** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D. C.  20549**

 

**FORM10-Q**

 
| **(Mark One)**                                                                                                                                                                             |       |                                                                                           |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                       |       |                                                                                           |
| ý                                                                                                                                                                                     | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|                                                                                                                                                                                       |       |                                                                                           |
| **For the  quarterly period ended September 30, 2005**                                                                                                                                     |
|                                                                                                                                                                                       |       |                                                                                           |
| **OR**                                                                                                                                                                                     |
|                                                                                                                                                                                       |       |                                                                                           |
| o                                                                                                                                                                                          | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                       |       |                                                                                           |
| **For the  transition period from               to              ** |
|                                                                                                                                                                                       |       |                                                                                           |
| **Commission  File No. 1-31946**                                                                                                                                                           |

 

**HOSPIRA, INC.**

 
| **A Delaware corporation** |   |   |   | I.R.S. Employer Identification |
|----------------------------|--------|--------|--------|--------------------------------|
|                       |   |   |   | No. **20-0504497**             |

 

**275 N. Field DriveLake Forest, Illinois 60045**

 

Telephone:**  (224) 212-2000**

 

Indicate by check mark whetherthe registrant (l) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of l934 during the preceding l2 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90days.     Yes  ý.  No o.

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).    Yes  o.No  ý.

 

Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct).     Yes  o.No  ý.

 

As of October 31, 2005,Hospira, Inc. had outstanding 160,852,753 common shares, par value $0.01 pershare.

 

 

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Table ofContents

 

**Hospira,Inc.**

 

**QuarterlyReport on Form 10-Q**

 

**Index**

 

 
|    | **Part I – Financial Information**                                                                                                |   |
|---------|----------------------------------------------------------------------------------------------------------------------------------------|--------|
|    |                                                                                                                                   |   |
| Item 1. | Financial Statements                                                                                                                   |   |
|    |                                                                                                                                   |   |
|    | Condensed Consolidated  Statements of Income (Unaudited) – Three and Nine Months Ended September 30,  2005 and September 30, 2004 | 3      |
|    |                                                                                                                                   |   |
|    | Condensed Consolidated  Statements of Cash Flows (Unaudited) – Nine Months Ended September 30, 2005  and September 30, 2004       | 4      |
|    |                                                                                                                                   |   |
|    | Condensed Consolidated  Balance Sheets (Unaudited) – September 30, 2005 and December 31, 2004                                     | 5      |
|    |                                                                                                                                   |   |
|    | Condensed Consolidated  Statement of Changes in Shareholders’ Equity (Unaudited) – Nine Months Ended  September 30, 2005     | 6      |
|    |                                                                                                                                   |   |
|    | Notes to Condensed  Consolidated Financial Statements (Unaudited)                                                                      | 7      |
|    |                                                                                                                                   |   |
| Item 2. | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                            | 16     |
|    |                                                                                                                                   |   |
| Item 3. | Quantitative and Qualitative  Disclosures about Market Risk                                                                            | 25     |
|    |                                                                                                                                   |   |
| Item 4. | Controls and Procedures                                                                                                                | 25     |
|    |                                                                                                                                   |   |
|    | **Part II – Other Information**                                                                                                   |   |
|    |                                                                                                                                   |   |
| Item 1. | Legal Proceedings                                                                                                                      | 26     |
|    |                                                                                                                                   |   |
| Item 2. | Changes in Securities  and Use of Proceeds                                                                                             | 27     |
|    |                                                                                                                                   |   |
| Item 6. | Exhibits                                                                                                                               | 27     |

 

2

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**PART I.  FINANCIAL INFORMATION**

 

**Item 1.  FinancialStatements**

 

**Hospira,Inc.**

 

**Condensed Consolidated Statements of Income**

 

**(Unaudited)**

 

***(dollars and shares in thousands, except for per share amounts)***

 
| ** **                                                  | ** ** | **Three Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net sales                                                   |       | $                                   | 613,898    |                               | $          | 618,184 |   | $ | 1,849,103 |   | $ | 1,810,749 |   |
| Net sales to  Abbott Laboratories                           |       | 42,672                              |       | 37,926                             |       | 131,443 |   | 133,971 |   |
| Total Net Sales                                             |       | 656,570                             |       | 656,110                            |       | 1,980,546 |   | 1,944,720 |   |
|                                                        |       |                                |       |                               |       |   |   |   |   |
| Cost of  products sold                                      |       | 429,008                             |       | 462,283                            |       | 1,316,790 |   | 1,371,927 |   |
| Gross Profit                                                |       | 227,562                             |       | 193,827                            |       | 663,756 |   | 572,793 |   |
|                                                        |       |                                |       |                               |       |   |   |   |   |
| Research and  development                                   |       | 35,525                              |       | 28,001                             |       | 96,767 |   | 80,534 |   |
| Selling,  general and administrative                        |       | 91,483                              |       | 71,899                             |       | 260,767 |   | 196,340 |   |
| Curtailment of post-retirement medical and  dental benefits |       | —                              |       | —                             |       | — |   | (64,636 | ) |
| Income From Operations                                      |       | 100,554                             |       | 93,927                             |       | 306,222 |   | 360,555 |   |
|                                                        |       |                                |       |                               |       |   |   |   |   |
| Interest  expense                                           |       | 6,916                               |       | 8,268                              |       | 20,942 |   | 10,952 |   |
| Other  (income), net                                        |       | (3,409                              | )          | (2,538                             | )          | (8,090 | ) | (1,144 | ) |
| Income Before Income Taxes                                  |       | 97,047                              |       | 88,197                             |       | 293,370 |   | 350,747 |   |
|                                                        |       |                                |       |                               |       |   |   |   |   |
| Income tax  expense                                         |       | 37,192                              |       | 26,882                             |       | 84,309 |   | 98,671 |   |
| Net Income                                                  |       | $                                   | 59,855     |                               | $          | 61,315 |   | $ | 209,061 |   | $ | 252,076 |   |
|                                                        |       |                                |       |                               |       |   |   |   |   |
| Earnings Per  Common Share:                                 |       |                                |       |                               |       |   |   |   |   |
| Basic                                                       |       | $                                   | 0.38       |                               | $          | 0.39 |   | $ | 1.32 |   | $ | 1.61 |   |
| Diluted                                                     |       | $                                   | 0.37       |                               | $          | 0.39 |   | $ | 1.30 |   | $ | 1.61 |   |
|                                                        |       |                                |       |                               |       |   |   |   |   |
| Weighted  Average Common Shares Outstanding:                |       |                                |       |                               |       |   |   |   |   |
| Basic                                                       |       | 160,103                             |       | 156,059                            |       | 158,643 |   | 156,054 |   |
| Diluted                                                     |       | 162,842                             |       | 156,672                            |       | 160,797 |   | 156,623 |   |

 

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

 

3

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**Hospira,Inc.**

 

**Condensed Consolidated Statements of CashFlows**

 

**(Unaudited)**

 

***(dollars in thousands)***

 
| ** **                                                                 | ** ** | **Nine Months Ended September 30** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                                                       |       |                               |       |   |   |
| Cash Flow  From (Used in) Operating Activities:                            |       |                               |       |   |   |
|                                                                       |       |                               |       |   |   |
| Net income                                                                 |       | $                                  | 209,061    |   | $ | 252,076 |   |
| Adjustments to reconcile net income to net  cash from operating activities |       |                               |       |   |   |
| Depreciation                                                               |       | 116,647                            |       | 99,867 |   |
| Amortization of intangibles                                                |       | 1,349                              |       | 3,215 |   |
| Curtailment of post-retirement medical and  dental benefits                |       | —                             |       | (64,636 | ) |
| Trade receivables                                                          |       | 398                                |       | (37,079 | ) |
| Inventories                                                                |       | (7,788                             | )          | 694 |   |
| Prepaid expenses and other assets                                          |       | (13,527                            | )          | (7,300 | ) |
| Trade accounts payable and other  liabilities                              |       | 77,375                             |       | 85,357 |   |
| Other, net                                                                 |       | 87,790                             |       | (46,315 | ) |
| Net Cash From Operating Activities                                         |       | 471,305                            |       | 285,879 |   |
|                                                                       |       |                               |       |   |   |
| Cash Flow  (Used in) From Investing Activities:                            |       |                               |       |   |   |
|                                                                       |       |                               |       |   |   |
| Acquisitions of property and equipment                                     |       | (189,525                           | )          | (168,721 | ) |
| Proceeds from asset dispositions                                           |       | 31,818                             |       | — |   |
| Acquisitions                                                               |       | (23,590                            | )          | — |   |
| Purchase of intangibles and other  investments                             |       | (7,200                             | )          | — |   |
| Sales of marketable securities                                             |       | 72,438                             |       | — |   |
| Net Cash (Used in) Investing Activities                                    |       | (116,059                           | )          | (168,721 | ) |
|                                                                       |       |                               |       |   |   |
| Cash Flow  From (Used in) Financing Activities:                            |       |                               |       |   |   |
|                                                                       |       |                               |       |   |   |
| Net transactions with Abbott Laboratories  prior to spin-off               |       | —                             |       | 24,209 |   |
| Pre-distribution dividend to Abbott                                        |       | —                             |       | (700,000 | ) |
| Payment to Abbott for international net  assets                            |       | (106,521                           | )          | — |   |
| Issuance of long-term debt, net of fees  paid                              |       | 1,750                              |       | 1,393,344 |   |
| Repayment of long-term debt                                                |       | (84                                | )          | (700,000 | ) |
| Other borrowings, net                                                      |       | 3,843                              |       | — |   |
| Proceeds from stock options exercised                                      |       | 97,612                             |       | 486 |   |
| Net Cash (Used in) From Financing  Activities                              |       | (3,400                             | )          | 18,039 |   |
|                                                                       |       |                               |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents              |       | (2,032                             | )          | 251 |   |
|                                                                       |       |                               |       |   |   |
| Net change  in cash and cash equivalents                                   |       | 349,814                            |       | 135,448 |   |
| Cash and  cash equivalents at beginning of period                          |       | 127,695                            |       | — |   |
| Cash and  cash equivalents at end of period                                |       | $                                  | 477,509    |   | $ | 135,448 |   |
|                                                                       |       |                               |       |   |   |
| Supplemental  Cash Flow Information                                        |       |                               |       |   |   |
|                                                                       |       |                               |       |   |   |
| Cash paid  (received) during the period for:                               |       |                               |       |   |   |
| Interest                                                                   |       | $                                  | 20,055     |   | $ | 2,399 |   |
| Income taxes  (refunds)                                                    |       | $                                  | (4,019     | ) | $ | 19,023 |   |

 

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

 

4

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**Hospira,Inc.**

 

**Condensed Consolidated BalanceSheets**

 

**(Unaudited)**

 

