UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2004March 31, 2005

For the transition period from                    to                    

Commission file number 1-4448

BAXTER INTERNATIONAL INC.

(Exact name of registrant as specified in its charter)

847-948-2000(847) 948-2000

(Registrant’s telephone number,

including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yesx    No¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yesx    No¨

The number of shares of the registrant’s Common Stock, par value $1.00 per share,

outstanding as of October 31, 2004April 29, 2005 was 616,448,448620,729,469 shares.

BAXTER INTERNATIONAL INC.

FORM 10-Q

For the quarterly period ended September 30, 2004March 31, 2005

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Baxter International Inc. and Subsidiaries

Condensed Consolidated Statements of Income (unaudited)

(in millions, except per share data)

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

Baxter International Inc. and Subsidiaries

Condensed Consolidated Balance Sheets (unaudited)

(in millions, except shares)

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

Baxter International Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (unaudited)

(in millions)

(brackets denote cash outflows)

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

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.Commission (SEC). Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (GAAP) 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, 2003.2004 Annual Report to Stockholders (2004 Annual Report).

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).nature. 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 20032004 financial statements and notes to the 20042005 presentation.

Stock compensation plans

The company has a number of stock-based employee compensation plans, including stock option, stock purchase, restricted stock and restricted stock unit plans. The company appliesmeasures stock-based compensation expense using 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 of accounting. Generally, 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 option and purchase subscriptions.plans. Expense is recognized relating to restricted stock and restricted stock unit grants and certain modifications to stock options.

Under the fair value method, expense would be recognized for the company’s employee stock option and purchase plans. The following table illustrates the effect onshows net income and earnings per share (EPS) ifhad the company had applied the fair value recognition provisionsmethod of Statement of Financial Accounting Standards (SFAS) No. 123, “Accountingaccounting 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.

		Three months ended September 30,						Nine months ended September 30,
(in millions, except per share data)		2004		2003				2004		2003
Net income, as reported		$276		$253				$282		$502
Add:
Stock-based employee compensation expense included in reported net income, net of tax		1		1				13		1
Deduct:
Total stock-based employee compensation expense determined under the fair value method, net of tax		(19)		(35)				(79)		(120)
Pro forma net income		$258		$219				$216		$383
Earnings per basic share
As reported		$0.45		$0.43				$0.46		$0.85
Pro forma		$0.42		$0.38				$0.35		$0.65
Earnings per diluted share
As reported		$0.45		$0.42				$0.46		$0.83
Pro forma		$0.42		$0.37				$0.35		$0.64

Changes inNew accounting principlesstandard

In December 2004, the 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)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 standard was to become effective July 1, 2005. In April 2005, the SEC amended Regulation S-X to provide a six-month adoption deferral period for public companies. Therefore, FASB No. 123-R will not become effective until January 1, 2006. The new rules provide for one of two transition elections, either prospective application or restatement (back to January 1, 1995). The company plans to adopt FASB No. 123-R on January 1, 2006 and has not yet decided which transition option the company will use. Management is in the process of analyzing 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,FASB No. 123-R and adoption ofassessing the revised standard did not have a material impact on the company’s future consolidated financial statements. The pro forma effect of expensing employee stock options and similar awards under existing rules is presented above.

2. SUPPLEMENTAL FINANCIAL INFORMATION

Net pension and other postemployment benefits expense

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

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 for determining whether plans are actuarially equivalent to Medicare (Part D) were issued in January 2005. Based on these final regulations, management expects the company’s OPEB plan to be actuarially equivalent to Medicare (Part D), and that the company will be eligible for the federal subsidy. In accordance with GAAP, the estimated reduction in the accumulated OPEB obligation due to the federal subsidy will be reflected as an actuarial gain. The actuarial

gain will be amortized, reducing OPEB plan expense in the future. The effect on the company’s consolidated financial statements is not expected to be material.

Net interest expense

Net interest expense consisted of the following.

Other income and expense, net

Other income and expense typicallyprincipally includes amounts relating to fluctuations in currencyforeign exchange, rates, minority interests, income and losses relating to equity method investments, and 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.losses.

Comprehensive income

Total comprehensive income was $352 million and $306$247 million for the three and nine months ended September 30, 2004, respectively,March 31, 2005 and $257 million and $539$191 million for the three and nine months ended September 30, 2003, respectively.March 31, 2004. The increase in comprehensive income during the quarter was2005 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 lowerincreased net income partially offset by changesand favorable movements in the value of the company’s net investment and foreignhedges, partially offset by unfavorable currency cash flow hedges.translation adjustments.

Earnings per share

The numerator for both basic and diluted EPS is net earnings available to common shareholders.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 unitsother common stock equivalents is reflected in the denominator for diluted EPS by application ofusing 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 thebasic shares (denominator) of the basic andto diluted per-share computations.shares.

