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

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Baxter International Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The unaudited interim condensed consolidated financial statements of Baxter International Inc. and its subsidiaries (the company or Baxter) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the company’s Form 10-K/A for the year ended December 31, 2003.

In the opinion of management, the interim condensed consolidated financial statements reflect all adjustments necessary for a fair presentation of the interim periods. All such adjustments, unless otherwise noted herein, are of a normal, recurring nature (refer to Note 2 for certain special charges recorded during the second quarter of 2004). The results of operations for the interim period are not necessarily indicative of the results of operations to be expected for the full year.

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

Stock compensation plans

The company has a number of stock-based employee compensation plans, including stock option, stock purchase and restricted stock plans. The company applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for these plans. In accordance with this intrinsic value method, no compensation expense is recognized for the company’s fixed stock options that have an exercise price equal to or greater than the market price on the date of grant, and employee stock purchase subscriptions. The following table illustrates the effect on net income and earnings per share (EPS) if the company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of FASB Statement No. 123,” to all stock-based employee compensation.

Changes in accounting principles

Financial Accounting Standards Board (FASB) Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46), was adopted July 1, 2003. Refer to the company’s 2003 Form 10-K/A for further information. In December 2003 the FASB revised and reissued FIN 46 (FIN 46-R). The provisions of FIN 46-R were required to be adopted no later than March 31, 2004. Baxter adopted FIN 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.

1A. RESTATEMENT OF PREVIOUSLY ISSUED CONSOLIDATED FINANCIAL STATEMENTS

The company has restated its previously issued financial statements for 2001 through 2003 and the first three quarters of 2004 as a result of inadequate reconciliations, leading to classification errors in tax and other related balance sheet accounts. Specifically, the company restated previously issued financial information contained in its Form 10-K/A Amendment No. 1 for the years ended December 31, 2003, 2002 and 2001 by filing a Form 10-K/A Amendment No. 2 for the year ended December 31, 2003. The company’s previously reported quarterly information in its Form 10-Q/A Amendment No. 1 for the quarter ended March 31, 2004 has been restated by filing a Form 10-Q/A Amendment No. 2 for the quarter ended March 31, 2004. The company’s previously reported quarterly information in its Forms 10-Q for the quarters ended June 30, 2004 and September 30, 2004 has been restated by filing a Form 10-Q/A Amendment No. 1 for each of the quarters ended June 30, 2004 and September 30, 2004.

As a result of the restatement, stockholders’ equity as of both September 30, 2004 and December 31, 2003 increased approximately $108 million, with offsetting decreases of approximately $157 to net tax liabilities and $49 million to goodwill. The restatement did not impact the consolidated statements of income or cash flows for the quarters or year-to-date periods ended September 30, 2004 and 2003.

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The following is a summary of the impact of the restatement on the previously filed consolidated balance sheets at September 30, 2004 and December 31, 2003.

Consolidated Balance Sheets at September 30, 2004 and December 31, 2003

2. SUPPLEMENTAL FINANCIAL INFORMATION

Net interest expense

Net interest expense consisted of the following.

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Other income and expense

Other income and expense typically includes amounts relating to fluctuations in currency exchange rates, minority interests, income and losses relating to equity method investments, divestiture gains and asset impairment charges.

The increase in other expense for the three months ended September 30, 2004 principally related to foreign currency fluctuations. The increase in other expense for the nine months ended September 30, 2004 principally related to foreign currency fluctuations and lower equity method income. Equity method income was lower in 2004 because Baxter divested its equity method investment in Acambis, Inc. in late 2003.

In addition, asset impairment charges totaled $18 million and $13 million for the nine-month periods ended September 30, 2004 and 2003, respectively. The charges related to investments whose declines in value were deemed to be other than temporary, with the investments written down to estimated fair value, as determined by reference to quoted market values, where available (see below for more information regarding the second quarter 2004 special charge). Other expense for the year-to-date period ended September 30, 2004 also included a charge relating to the application of FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45), to the company’s guarantee of the Shared Investment Plan loans, as further discussed in Note 9. Included in other expense in the year-to-date period ended September 30, 2003 were $11 million in costs associated with the redemption of the company’s convertible bonds.