***(dollars in thousands except for share data)***

 
| ** **                                                                                                                            | ** ** | **September 30** | ** ** | **December 31** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-----------------|------------|
| ** **                                                                                                                            | ** ** | **2005**         | ** ** | **2004**        | ** ** |
| **Assets**                                                                                                                            |       |             |       |            |       |
| Current  Assets:                                                                                                                      |       |             |       |            |       |
| Cash and cash equivalents                                                                                                             |       | $                | 477,509    |            | $          | 127,695 |   |
| Marketable securities                                                                                                                 |       | —           |       | 72,438          |       |
| Trade receivables, less allowances of  $15,473 in 2005 and $16,083 in 2004                                                            |       | 316,915          |       | 326,356         |       |
| Inventories:                                                                                                                          |       |             |       |            |       |
| Finished products                                                                                                                     |       | 288,386          |       | 330,111         |       |
| Work in process                                                                                                                       |       | 91,881           |       | 70,329          |       |
| Materials                                                                                                                             |       | 128,941          |       | 117,884         |       |
| Total inventories                                                                                                                     |       | 509,208          |       | 518,324         |       |
| Prepaid expenses, deferred income taxes and  other receivables                                                                        |       | 172,570          |       | 153,512         |       |
| Total Current Assets                                                                                                                  |       | 1,476,202        |       | 1,198,325       |       |
| Property and  equipment, at cost                                                                                                      |       | 2,186,960        |       | 2,173,933       |       |
| Less: accumulated depreciation and  amortization                                                                                      |       | 1,204,754        |       | 1,227,629       |       |
| Net Property and Equipment                                                                                                            |       | 982,206          |       | 946,304         |       |
| Intangible  assets, net of amortization                                                                                               |       | 15,408           |       | 1,057           |       |
| Goodwill                                                                                                                              |       | 89,197           |       | 80,973          |       |
| Other assets                                                                                                                          |       | 125,493          |       | 116,131         |       |
| Total Assets                                                                                                                          |       | $                | 2,688,506  |            | $          | 2,342,790 |   |
| **Liabilities and Shareholders’ Equity**                                                                                         |       |             |       |            |       |
| Current  Liabilities:                                                                                                                 |       |             |       |            |       |
| Short-term borrowings                                                                                                                 |       | $                | 5,038      |            | $          | — |   |
| Trade accounts payable                                                                                                                |       | 128,673          |       | 101,537         |       |
| Salaries payable and other accruals                                                                                                   |       | 392,827          |       | 268,615         |       |
| Due to Abbott, net                                                                                                                    |       | 66,230           |       | 166,042         |       |
| Total Current Liabilities                                                                                                             |       | 592,768          |       | 536,194         |       |
| Due to  Abbott, net                                                                                                                   |       | —           |       | 23,100          |       |
| Long-term  debt                                                                                                                       |       | 693,658          |       | 698,841         |       |
| Post-retirement  obligations, deferred income taxes and other long-term liabilities                                                   |       | 104,795          |       | 100,736         |       |
| Commitments  and Contingencies                                                                                                        |       |             |       |            |       |
| Shareholders’  Equity:                                                                                                           |       |             |       |            |       |
| Common stock, par value $0.01 - authorized:  400,000,000 shares;  issued and outstanding shares: 2005: 160,756,007; 2004: 156,969,662 |       | 1,608            |       | 1,570           |       |
| Preferred stock, par value $0.01 -  authorized: 50,000,000 shares;  issued and outstanding: 0 shares                                  |       | —           |       | —          |       |
| Unearned compensation                                                                                                                 |       | (175             | )          | (114            | )          |
| Additional paid-in capital                                                                                                            |       | 904,692          |       | 791,252         |       |
| Retained earnings                                                                                                                     |       | 412,383          |       | 203,322         |       |
| Accumulated other comprehensive (loss)                                                                                                |       | (21,223          | )          | (12,111         | )          |
| Total Shareholders’ Equity                                                                                                       |       | 1,297,285        |       | 983,919         |       |
| Total  Liabilities and Shareholders’ Equity                                                                                      |       | $                | 2,688,506  |            | $          | 2,342,790 |   |

 

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

 

5

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**Hospira,Inc.**

 

**Condensed Consolidated Statementof Changes in Shareholders’ Equity**

 

**(Unaudited)**

 

***(dollars and shares in thousands)***

 
| ** **                                                                | ** ** | ** **       | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **     | ** ** | ** **       | ** ** | ** **   | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------|------------|------------------|------------|-------------------|------------|-----------------|------------|----------------|------------|------------------|------------|--------------|------------|------------|------------|
| ** **                                                                | ** ** | ** **       | ** ** | ** **        | ** ** | **Other**       | ** ** | **Additional** | ** ** | ** **       | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                                                | ** ** | **Common Stock** | ** ** | **Comprehensive** | ** ** | **Paid-in**     | ** ** | **Unearned**   | ** ** | **Retained**     | ** ** | ** **   | ** ** |
| ** **                                                                | ** ** | **Shares**       | ** ** | **Amount**        | ** ** | **(Loss)**      | ** ** | **Capital**    | ** ** | **Compensation** | ** ** | **Earnings** | ** ** | **Total**  | ** ** |
|                                                                      |       |             |       |              |       |            |       |           |       |             |       |         |       |       |       |
| **Balances at December 31, 2004**                                         |       | 156,970          |       | $                 | 1,570      |            | $          | (12,111        | )          | $                | 791,252    |         | $          | (114       | )          | $ | 203,322 |   | $ | 983,919 |   |
|                                                                      |       |             |       |              |       |            |       |           |       |             |       |         |       |       |       |
| Net Income                                                                |       | —           |       | —            |       | —          |       | —         |       | —           |       | 209,061      |       | 209,061    |       |
|                                                                      |       |             |       |              |       |            |       |           |       |             |       |         |       |       |       |
| Other  comprehensive loss                                                 |       | —           |       | —            |       | (9,112          | )          | —         |       | —           |       | —       |       | (9,112     | )          |
|                                                                      |       |             |       |              |       |            |       |           |       |             |       |         |       |       |       |
| Changes in shareholders’ equity related to  incentive stock programs |       | 3,786            |       | 38                |       | —          |       | 113,440        |       | (61              | )          | —       |       | 113,417    |       |
|                                                                      |       |             |       |              |       |            |       |           |       |             |       |         |       |       |       |
| **Balances at September 30, 2005**                                        |       | 160,756          |       | $                 | 1,608      |            | $          | (21,223        | )          | $                | 904,692    |         | $          | (175       | )          | $ | 412,383 |   | $ | 1,297,285 |   |

 

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

 

6

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**Hospira,Inc.**

 

**Notes to Condensed ConsolidatedFinancial Statements**

 

**September30, 2005**

 

**(Unaudited)**

 

**Note 1 –Basis ofPresentation**

 

These condensedconsolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”) and, therefore,do not include all information and footnote disclosures normally included inaudited financial statements. However, in the opinion of management, alladjustments, consisting only of normal recurring adjustments, unless otherwisenoted herein, necessary to present fairly the results of operations, financialposition and cash flows have been made. These condensed consolidated financialstatements should be read in conjunction with the consolidated financialstatements and notes thereto included in Hospira’s Annual Report on Form 10-Kfor the year ended December 31, 2004. The results of operations for anyinterim period are not necessarily indicative of the results of operations tobe expected for the full year.

 

Hospira became a separate public company pursuant to aspin-off from Abbott Laboratories (“Abbott”) on April 30, 2004 (the “spin-offdate”). Theaccompanying unaudited interim condensed consolidated financial statementsreflect Hospira’s operations as a separate, stand-alone entity for all periodssubsequent to April 30, 2004. For periods through April 30, 2004, the financialstatements reflect the historical operations of Hospira when it operated as apart of Abbott and include expense allocations related to services provided toHospira by Abbott. Hospira considers those allocations to be reasonablereflections of the utilization of services provided. As the financialstatements for the nine months ended September 30, 2004 combine Hospira’soperations as part of Abbott prior to the spin-off and as a separate,stand-alone entity after the spin-off, they do not reflect Hospira’s results ofoperations, financial position and cash flows had Hospira been a stand-alonecompany throughout this period. 

 

In connection with the spin-off, Hospira and Abbottagreed that the legal transfer of certain operations and assets (net ofliabilities) outside the United States would occur, and be completed, withintwo years after the spin-off. These operations and assets are used in theconduct of Hospira’s international business and Hospira is subject to the risksand entitled to the benefits generated by such operations and assets. Hospirais dependent on Abbott’s international infrastructure until such legaltransfers occur in each international country. These transfers began in thesecond quarter of 2005. 

 

**Note 2 –RecentlyIssued Accounting Standards**

 

In November 2004, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 151,“InventoryCosts.” This statement clarifies the accounting for abnormal amounts of idlefacilities expense, freight, handling costs and wasted material. This statementrequires that those items be recognized as current-period expenses. Inaddition, the statement requires that allocation of fixed overhead to the costof conversion be based on the normal capacity of the production facilities. ForHospira, this statement is effective for inventory costs incurred afterDecember 31, 2005. Hospira is currently evaluating the potential impact of SFASNo. 151 on its financial position and results of operations. 

 

In December 2004, the FASB issued SFAS No. 123R, “Share-BasedPayment,” which requires, among other changes, that the cost resulting from allshare-based payment transactions be recognized as compensation cost over thevesting period based on the fair value of the instrument on the date of grant.SFAS No. 123R revises SFAS No. 123, “Accounting for Stock-Based Compensation,”which previously allowed pro forma disclosure of certain share-basedcompensation expense. Further, SFAS No. 123R supercedes Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” whichpreviously allowed the intrinsic value method of accounting for stock optionsrather than the fair value method when determining option value used to measurecompensation cost. Since Hospira currently accounts for share-based paymentsusing the intrinsic value method, Hospira’s results of operations have notincluded the recognition of compensation expense. Had Hospira applied thefair-value criteria established in SFAS No. 123R to previous stock optiongrants, the impact to the results of operations would have approximated the proforma expense under SFAS No. 123, which is disclosed in Note 12. On April 14,2005, the SEC adopted a rule that amended the compliance date of SFAS No. 123Rto require implementation no later than the beginning of the first fiscal yearwhich begins after June 15, 2005 (January 1, 2006 for Hospira). The effect ofadopting SFAS No. 123R on diluted earnings per share in future periods isdependent on the number of options granted in the future, the terms of thoseawards and their fair values.

 

The American Jobs CreationAct of 2004 (“Jobs Act”), which was signed into law on October 22, 2004,provides for a special one-time dividends received deduction on therepatriation of certain foreign earnings to a U.S. taxpayer, provided certaincriteria are met. Hospira has determined that it will repatriate $175 millionof qualified undistributed foreign earnings. In accordance with FASB StaffPosition 109-2, “Accounting and Disclosure Guidance for the Foreign EarningsRepatriation Provision within the American Jobs Creation Act of 2004,” theincome tax related to this repatriation is $9.5 million and has been recognizedin the third quarter of

 

7

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2005. The repatriation offunds will occur during the fourth quarter of 2005.

 

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections” (“SFAS No. 154”), which changes the requirementsfor the accounting and reporting of a voluntary change in accounting principle.The statement requires retrospective application to prior periods’ financialstatements, or the latest practicable date, as the required method forreporting a change in accounting principle. Previous rules generally requiredthat changes in accounting principles were recognized by including thecumulative effect of the change in net income in the period of change. SFAS No.154 is effective for accounting changes made in fiscal years beginning afterDecember 15, 2005. Adoption of this standard is not expected to have a materialeffect on Hospira’s financial position or results of operations.

 

**Note 3 – Acquisitions andDispositions**

 

In July 2005, Hospira acquired Physiometrix, Inc., adeveloper of non-invasive medical devices. The acquisition broadens Hospira’s portfolio of products for thehospital operating room and intensive care unit, providing brain-functionmonitoring devices used during surgical and diagnostic procedures. Hospira paid$23.6 million in cash for all outstanding shares of Physiometrix plustransaction costs and assumed Physiometrix’s debt of $1 million. Based on the preliminaryallocation of purchase price, the acquisition resulted in intangible assets of$9.9 million that will be amortized over 10 years, non-tax deductible goodwillof $8.2 million, net deferred tax assets of $8.0 million and other assets andliabilities, net of $(1.5) million. The impact of the acquisition is notexpected to be material to Hospira’s results of operations in 2005.

 

In the third quarter of 2005, Hospira acquired therights to certain technologies and generic pharmaceutical products for $5.2million, including the rights to an Abbreviated New Drug Application filed withthe Food and Drug Administration. These intangible assets will be amortizedover an average life of 8 years. 

 

In May 2005, Hospira entered into a strategicmanufacturing, commercialization and development agreement with ICU Medical,Inc. (“ICU”) and sold its Salt Lake City, Utah, manufacturing facility andrelated equipment and inventory to ICU for $31.8 million in cash. As a resultof these agreements, during the first quarter of 2005, Hospira classified theproperty and equipment to be sold under the agreements, totaling $20.7 million,as held for sale. In accordance with SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” Hospira recorded an impairmentcharge of $2.4 million, representing the amount by which the carrying value ofthe assets exceeds the fair value less cost to sell. In addition, raw materialsand work in process inventory of $10.1 million were sold as part of thetransaction. In connection with the closing of the sale in the second quarterof 2005, Hospira recorded a loss of $13.4 million, which is Hospira’s bestestimate of the cost of certain obligations that Hospira is required toreimburse ICU for up to 24 months after closing. Both the impairment and theloss related to obligations assumed are recorded in cost of products sold.Through September 30, 2005, cash paid related to these obligations is $3.6million.

