased net interest expense will vary based on floating
interest rates and foreign exchange rates, and the timing of the
company’s settlements. Based on interest rates at December 31,
2004, the increase in net interest expense is estimated to be
approximately $20 million on an annual basis.

In accordance with FASB No. 149, “Amendment of Statement 133
on Derivative Instruments and Hedging Activities,” when the cross-
currency swaps are settled, the cash flows will be reported within the
financing section of the consolidated statement of cash flows. When
the mirror swaps are settled, the cash flows will be reported in the
operating section of the consolidated statement of cash flows.

Other Foreign Currency Hedges
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 denomi-
nated in a foreign currency. These derivative instruments are not
formally designated as hedges, and the change in fair value of the

Equity Forward Agreements
In order to partially offset the potentially dilutive effect of employee
stock options, the company had periodically entered into forward
agreements with independent third parties related to the company’s
common stock. The forward agreements, which had a fair value of
zero at inception, required the company to purchase its common
stock from the counterparties on specified future dates and at
the company had
specified prices. At December 31, 2002,
outstanding forward agreements related to 15 million shares,
which had maturity dates in 2003, and exercise prices ranging
from $33 to $52 per share, with a weighted-average exercise price
of $49 per share. During 2002 and 2003, the company settled all
of its outstanding agreements. The physically settled agreements
related to 15 million shares and 22 million shares of Baxter com-
mon stock in 2003 and 2002, respectively. Such common stock
repurchases totaled $714 million in 2003 and $1.14 billion in
2002. The settlement of the equity forward agreements did not
have a material impact on the company’s diluted EPS. Management
does not intend to enter into equity forward agreements in the
future.

Book Values and Fair Values of Financial Instruments

as of December 31 (in millions)

2004

2003

2004

2003

Book values

Approximate fair values

Assets
Long-term insurance

receivables

Investments in affiliates
Foreign currency hedges
Interest rate hedges
Cross-currency swaps

Liabilities
Short-term debt
Current maturities of long-
term debt and lease
obligations

Short-term borrowings

classified as long-term
Other long-term debt and

lease obligations

Foreign currency hedges
Interest rate hedges
Cross-currency swaps
Long-term litigation

66 $ 105 $
20
61
5
129

45
47
—
—

64 $ 102
45
20
47
61
—
5
—
129

207

150

207

150

154

—

391

—

391

3,933
158
12
1,301

4,030
198
18
957

4,158
158
12
1,301

4,257
198
18
957

liabilities

113

141

109

136

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The fair values of certain of the company’s cost method investments
in affiliates are not readily determinable as the securities are not
traded in a market. For those investments, fair value is assumed to
approximate carrying value.

NOTE 8

COMMON AND PREFERRED STOCK

Stock Compensation Plans

Although the company’s litigation remains unresolved by final orders
or settlement agreements in some cases, the estimated fair values
of
insurance receivables and long-term litigation liabilities were
computed by discounting the expected cash flows based on
currently available information. The approximate fair values of other
assets and liabilities are based on quoted market prices, where
available. The carrying values of all other financial
instruments
approximate their fair values due to the short-term maturities of
these assets and liabilities.

NOTE 7

LIABILITIES

Stock Option Plans
Stock options have been granted to employees at various dates.
Most grants have a 10-year term and have an exercise price at least
equal to 100% of the market value on the date of grant. Vesting
terms vary, with the majority of outstanding options vesting 100% in
three years. As of December 31, 2004, 29,549,824 authorized
shares are available for future awards under the company’s stock
option plans.

Stock Options Outstanding
The following is a summary of stock options outstanding at
December 31, 2004.

Accounts Payable and Accrued Liabilities

(option shares in thousands)

Options outstanding

Vested options

as of December 31 (in millions)

2004

2003

Accounts payable, principally trade
Employee compensation and withholdings
Litigation
Pension and other employee benefits
Property, payroll and certain other taxes
Interest
Common stock dividends payable
Cross-currency swaps
Foreign currency hedges
Restructuring
Other

$ 834
264
55
156
132
47
359
465
107
305
807

$ 929
247
74
152
115
40
356
172
97
142
783

Accounts payable and accrued liabilities

$3,531

$3,107

Other Long-Term Liabilities

as of December 31 (in millions)

2004

2003

Pension and other employee benefits
Litigation
Cross-currency swaps
Foreign currency hedges
Other

$1,137
113
836
51
86

$1,041
141
785
101
138

Other long-term liabilities

$2,223

$2,206

Weighted-

average

Weighted-

Range of

exercise

remaining

contractual

prices

Outstanding

life (years)

$13-26
27-28
29-39
40-44
45-47
48-56

$13-56

4,992
12,600
16,827
10,571
11,396
10,241

66,627

2.2
7.0
6.8
5.9
6.2
7.0

6.3

average

exercise

price

$21.55
27.22
30.77
41.28
45.42
51.95

Vested

4,872
4,747
7,613
10,571
11,396
5,653

Weighted-

average

exercise

price

$21.46
26.83
31.76
41.28
45.42
49.63

$36.84

44,852

$38.09

As of December 31, 2003 and 2002, there were 34,662,000 and
24,438,000 options exercisable, respectively, at weighted-average
exercise prices of $32.26 and $29.19, respectively.

Stock Option Activity

(option shares in thousands)

Weighted-average

exercise price

Options outstanding at December 31, 2001 65,706
11,832
Granted
(4,112)
Exercised
(3,596)
Forfeited

Options outstanding at December 31, 2002 69,830
10,833
Granted
(1,827)
Exercised
(5,995)
Forfeited

Options outstanding at December 31, 2003 72,841
7,350
Granted
(4,350)
Exercised
(9,214)
Forfeited

$ 36.59
45.87
25.46
43.96

38.44
27.39
20.08
42.28

36.94
29.69
23.73
38.11

Options outstanding at December 31, 2004 66,627

$36.84

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Employee Stock Purchase Plans
Nearly all employees are eligible to participate in the company’s em-
ployee stock purchase plans. The employee purchase price
is the lower of 85% of the closing market price on the date of
subscription or 85% of the closing market price on the purchase
dates, as defined by the plans. For subscriptions that begin on or
after April 1, 2005, the employee purchase price will be 95% of the
closing market price on the purchase date, as defined by the plans.
At December 31, 2004, 7,928,089 authorized shares of common
stock are available for purchase under these plans. Under the plans,
the company sold shares totaling 2,896,506 in 2004, 2,906,942 in
2003 and 1,552,797 in 2002.

Restricted Stock Plans
The company has programs in which it grants restricted stock to
key employees. In addition, the company’s non-employee directors
are compensated with a combination of restricted stock, stock
options and cash. During 2004, 2003 and 2002, 55,787, 54,441
and 25,171 shares, respectively, of restricted stock were granted
with weighted-average grant-date fair values of $31.82, $25.27 and
$44.96 per share, respectively. At December 31, 2004, 101,634
shares of stock were subject to restrictions, the majority of which
lapse in 2005, 2006 and 2010.