Comprehensive income

Total comprehensive income was $352 million and $306 million for the three and nine months ended September 30, 2004, respectively, and $257 million and $539 million for the three and nine months ended September 30, 2003, respectively. The increase in comprehensive income during the quarter was principally related to favorable currency translation adjustments and higher net income. The decrease in comprehensive income during the year-to-date period was principally related to unfavorable currency translation adjustments and lower net income, partially offset by changes in the value of the company’s net investment and foreign currency cash flow hedges.

Earnings per share

The numerator for both basic and diluted EPS is net earnings available to common shareholders. 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 units is reflected in the denominator for diluted EPS by application of the treasury stock method under SFAS No. 128, “Earnings per Share.” Prior to the adoption of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” on July 1, 2003, the dilutive effect of equity forward agreements was reflected in the denominator for diluted EPS by application of the reverse treasury stock method. Refer to the 2003 Form 10-K/A for additional information regarding the company’s equity units (which did not have a dilutive effect in either 2004 or 2003), as well as the equity forward agreements (which were terminated during the third quarter of 2003). The following is a reconciliation of the shares (denominator) of the basic and diluted per-share computations.

Inventories

Inventories consisted of the following.

Goodwill

Goodwill was $871$859 million $602(as restated), $568 million (as restated) and $167$164 million (as restated) for the Medication Delivery, BioScience and Renal segments, respectively, at September 30, 2004. Goodwill was $872$860 million $605(as restated), $571 million (as restated) and $171$168 million (as restated) for the Medication Delivery, BioScience and Renal segments, respectively, at December 31, 2003. The change in the goodwill balance for each segment principally related to fluctuations in currency exchange rates.

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Other intangible assets

The following is a summary of the company’s intangible assets subject to amortization at September 30, 2004 and December 31, 2003. Intangible assets with indefinite useful lives are not material to the company.

The amortization expense for these intangible assets was $16 million and $11 million for the three months ended September 30, 2004 and 2003, respectively, and $48 million and $38 million for the nine months ended September 30, 2004 and 2003, respectively. At September 30, 2004, the anticipated annual amortization expense for these intangible assets is $67 million, $60 million, $56 million, $45 million, $41 million and $39 million in 2004, 2005, 2006, 2007, 2008 and 2009, respectively.

Product warranties

The following is a summary of activity in the product warranty liability.

Second quarter 2004 special charges

Financial results for the nine-month period ended September 30, 2004 include several special charges recorded during the second quarter, in addition to the restructuring charge discussed in Note 4. These special charges, as summarized below, reduced pre-tax income from continuing

operations by $115 million, and reduced net income for the nine months ended September 30, 2004 by $20 million or $0.03 per diluted share. By line item, cost of goods sold increased $45 million, marketing and administrative expenses increased $55 million, other expense, net 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). This reserve was determined based on Cerus’ current financial position. 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 9 for further information regarding the Shared Investment Plan. While the company has not forgiven any of these loans and is pursuing repayment of the defaulted amounts, a reserve was recorded for potential losses, representing the amount that 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.

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.

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Hedges

As discussed in the 2003 Form 10-K/A, the company uses forwards 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 European sales launch of ADVATE (Antihemophilic Factor (Recombinant), Plasma/Albumin-Free Method) rAHF-PFM, the 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 had been 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.

Pathogen Inactivation program assets

As a result of lower than expected sales from the company’s Pathogen 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.

3. DISCONTINUED OPERATIONS

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. Refer to the 2003 Form 10-K/A for further information.

During 2003, the company sold RMS Lifeline, Inc. and RMS Disease Management, Inc. and the Medication Delivery segment’s offsite pharmacy admixture products and services business, and closed or had under contract the majority of transactions in connection with the divestiture of the Renal Therapy Services centers. Management expects the divestiture plan to be completed during 2004.