 

**Note 4 – Restructuring Costs**

 

In August 2005, Hospira announced plans to close itsmedical device manufacturing plant in Donegal, Ireland. Products produced atthe Donegal plant are expected to move to Hospira facilities in Costa Rica andthe Dominican Republic, whichhave available manufacturing capacity to absorb the transfers.Approximately 550 Donegal employees will be affected by the closing. Theaggregate charges that Hospira will incur related to the plant closing areexpected to be in the range of $30 million to $40 million on a pre-tax basisand will be reported in the International segment. The restructuring costsconsist primarily of costs related to severance and other employee benefitcosts, additional depreciation resulting from the decreased useful lives of thebuilding and certain equipment, and other exit costs. Hospira expects to incurseverance and certain other employee benefit costs over the expected serviceperiod of the related employees and all other exit costs as they are incurredthrough mid 2007. As of September 30, 2005, Hospira incurred pre-tax costs of$2.3 million, which are recorded in cost of products sold and primarily relateto severance and other employee benefit costs. To date, no cash payments havebeen made for these costs. 

 

**Note 5 – Income Taxes**

 

Taxes on income reflect the estimated annual effectiverates, excluding the effect of significant unusual items, and are determined ona separate-return basis through April 30, 2004, at which time Hospira became aseparate stand-alone taxpayer. During the third quarter of 2005, Hospira increasedits annual effective tax rate from 24% to 25.5% due to an increase in expectedearnings in the U.S., which has a higher tax rate than foreign jurisdictions.This rate excludes the effect of the tax related to the repatriation of fundsof $9.5 million, as noted above in Note 2. During the third quarter of 2004,Hospira increased its annual effective tax rate, excluding the impact of thecurtailment of post-retirement medical and dental benefits, from 24% to 26%.The effective tax rates are less than the statutory U.S. federal income taxrate principally due to the benefit of tax exemptions, of varying durations, inseveral non-U.S. taxing jurisdictions. Abbott retained responsibility for alltax liabilities through April 30, 2004.

 

**Note 6 - Earnings per Share**

 

Basic earnings per share are computed by dividing netincome by the number of weighted average common shares outstanding 

 

8

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during the reporting period.  Diluted earnings per share are calculated to giveeffect to all potentially dilutive common shares that were outstanding duringthe reporting period. For periods through April 30, 2004, basic and dilutedearnings per share are computed using the number of shares of Hospira commonstock outstanding on April 30, 2004, the date on which the Hospira common stockwas distributed to the shareholders of Abbott. On the spin-off date,outstanding Abbott awards for non-retirement eligible Hospira employees werecancelled and replaced by new awards for Hospira common stock.  The new awards maintained both thepre-conversion aggregate intrinsic value of each award and the ratio of theexercise price per share to the market value per share.  Abbott awards granted to Hospira employeeswho were retirement eligible on the spin-off date remained options to purchaseAbbott stock and have no impact on Hospira share dilution.  The following table shows the effect of stockoptions on the weighted average number of shares outstanding used incalculating diluted earnings per share:

 

*(shares in thousands)*

 
| ** **                                           | ** ** | **Three Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
|------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                           | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted  average common shares outstanding          |       | 160,103                             |       | 156,059                            |       | 158,643 |   | 156,054 |   |
| Assumed  exercise of stock options                   |       | 2,739                               |       | 613                                |       | 2,154 |   | 569 |   |
| Weighted  average dilutive common shares outstanding |       | 162,842                             |       | 156,672                            |       | 160,797 |   | 156,623 |   |

 

The number of outstanding options to purchase Hospirastock for which the exercise price of the options exceeded the average stockprice was 0.2 million and 1.6 million for the three and nine months endedSeptember 30, 2005, respectively, and 5.0 million for the three and nine monthsended September 30, 2004.  Accordingly,these options are excluded from the diluted earnings per share calculation forthese periods.

 

**Note**** 7****– Litigation**

 

Hospira, Abbott, or in some instances both, areinvolved in various claims and legal proceedings, including product liabilityclaims and proceedings related to Hospira’s business.

 

Various state and federal agencies, including the U.S.Department of Justice and various state attorneys general, are investigating anumber of pharmaceutical companies, including Abbott, for allegedly engaging inimproper marketing and pricing practices with respect to certain Medicare andMedicaid reimbursable products, including practices relating to averagewholesale price (“AWP”).  These are civilinvestigations that are seeking to identify the practices and determine whetherthose practices violated any laws, including federal and state false claimsacts, or constituted fraud in connection with the Medicare and/or Medicaidreimbursement paid to third parties.  Inaddition, Abbott is a defendant in a number of purported class actions onbehalf of individuals or entities, including healthcare insurers and otherthird-party payors, that allege generally that Abbott and numerous otherpharmaceutical companies reported false or misleading pricing information inconnection with federal, state and private reimbursement for certain drugs.  Many of the products involved in theseinvestigations and lawsuits are Hospira products.  Hospira is cooperating with the authoritiesin these investigations. There may be additional investigations or lawsuits, oradditional claims in the existing investigations or lawsuits, initiated withrespect to these matters in the future. Hospira cannot be certain that it will not be named as a subject ordefendant in these investigations or lawsuits. Hospira has been added as a defendant in one AWP proceeding, *The State of Texas ex rel. Ven-A-Care of the FloridaKeys, Inc. v. Abbott Laboratories Inc., Hospira, Inc., B. Braun Medical Inc.and Baxter Healthcare Corporation,*Case No. GV401286, pending in theDistrict Court of Travis County, Texas. The lawsuit alleges generally that the defendants made falserepresentations of prices and costs for drugs directly and indirectly to theTexas Medicaid Program.  Abbott willindemnify Hospira for liabilities associated with pending or future AWPinvestigations and lawsuits only to the extent that they are of the same natureas the lawsuits and investigations that existed against Abbott as of thespin-off date and relate to the sale of Hospira products prior to thespin-off.  Hospira will assume any otherlosses that may result from these investigations and lawsuits related toHospira’s products. These investigations and lawsuits could result in changesto Hospira’s business practices or pricing policies, civil or criminal monetarydamages, penalties or fines, imprisonment and/or exclusion of Hospira productsfrom participation in federal and state healthcare programs, includingMedicare, Medicaid and Veterans’ Administration health programs, any of whichcould have a material adverse effect on its business, profitability and financialcondition.

 

Hospira has been named as a defendant in a lawsuitbrought by three employees alleging generally that the spin-off of Hospira fromAbbott Laboratories adversely affected employee benefits in violation of theEmployee Retirement Income Security Act of 1974.  The lawsuit was filed on November 8, 2004, inthe United States District Court for the Northern District of Illinois, and iscaptioned: *Myla Nauman, Jane Roller andMichael Loughery v. Abbott Laboratories and Hospira, Inc*. Thelawsuit seeks class action certification on behalf of “All employees of Abbottwho were participants and beneficiaries of the Abbott Benefit Plans whoseemployment with Abbott was terminated between August 22, 2003 and April 30,2004, as a result of the spin-off announced by Abbott on August 22, 2003.” OnApril 27, 2005, the court issued an opinion denying the motions of Abbott andHospira to dismiss the complaint. The ruling is not a determination of themerits of the plaintiffs’ claims. Hospira denies all material allegationsasserted against it in the complaint.

 

9

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On August 12, 2005, Retractable Technologies, Inc. (“RTI”)filed a lawsuit against Abbott Laboratories, Inc. alleging breach of contractand fraud in connection with a National Marketing and Distribution Agreement (“Agreement”)between Abbott and RTI signed in May 2000. *Retractable Technologies,Inc. v. Abbott Laboratories, Inc.*, Case No. 505CV157, pending inU.S. District Court for the Eastern District of Texas. RTI purported toterminate the contract for breach in 2003. The lawsuit alleges that Abbottmisled RTI and breached the Agreement in connection with Abbott’s marketingefforts. RTI seeks unspecified monetary damages as well as punitive damages. Hospirahas conditionally agreed to defend and indemnify Abbott in connection with thislawsuit, which involves a contract carried out by Abbott’s former HospitalProducts Division. Abbott denies all material allegations in the complaint.Additionally, Abbott maintains that the dispute must be resolved byarbitration, in accordance with the terms of the Agreement. Abbott intends topursue claims against RTI for breach of the Agreement in arbitration or infederal court. Hospira is entitled, pursuant to its agreements with Abbott, toany amounts recovered due to RTI’s breach of the Agreement.

 

Hospira’s product liability claim exposures areevaluated each reporting period. Hospira’s reserves, which are immaterial atSeptember 30, 2005, are the best estimate of loss, as defined by SFAS No.5, “Accounting for Contingencies.” 

 

Based upon information that is currently available,management believes that the likelihood of a material loss in excess ofrecorded amounts is remote.

 

Additional legal proceedings may occur that may resultin a change in the estimated reserves recorded by Hospira. It is not feasibleto predict the outcome of such proceedings with certainty and there can be noassurance that their ultimate disposition will not have a material adverseeffect on Hospira’s financial position, cash flows, or results of operations.

 

**Note 8  - Post-Retirement Benefits**

 

Retirement plans consist of defined benefit (“pension”),defined contribution, and post-retirement medical and dental plans.  The pension and post-retirement medical anddental plans cover certain employees both in and outside of the UnitedStates.  

 

In connection with the spin-off, Hospira and Abbottentered into an Employee Benefits Agreement, which provided that Abbott retainliabilities for pension benefits for U.S. non-union and international employeeswho were retired as of the spin-off date and liabilities for post-retirementmedical and dental benefits for U.S. non-union employees who were retired oreligible to retire as of the spin-off date.

 

***Net Pension andMedical and Dental Benefit Cost***

 

In the second quarter of 2004, Hospira announced aseries of benefit plan changes including the enhancement of its 401(k) definedcontribution plan, the freezing of the U.S. non-union pension plan and the discontinuationof the U.S. non-union post-retirement medical and dental plan. Thediscontinuation of the U.S. non-union post-retirement medical and dental planwas effective May 1, 2004.  EffectiveDecember 31, 2004, the U.S. non-union pension plan was frozen. Eligibleemployees covered by the plan will continue to age into their benefits and willbe entitled to all benefits earned when they retire. Beginning January 1, 2005,all U.S. non-union employees became eligible to receive an additional company-matchingcontribution to the 401(k) plan and employees that are age 40 and above, as ofDecember 31, 2004, became eligible to receive an additional company-matchingcontribution for five years beginning in 2005.

 

Net cost (benefit) recognized for the three and ninemonths ended September 30, 2005 and 2004 for the major pension plans andpost-retirement medical and dental benefit plans, is as follows:

 

*(dollars in thousands)*

 
| ** **                                        | ** ** | **Pension Plans**                    | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                        | ** ** | **Three Months Ended  September 30** | ** ** | **Nine Months Ended  September 30** | ** ** |
| ** **                                        | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2005** | ** ** | **2004(1)** | ** ** |
| Service cost  for benefits earned during the year |       | $                                    | 529        |   | $ | 3,881 |   | $ | 1,587 |   | $ | 18,648 |   |
| Interest  cost on projected benefit obligations   |       | 5,508                                |       | 5,212 |   | 16,524 |   | 24,396 |   |
| Expected  return on plans’ assets            |       | (7,345                               | )          | (6,980 | ) | (22,035 | ) | (28,590 | ) |
| Net  amortization                                 |       | 306                                  |       | 203 |   | 918 |   | 2,891 |   |
| Curtailment  of benefits                          |       | —                               |       | — |   | — |   | 1,500 |   |
| Net pension  (benefit) cost                       |       | $                                    | (1,002     | ) | $ | 2,316 |   | $ | (3,006 | ) | $ | 18,845 |   |

 

10

----

 

----

Notes

(1)   Includescosts allocated from Abbott through the spin-off date for all Hospiraemployees, including employees who were retired as of the spin-off date.

 

*(dollarsin thousands)*

 
| ** **                                        | ** ** | **Medical and Dental Plans**         | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                        | ** ** | **Three Months Ended  September 30** | ** ** | **Nine Months Ended  September 30** | ** ** |
| ** **                                        | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2005** | ** ** | **2004(1)** | ** ** |
| Service cost  for benefits earned during the year |       | $                                    | 359        |   | $ | 521 |   | $ | 1,077 |   | 6,412 |   |
| Interest  cost on projected benefit obligations   |       | 789                                  |       | 1,012 |   | 2,367 |   | 8,823 |   |
| Net  amortization                                 |       | 483                                  |       | 797 |   | 1,449 |   | 1,978 |   |
| Curtailment                                       |       | —                               |       | — |   | — |   | (64,636 | ) |
| Net medical  and dental cost (benefit)            |       | $                                    | 1,631      |   | $ | 2,330 |   | $ | 4,893 |   | $ | (47,423 | ) |
|                                                   |            |                                      |            |  |  |  |  |  |  |  |  |  |  |

 

----

Notes

(1)   Includescosts allocated from Abbott through the spin-off date for all U.S. Hospiraemployees, including employees who were retired or eligible to retire as of thespin-off date.