Stock Repurchase Programs
As authorized by the board of directors, from time to time the
company repurchases its stock on the open market to optimize its
capital structure depending upon its cash flows, net debt level and
current market conditions. As of December 31, 2004, $243
million was available under the board of directors’ October 2002
authorization. No open-market repurchases were made in 2004 or
2003. As discussed in Note 6, in 2003 and 2002 the company
repurchased its stock from counterparty financial
institutions in
conjunction with the settlement of its equity forward agreements. In
2004, all of the stock repurchases were from Shared Investment
to Note 5
Plan participants in private transactions. Refer
for information regarding the Shared Investment Plan. Total stock
repurchases (including those associated with the settlement of
equity forward agreements and the Shared Investment Plan) were
$18 million in 2004, $714 million in 2003, and $1.17 billion
in 2002.

Issuances of Stock
the company issued 22 million shares of
In September 2003,
common stock in an underwritten offering and received net
proceeds of $644 million. In December 2002, the company issued
14.95 million shares of common stock in an underwritten offering
and received net proceeds of $414 million. The net proceeds from
these issuances were principally used to fund acquisitions,
retire a portion of the company’s debt, for other general corporate
purposes and to settle equity forward agreements. Also, refer to
Note 5 regarding the December 2002 issuance of equity units,
which include purchase contracts that obligate the holders to

purchase between 35.0 and 43.4 million shares (based upon a
specified exchange ratio) of Baxter common stock in February 2006
for $1.25 billion.

Authorized Shares
to the
In May 2002, shareholders approved an amendment
Incorporation to increase the
company’s Restated Certificate of
number of authorized shares of common stock to two billion shares
from one billion shares. The additional shares enhance the
company’s flexibility in connection with possible future actions, such
as stock splits, stock dividends, acquisitions, financings and other
corporate purposes.

Common Stock Dividends
the board of directors declared an annual
In November 2004,
dividend on the company’s common stock of $0.582 per share. The
dividend, which was payable on January 5, 2005 to stockholders of
record as of December 10, 2004, is a continuation of the current
annual rate.

Other
The board of directors is authorized to issue up to 100 million
shares of no par value preferred stock in series with varying terms
as it determines. In March 1999, common stockholders received
a dividend of one preferred stock purchase right
(collectively,
the Rights)
for each share of common stock. As a result of
the two-for-one split of the company’s common stock in May 2001,
each outstanding share of common stock is now accompanied by
one-half of one Right. The Rights may become exercisable at a
specified time after (1) the acquisition by a person or group of 15
percent or more of the company’s common stock or (2) a tender or
exchange offer for 15 percent or more of the company’s common
stock. Once exercisable, the holder of each Right is entitled to
purchase, upon payment of
the
company’s common stock having a market value equal to two
times the exercise price of the Rights. The Rights have a current
exercise price of $275. The Rights expire on March 23, 2009, un-
less earlier redeemed by the company under certain circumstances
at a price of $0.01 per Right.

the exercise price, shares of

NOTE 9

RETIREMENT AND OTHER BENEFIT PROGRAMS

The company sponsors a number of qualified and nonqualified
pension plans for its employees. The company also sponsors
certain unfunded contributory health-care and life insurance benefits
for substantially all domestic retired employees.

The company uses a measurement date of September 30 for
its pension and other postemployment benefit (OPEB) plans. The
benefit plan information disclosed below pertains to all of
the
company’s retirement and other benefit plans, both relating to
plans in the United States as well as in foreign countries.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

as of and for the years ended

December 31 (in millions)

Pension benefits

OPEB

2004

2003

2004

2003

(in millions)

Projected benefit obligation
ABO
Fair value of plan assets

2004

2003

$2,620
2,437
1,564

$2,371
2,183
1,309

Benefit obligations
Beginning of period
Service cost
Interest cost
Participant contributions
Actuarial loss
Benefit payments
Foreign exchange and other

$ 2,547 $ 2,075 $ 491 $ 407
67
7
27
137
5
6
62
305
(18)
(94)
—
52

77
151
6
144
(106)
19

9
29
9
46
(21)
—

End of period

2,838

2,547

563

491

Fair value of plan assets
Beginning of period
Actual return on plan assets
Employer contributions
Participant contributions
Benefit payments
Foreign exchange and other

1,433
182
213
6
(106)
11

1,275
187
40
5
(94)
20

End of period

1,739

1,433

—
—
12
9
(21)
—

—

—
—
12
6
(18)
—

—

Funded status
Funded status at end of

period

Unrecognized net losses
Fourth quarter contributions
and benefit payments

Net amount recognized at

(1,099)
1,366

(1,114)
1,282

(563)
201

(491)
163

December 31

276 $ 255 $(353) $(325)

Additional Minimum Liability
If the ABO relating to a pension plan exceeds the fair value of the
plan’s assets, the liability established for that pension plan must
be at least equal to that excess. The additional minimum liability
that must be recorded to state the plan’s pension liability at this
unfunded ABO amount is charged directly to AOCI. As a result of
unfavorable asset returns in certain prior years and a decline in
interest
the company recorded an additional minimum
liability relating to certain plans. The net-of-tax reduction to AOCI
totaled $48 million, $170 million and $517 million for the years
ended December 31, 2004, 2003 and 2002, respectively. These
entries had no impact on the company’s results of operations.

rates,

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

The Investment Committee’s significant documented goals and
guidelines include the following.

Amounts recognized in

the consolidated
balance sheets
Prepaid benefit cost
Accrued benefit liability
Additional minimum liability
Intangible asset
AOCI (a component of
stockholders’ equity)

Net amount recognized at

497 $ 452 $ — $ —
(325)
(221)
—
(1,140)
—
2

(197)
(1,060)
—

(353)
—
—

1,138

1,060

—

December 31

276 $ 255 $(353) $(325)

The accumulated benefit obligation (ABO) was $2.59 billion at the
2004 measurement date and $2.30 billion at the 2003 measure-
ment date.

The information above represents the totals for all of the company’s
defined benefit pension plans. The following is information for
Baxter’s defined benefit pension plans with an ABO in excess of
plan assets at the indicated measurement dates.

(cid:127)

ranges

percentage

Targeted long-term performance expectations relative to
applicable market indices, such as Standard & Poor’s,
Russell, MSCI EAFE, and other indices,
allocation
asset
Targeted
(summarized in the table below),
Diversification of assets among third-party investment
managers, and by geography, industry, stage of business
cycle and other measures,
Specified investment holding and transaction prohibitions
(for example, private placements or other
restricted
securities, securities that are not traded in a sufficiently
derivatives,
active market,
commodities and margin transactions),
Specified portfolio percentage limits on holdings in a
single corporate or other entity (generally 5%, except for
in United States Government or agency
holdings
securities),
Specified average credit quality for
the fixed-income
securities portfolio (at least AA- by Standard & Poor’s or
AA3 by Moody’s),

certain

sales,

short

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(cid:127)

Specified portfolio percentage limits on foreign holdings,
by asset category, and
Quarterly monitoring of investment manager performance
and adherence to the Investment Committee’s policies.