Net revenues relating to the discontinued businesses were $2 million and $42 million for the three months ended September 30, 2004 and 2003, respectively, and $22 million and $142 million for the nine months ended September 30, 2004 and 2003, respectively. During 2004, discontinued operations generated income of $17 million and $5 million for the three- and nine-month periods ended September 30, respectively (net of tax benefits of $24 million and $28 million, respectively). The income was principally related to tax and other adjustments, as the company completes divestitures. During 2003, discontinued operations generated losses of $5 million and $17 million for the three- and nine-month periods ended September 30, respectively (net of tax benefits of $3 million and $6 million, respectively).

Included in the pre-tax charge was $269 million pertaining to asset impairments, principally relating to goodwill and property and equipment. Also included in the 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. Approximately $2 million of the reserve for cash costs was utilized during 2004. The remaining reserve is insignificant and is expected to be substantially utilized in 2004.

4. RESTRUCTURING INITIATIVES

Second quarter 2004 restructuring charge

In January 2004, management announced plans (which were finalized during the second quarter of 2004) to implement restructuring initiatives (in addition to the actions initiated in 2003, as discussed below). Management undertook these actions in order to reduce the company’s overall cost structure and to drive sustainable improvements in financial performance.

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 and closing additional plasma collection centers. In addition, the company is exiting certain other facilities and activities. As a result, management recorded a restructuring charge in the second quarter of 2004 totaling $543 million ($394 million, or $0.64 per diluted share, on an after-tax basis), principally for severance and costs associated with the closing of facilities and the exiting of contracts.

Included in the 2004 pre-tax charge was $196 million relating to asset impairments, almost all of which was to write down property, plant and equipment (PP&E), based on market data for the assets. Also included in the 2004 pre-tax charge was $347 million for cash costs, principally pertaining to severance and other employee-related costs. Approximately one third of the targeted positions have been eliminated as of September 30, 2004.

Second quarter 2003 restructuring charge

During the second quarter of 2003, the company recorded a $337 million restructuring charge ($202 million, or $0.33 per diluted share, on an after-tax basis) principally associated with management’s decision to close certain facilities and reduce headcount on a global basis. Management decided to take these actions in order to position the company more competitively and to enhance profitability. The company has closed 26 plasma collection centers across the United States, as well as a plasma fractionation facility located in Rochester, Michigan. In addition, the company has 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 charge were costs related to other reductions in the company’s workforce.

Included in the 2003 pre-tax charge was $128 million relating to asset impairments, principally to write down PP&E, and 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 pre-tax 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 September 30, 2004, and the program is substantially complete, except for remaining severance and other cash payments to be made in the future.

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Restructuring reserves

The following summarizes activity in the company’s restructuring reserves for cash costs for the nine-month period ended September 30, 2004.

With respect to the 2003 restructuring charge, the majority of the severance and other costs are expected to be paid in 2004. With respect to the 2004 restructuring charge, approximately $50 million is expected to be paid during the remainder of 2004, approximately $150 million in 2005, and the remainder in 2006.

5. SECURITIZATIONS

Where economical, the company has entered into agreements with various financial institutions in which undivided interest in certain pools of receivables are sold. Refer to the 2003 Form 10-K/A for further information regarding these arrangements. There have been no material changes in the company’s accounting policies with respect to its securitization arrangements. The key assumptions used in measuring the fair values of the retained interests are substantially unchanged from those disclosed in the 2003 Form 10-K/A.

Baxter’s securitization arrangements resulted in net cash outflows of $84 million and $274 million for the three and nine months ended September 30, 2004, respectively, and generated net cash inflows of $10 million and net cash outflows of $44 million for the three and nine months ended September 30, 2003, respectively.

A summary of the activity for these securitization arrangements is as follows.

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6. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS

Net pension and other postretirement benefits cost

The following is a summary of net expense relating to the company’s pension and other postretirement benefit plans.