 

Hospira’s employees participated through the spin-offdate in the Abbott Laboratories Stock Retirement Plan that is Abbott’sprincipal defined contribution plan, and thereafter in the Hospira 401(k)Retirement Savings Plan. Hospira’s contributions to these defined contributionplans for the three months ended September 30, 2005 and 2004 were $9.0 millionand $5.8 million, respectively.  For thenine months ended September 30, 2005 and 2004 contributions were $39.3 millionand $15.3 million, respectively. Included in the nine months ended September30, 2005 is a $13.8 million one-time company contribution that was announcedand accrued in 2004. 

 

***Cash Funding***

 

Hospira funds its domestic pension plans according toIRS funding limitations. Based on those limitations, Hospira does not expect tocontribute to its U.S. pension plans in 2005.

 

**Note 9 – Short-term Borrowings andLong-term Debt**

 

Hospira has outstanding $700 million aggregateprincipal amount of notes, consisting of $300 million principal amount offive-year senior unsecured notes and $400 million principal amount of ten-yearsenior unsecured notes. The $300 million five-year notes bear interest at arate of 4.95% per annum and mature on June 15, 2009, and the $400 millionten-year notes bear interest at a rate of 5.9% per annum and mature on June 15,2014.  

 

In January 2005, Hospira entered into interest rateswap transactions whereby the $300 million five-year senior unsecured notes duein June 2009 were effectively converted from fixed to floating rate debt. AtSeptember 30, 2005, the fair value of the interest rate swap is not material. 

 

In March 2005, Hospira issued economic developmentpromissory notes, the proceeds of which were used for a distribution facilityexpansion. The $1.75 million ten-year notes bear a fixed rate of interest of2%, with principal and interest due monthly.

 

During the third quarter of 2005, Hospira entered intovarious loan agreements related to the legal transfer of certain internationaloperations from Abbott. Hospira borrowed 270 million Chilean Pesos ($0.5million U.S. Dollars) and, in two separate loans, 10 billion Colombian Pesos (atotal of $4.3 million U.S. Dollars). The Chilean loan bears interest of 5.4%and is due November 2005. The loans of 8 billion and 2 billion Colombian Pesosbear interest of 9% and 8.8% and are due March 2006 and October 2005,respectively. Principal and interest on these loans are due uponexpiration.  

 

Hospira’s revolving credit facility consists of anunsecured revolving credit facility of $375 million (“Revolver”) that isavailable for working capital and other requirements. On April 29, 2005, the Revolver was amendedto reduce or eliminate certain restrictions, in order to increase Hospira’soperating flexibility. The Revolver allows Hospira to borrow funds on anunsecured basis at variable interest rates as short-term cash needs dictate. Asof September 30, 2005, Hospira had no amounts outstanding under the Revolver.

 

The amended Revolver and theSenior Unsecured Notes contain, among other provisions, covenants with whichHospira must comply while they are in force. The covenants limit Hospira’sability to allow liens on its properties or assets, or merge or 

 

11

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consolidate with any othercorporation. The amended Revolver also limits Hospira’s ability to sell itsassets.  Under the amended Revolver,Hospira must also comply with certain financial covenants, including interestcoverage ratio, leverage ratio and minimum consolidated net worth. As ofSeptember 30, 2005, Hospira was in compliance with all covenants under theamended Revolver and the Senior Unsecured Notes.

 

**Note 10 - Comprehensive Income, netof tax**

 

*(dollars in thousands)*

 
| ** **                                                 | ** ** | **Three Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Foreign  currency translation gains (losses)               |       | $                                   | 243        |                               | $          | 1,531 |   | $ | (10,643 | ) | $ | (37,927 | ) |
| Unrealized gains (losses) on marketable  equity securities |       | 1,951                               |       | (670                               | )          | 1,531 |   | 16 |   |
| Minimum  pension liability adjustment                      |       | —                              |       | —                             |       | — |   | 47,324 |   |
| Total other  comprehensive (loss) income                   |       | 2,194                               |       | 861                                |       | (9,112 | ) | 9,413 |   |
| Less effect  of distribution from Abbott                   |       | —                              |       | —                             |       | — |   | (48,475 | ) |
| Adjusted  other comprehensive (loss)                       |       | 2,194                               |       | 861                                |       | (9,112 | ) | (39,062 | ) |
| Net Income                                                 |       | 59,855                              |       | 61,315                             |       | 209,061 |   | 252,076 |   |
| Total  Comprehensive Income                                |       | $                                   | 62,049     |                               | $          | 62,176 |   | $ | 199,949 |   | $ | 213,014 |   |

 
| ** **                                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                               | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| Cumulative  foreign currency translation gains                           |       | $                 | 863        |             | $          | 11,506 |   |
| Cumulative  minimum pension liability adjustments, net of tax            |       | (25,360           | )          | (25,360          | )          |
| Cumulative  unrealized gains on marketable equity securities, net of tax |       | 3,274             |       | 1,743            |       |
| Accumulated  Other Comprehensive (Loss)                                  |       | $                 | (21,223    | )                | $          | (12,111 | ) |

 

**Note 11 - Segment Information**

 

Hospira’s principal business is the development,manufacture and sale of a broad line of hospital products, including specialtyinjectable pharmaceuticals and medication delivery systems, and the provisionof injectable pharmaceutical contract manufacturing services. Hospira has tworeportable segments: U.S. and International. 

 

Hospira’s underlying accounting records are maintainedon a legal entity basis for government and public reporting requirements.Segment disclosures are on a performance basis consistent with internalmanagement reporting.  Certain immaterialreclassifications have been made to the basis of presentation to facilitatecomparable reporting. For internal management reporting, intersegment transfersof inventory are recorded at standard cost and are not a measure of segmentincome from operations. The costs of certain corporate functions that benefitthe entire organization are not allocated. The following segment informationhas been prepared in accordance with the internal accounting policies ofHospira, as described above.

 

12

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*(dollars in thousands)*

 
| ** **                  | ** ** | **Three  Months Ended September 30** | ** ** | **Nine  Months Ended September 30** | ** ** |
|-----------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                  | ** ** | **Net  Sales**                       | ** ** | **Income  from Operations**         | ** ** | **Net  Sales** | ** ** | **Income  from Operations** | ** ** |
| ** **                  | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004 (1)** | ** ** |
|                        |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S.                        |       | $                                    | 551,329    |                                | $          | 556,830 |   | $ | 98,905 |   | $ | 87,452 |   | $ | 1,651,099 |   | $ | 1,633,262 |   | $ | 289,731 |   | $ | 327,091 |   |
|                        |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| International               |       | 105,241                              |       | 99,280                              |       | $ | 15,805 |   | 22,333 |   | 329,447 |   | 311,458 |   | 57,997 |   | 74,165 |   |
| Total reportable  segments  |       | $                                    | 656,570    |                                | $          | 656,110 |   | 114,710 |   | 109,785 |   | $ | 1,980,546 |   | $ | 1,944,720 |   | 347,728 |   | 401,256 |   |
| Corporate  functions        |       |                                 |       |                                |       | (14,156 | ) | (15,858 | ) |   |   |   |   | (41,506 | ) | (40,701 | ) |
| Income from operations      |       |                                 |       |                                |       | 100,554 |   | 93,927 |   |   |   |   |   | 306,222 |   | 360,555 |   |
| Other                       |       |                                 |       |                                |       | (3,507 | ) | (5,730 | ) |   |   |   |   | (12,852 | ) | (9,808 | ) |
| Income before  income taxes |       |                                 |       |                                |       | $ | 97,047 |   | $ | 88,197 |   |   |   |   |   | $ | 293,370 |   | $ | 350,747 |   |

 

----

(1) 2004 U.S. Income from operations includes curtailment benefit of$64,636.

 

**Note 12 – Incentive Stock Programs**

 

Certain employees of Hospira who were Abbott employeesprior to the spin-off held stock option awards granted under Abbott incentivestock programs.  For employees who wereretirement eligible at the spin-off date, these awards remained options topurchase Abbott stock (“unconverted options”). 

 

For those employees who were not retirement eligibleat the spin-off date, the Abbott stock option awards were cancelled andreplaced by new awards of options (“converted options”) to purchase Hospiracommon stock at the time of the spin-off. The converted options maintain both the pre-conversion aggregateintrinsic value of each award and the ratio of the exercise price per share tothe market value per share.  All otherterms of the converted options remain the same. 

 

In May 2004, Hospira awarded a Founders Grant of 8.4million options to substantially all employees in the United States and certaininternational employees, at the fair market value at the time of grant. Theseoptions generally vested in six months and have a five-year term for allemployees except for corporate officers, whose options vest over three yearsand have a ten-year term.

 

In May 2005, 2.6 million options were granted tocertain employees for the 2005 annual stock option grant. These options wereawarded at the fair market value at the time of grant, generally vest overthree years and have a ten-year term.

 

Hospira measures compensation cost using the intrinsicvalue-based method of accounting for stock options. In accordance with theintrinsic value method, no compensation expense is recognized for Hospira’sstock option plans. If the fair value method of accounting was used for theAbbott and Hospira options, net income and earnings per share (EPS) in theperiods during 2005 and 2004 would have been as follows:

 

13

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*(dollars in thousands)*

 
| ** **                                                               | ** ** | **Three Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                               | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net Income,  as reported                                                 |       | $                                   | 59,855     |                               | $          | 61,315 |   | $ | 209,061 |   | 252,076 |   |
| Hospira  stock-based compensation, net of tax                            |       | (3,583                              | )          | (17,193                            | )          | (11,096 | ) | (29,193 | ) |
|                                                                     |       |                                |       |                               |       |   |   |   |   |
| Pro forma net income including Hospira  stock-based compensation expense |       | 56,272                              |       | 44,122                             |       | 197,965 |   | 222,883 |   |
| Abbott  stock-based compensation, net of tax (1)                         |       | —                              |       | —                             |       | — |   | (7,048 | ) |
| Pro forma net income including all  stock-based compensation expense     |       | $                                   | 56,272     |                               | $          | 44,122 |   | $ | 197,965 |   | $ | 215,835 |   |
|                                                                     |       |                                |       |                               |       |   |   |   |   |
| Basic EPS,  as reported                                                  |       | $                                   | 0.38       |                               | $          | 0.39 |   | $ | 1.32 |   | $ | 1.61 |   |
| Basic EPS,  pro forma                                                    |       | $                                   | 0.35       |                               | $          | 0.28 |   | $ | 1.25 |   | $ | 1.38 |   |
| Diluted EPS,  as reported                                                |       | $                                   | 0.37       |                               | $          | 0.39 |   | $ | 1.30 |   | $ | 1.61 |   |
| Diluted EPS,  pro forma                                                  |       | $                                   | 0.34       |                               | $          | 0.28 |   | $ | 1.23 |   | $ | 1.38 |   |

 

----

Notes

(1)   For periods prior to the spin-off, theseamounts reflect the Abbott stock-based compensation for Hospira employees,whether or not those awards were cancelled and replaced by Hospira awards atthe time of the spin-off. For periods subsequent to the spin-off, Abbott awardsfor Hospira employees who were not retirement eligible were converted toHospira options, and only the corresponding unvested portion of such awardsimpacts pro forma income. 