The expected benefit payments above reflect the company’s share
of the total benefits expected to be paid from the plans’ assets (for
funded plans) or from the company’s assets (for unfunded plans).

Net Periodic Benefit Cost (Income)

Pension Plan Asset Allocations

Target

allocation

ranges

2005

Equity securities
Fixed-income securities

70% to 80%

and other

20% to 30%

Total

100%

Actual year-end

allocation of

plan assets

2004

85%

15%

100%

2003

84%

16%

100%

In late 2004, management decided to change the target asset
allocation ranges, reducing the equity securities weighting in the
overall asset portfolio over time and increasing the portion of the
portfolio invested in fixed-income securities.

Expected Pension and OPEB Plan Funding
The company’s funding policy for its defined benefit pension plans is
to contribute amounts sufficient to meet legal funding requirements,
plus any additional amounts that management may determine to
be appropriate considering the funded status of the plans, tax
deductibility, the cash flows generated by the company, and other
factors. Management expects to fund approximately $100 million
to its primary plans in the United States and Puerto Rico in 2005.
Management expects that Baxter will have cash outflows of approx-
imately $22 million in 2005 relating to its OPEB plans. With respect
to the pension plan covering domestic employees, the United States
Congress has been considering various changes to the pension plan
funding rules, which could affect future required cash contributions.
Management’s expected future contributions and benefit payments
disclosed in this report are based on current laws and regulations,
and do not reflect any potential future legislative changes.

Expected Pension and OPEB Plan Payments for Next 10 Years

(in millions)

2005
2006
2007
2008
2009
2010 through 2014

Pension

benefits

$ 113
116
120
128
137
846

OPEB

$ 22
24
26
28
29
171

Total expected benefit payments

for next 10 years

$1,460

$300

years ended December 31 (in millions)

2004

2003

2002

Pension benefits
Service cost
Interest cost
Expected return on plan assets
Amortization of net loss, prior service

$ 77 $ 67
137
(176)

151
(187)

$ 50
125
(193)

cost and transition obligation

Net periodic pension benefit cost

(income)

$ 103 $ 51

$ (16)

OPEB
Service cost
Interest cost
Amortization of net loss and prior

service cost

9 $

7
27

5
24

Net periodic other benefit cost

$ 47 $ 40

$ 31

The amounts in the table above primarily pertain to continuing
operations.

Weighted-Average Assumptions Used in Determining Benefit
Obligations

Discount rate
United States and Puerto

Rico plans

International plans
Rate of compensation

increase

United States and Puerto

Rico plans

International plans
Annual rate of increase in

the per-capita cost

Rate decreased to

by the year ended

Pension benefits

OPEB

2004

2003

2004

2003

5.75% 6.00%
5.12% 5.35%

5.75% 6.00%
n/a

n/a

4.50% 4.50%
3.44% 3.78%

n/a
n/a

n/a
n/a
n/a

n/a 10.00% 10.00%
5.00% 5.00%
n/a
2007
n/a

2010

The assumptions used in calculating the 2004 measurement date
benefit obligations will be used in the calculation of net expense
in 2005.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost (Income)

Discount rate
United States and Puerto Rico plans
International plans
Expected return on plan assets
United States and Puerto Rico plans
International plans
Rate of compensation increase
United States and Puerto Rico plans
International plans
Annual rate of increase in the per-capita cost
Rate decreased to

by the year ended

Pension benefits

OPEB

2004

2003

2002

2004

2003

2002

6.00%
5.35%

6.75%
5.41%

7.50%
5.95%

6.00%
n/a

6.75%
n/a

7.50%
n/a

10.00%
7.62%

10.00%
7.48%

11.00%
7.49%

n/a
n/a

4.50%
3.78%
n/a
n/a
n/a

4.50%
3.75%
n/a
n/a
n/a

4.50%
3.88%
n/a
n/a
n/a

n/a
n/a
10.00%
5.00%
2007

n/a
n/a
10.20%
5.00%
2007

n/a
n/a
11.39%
5.00%
2007

Management establishes the expected return on plan assets
assumption primarily based on a review of historical compound
average asset returns, both company-specific and relating to the
broad market (based on the company’s current and planned asset
allocation). Management also applies its judgment, based on an
analysis of current market information and future expectations, in
arriving at the expected return assumption. Management revised
the asset return assumption to be used in determining net pension
expense from 10% for 2004 to 8.5% for 2005 based on these
reviews. The change in the assumption is primarily due to
anticipated changes in the company’s pension trust asset allocation,
shifting to a higher mix of fixed-income investments versus equity
investments.

Effect of a One-Percent Change in Assumed Health-Care Cost
Trend Rate

One percent

increase

decrease

years ended December 31 (in millions)

2004

2003

2004

2003

Effect on total of service and interest
cost components of OPEB cost

Effect on OPEB obligation

$ 5 $ 4 $ 4 $ 3
$73 $75 $61 $61

Medicare Prescription Drug, Improvement and Modernization Act
In December 2003, the Medicare Prescription Drug, Improvement
and Modernization Act
(the Act) was signed into law. The Act
introduces a prescription drug benefit under Medicare (Part D) as
well as a federal subsidy to sponsors of retiree health-care benefit
plans that provide a benefit that is at least actuarially equivalent to
Medicare (Part D). The final regulations necessary to implement
the Act were issued in January 2005. The effects of the Act are
not recognized in the company’s net OPEB plan expense and
obligation as management is not yet able to determine whether
the company’s benefits are actuarially equivalent
to Medicare
(Part D). However, based on preliminary analyses, management
the Act on the company’s
has determined that any impact of
consolidated financial statements will not be material.

Defined Contribution Plan
Most United States employees are eligible to participate in a
qualified defined contribution plan. Company matching contributions
relating to continuing operations were $22 million in 2004, $23
million in 2003 and $22 million in 2002.

NOTE 10

INTEREST AND OTHER EXPENSE, NET

Net Interest Expense

years ended December 31 (in millions)

2004

2003

2002

Interest costs
Interest costs capitalized

Interest expense
Interest income

Total net interest expense

Continuing operations
Discontinued operations

Other Expense, Net

$144
(18)

126
(27)

$ 99

$ 99
$ —

$155
(37)

118
(28)

$ 90

$ 87
$ 3

$101
(30)

71
(19)

$ 52

$ 51
$ 1

years ended December 31 (in millions)

2004

2003

2002

Equity method loss (income) and minority

interests

Asset dispositions and impairments, net
Foreign exchange
Costs relating to early extinguishment of

debt

Other

$ 7
17
36

—
17

$(14)
(6)
35

11
16

$19
68
(6)

—
11

Total other expense, net

$77

$ 42

$92

The increase in equity method income in 2003 primarily related to
the company’s investment in Acambis. The increase in Acambis’
its
earnings was primarily due to the substantial completion of

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

smallpox vaccine contract with the United States Government.
Equity method income was lower in 2004 because Baxter divested
its investment in Acambis in late 2003.