		Three months ended September 30,				Nine months ended September 30,
(in millions)		2004		2003		2004		2003
Basic shares		615		589		613		595
Effect of dilutive securities
Employee stock options		3		1		3		1
Equity forward agreements		—		—		—		7
Employee stock purchase plans		1		2		1		1
Diluted shares		619		592		617		604

Inventories

Inventories consisted of the following.

Goodwill

Goodwill was $871$895 million, $602$578 million and $167$144 million for the Medication Delivery, BioScience and Renal segments, respectively, at September 30, 2004.March 31, 2005. Goodwill was $872$895 million, $605$583 million and $171$170 million for the Medication Delivery, BioScience and Renal segments, respectively, at December 31, 2003.2004. The change in the goodwill balance for each segment principally related to foreign currency fluctuations and a divestiture in currency exchange rates.

Other intangible assets

The following is a summary of the company’s intangible assets subject to amortization at September 30, 2004March 31, 2005 and December 31, 2003.2004. Intangible assets with indefinite useful lives are not material to the company.material.

The amortization expense for these intangible assets was $16 million and $11$14 million for the three months ended September 30, 2004March 31, 2005 and 2003, respectively, and $48 million and $38$16 million for the ninethree months ended September 30, 2004 and 2003, respectively.March 31, 2004. At September 30, 2004,March 31, 2005, the anticipated annual amortization expense for these intangible assets is $67 million, $60 million, $56 million, $45$54 million, $46 million, $41 million, $40 million and $39 million in 2004, 2005, 2006, 2007, 2008, 2009 and 2009,2010, 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 reservesSecuritization arrangements

The company establishedcompany’s securitization arrangements resulted in net cash outflows of $52 million for the three months ended March 31, 2005 and $43 million for the three months ended March 31, 2004. A summary of the activity is as follows.

The American Jobs Creation Act of 2004

In October 2004, the American Jobs Creation Act of 2004 (the Jobs Creation Act) was enacted. The Act includes numerous provisions, including the creation of a reserve duetemporary 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 expects to complete its evaluation by the end of the third quarter of 2005. Refer 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 9Annual Report 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.information.

3. RESTRUCTURING INITIATIVES

Inventories2004 Restructuring Charge

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 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 inDuring 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$543 million pre-taxrestructuring 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. The charge was primarily for severance and costs associated with the closing of facilities (including the closure of additional plasma collection centers) 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 quartersthree-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 thirdthree-quarters of the targeted positions have been eliminated as of September 30, 2004.March 31, 2005.

Second quarter 2003 restructuring chargeRestructuring 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 takeundertook 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 asand a plasma fractionation facility located in Rochester, Michigan.facility. In addition, the company has consolidated and integrated several facilities, including facilities in Maryland; Frankfurt, Germany; Issoire, France; and Mirandola, Italy.facilities. 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,March 31, 2005, and the program is substantially complete, except for remaining severance and other cash payments to be made in the future.

Restructuring reservesReserves

The following summarizes activity in the company’s restructuring reserves for cash costs for the nine-month period ended September 30, 2004.through March 31, 2005.

With respect to the 2003 restructuring charge, the majority of the severance and other costs areremaining reserve is expected to be paid in 2004.utilized during 2005. With respect to the 2004 restructuring charge, approximately $50$150 million of the reserve is expected to be paidutilized during full-year 2005, with the remainder of 2004, approximately $150 million in 2005, and the remainderto be utilized 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.

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.

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). Detailed final regulations necessary to implement the Act have not yet been issued. The effects of the Act are not recognized in the company’s net expense and benefit 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 has determined that any impact of the Act on the company’s consolidated financial statements will not be material.

7.4. LEGAL PROCEEDINGS COMMITMENTS AND CONTINGENCIES

Refer to “Part II –- Item 1. Legal Proceedings” below.

8.5. SEGMENT INFORMATION

The company operates in three segments, each of which areis a strategic businessesbusiness that areis managed separately because each business develops, manufactures and sells distinct products and services. The segments and a description of their businessesproducts and services are as follows:

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 antibiotic therapy;chemotherapy;BioScience, which develops biopharmaceuticals, biosurgery products, vaccines and blood collection, processing and storage products and technologies for transfusion therapies; andRenal, which develops products and provides services to treat end-stage kidney disease.

Certain items are maintained at the corporate headquarterslevel (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 in-process research and development, restructuring and restructuring)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.

Financial information for the company’s segments for the quarter and year-to-date periodquarters ended September 30March 31 is as follows.

The following is a reconciliation of segment pre-tax income to income from continuing operations before income taxesto the totals per the consolidated income statements.