 

The weighted average fair value for the Hospira optionsgranted in the three and nine months ended September 30, 2005 was $11.20 and$11.25, respectively. The weighted average fair value for the Hospira optionsgranted in the three and nine months ended September 30, 2004 was $6.91 and$6.61, respectively. The weighted average fair value for the Abbott optionsgranted in the nine months ended September 30, 2004 was $11.79. The fair valuewas estimated using the Black-Scholes option-pricing model based on theweighted average market price at the grant date and the weighted averageassumptions specific to the underlying options. The historical Abbottassumptions relate to Abbott stock and are therefore based on Abbott’svaluation assumptions. The assumptions utilized for option grants during theperiods presented are as follows:

 
| ** **                                                           | ** ** | **Three Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                            | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Hospira Stock Options Black-Scholes  assumptions (weighted average): |       |                                |       |                               |       |   |   |   |   |
| Volatility                                                           |       | 30.0%                               |       | 32.0%                              |       | 30.0% |   | 32.0% |   |
| Expected  life (years)                                               |       | 3.3                                 |       | 2.5                                |       | 4.9 |   | 2.9 |   |
| Risk-free  interest rate                                             |       | 4.2%                                |       | 2.75%                              |       | 3.9% |   | 2.9% |   |
| Dividend  yield                                                      |       | 0.0%                                |       | 0.0%                               |       | 0.0% |   | 0.0% |   |
|                                                                 |       |                                |       |                               |       |   |   |   |   |
| Abbott Stock Options Black-Scholes  assumptions (weighted average):  |       |                                |       |                               |       |   |   |   |   |
| Volatility                                                           |       | N/A                                 |       | N/A                                |       | N/A |   | 32.0% |   |
| Expected  life (years)                                               |       | N/A                                 |       | N/A                                |       | N/A |   | 5.4 |   |
| Risk-free  interest rate                                             |       | N/A                                 |       | N/A                                |       | N/A |   | 2.9% |   |
| Dividend  yield                                                      |       | N/A                                 |       | N/A                                |       | N/A |   | 2.2% |   |

 

14

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**Note13 – Relationship with Abbott**

 

Hospira operated as part of Abbott through thespin-off date, during which time Abbott provided various services to Hospira.The cost of these services was allocated to Hospira utilizing variousallocation methods which management believes were reasonable. In connectionwith the spin-off, Hospira and Abbott entered into agreements pursuant to whichHospira and Abbott provide to the other, on an interim, transitional basis,various services. The agreed-upon charges for such services are generallyintended to allow the servicing party to recover all out-of-pocket costs plus amark up.  The services generallycommenced on the spin-off date and will terminate no later than 24 monthsfollowing the spin-off date. The receiving party may terminate the agreementrelated to such services upon prior written notice. The net cost of thesevarious services to Hospira was $1 million and $4 million for the three andnine months ended September 30, 2005. Prior year amounts of $4 million and $10million for the three and nine months ended September 30, 2004 include thosecosts that were allocated to Hospira as a part of Abbott, as well as costscharged by Abbott under transition service agreements subsequent to thespin-off date, including the costs related to leases noted below. 

 

In addition, Hospira leases floor space in certainAbbott facilities. The terms of the leases range from two to ten years from thespin-off date, unless terminated earlier by Hospira, and include additionalservices provided by Abbott. These additional services are integral to thefacilities and primarily include manufacturing support functions, qualityassurance and information technology systems. The cost for the leases and additional services was $6 million and $20million for the three and nine months ended September 30, 2005 and $8 millionand $22 million for the three and nine months ended September 30, 2004.

 

Both Hospira and Abbott have provided and willcontinue to provide manufacturing services to the other. Prior to the spin-offdate, under Abbott’s and Hospira’s internal reporting practices, these serviceswere provided at cost to the purchasing entity and Hospira’s sales to Abbottincluded the value of the bulk material. Subsequent to the spin-off date, formanufacturing services provided to Abbott, Hospira records as revenue its costsplus a third-party manufacturing profit and, for certain products, Hospirareceives the bulk material from Abbott and the mark up is on the value-addedportion only.  Inventory that Hospira purchasesfrom Abbott is at Abbott’s cost plus a third-party manufacturing profit. Salesto Abbott amounted to $43 million and $131 million for the three and ninemonths ended September 30, 2005, and $38 million and $134 million for the threeand nine months ended September 30, 2004, respectively. Product purchases fromAbbott were $22 million and $61 million for the three and nine months endedSeptember 30, 2005, and $15 million and $55 million for the three and ninemonths ended September 30, 2004, respectively. 

 

In connection with the spin-off, Hospira and Abbottagreed that the legal transfer of certain operations and assets (net ofliabilities) outside the United States would occur, and be completed, withintwo years after the spin-off. These operations and assets are used in theconduct of Hospira’s international business and Hospira is subject to the risksand entitled to the benefits generated by such operations and assets. Hospirais obligated to pay Abbott for these operations and assets, and assume thecorresponding liabilities, over a two-year period after the spin-off date asHospira establishes its business infrastructure outside the United States andobtains regulatory approval for the transfer of the marketing authorizationsfor Hospira products to local Hospira affiliates or third-party distributors.The amount payable is equal to the net book value of those assets andliabilities at the time of such transfer. Accordingly, the net book value willbe affected by normal operations, exchange rates and other business factors.Hospira pays Abbott interest, at local prevailing short-term rates, inconnection with Hospira’s use of certain of these assets during that period. Asof September 30, 2005, the net book value of the assets and liabilities thathad not yet transferred was $146.2 million. The net book value is primarilycomprised of accounts receivable of $52.2 million, inventory of $57.1 million,equipment of $35.4 million and other, net of $1.5 million. Each amount has beenincluded in the corresponding balance sheet line item. The amount due to Abbottfor the net book value of assets and liabilities is offset by $84.4 million foritems that are due from Abbott related to the international business. Theseitems include amounts due for operating profits and inventory purchases of Hospiraproducts to support the international business. All amounts outstanding betweenHospira and Abbott are included in Due to Abbott, Net on the balance sheet. Inthe second and third quarter of 2005, the net assets of several countries werelegally transferred from Abbott. The total amounts paid were $60.7 million and$106.5 million for the three and nine months ended September 30, 2005,respectively. Subsequent to September 30, 2005, the net assets of severaladditional countries were transferred. Hospira expects to transfer the netassets of additional countries each quarter throughout the remaining transitionperiod. 

 

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**Item2.  Management’s Discussion And AnalysisOf Financial Condition And Results Of Operations**

 

**Overview**

 

Hospira is a global specialty pharmaceutical andmedication delivery company that is focused on products that improve theproductivity, safety and efficacy of patient care in the acute caresetting.  Hospira is a leader in thedevelopment, manufacture and marketing of specialty injectable pharmaceuticalsand medication delivery systems that deliver drugs and intravenous (I.V.)fluids. Hospira is also a leading provider of contract manufacturing servicesto pharmaceutical and biotechnology companies for formulation development,filling and finishing of injectable pharmaceuticals. Hospira’s broad portfolioof products is used by hospitals and alternate site providers, such as clinics,home healthcare providers and long-term care facilities. 

 

**Transition from Abbott**

 

Hospira became a separate public company on April 30,2004, pursuant to a spin-off from Abbott Laboratories. For all periods prior tothe spin-off, Hospira operated as a part of Abbott’s Hospital Products andInternational segments. References to the historical assets, liabilities,products, businesses or activities of Hospira prior to the spin-off aregenerally intended to refer to the historical assets, liabilities, products,businesses or activities of the business as it was conducted as part of Abbottand its subsidiaries prior to the spin-off. Hospira’s condensed consolidatedfinancial statements for the three and nine months ended September 30, 2005 andthe three months ended September 30, 2004 reflect Hospira’s operations as aseparate, stand-alone entity subsequent to the spin-off. The financialstatements for the nine months ended September 30, 2004 combine Hospira’soperations as part of Abbott prior to the spin-off and as a separate,stand-alone entity after the spin-off, and do not reflect Hospira’s results ofoperations, financial position and cash flows had Hospira been a stand-alonecompany throughout this period. 

 

In connection with the spin-off, Hospira and Abbottagreed that the legal transfer of certain operations and assets (net ofliabilities) outside the United States would occur, and be completed, withintwo years after the spin-off. These operations and assets are used in theconduct of Hospira’s international business and Hospira is subject to the risksand entitled to the benefits generated by the operations and assets. Hospira isdependent on Abbott’s international infrastructure until such legal transfersoccur in each international country. In the second and third quarter of 2005,the net assets of several countries were legally transferred from Abbott.Subsequent to September 30, 2005, the net assets of several additionalcountries were transferred. Hospira expects to transfer the net assets ofadditional countries each quarter throughout the remaining transition period.

 

Subsequent to the spin-off, Hospira expects tocontinue to incur increased expenses on an ongoing basis, including expensesrelating to establishing corporate functions, operating and maintaininginformation technology systems, and operating internationally on a stand-alonebasis. Additionally, Hospira expects to incur expenses on a non-recurring,transitional basis, including those related to the establishment of newfacilities, the build-out of independent information technology systems, andproduct registration and re-labeling. These non-recurring transitional costsare estimated to total approximately $100 million (pre-tax) over the 24-monthperiod subsequent to the spin-off, of which $63.4 million has been incurredthrough September 30, 2005. During the three and nine months ended September30, 2005, $10.1 million and $31.0 million, respectively, of non-recurringtransition costs were incurred. 

 

**Critical Accounting Policies**

 

The preparation of financial statements in accordancewith generally accepted accounting principles (GAAP) requires management tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses. A summary of Hospira’s significantaccounting policies is included in Note 1 to the company’s consolidatedfinancial statements, which are included in Hospira’s Annual Report on Form10-K for the year ended December 31, 2004. Certain of Hospira’s accountingpolicies are considered critical, as these policies require significant, difficultor complex judgments by management, often employing the use of estimates aboutthe effects of matters that are inherently uncertain. Such policies aresummarized in “Item 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations” of Hospira’s Annual Report on Form 10-Kfor the year ended December 31, 2004. There have been no significant changes inthe application of the critical accounting policies since December 31, 2004.

 

**RecentlyIssued Accounting Standards**

 

In November 2004, the FASBissued SFAS No. 151,“Inventory Costs.” This statement clarifies the accountingfor the abnormal amount of idle facilities expense, freight, handling costs andwasted material. This statement requires that those items be recognized as current-periodexpenses. In addition, the statement requires that allocation of fixed overheadto the cost of conversion be based on the normal capacity of the productionfacilities.  For Hospira, this statementis effective for inventory costs incurred after December 31, 2005. Hospira iscurrently evaluating the potential impact of SFAS No. 151 on its financialposition and results of operations.

 

In December 2004, the FASB issued SFAS No. 123R, “Share-BasedPayment,” which requires, among other changes, that the cost

 

16

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resulting from all share-based payment transactions berecognized as compensation cost over the vesting period based on the fair valueof the instrument on the date of grant. SFAS No. 123R revises SFAS No. 123, “Accountingfor Stock-Based Compensation,” which previously allowed pro forma disclosure ofcertain share-based compensation expense. Further, SFAS No. 123R supercedesAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” which previously allowed the intrinsic value method of accountingfor stock options rather than the fair value method when determining optionvalue used to measure compensation cost. Since Hospira currently accounts forshare-based payments using the intrinsic value method, Hospira’s results ofoperations have not included the recognition of compensation expense. HadHospira applied the fair-value criteria established in SFAS No. 123R toprevious stock option grants, the impact to the results of operations wouldhave approximated the pro forma expense under SFAS No. 123, which is disclosedin Note 12. On April 14, 2005, the SEC adopted a rule that amended thecompliance dates of SFAS No. 123R to require implementation no later than thebeginning of the first fiscal year which begins after June 15, 2005 (January 1,2006 for Hospira). The effect of adopting SFAS No. 123R on diluted earnings pershare in future periods is dependent on the number of options granted in thefuture, the terms of those awards and their fair values.

 

The American Jobs CreationAct of 2004 (“Jobs Act”), which was signed into law on October 22, 2004,provides for a special one-time dividends received deduction on therepatriation of certain foreign earnings to a U.S. taxpayer, provided certaincriteria are met. Hospira has determined that it will repatriate $175 millionof qualified undistributed foreign earnings. In accordance with FASB StaffPosition 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings RepatriationProvision within the American Jobs Creation Act of 2004,” the income taxrelated to this repatriation is $9.5 million and has been recognized in thethird quarter of 2005. The repatriation of funds will occur during the fourthquarter of 2005.

 

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections” (“SFAS No. 154”), which changes the requirementsfor the accounting and reporting of a voluntary change in accounting principle.The statement requires retrospective application to prior periods’ financialstatements, or the latest practicable date, as the required method forreporting a change in accounting principle. Previous rules generally requiredthat changes in accounting principles were recognized by including the cumulativeeffect of the change in net income in the period of change. SFAS No. 154 iseffective for accounting changes made in fiscal years beginning after December15, 2005. Adoption of this standard is not expected to have a material effecton Hospira’s financial position or results of operations.

 

**2005 Third Quarter Highlights**

 

•      Launchedthe generic injectable drug ceftriaxone in the United States on the day ofpatent expiration, capturing an estimated initial hospital market share of 35percent. 

 

•      Addedfive new compounds to the generic injectable drug pipeline, scheduled forlaunch in 2008 and beyond.  