Expenses relating to asset dispositions and impairments, net totaled
$17 million in 2004, and primarily included the $15 million second
quarter 2004 special charge relating to the company’s Pathogen
Inactivation program, as further discussed in Note 4. Net gains from
asset dispositions totaled $40 million in 2003, including a $36
million gain relating to the December divestiture of the company’s
common stock holdings in Acambis. These divestiture gains were
offset by $34 million in impairment charges relating to investments
with declines in value that were deemed to be other than temporary.
Included in asset dispositions and impairments, net in 2002 were
$70 million in impairment charges relating to investments in publicly-
traded companies with declines in value that were deemed to be
other than temporary. Also included in asset dispositions and
impairments, net in 2002 were write-offs of certain fixed assets and
gains on the sale of certain land and facilities.

With respect to investment impairment charges, the investments
were written down to their fair values, as determined by reference to
quoted market prices, where available. All available information is
evaluated in management’s quarterly analyses of whether any
declines in the fair values of individual securities are considered
other than temporary. Management concluded that the declines in
value were other than temporary principally due to the significance
and duration of the declines in value. In addition, with respect to the
$70 million of impairment charges recorded in 2002, significant
unfavorable events occurred in the period the charge was recorded,
causing management to conclude the declines in value were other
than temporary. One of the investees announced during the period
its decision to immediately commence a wind-down of operations
principally due to its unsuccessful efforts to raise capital or to effect
a business combination with another company, and the other
investee received information from regulatory entities regarding the
absence of material progress regarding one of its products under
development. At December 31, 2004,
the
the book values of
company’s investments approximated their estimated fair values.

NOTE 11

TAXES

Income Before Income Tax Expense by Category

years ended December 31 (in millions)

United States
International

2004

$ 57
373

2003

2002

$ 776
353

$ 502
884

Income from continuing

operations before income taxes
and cumulative effect of
accounting changes

$430

$1,129

$1,386

Income Tax Expense

years ended December 31 (in millions)

2004

2003

2002

Current

United States
Federal
State and local

International

$ 46
14
105

$(138)
9
243

Current income tax expense

165

114

$102
—
191

293

Deferred

United States
Federal
State and local

International

(139)
(23)
44

150
37
(79)

33
39
(5)

Deferred income tax expense

(benefit)

(118)

108

Income tax expense

$ 47

$ 222

$360

The income tax expense for continuing operations was calculated for
Baxter on a stand-alone basis (without income or loss from discontinued
operations). Included in net income tax expense in 2004 was a $25
million benefit related to tax rate changes in certain foreign jurisdictions,
which impacted the related deferred tax assets and liabilities.

Deferred Tax Assets and Liabilities

as of December 31 (in millions)

2004

2003

Deferred tax assets

Asset basis differences
Accrued expenses
Accrued retirement benefits
Alternative minimum tax credit
Tax credits and net operating losses
Valuation allowances

Total deferred tax assets

Deferred tax liabilities

Asset basis differences
Subsidiaries’ unremitted earnings
Other

Total deferred tax liabilities

76
616
137
156
688
(288)

$ —
548
125
156
429
(168)

1,385

1,090

—
9
110

119

14
9
168

191

Net deferred tax asset

$1,266

$ 899

At December 31, 2004, the company had United States operating
loss carryforwards totaling $628 million, general business tax credit
carryforwards totaling $64 million and foreign tax credit carry-
forwards totaling $48 million. Of these amounts, $41 million of the
operating loss carryforwards will expire between 2010 and 2022,
$162 million will expire in 2023 and $425 million will expire in
2024. The general business credits will begin expiring in 2011
through 2023 and the foreign tax credits will begin expiring in 2012
through 2014. At December 31, 2004, the company had foreign
net operating loss carryforwards totaling approximately $1.4 billion.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Of this amount, $3 million expires in 2005, $381 million expires in
2007, $23 million expires in 2008, $75 million expires in 2009,
$205 million expires in 2010, $373 million expires in 2011, $13
million expires after 2011 and $324 million has no expiration date.
Realization of these operating loss and tax credit carryforwards
depends on generating sufficient taxable income in future periods. A
valuation allowance of $288 million has been recorded at December
31, 2004 to reduce the deferred tax assets associated with operat-
ing loss and tax credit carryforwards, as well as amortizable assets
in loss entities, that the company does not expect to fully realize
prior to expiration.

The company will continue to evaluate the need for an additional
valuation allowance with respect to its foreign tax credits in 2005,
and there is a reasonable possibility that certain planning decisions
will lead to a requirement for an additional allowance.

Income Tax Expense Reconciliation

years ended December 31 (in millions)

2004

2003

2002

Income tax expense at United States

statutory rate

Operations subject to tax incentives
State and local taxes
Foreign tax expense (income)
IPR&D charges
Nondeductible foreign dividends
Tax settlements
Restructuring, impairment and other

special charges

Other factors

Income tax expense

$ 150
(174)
(17)
44
11
—
(55)

$ 396
(148)
8
4
—
35
(59)

$ 485
(161)
21
(3)
36
—
(8)

98
(10)

(17)
3

(2)
(8)

$ 47

$ 222

$ 360

Tax Incentives
The company has received tax incentives in Puerto Rico and certain
other taxing jurisdictions outside the United States. The financial
impact of the reductions as compared to the United States statutory
rate is indicated in the table above. The tax reductions as compared
to the local statutory rate favorably impacted earnings per diluted
share by $0.23 in 2004, $0.20 in 2003 and $0.21 in 2002. The
Puerto Rico grant provides that
the company’s manufacturing
operations will be partially exempt from local taxes until the year
2013. Appropriate taxes have been provided for these operations
assuming repatriation of all available earnings. The tax incentives in
the other jurisdictions continue until at least 2006.

Examinations of Tax Returns
United States federal
income tax returns filed by Baxter through
December 31, 2001 have been examined and closed by the Internal
Revenue Service. Favorable settlements have been reached with
respect to tax matters in certain jurisdictions at amounts less than
previously accrued. The company has ongoing audits in the United
States (federal and state) and international
jurisdictions, including
Austria, Colombia, France, Germany, Japan and Spain. In the opinion
of management, the company has made adequate tax provisions for
all years subject to examination.

The American Jobs Creation Act of 2004
In October 2004, the American Jobs Creation Act of 2004 (the
Jobs Creation Act) was enacted. The Jobs Creation Act includes
numerous provisions, including the creation of a temporary incentive
for United States multinationals to repatriate accumulated income
earned abroad. The temporary tax deduction of 85% of certain
repatriated foreign earnings is subject to a number of limitations.
Detailed final guidance necessary to implement the Jobs Creation
Act has not yet been issued by the Internal Revenue Service.
Management is analyzing the provisions of the Jobs Creation Act
and has not yet determined the effects, if any, on the company’s
plans or its consolidated financial statements. Management has not
determined when it will complete its evaluation.