 

•      Launchedthe international regional headquarters for Latin America in Mexico City.Transferred the operations and net assets in 18 countries from AbbottLaboratories to Hospira. Through September 30, 2005, Hospira has launched threeof its four regional headquarters, and transferred operations in 20 countries.

 

•      Announcedthe planned closure of a medical device manufacturing plant in Donegal, Ireland.Products manufactured at the Donegal plant are expected to move to Hospira’sfacilities in Costa Rica and the Dominican Republic.

 

•      Completedthe acquisition of Physiometrix, Inc., a medical device manufacturer. Theacquisition will broaden Hospira’s portfolio of products for the hospitaloperating room and intensive care unit, providing brain-function monitoringdevices used during surgical and diagnostic procedures. 

 

**Risk Factors**

 

Pleaserefer to “Item 1. Business - Risk Factors” in Hospira’s Annual Report on Form10-K for the year ended December 31, 2004 for a discussion of risks to whichHospira’s business, financial condition, results of operations and cash flowsare subject.  

 

**Factorsthat Influence Results of Operations**

 

In “Item7. Management’s Discussion and Analysis of Financial Condition and Results ofOperation” in Hospira’s Annual Report on Form 10-K for the year ended December31, 2004, Hospira highlighted certain factors that influence its results ofoperations.  Other than as discussed below, Hospira is not aware of anysignificant changes in such factors since December 31, 2004.

 

As disclosed in Note 4, in August 2005, Hospiraannounced plans to close its medical device manufacturing plant in Donegal,Ireland. Products produced at the Donegal plant are expected to move to Hospirafacilities in Costa Rica and the Dominican Republic, which haveavailable manufacturing capacity to absorb the transfers. Approximately550 Donegal employees will be 

 

17

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affected by the closing. The aggregate charges thatHospira will incur related to the plant closing are expected to be in the rangeof $30 million to $40 million on a pre-tax basis and will be reported in theInternational segment. The restructuring costs consist primarily of costsrelated to severance and other employee benefit costs, additional depreciationresulting from the decreased useful lives of certain equipment and building,and other exit costs. Hospira expects to incur severance and certain otheremployee benefit costs over the expected service period of the relatedemployees and all other exit costs as they are incurred through mid 2007. As ofSeptember 30, 2005, Hospira incurred pre-tax costs of $2.3 million, which arerecorded in cost of products sold and primarily relate to severance and otheremployee benefit costs. To date, no cash payments have been made for thesecosts. 

 

Hospirauses resins and other materials dependent on oil and natural gas as rawmaterials in many of its products. The cost of resins and other raw materials,as well as utilities and freight involved in the manufacturing and shipping ofHospira’s products, are increasing significantly. As a result, Hospira isexperiencing increased costs to produce its products. Hospira may be able tomitigate a portion of these cost increases through price increases, and isinvestigating other means to minimize their impact. However, Hospira may not beable to offset these cost increases, which could result in lower margins. 

 

Until thesecond quarter of 2005, Hospira had historically distributed certain imagingagent products of Berlex, Inc. During the fourth quarter of 2004, Hospirareceived notification from Berlex that it was exercising the “wind-down” clausein the distribution agreement. The wind-down was completed in the secondquarter of 2005, and Hospira no longer distributes Berlex imaging agents.Hospira recognized sales under the completed Berlex agreement of $67 million inthe first half of 2005. Operating profits for the full year 2005 related to thetermination of the Berlex distribution agreement have been negatively affectedby $9 million compared to 2004.

 

Some wholesalers of Hospira’s genericinjectable pharmaceutical products are attempting to implement a fee-for-servicemodel for the distribution of such products. Hospira is evaluating thepotential impact of this possible change on its drug wholesale business model.Certain drug wholesalers have taken unilateral steps to implement service feesand are invoicing Hospira for these fees. One wholesaler has deducted thesefees from amounts payable to Hospira. Hospira denies that it owes additional service fees under its existingcontracts with these drug wholesalers and has not recorded any provisions forthese fees. Hospira is continuing to address this matter with the drugwholesalers, group purchasing organizations (“GPO”) and its customers toresolve this matter. If Hospira does not reach a satisfactory resolution ofthis matter with the wholesalers, Hospira will consider directly distributingthese products.  If these fees aresuccessfully implemented or if Hospira uses alternative methods ofdistribution, including direct distribution, Hospira could experience increasedcosts to distribute its products, which could be material.

 

Approximately 50 percent of Hospira’s net sales aremade under numerous contracts with GPO’s. Typically, these contracts cover aportion of Hospira’s product lines, specify the prices for Hospira’s products,and are effective for three to five years. Generally, the contracts areextended or competitively bid prior to contract expiration. Hospira had fiveGPO pharmacy contracts to be renewed or renegotiated during 2005. Of these fiveGPO pharmacy contracts, three have been extended into 2006 and two newmulti-year contracts were signed. 

 

**Results of operations for the threemonths ended September 30, 2005 compared to September 30, 2004**

 

*Net Sales*

 

Net sales increased 0.1% in the third quarter of 2005compared to the third quarter of 2004. Sales to third parties represented a(0.6)% decline in overall sales, driven by volume/mix of (3.0)%, which includesthe unfavorable impact of the Berlex contract termination of (7.9)% as well as1.1% related to sales-type lease accounting for pumps, partially offset by theimpact of exchange of 0.5% and price of 1.9%. In late 2004, Hospira changed itsbusiness model, which resulted in sales-type lease accounting for certain newpump leases. Sales to Abbott had a favorable impact of 0.7% on overall sales, drivenby increased demand.

 

18

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Acomparison of product line sales is as follows:

 

**Hospira, Inc.**

**Sales by Product Line**

**(Unaudited)**

**(dollars in millions)**

 
| ** **                                        | ** ** | **Three Months Ended September 30** | ** ** |
|---------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                        | ** ** | ** **                          | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                                        | ** ** | ** **                          | ** ** | ** ** | ** ** | **Change** | ** ** |
| ** **                                        | ** ** | ** **                          | ** ** | ** ** | ** ** | **vs. Prior** | ** ** |
| ** **                                        | ** ** | **2005**                            | ** ** | **2004** | ** ** | **Year*** | ** ** |
| U.S. —                                       |       |                                |       |   |   |   |   |
| Specialty  Injectable Pharmaceuticals             |       | $                                   | 205        |   | $ | 235 |   | (12.6 | ) |
| Medication  Delivery Systems                      |       | 206                                 |       | 187 |   | 10.3 |   |
| Injectable  Pharmaceutical Contract Manufacturing |       | 44                                  |       | 46 |   | (4.5 | ) |
| Sales to  Abbott Laboratories                     |       | 26                                  |       | 24 |   | 4.1 |   |
| Other                                             |       | 71                                  |       | 65 |   | 8.9 |   |
|                                              |       |                                |       |   |   |   |   |
| Total U.S.                                        |       | 552                                 |       | 557 |   | (1.0 | ) |
|                                              |       |                                |       |   |   |   |   |
| International  —                             |       |                                |       |   |   |   |   |
|                                              |       |                                |       |   |   |   |   |
| Sales to  Third Parties                           |       | 88                                  |       | 85 |   | 2.6 |   |
| Sales to  Abbott Laboratories                     |       | 17                                  |       | 14 |   | 27.9 |   |
|                                              |       |                                |       |   |   |   |   |
| Total  International Sales                        |       | 105                                 |       | 99 |   | 6.0 |   |
|                                              |       |                                |       |   |   |   |   |
| Consolidated  Net Sales                           |       | $                                   | 657        |   | $ | 656 |   | 0.1 |   |

 

----

* Percent change computed basedon unrounded numbers.

 

The sales decrease in Specialty InjectablePharmaceuticals was primarily due to the termination of the Berlex imagingagents distribution agreement. Sales of the remainder of the SpecialtyInjectable Pharmaceuticals product line were strong, driven by the impact ofthe launch of ceftriaxone, increased sales of syringe products, increased salesof certain anti-infective products (which Hospira believes was partially drivenby a competitor’s inability to supply product), and favorable price. The salesincrease in Medication Delivery Systems was driven by growth in both medicationmanagement systems and infusion therapy products. The growth in medicationmanagement was due to placements of Hospira’s newer technology Plum A+® pumpswith Hospira MedNetTM and the impact of the change in business model in late2004, which resulted in sales-type lease accounting for certain new pumpleases. The growth in infusion therapy product sales was driven by favorablevolume/mix, partially offset by the expiration of a contract under whichHospira sold product to a competitor.****The salesdecrease in Injectable Pharmaceutical Contract Manufacturing was primarily dueto the termination of certain contracts, partially offset by favorable price. 

 

The increase in U.S. Salesto Abbott was primarily due to increased demand by Abbott for several of itsproducts. The increase in Other U.S. sales was primarily due to increased salesof new products (ceftriaxone and deferoxamine) to alternate site healthcarecustomers. Hospira expects increased competition to negatively impact its deferoxaminesales in the future.

 

International Sales to ThirdParties were up, reflecting favorable exchange, partially offset by thetermination of a third party manufacturing contract.  International Sales to Abbott increasedprimarily due to increased demand.

 

*Gross Profit*

 

Gross profit increased $33.7 million, or 17.4 %, forthe quarter ended September 30, 2005, compared with the same period in 2004.Gross profit margin increased to 34.7 % for the third quarter of 2005, from29.5 % for the third quarter of 2004. The increased margin is primarily theresult of volume/product mix improvement of 3.8%, which includes the impact ofBerlex of 2.0%, price of 1.2%, and other changes of 0.2%. 

 

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*Research and Development*

 

Research and development expenses increased $7.5million, or 26.9 %, for the quarter ended September 30, 2005, compared with thesame period in 2004. The increase was primarily due to spending on new productdevelopment related to integrated software for drug delivery devices that helpprevent medication errors, a next generation drug delivery device and newcompounds added to Hospira’s generic injectable drug pipeline. Research anddevelopment expenses increased to 5.4 % of net sales for the quarter endedSeptember 30, 2005, compared with 4.3 % of net sales for the same period in2004. 

 

*Selling, General and Administrative*

 

Selling, general and administrative expenses increased$19.6 million, or 27.2%, for the quarter ended September 30, 2005, comparedwith the same period in 2004. The increase was primarily due to additionalcosts related to becoming a separate stand-alone public company.  These costs include the establishment ofcorporate functions, information technology and other costs relating to establishingbusiness infrastructure outside the United States. Selling, general andadministrative expenses increased to 13.9 % of net sales for the quarter endedSeptember 30, 2005, compared with 11.0 % of net sales for the same period in2004.

 

*Interest and Other (Income), Net*

 

Interest expense was $6.9 million for the quarterended September 30, 2005, compared to $8.3 million in the same period in 2004.The decrease was primarily due to the interest rate swap entered into in 2005and higher capitalized interest in 2005. Other (income), net was $(3.4) millionfor the three months ended September 30, 2005 compared to $(2.5) million forthe three months ended September 30, 2004. The change was primarily related tohigher interest income in 2005. 

 

*Income Tax Expense*

 

The effective tax rate was 38.3% for the quarter endedSeptember 30, 2005, compared to 30.5% for the same period in 2004. In the thirdquarter of 2005, Hospira increased its annual effective tax rate from 24% to25.5%, excluding the impact of the repatriation noted below, due to an increasein expected earnings in the U.S., which has a higher tax rate than foreignjurisdictions. The effective tax rates are less than the statutory U.S. federalincome tax rate principally due to the benefit of tax exemptions, of varyingdurations, in several taxing jurisdictions. In addition, included in the thirdquarter of 2005 is tax of $9.5 million related to the decision to repatriateundistributed foreign earnings of $175 million under the Jobs Act. Therepatriation of funds will occur in the fourth quarter of 2005. The thirdquarter of 2004 included the impact of a change in the estimated 2004 annualeffective tax rate from 24% to 26%. 

 

**Results of operations for the ninemonths ended****September****30, 2005 compared to****September********30, 2004**

 

The results of Hospira’s operations for the nine months ended September 30, 2004combine Hospira’s operations as a part of Abbott for periods prior to thespin-off date and Hospira’s operations as a separate, stand-alone entity afterthe spin-off date.

 

*Net Sales*

 

Net sales increased 1.8% for the nine months ended September 30, 2005,compared to the nine monthsended September 30, 2004. Sales to third parties represented 1.9% growth inoverall sales, driven by exchange of 0.5%, price of 1.3% and volume/product mixof 0.1%, which includes the unfavorable impact of the Berlex contracttermination of (4.0)% as well as 1.0% related to sales-type lease accountingfor pumps. In late 2004, Hospira changed its business model, which resulted insales-type lease accounting for certain new pump leases. Sales to Abbott had anunfavorable impact of (0.1)% on overall sales growth, driven by the exclusionof the bulk drug cost from the pricing for certain products post-spin,partially offset by increased demand.  

 

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Acomparison of product line sales is as follows:

 

**Hospira, Inc.**

**Sales by Product Line**

**(Unaudited)**

**(dollars in millions)**

 
| ** **                                        | ** ** | **Nine Months Ended September 30** | ** ** |
|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                                        | ** ** | ** **                         | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                                        | ** ** | ** **                         | ** ** | ** ** | ** ** | **Change** | ** ** |
| ** **                                        | ** ** | ** **                         | ** ** | ** ** | ** ** | **vs. Prior** | ** ** |
| ** **                                        | ** ** | **2005**                           | ** ** | **2004** | ** ** | **Year*** | ** ** |
| U.S. —                                       |       |                               |       |   |   |   |   |
| Specialty  Injectable Pharmaceuticals             |       | $                                  | 631        |   | $ | 661 |   | (4.6 | ) |
| Medication  Delivery Systems                      |       | 599                                |       | 566 |   | 5.8 |   |
| Injectable  Pharmaceutical Contract Manufacturing |       | 146                                |       | 130 |   | 12.6 |   |
| Sales to  Abbott Laboratories                     |       | 80                                 |       | 95 |   | (15.1 | ) |
| Other                                             |       | 195                                |       | 181 |   | 7.4 |   |
|                                              |       |                               |       |   |   |   |   |
| Total U.S.                                        |       | 1,651                              |       | 1,633 |   | 1.1 |   |
|                                              |       |                               |       |   |   |   |   |
| International  —                             |       |                               |       |   |   |   |   |
|                                              |       |                               |       |   |   |   |   |
| Sales to  Third Parties                           |       | 279                                |       | 273 |   | 2.3 |   |
| Sales to  Abbott Laboratories                     |       | 51                                 |       | 39 |   | 30.3 |   |
|                                              |       |                               |       |   |   |   |   |
| Total  International Sales                        |       | 330                                |       | 312 |   | 5.8 |   |
|                                              |       |                               |       |   |   |   |   |
| Consolidated  Net Sales                           |       | $                                  | 1,981      |   | $ | 1,945 |   | 1.8 |   |

 

----

* Percent change computed basedon unrounded numbers.

 

Sales in Specialty Injectable Pharmaceuticalsdeclined, reflecting the termination of the Berlex imaging agents distribution agreementand the impact of increased generic competition on Hospira’s Corlopam® product.Sales of the remainder of the Specialty Injectable Pharmaceuticals product linewere strong, driven by the impact of sales of new products (ceftriaxone andfluconazole), increased volumes of syringe products, certain anti-infectives(which Hospira believes was partially driven by a competitor’s inability tosupply product in the third quarter of 2005) and generic anesthesia products;and favorable price. The sales increase in Medication Delivery Systems wasdriven by growth in medication management systems, partially offset by adecline in infusion therapy products. The growth in medication management was due to placements of Hospira’snewer technology Plum A+® pumps with Hospira MedNetTM and the impact of thechange in business model in late 2004, which resulted in sales-type leaseaccounting for certain new pump leases. The decline in infusion therapy productsales was driven by the expiration of a contract under which Hospira soldproduct to a competitor, as well as lower pricing on sets, partially offset byother favorable volume/mix.****The salesincrease in Injectable Pharmaceutical Contract Manufacturing was primarily dueto favorable price and growth in demand for several existing supply agreements,partially offset by the impact of the termination of certain contracts. 

 

The decrease in U.S. Sales to Abbott was due to theexclusion of the cost of the bulk drug subsequent to the spin-off for certainproducts manufactured for Abbott, while 2004 (through April) included the costof these bulk drugs. This reflects the post spin-off manufacturing arrangementbetween Hospira and Abbott, under which Abbott transfers the bulk drug toHospira for processing and Hospira’s sales include only the value-added portionplus a markup for these products. This reduction was partially offset byincreased demand by Abbott for several of its products and by the markup onproduct sold to Abbott after the spin-off. The increase in Other U.S. sales wasprimarily due to increased sales of new products (ceftriaxone and deferoxamine) toalternate site healthcare customers, partially offset by a decline in criticalcare products. Hospira expectsincreased competition to negatively impact its deferoxamine sales in thefuture.

 

International Sales to Third Parties increasedprimarily due to favorable foreign exchange rates, partially offset by lowervolumes and the termination of a third party manufacturing contract.International Sales to Abbott increased primarily due to the impact of 

 

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the markup on products sold to Abbott after thespin-off, coupled with volume related to an additional product manufactured forAbbott subsequent to the spin-off, partially offset by reduced demand on other products.

 

*Gross Profit*

 

Gross profit increased $91.0 million, or 15.9%, forthe nine months ended September 30, 2005, compared with the same period in2004. Gross profit margin increased to 33.5% for the nine months ended 2005,from 29.5 % for the nine months ended 2004. The increased margin is primarilythe result of volume/product mix improvement of 2.5%, which includes the impactof Berlex of 0.9%; reduced benefit costs of 1.1% as a result of the changes inbenefit plans in 2004; price of 0.9%, and other changes of 0.2%. Theseincreases were partially offset by charges of (0.7)% resulting from assetimpairment and obligations assumed related to the sale of the Salt Lake City,Utah manufacturing facility to ICU Medical. 

 

*Research and Development*

 

Research and development expenses increased $16.2million, or 20.2%, for the nine months ended September 30, 2005, compared withthe same period in 2004. The increase was primarily due to spending on newproduct development related to integrated software for drug delivery devicesthat help prevent medication errors, a next generation drug delivery device andnew compounds added to Hospira’s generic injectable drug pipeline, partiallyoffset by reduced benefit costs as a result of the changes in benefit plans in2004. Research and development expenses increased to 4.9% of net sales for thenine months ended September 30, 2005, compared with 4.1% of net sales for thesame period in 2004. 

 

*Selling, General and Administrative*

 

Selling, general and administrative expenses increased$64.4 million, or 32.8%, for the nine months ended September 30, 2005, comparedwith the same period in 2004. The increase was primarily due to additionalcosts related to becoming a separate stand-alone public company. These costsinclude the establishment of corporate functions, information technology andother costs relating to establishing business infrastructure outside the UnitedStates. The increase in costs was partially offset by reduced employee benefitcosts as a result of the changes in benefit plans in 2004. Selling, general andadministrative expenses increased to 13.2% of net sales for the nine monthsended September 30, 2005, compared with 10.1% of net sales for the same periodin 2004.

 

*Curtailmentof Post-retirement Medical and Dental Benefits*

 

In the second quarter of 2004, Hospira evaluated itsretirement benefit programs and announced a series of benefit plan changeswhich included the discontinuation of the U.S. non-union post-retirementmedical and dental plan. The effect of the discontinuation of thepost-retirement medical and dental plan was a non-cash pre-tax benefit of $64.6million resulting from the reversal of the related liability.

 

*Interest and Other (Income), Net*

 

Interest expense was $20.9 million for the nine monthsended September 30, 2005, compared to $11.0 million in the same period in 2004.The increase was primarily due to interest relating to the senior unsecurednotes, which were issued in June 2004 to repay the senior unsecured creditfacility that Hospira incurred as part of the spin-off. Other (income), net was$(8.1) million for the nine months ended September 30, 2005, compared to $(1.1)million for the nine months ended September 30, 2004. The change was primarilyrelated to interest income in 2005. Prior to the spin-off, Hospira, as part ofAbbott, did not hold cash.

 

*Income Tax Expense*

 

The effective tax rate was 28.7% for nine months endedSeptember 30, 2005, compared to 28.1% for the same period in 2004. In the thirdquarter of 2005, Hospira increased its annual effective tax rate from 24% to25.5%, excluding the impact of the repatriation noted below, due to an increasein expected earnings in the U.S., which has a higher tax rate than foreignjurisdictions. The effective tax rates are less than the statutory U.S. federalincome tax rate principally due to the benefit of tax exemptions, of varyingdurations, in several taxing jurisdictions. Included in the nine months endedSeptember 30, 2005 is tax of $9.5 million related to the decision to repatriateundistributed foreign earnings of $175 million under the Jobs Act. Therepatriation of funds will occur in the fourth quarter of 2005. The effectivetax rate for the nine months ended September 30, 2004 included the impact of asignificant unusual item, the curtailment of the post-retirement medical anddental plan noted above and a change in the 2004 estimated annual effective taxrate, excluding the effect of the curtailment, from 24% to 26%. 

 

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**Liquidity and Capital Resources atSeptember 30, 2005 compared with December 31, 2004**

 

Net Cash From Operating Activities continues to beHospira’s primary source of funds to finance operating needs and capital expenditures.Capital resources include cash on hand and borrowing availability under Hospira’s$375 million credit facility.

 

Operating activities providednet cash of $471.3 million, primarily driven by net income of $209.1 million,non-cash depreciation and amortization charges of $118.0 million, and changesin operating assets and liabilities of $144.2 million. The changes in operatingassets and liabilities consist primarily of an increase in salaries payable andother accruals including those resulting from obligations assumed related tothe sale of the Salt Lake City, Utah manufacturing facility to ICU and rebates,an increase in accounts payable, and an increase in taxes payable, net of cashpayments, which is included in Other, net.

 

Net Cash Used in Investing Activities of $116.1million includes capital expenditures of $189.5 million for upgrading andexpanding manufacturing and administrative support facilities and informationtechnology systems. In addition, investing activities includes the use of cashof $23.6 million for the acquisition of Physiometrix and purchases of certainintangibles and other investments of $7.2 million. These are offset by $72.4million in proceeds from the sales of marketable debt securities and $31.8million in proceeds from the sale of the Salt Lake City, Utah manufacturingfacility and related assets to ICU.  

 

Net Cash Used in Financing Activities of $3.4 millionconsists primarily of payments to Abbott for international net assets of  $106.5 million, and other borrowingactivities, which are further described below, offset by proceeds from employeestock option exercises of $97.6 million. 

 

Hospira believes that its current capital resources,including cash and cash equivalents, cash generated from operations, and fundsavailable from its revolving credit facility will be sufficient to finance itsoperations, including product development, transition costs, international netasset transfers, and capital expenditures, for the foreseeable future.

 

In March 2005, Hospira issued economic developmentpromissory notes, the proceeds of which were used for a distribution facilityexpansion. The $1.75 million ten-year notes bear a fixed rate of interest of2%, with principal and interest due monthly.

 

During the third quarter of 2005, Hospira entered intovarious loan agreements related to the legal transfer of certain operationsfrom Abbott. Hospira borrowed 270 million Chilean Pesos ($0.5 million U.S.Dollars) and, in two separate loans, 10 billion Colombian Pesos (a total of $4.3million U.S. Dollars). The Chilean loan bears interest of 5.4% and is dueNovember 2005. The loans of 8 billion and 2 billion Colombian Pesos bearinterest of 9% and 8.8% and are due March 2006 and October 2005, respectively.Principal and interest on these loans are due upon expiration. It isanticipated that, over time, local borrowings such as these will be used tooptimize the capital structure in certain foreign affiliates.

 

Hospira’s revolving credit facility consists of anunsecured revolving credit facility of $375 million (“Revolver”) that isavailable for working capital and other requirements. On April 29, 2005, the Revolver was amendedto reduce or eliminate certain restrictions, in order to increase Hospira’soperating flexibility. The Revolver allows Hospira to borrow funds on anunsecured basis at variable interest rates as short-term cash needs dictate. Asof September 30, 2005, Hospira had no amounts outstanding under the Revolver.

 

The amended Revolver and theSenior Unsecured Notes contain, among other provisions, covenants with whichHospira must comply while they are in force. The covenants limit Hospira’sability to allow liens on its properties or assets, or merge or consolidatewith any other corporation.  The amendedRevolver also limits Hospira’s ability to sell its assets.  Under the amended Revolver, Hospira must alsocomply with certain financial covenants, including interest coverage ratio,leverage ratio and minimum consolidated net worth. As of September 30, 2005,Hospira was in compliance with all covenants under the amended Revolver and theSenior Unsecured Notes.