No provision is made for United States income taxes on the undis-
tributed earnings of non-United States subsidiaries. These earnings
are currently deemed to be permanently invested. The United States
federal
income taxes, net of applicable credits, on the foreign
unremitted earnings of $5.01 billion, would be approximately $1.17
billion as of December 31, 2004. The foreign unremitted earnings
and United States federal
income tax amounts were $4.18 billion
and $1.02 billion, respectively, as of December 31, 2003.

NOTE 12

LEGAL PROCEEDINGS

liability,

intellectual

involving product

Baxter is named as a defendant in a number of lawsuits, claims and
property,
proceedings
environmental, commercial transactions, the Employee Retirement
Income Security Act of 1974, as amended (ERISA), securities,
pricing, employment relations, tax, regulatory and other matters (in
this discussion of legal matters, “Baxter” may refer to one or more
subsidiaries of the company). Management has assessed the like-
lihood of adverse judgments or outcomes relating to these matters.
For probable losses, management has estimated the loss or the
range of reasonably possible losses, and has established liabilities
in accordance with GAAP for certain of
these proceedings.
Management also records any insurance recoveries that are prob-
able of occurring. There is a possibility that the resolution of these
loss in excess of presently
matters could result in an additional
established liabilities. Also, there is a possibility that the resolution
of certain of the company’s legal contingencies for which there is
no liability recorded could result in a loss. Management is not able
to estimate the amount of such loss or additional loss (or range of
loss or additional loss). However, management believes that, while
such a future charge could have a material adverse impact on the
company’s net income and cash flows in the period in which it is
recorded or paid, no such charge would have a material adverse
effect on Baxter’s consolidated financial position. Baxter’s most
significant legal matters are described below.

At December 31, 2004, total legal liabilities were $168 million and
total insurance receivables were $106 million.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Product Liability

Mammary Implant Litigation
Baxter and certain other companies are named as defendants in a
number of claims and lawsuits alleging damages for personal injuries
of various types resulting from silicone mammary implants previously
manufactured by the Heyer-Schulte division of American Hospital
Supply Corporation (AHSC). AHSC, which was acquired by Baxter in
1985, divested its Heyer-Schulte division in 1984. It is not known
how many of these claims and lawsuits involve products manufac-
tured and sold by Heyer-Schulte, as opposed to other manufacturers.
In December 1998, a panel of
independent medical experts
appointed by a federal
judge announced its findings that reported
medical studies contained no clear evidence of a connection between
silicone mammary implants and traditional or atypical systemic
diseases. In June 1999, a similar conclusion was announced by a
committee of
independent medical experts from the Institute of
Medicine, an arm of the National Academy of Sciences. The majority
of the claims and lawsuits against the company have been resolved.
Certain of the proceedings are ongoing, as described below.

As of December 31, 2004, Baxter was named as a defendant or co-
defendant in 67 lawsuits relating to mammary implants, brought by
approximately 154 plaintiffs. Of those plaintiffs, ten are included
in the Lindsey class action Revised Settlement described below.
Additionally, 57 plaintiffs have opted out of the Revised Settlement,
and the status of the remaining plaintiffs with pending lawsuits is
unknown. Some of the opt-out plaintiffs filed their cases naming
multiple defendants and without product identification; thus,
it is
believed that not all of the opt-out plaintiffs will have viable claims
against the company. As of December 31, 2004, 27 of the opt-out
plaintiffs had confirmed Heyer-Schulte mammary implant product
identification. Furthermore, during 2004, Baxter obtained dismissals,
or agreements for dismissals, with respect to 76 plaintiffs.

In addition to the individual suits against the company, a class action on
behalf of all
individuals with silicone mammary implants was filed on
March 23, 1994 and is pending in the United States District Court
(U.S.D.C.) for the Northern District of Alabama involving most manu-
facturers of such implants, including Baxter as successor to AHSC
(Lindsey, et al., v. Dow Corning, et al., U.S.D.C., N. Dist. Ala., CV
94-P-11558-S). The class action was certified for settlement purposes
only by the court on September 1, 1994, and the settlement terms
were subsequently revised and approved on December 22, 1995 (the
Revised Settlement). All appeals directly challenging the Revised Settle-
ment have been dismissed. In addition to the Lindsey class action, the
company also has been named in three other purported class actions in
various state and provincial courts, only one of which is certified.

On March 31, 2000, the United States Department of Justice filed an
action in the federal district court in Birmingham, Alabama against
Baxter and other manufacturers of silicone mammary implants, as
well as the escrow agent for the Revised Settlement fund, seeking
reimbursement under various federal statutes for medical care

provided to various women with mammary implants. On September
26, 2001, the District Court granted the motion of all defendants,
to dismiss the action. The federal government
including Baxter,
appealed the dismissal and on September 15, 2003 the Eleventh
Circuit Court of Appeals reversed the order of dismissal and
remanded the case to the District Court. The defendants, including
in the United States
Baxter, filed a petition for a writ of certiorari
Supreme Court, which petition was denied in June 2004. In October
2004,
between
all defendants, including Baxter, and the Department of Justice.

the District Court

settlement

approved

Plasma-Based Therapies Litigation
Baxter currently is a defendant in a number of claims and lawsuits
brought by individuals who have hemophilia, and their families, all
seeking damages for injuries allegedly caused by anti-hemophilic
factor concentrates VIII or IX derived from human blood plasma
(factor concentrates) processed by the company from the late
1970s to the mid-1980s. The typical case or claim alleges that the
individual was infected with the HIV virus by factor concentrates,
which contained the HIV virus. None of these cases involves factor
concentrates currently processed by the company.

As of December 31, 2004, Baxter was named as a defendant in 15
lawsuits and has received notice of 145 claims in the United States,
France, Ireland, Italy, Japan and Spain. The U.S.D.C. for the Northern
District of Illinois has approved a settlement of United States federal
court factor concentrate cases. As of December 31, 2004, all 6,246
claimant groups eligible to participate in the settlement have been
paid. In addition, the company and other manufacturers have been
named as defendants in 13 lawsuits, seven of which are purported
class actions, pending in the U.S.D.C. for the Northern District of
Illinois on behalf of claimants, who are primarily non-United States
residents, seeking unspecified damages for HIV and/or Hepatitis C
infections from their use of plasma-based factor concentrates.

In addition, Immuno International AG (Immuno), acquired by Baxter in
1996, has unsettled claims and lawsuits for damages for injuries
allegedly caused by its plasma-based therapies. The typical claim
alleges that the individual with hemophilia was infected with HIV and/
or Hepatitis C by factor concentrates. Additionally, Immuno faces
multiple claims stemming from its vaccines and other biologically
derived therapies. Pursuant to the stock purchase agreement be-
tween the company and Immuno, as revised in April 1999,
approximately $20 million of the purchase price is being withheld
to cover these contingent liabilities.

Baxter is also named in a number of claims and lawsuits brought by
individuals who infused the company’s GAMMAGARD IVIG (intravenous
immunoglobulin), all of whom are seeking damages for Hepatitis C
infections allegedly caused by infusing GAMMAGARD IVIG. As of De-
cember 31, 2004, Baxter was a defendant in nine lawsuits and has
received notice of six claims in the United States, France, Denmark,
Italy, Germany and Spain. One class action in the United States has
been certified. In September 2000, the U.S.D.C. for the Central

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

District of California approved a settlement of the class action that
would provide financial compensation for United States individuals who
used GAMMAGARD IVIG between January 1993 and February 1994.

Althane Dialyzers Litigation
Baxter has been named as a defendant in a number of civil cases
seeking unspecified damages for alleged injury from exposure to
Baxter’s Althane series of dialyzers, which were withdrawn from the
market in 2001. All of these suits have been resolved, although the
possibility of additional suits being filed cannot be excluded.
Currently, there are a number of claims from Croatian citizens and
one from the Spanish Ministry of Health, although suits have not been
filed. The company previously reached settlements with a number of
families of patients who died or were injured in Spain, Croatia and the
United States allegedly after undergoing hemodialysis on an Althane
dialyzer. The United States government is investigating the matter
and Baxter has received a subpoena to provide documents. Baxter is
fully cooperating with the Department of Justice.

Vaccines Litigation
As of December 31, 2004, Baxter has been named a defendant,
along with others, in 148 lawsuits filed in various state and United
States federal courts, four of which are purported class actions,
injunctive relief and medical monitoring for
seeking damages,
claimants alleged to have contracted autism or other attention
deficit disorders as a result of exposure to vaccines for childhood
diseases containing the preservative Thimerosal. These vaccines
were formerly manufactured and sold by North American
Vaccine,
Inc., which was acquired by Baxter in June 2000, as
well as other companies. As of December 31, 2004, ten suits
have been dismissed based on the application of
the National
Vaccine Injury Compensation Act. Additional Thimerosal cases may
be filed in the future against Baxter and companies that marketed
Thimerosal-containing products.

Other
As of September 30, 1996, the date of the spin-off of Allegiance
Corporation (Allegiance) from Baxter, Allegiance assumed the defense
litigation involving claims related to Allegiance’s businesses,
of
injuries as a result of
including certain claims of alleged personal
exposure to natural rubber latex gloves. Allegiance, which merged with
Cardinal Health, Inc. in 1999, has not been named in most of this
litigation but will be defending and indemnifying Baxter pursuant to
certain contractual obligations for all expenses and potential liabilities
associated with claims pertaining to latex gloves. As of December 31,
2004, the company was named as a defendant in 21 lawsuits.

Pricing
As of December 31, 2004, Baxter and certain of its subsidiaries
were named as defendants, along with others,
in 19 lawsuits
brought in various state and United States federal courts which
allege that Baxter and other defendants reported artificially inflated
average wholesale prices for Medicare and Medicaid eligible drugs.
These cases have been brought by private parties on behalf of

various purported classes of purchasers of Medicare and Medicaid
eligible drugs, as well as by state attorneys general. As further
explained below, all but six cases were consolidated in the U.S.D.C.
for the District of Massachusetts for pretrial case management
under Multi District Litigation rules. Claimants seek unspecified
damages and declaratory and injunctive relief under various state
the con-
and/or federal statutes. After the partial dismissal of
solidated amended complaint, the plaintiffs filed an amended master
consolidated class action complaint that the defendants, including
Baxter, moved to dismiss. In February 2004, the court granted in
part and denied in part the defendants’ motion to dismiss. The law-
suits against Baxter include eight lawsuits brought by state attor-
neys general, which allege that prices for Medicare and Medicaid
eligible drugs were artificially inflated and seek unspecified dam-
ages, injunctive relief, civil penalties, disgorgement, forfeiture and
restitution. Specifically, in January 2002, the Attorney General of
Nevada filed a civil suit in the Second Judicial District Court of
Washoe County, Nevada. In February 2002, the Attorney General of
Montana filed a civil suit in the First Judicial District Court of Lewis
and Clark County, Montana. In June 2003, the U.S.D.C. for the Dis-
trict of Massachusetts remanded the Nevada case to Washoe Coun-
ty, Nevada and denied the plaintiffs’ motion to remand the Montana
case. In January 2004, the District Court remanded another case
filed in state court to the Superior Court of Maricopa County, Arizo-
na. In March 2004, the Attorney General of Pennsylvania filed a civil
suit in the Commonwealth Court of Pennsylvania. That action was
dismissed in February 2005. In March 2005, the Attorney General
of Pennsylvania filed an amended complaint. In May 2004, the Attor-
ney General of Texas filed a civil suit in the District Court of Travis
County, Texas. In June 2004, the Attorney General of Wisconsin
filed a civil suit in the Circuit Court of Dane County, Wisconsin. In
November 2004, the Attorney General of Kentucky filed a civil suit in
the Circuit Court of Franklin County, Kentucky. During the first quar-
ter of 2005, Baxter has been named as a defendant in seven addi-
tional cases, three of which have been served upon the company. In
January 2005, the Attorney General of Alabama filed a civil suit in
the Circuit Court of Montgomery County, Alabama.
In February
2005, the Attorney General of Illinois filed a civil suit in the Circuit
Court of Cook County, Illinois. Various state and federal agencies
investigations into the marketing and pricing
are conducting civil
to Medicare and
practices of Baxter and others with respect
Medicaid reimbursement. These investigations may result
in
additional cases being filed by various state attorneys general.

Securities and Other
In July 2003, Baxter received a request from the Midwest Regional
Office of the Securities and Exchange Commission (SEC) for the
voluntary production of documents and information concerning
revisions to the company’s growth and earnings forecasts for 2003
and the establishment of certain reserves. The company has also
been requested to voluntarily provide information as to the events
in connection with the restatement of
its consolidated financial
statements, which was announced on July 22, 2004. The company
is cooperating fully with the SEC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

These

consolidated

In August 2002, six purported class action lawsuits were filed in
the U.S.D.C. for the Northern District of Illinois naming Baxter and
its then Chief Executive Officer and then Chief Financial Officer as
defendants.
and
lawsuits, which were
sought recovery of unspecified damages, alleged that the defend-
ants violated the federal securities laws by making misleading
statements that allegedly caused Baxter common stock to trade at
inflated levels. In December 2002, plaintiffs filed their consolidated
amended class action complaint, which named nine additional
Baxter officers as defendants. In July 2003, the U.S.D.C. for the
Northern District of Illinois dismissed in its entirety the consolidated
amended class action complaint. In July 2004, the Seventh Circuit
Court of Appeals reversed the order of dismissal and remanded the
case to the District Court. In September 2004, the Seventh Circuit
Court of Appeals denied motions by Baxter for rehearing, rehearing
en banc and to stay the order to remand the case pending a petition
for a writ of certiorari to the United States Supreme Court.
In
December 2004, Baxter filed its petition for a writ of certiorari in the
United States Supreme Court. Plaintiffs filed a revised consolidated
amended complaint in the District Court in November 2004. Baxter
filed its motion to dismiss the complaint
in December 2004.
The District Court denied Baxter’s motion to dismiss in February
2005.

Illinois,

for the Northern District of

In July 2004, a purported class action lawsuit was filed in the
U.S.D.C.
in connection with
the previously disclosed restatement, naming Baxter and its current
Chief Executive Officer and Chief Financial Officer and their
predecessors as defendants. The lawsuit, which seeks recovery of
unspecified damages, alleges that
the defendants violated the
federal securities laws by making false and misleading statements
regarding the company’s financial results, which allegedly caused
Baxter common stock to trade at inflated levels during the period
between April 2001 and July 2004. Three similar purported class
action lawsuits were filed in the third quarter of 2004 in the
the same
U.S.D.C.
defendants. These cases have been consolidated before a single
judge. In October 2004, a solitary plaintiff filed a purported class
action against Baxter in the Circuit Court of Cook County, Illinois
federal securities law through Baxter’s
alleging a breach of
secondary offering of common stock in September 2003. The
plaintiff alleges that the offering price of these shares was artificially
inflated by virtue of the financial statements that the company filed
prior to and concurrent with the offering, which the company later
amended in connection with the restatement, and seeks unspecified
damages. Baxter has removed this case to the U.S.D.C. for the
Northern District of Illinois and it has also been consolidated with the
other federal cases. In January 2005, plaintiffs filed a consolidated
amended complaint in the District Court. In February 2005, Baxter
filed its motion to dismiss.

Illinois against

The company believes that it may be subject to additional class action
in connection with the
litigation and regulatory proceedings
events preceding the restatement announced in the third quarter of
2004.

In October 2004, a sole plaintiff filed a purported class action in
the U.S.D.C. for the Northern District of Illinois against Baxter and
its current Chief Executive Officer and Chief Financial Officer and
their predecessors for alleged violations of ERISA. The plaintiff
alleges that these defendants, along with the Administrative and
Investment Committees of the company’s Incentive Investment Plan
and Puerto Rico Savings and Investment Plan (the Plans), which are
the company’s 401(k) plans, breached their fiduciary duties to the
Plans’ participants by offering Baxter common stock as an
investment option in each of
these Plans during the period of
January 2001 to October 2004. Plaintiff alleges that Baxter
common stock traded at artificially inflated prices during this period
and seeks unspecified damages and declaratory and equitable
relief. The plaintiff seeks to represent a class of
the Plans’
participants who elected to acquire Baxter common stock through
the Plans between January 2001 and the present.

In August and September 2004,
three plaintiffs filed separate
derivative lawsuits in the Circuit Court of Cook County, Illinois against
the company’s Chief Executive Officer and Chief Financial Officer
and certain other current and former officers and directors of the
company. These actions, which plaintiffs purport to bring on the
company’s behalf, seek unspecified damages for alleged breaches of
fiduciary duty in connection with the company’s disclosures of its
financial results between April 2001 and July 2004. These three
cases have been consolidated before one judge in the state court.

In April 2003, A. Nattermann & Cie GmbH and Aventis Behring L.L.C.
filed a patent infringement lawsuit in the U.S.D.C. for the District of
Delaware naming Baxter Healthcare Corporation as the defendant.
In November 2003,
the plaintiffs dismissed the lawsuit without
prejudice. The complaint, which sought injunctive relief, alleged that
Baxter’s planned manufacture and sale of ADVATE would infringe
United States Patent No. 5,565,427. A reexamination of the patent is
pending before the United States Patent and Trademark Office.

NOTE 13

SEGMENT INFORMATION

Baxter operates in three segments, each of which is a strategic
business that is managed separately because each business develops,
manufactures and sells distinct products and services. The segments
and a description of their products and services are as follows:
intravenous
Medication Delivery, which provides a range of
solutions and specialty products that are used in combination
for fluid replenishment, general anesthesia, nutrition therapy, pain
management, antibiotic therapy and chemotherapy; BioScience,
which develops biopharmaceuticals, biosurgery products, vaccines and
blood collection, processing and storage products and technologies
for transfusion therapies; and Renal, which develops products and
provides services to treat end-stage kidney disease.

Management uses more than one measurement and multiple views
of data to measure segment performance and to allocate resources
to the segments. However, the dominant measurements are con-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

sistent with the company’s consolidated financial statements and,
accordingly, are reported on the same basis herein. Management
evaluates the performance of its segments and allocates resources
to them primarily based on pre-tax income along with cash flows
and overall economic returns.
Intersegment sales are generally
accounted for at amounts comparable to sales to unaffiliated cus-
tomers, and are eliminated in consolidation. The accounting policies
of the segments are substantially the same as those described in
the summary of significant accounting policies in Note 1.

Certain items are maintained at the corporate level
(Corporate)
and are not allocated to the segments. They primarily include
most of the company’s debt and cash and equivalents and related
net interest expense, corporate headquarters costs, certain non-
strategic investments and related income and expense, certain
nonrecurring gains and losses, certain special charges (such
as IPR&D, restructuring, and certain asset impairments), deferred
income taxes, certain foreign currency
fluctuations, certain
employee benefit costs, the majority of the foreign currency and
interest rate hedging activities, and certain litigation liabilities and
related insurance receivables. With respect to depreciation and
amortization, and expenditures for long-lived assets, the difference
between the segment totals and the consolidated totals principally
relate to assets maintained at Corporate.

Segment Information

Medication

(in millions)

Delivery BioScience

Renal

Other

Total

$4,047 $3,504 $1,958 $

— $ 9,509

Pre-Tax Income Reconciliation

years ended December 31 (in millions)

2004

2003

2002

Total pre-tax income from segments

$1,823 $1,756 $1,587

Unallocated amounts

IPR&D
Restructuring charges
Net interest expense
Foreign exchange fluctuations

—
(543)
(99)

—
(337)
(87)

(163)
(26)
(51)

and hedging activities

(103)

(89)

Asset dispositions and
impairments, net
Costs relating to early

extinguishment of debt

Other Corporate items

Consolidated income from continuing
operations before income taxes
and cumulative effect of accounting
changes

Assets Reconciliation

(357)

(34)

(47)

—
(291)

(11)
(69)

—
(6)

$ 430 $1,129 $1,386

as of December 31 (in millions)

2004

2003

Total segment assets

Cash and equivalents
Deferred income taxes
Insurance receivables
PP&E, net
Other Corporate assets

$10,793
1,109
1,163
106
230
746

$10,765
925
896
131
349
641

209

184

116

601

Consolidated total assets

$14,147

$13,707

751

711
4,421 4,557 1,815

361 (1,393)

430
3,354 14,147

expenditures

236

169

122

558

Geographic Information
Net sales are based on product shipment destination and long-lived
assets are based on physical location.

years ended December 31 (in millions)

2004

2003

2002

$ 3,827 $ 3,269 $ 1,808 $

— $ 8,904

204

150

547

721
4,119

719
4,995

316
1,651

(627)
2,942

1,129
13,707

Net sales
United States
Germany
United Kingdom
Japan
Other countries

$4,460
510
482
416
3,641

$ 4,279
509
399
403
3,314

$3,974
422
356
388
2,959

expenditures

264

337

149

792

Consolidated net sales

$9,509

$ 8,904

$8,099

$ 3,311 $ 3,096 $ 1,692 $

— $ 8,099

as of December 31 (in millions)

2004

2003

168

128

440

593
3,617

658
4,370

336
1,270

(201)
3,171

1,386
12,428

PP&E, net
United States
Austria
Other countries

Consolidated PP&E, net

$2,145
517
1,707

$2,269
569
1,754

$4,369

$4,592

expenditures

229

382

137

104

852

2004
Net sales
Depreciation and
amortization
Pre-tax income

(loss)
Assets
Capital

2003
Net sales
Depreciation and
amortization
Pre-tax income

(loss)
Assets
Capital

2002
Net sales
Depreciation and
amortization
Pre-tax income

(loss)
Assets
Capital

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Significant Product Sales
The following is a summary of net sales as a percentage of consolidated net sales for the company’s principal product lines.

years ended December 31

Recombinants
Plasma Proteins1
Peritoneal Dialysis Therapies
IV Therapies2

2004

14%
11%
15%
12%

2003

13%
11%
15%
12%

2002

12%
12%
16%
12%

1 Includes plasma-derived hemophilia (FVII, FVIII, FIX and FEIBA), albumin, biosurgery (Tisseel) and other plasma-based products. Excludes antibody therapies.
2 Principally includes intravenous solutions and nutritional products.

Significant Relationship
Sales by various Baxter businesses to members of a large hospital buying group, Premier Purchasing Partners L.P. (Premier), pursuant to
various contracts within Premier, represented approximately 7.7%, 8.4% and 8.9% of the company’s net sales in 2004, 2003 and 2002,
respectively. The company has a number of contracts with Premier that are independently negotiated and expire on various dates. These
agreements allow the members of the Premier group, which change over time, to purchase from the suppliers of their choice. Baxter’s
sales could be adversely affected if any of its contracts with Premier are terminated in part or in their entirety, or members decide to
purchase from another supplier.

NOTE 14

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

years ended December 31 (in millions, except per share data)

2004
Net sales
Gross profit
Income (loss) from continuing operations1
Net income (loss)1
Per common share

Income (loss) from continuing operations1

Basic
Diluted

Net income (loss)1

Basic
Diluted

Dividends declared
Market price

High
Low

2003
Net sales
Gross profit
Income from continuing operations before cumulative effect of accounting changes2
Net income2
Per common share

Income from continuing operations before cumulative effect of accounting changes2

Basic
Diluted
Net income2
Basic
Diluted

Dividends declared
Market price

High
Low

First

quarter

Second

quarter

Third

quarter

Fourth

quarter

Total year

$2,209 $2,379 $2,320 $2,601 $9,509
3,915
383
388

1,120
106
106

939
(169)
(170)

963
259
276

893
187
176

0.31
0.30

0.29
0.28
—

(0.28)
(0.28)

(0.28)
(0.28)
—

0.42
0.42

0.17
0.17

0.62
0.62

0.45
0.45

0.17
0.17
— 0.582

0.63
0.63
0.582

31.74
28.76

34.51
30.45

33.95
29.54

34.59
29.68

34.59
28.76

$ 1,995 $ 2,162 $ 2,216 $ 2,531 $ 8,904
3,953
907
866

1,135
371
364

878
215
214

969
275
253

971
46
35

0.36
0.36

0.36
0.35
—

0.08
0.08

0.06
0.06
—

0.47
0.46

0.61
0.60

0.43
0.42

0.60
0.59
— 0.582

31.20
18.64

26.45
18.56

30.66
23.99

31.10
26.44

1.51
1.50

1.44
1.43
0.582

31.20
18.56

1 As further discussed in Note 4, the second quarter of 2004 includes a $543 million pre-tax restructuring charge and a $115 million pre-tax special charge, and the

fourth quarter of 2004 includes a $289 million pre-tax asset impairment charge.

2 The first quarter of 2003 includes a $13 million pre-tax investment impairment charge. The second quarter of 2003 includes a $337 million pre-tax restructuring
charge and an $11 million pre-tax expense relating to the early extinguishment of debt. The fourth quarter of 2003 includes $42 million in pre-tax gains relating to
asset divestitures and $21 million of pre-tax investment impairment charges.

Baxter common stock is listed on the New York, Chicago, Pacific and SWX Swiss stock exchanges. The New York Stock Exchange is the principal
market on which the company’s common stock is traded. At February 28, 2005, there were approximately 60,889 holders of record of the
company’s common stock. The equity units discussed in Note 5 are also listed on the New York Stock Exchange under the symbol “BAX Pr.”

Board of Directors

Executive Officers

Corporate Officers

DIRECTORS AND OFFICERS

Walter E. Boomer
Retired Chairman and Chief Executive Officer
Rogers Corporation

Joy A. Amundson
Corporate Vice President
President, BioScience

Blake E. Devitt
Former Senior Audit Partner and Director,
Pharmaceutical and Medical Device
Industry Practice
Ernst & Young LLP

John D. Forsyth
Chairman and Chief Executive Officer
Wellmark Blue Cross Blue Shield

Gail D. Fosler
Executive Vice President and
Chief Economist
The Conference Board

James R. Gavin III, M.D., Ph.D.
Immediate Past President
Morehouse School of Medicine

Joseph B. Martin, M.D., Ph.D.
Dean of the Faculty of Medicine
Harvard Medical School

Robert L. Parkinson, Jr.
Chairman of the Board, Chief Executive Officer
and President
Baxter International Inc.

Carole Uhrich Shapazian
Former Executive Vice President
Maytag Corporation

Thomas T. Stallkamp
Industrial Partner
Ripplewood Holdings L.L.C.

Kees J. Storm
Former Chairman of the Executive Board
AEGON N.V. (The Netherlands)

Albert P.L. Stroucken
Chairman, President and Chief Executive Officer
H.B. Fuller Company

Fred L. Turner
Former Senior Chairman
McDonald’s Corporation

Carlos del Salto
Corporate Vice President
President, Intercontinental/Asia

David F. Drohan
Corporate Vice President
President, Medication Delivery

J. Michael Gatling
Corporate Vice President
Global Manufacturing Operations

Lawrence T. Gibbons
Corporate Vice President
Quality
John J. Greisch
Corporate Vice President
Chief Financial Officer

Karen J. May
Corporate Vice President
Human Resources

Bruce McGillivray
Corporate Vice President
President, Renal

Robert L. Parkinson, Jr.
Chairman of the Board, Chief Executive
Officer and President

Marla S. Persky
Acting General Counsel and
Acting Corporate Secretary

Norbert G. Riedel, Ph.D.
Corporate Vice President
Chief Scientific Officer

James E. Utts
Corporate Vice President
President, Europe

Robert M. Davis
Corporate Vice President
Treasurer

J. Robert Hurley
Corporate Vice President

John C. Moon
Corporate Vice President
Chief Information Officer

Honorary Director
William B. Graham
Chairman Emeritus of the Board
Baxter International Inc.