  

In connection with the spin-off, Hospira and Abbottagreed that the legal transfer of certain operations and assets (net ofliabilities) outside the United States would occur, and be completed, withintwo years after the spin-off. These operations and assets are used in theconduct of Hospira’s international business and Hospira is subject to the risksand entitled to the benefits generated by such operations and assets. Hospirais obligated to pay Abbott for these operations and assets, and assume thecorresponding liabilities, over a two-year period after the spin-off date asHospira establishes its business infrastructure outside the United States andobtains regulatory approval for the transfer of the marketing authorizationsfor Hospira products to local Hospira affiliates or third-party distributors.The amount payable is equal to the net book value of those assets andliabilities at the time of such transfer. Accordingly, the net book value willbe affected by normal operations, exchange rates and other business factors.Hospira pays Abbott interest, at local prevailing short-term rates, inconnection with Hospira’s use of certain of these assets during that period. Asof September 30, 2005, the net book value of the assets and liabilities thathad not yet transferred was $146.2 million. The net book value is primarilycomprised of accounts receivable of $52.2 million, inventory of $57.1 million,equipment of $35.4 million and other, net of $1.5 million. Each amount has beenincluded in the corresponding balance sheet line item. The amount due to Abbottfor the net book value of assets and liabilities is offset by $84.4 million foritems that are due from Abbott related to the international business. Theseitems include amounts due for operating profits and inventory purchases ofHospira products to support the 

 

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international business. All amounts outstanding betweenHospira and Abbott are included in Due to Abbott, Net on the balance sheet. Inthe second and third quarter of 2005, the net assets of several countries werelegally transferred from Abbott. The total amounts paid were $60.7 million and$106.5 million for the three and nine months ended September 30, 2005,respectively. Subsequent to September 30, 2005, the net assets of severaladditional countries were transferred. Hospira expects to transfer the netassets of additional countries each quarter throughout the remaining transitionperiod.

 

**Contractual Obligations**

 

Hospira has nomaterial exposures to off-balance sheet arrangements, no special purposeentities, and no activities that include non-exchange-traded contractsaccounted for at fair value.  

 

The followingtable summarizes Hospira’s estimated contractual obligations as of September 30, 2005 (dollars in millions):

 
| ** **                                                                   | ** ** | **Payment Due by Period** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                   | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2010 and** | ** ** |
| ** **                                                                   | ** ** | **Total**                 | ** ** | **2005** | ** ** | **2006-2007** | ** ** | **2008-2009** | ** ** | **Thereafter** | ** ** |
| Long-term  debt and interest payments                                        |       | $                         | 997.9      |   | $ | 20.7 |   | $ | 80.9 |   | $ | 377.2 |   | $ | 519.1 |   |
| Lease  obligations                                                           |       | 164.8                     |       | 6.8 |   | 41.8 |   | 37.9 |   | 78.3 |   |
| Purchase  commitments (1)                                                    |       | 404.0                     |       | 276.5 |   | 122.5 |   | 5.0 |   | — |   |
| Other long-term liabilities reflected on  the consolidated balance sheet (2) |       | 18.4                      |       | — |   | 18.4 |   | — |   | — |   |
| Amounts due to Abbott for transfer of certain  international net assets (3)  |       | 146.2                     |       | 36.9 |   | 109.3 |   | — |   | — |   |
| Total                                                                        |       | $                         | 1,731.3    |   | $ | 340.9 |   | $ | 372.9 |   | $ | 420.1 |   | $ | 597.4 |   |

 

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(1)   Purchase commitments consist primarily of inventory purchases madein the normal course of business to meet operational requirements.

(2)   Excludes $86.4 million of other long-term liabilities relatedprimarily to post-retirement benefit plans. 

(3)   The amount due to Abbott for the acquisition of certaininternational net assets excludes an offsetting amount of $84.4 million foritems that are due from Abbott related to the international business. Theseinclude amounts due for operating profits and inventory purchases of Hospiraproducts to support the international business.

 

**Legislative Issues**

 

The Jobs Act, signed into law in October 2004,provides for a special one-time dividends received deduction on therepatriation of certain foreign earnings to a U.S. taxpayer, provided certaincriteria are met. Hospirahas determined that it will repatriate $175 million of qualified undistributedforeign earnings. The income tax related to this repatriation is $9.5 millionand has been recognized in the third quarter of 2005. The repatriation of fundswill occur during the fourth quarter of 2005.

 

Hospira’s primary markets are highly competitive andsubject to substantial government regulation. Hospira expects debate tocontinue at both the federal and state levels over the availability, method ofdelivery and payment for healthcare products and services. If additionallegislation is enacted, it could have the effect of reducing prices, orreducing the rate of price increases, for medical products and services.International operations are also subject to a significant degree of governmentregulation. It is not possible to predict the extent to which Hospira or thehealthcare industry in general might be adversely affected by these factors inthe future. 

 

**Private Securities Litigation ReformAct of 1995 — A Caution Concerning Forward-Looking Statements**

 

Under the safe harbor provisions of the PrivateSecurities Litigation Reform Act of 1995, Hospira cautions investors that anyforward-looking statements or projections made by Hospira, including those madein this document, are subject to risks and uncertainties that may cause actualresults to differ materially from those projected. In some cases, thesestatements can be identified by the use of forward-looking words such as “may,”“will,” “should,” “anticipate,” “estimate,” “expect,” “plan,” “believe,” “predict,”“potential,” “project,” “intend,” “could,” or similar expressions. Inparticular, statements regarding Hospira’s plans, strategies, prospects andexpectations regarding Hospira’s business are forward-looking statements. Pleasebe aware that these statements and any other forward-looking statements in thisdocument only reflect Hospira’s expectations and are not guarantees ofperformance. These statements involve risks, uncertainties and assumptions.Many of these risks, uncertainties and assumptions are beyond Hospira’scontrol, and may cause actual results and performance to differ materially fromHospira’s expectations. 

 

Economic, competitive, governmental, technological andother factors that may affect Hospira’s operations are discussed in 

 

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Hospira’s Annual Report on Form 10-K for the yearended December 31, 2004.  Accordingly,undue reliance should not be placed on the forward-looking statements containedin this document. These forward-looking statements speak only as of the date onwhich the statements were made. Hospira undertakes no obligation to update orrevise publicly any forward-looking statements, whether as a result of newinformation, future events or otherwise.

 

**Item 3.  QuantitativeAnd Qualitative Disclosures About Market Risk**

 

In January 2005, Hospira entered into interest rateswap transactions whereby the $300 million five-year senior unsecured notes duein June 2009 were effectively converted from fixed to floating rate debt.  The objectives of the transactions enteredinto were to (i) maintain a capital structure containing appropriate amounts offixed and floating rate debt, and (ii) lower the interest expense on thesenotes in the near term. Hospira does not expect cash flows from debt relatedinterest rate-sensitive instruments to be affected to a significant degree byreasonable changes in market interest rates.

 

There have been no other material changes to theinformation provided in Hospira’s Annual Report on Form 10-K for the year endedDecember 31, 2004.

 

**Item 4.****   ****Controls and Procedures**

 

(a)   *Evaluation ofdisclosure controls and procedures. *The Chief Executive Officer, ChristopherB. Begley, and Chief Financial Officer, Terrence C. Kearney, evaluated theeffectiveness of Hospira’s disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934) asof the end of the period covered by this report, and concluded that Hospira’sdisclosure controls and procedures were effective. 

 

**(b)****  ***Changes in internalcontrols.*Hospira is in the process of implementing itsindependent information technology system (SAP) both in and outside the UnitedStates. Current plans are to implement all modules of SAP globally, except atthe manufacturing plants, over the next year. Ongoing processes and controlswill be modified during the implementation period as is expected with a majorsystem implementation. Also during the period, business operations in several countrieshave transitioned from Abbott to Hospira. Inherent in such transitions arechanges in Hospira’s internal controls, as processes that were previouslyperformed by Abbott personnel, utilizing Abbott systems, are now beingperformed by Hospira personnel, utilizing Hospira systems (including SAP).  In connection with the implementation of SAPand the transition of the international operations, Hospira has updated, andwill continue to update, its internal control over financial reporting asnecessary to accommodate modifications to its business processes and accountingprocedures. There have been no other changes in internal control over financialreporting that occurred during the period that have materially affected or arereasonably likely to materially affect Hospira’s internal control overfinancial reporting.

 

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**PARTII.  OTHER INFORMATION**

 

**Item1.****       LegalProceedings**

 

Various state and federal agencies, including the U.S.Department of Justice and various state attorneys general, are investigating anumber of pharmaceutical companies, including Abbott, for allegedly engaging inimproper marketing and pricing practices with respect to certain Medicare andMedicaid reimbursable products, including practices relating to averagewholesale price (“AWP”).  These are civilinvestigations that are seeking to identify the practices and determine whetherthose practices violated any laws, including federal and state false claimsacts, or constituted fraud in connection with the Medicare and/or Medicaidreimbursement paid to third parties.  Inaddition, Abbott is a defendant in a number of purported class actions onbehalf of individuals or entities, including healthcare insurers and otherthird-party payors, that allege generally that Abbott and numerous otherpharmaceutical companies reported false or misleading pricing information inconnection with federal, state and private reimbursement for certaindrugs.  Many of the products involved inthese investigations and lawsuits are Hospira products.  Hospira is cooperating with the authoritiesin these investigations. There may be additional investigations or lawsuits, oradditional claims in the existing investigations or lawsuits, initiated withrespect to these matters in the future. Hospira cannot be certain that it will not be named as a subject ordefendant in these investigations or lawsuits. Hospira has been added as a defendant in one AWP proceeding, *The State of Texas ex rel. Ven-A-Care of the FloridaKeys, Inc. v. Abbott Laboratories Inc., Hospira, Inc., B. Braun Medical Inc.and Baxter Healthcare Corporation,*Case No. GV401286, pending in theDistrict Court of Travis County, Texas. The lawsuit alleges generally that the defendants made falserepresentations of prices and costs for drugs directly and indirectly to theTexas Medicaid Program.  Abbott willindemnify Hospira for liabilities associated with pending or future AWPinvestigations and lawsuits only to the extent that they are of the same natureas the lawsuits and investigations that existed against Abbott as of thespin-off date and relate to the sale of Hospira products prior to thespin-off.  Hospira will assume any otherlosses that may result from these investigations and lawsuits related to Hospira’sproducts. These investigations and lawsuits could result in changes to Hospira’sbusiness practices or pricing policies, civil or criminal monetary damages,penalties or fines, imprisonment and/or exclusion of Hospira products fromparticipation in federal and state healthcare programs, including Medicare,Medicaid and Veterans’ Administration health programs, any of which could havea material adverse effect on its business, profitability and financialcondition.

 

Hospira has been named as a defendant in a lawsuitbrought by three employees alleging generally that the spin-off of Hospira fromAbbott Laboratories adversely affected employee benefits in violation of theEmployee Retirement Income Security Act of 1974. The lawsuit was filed on November8, 2004, in the United States District Court for the Northern District ofIllinois, and is captioned: *Myla Nauman,Jane Roller and Michael Loughery v. Abbott Laboratories and Hospira, Inc*.The lawsuit seeks class action certification on behalf of “All employees ofAbbott who were participants and beneficiaries of the Abbott Benefit Planswhose employment with Abbott was terminated between August 22, 2003 and April30, 2004, as a result of the spin-off announced by Abbott on August 22, 2003.”On April 27, 2005, the court issued an opinion denying the motions of Abbottand Hospira to dismiss the complaint. The ruling is not a determination of themerits of the plaintiffs’ claims. Hospira denies all material allegationsasserted against it in the complaint.

 

On August 12, 2005, Retractable Technologies, Inc. (“RTI”)filed a lawsuit against Abbott Laboratories, Inc. alleging breach of contractand fraud in connection with a National Marketing and Distribution Agreement (“Agreement”)between Abbott and RTI signed in May 2000. *Retractable Technologies,Inc. v. Abbott Laboratories, Inc.*, Case No. 505CV157, pending inU.S. District Court for the Eastern District of Texas. RTI purported toterminate the contract for breach in 2003. The lawsuit alleges that Abbott misledRTI and breached the Agreement in connection with Abbott’s marketing efforts.RTI seeks unspecified monetary damages as well as punitive damages. Hospira hasconditionally agreed to defend and indemnify Abbott in connection with thislawsuit, which involves a contract carried out by Abbott’s former HospitalProducts Division. Abbott denies all material allegations in the complaint.Additionally, Abbott maintains that the dispute must be resolved byarbitration, in accordance with the terms of the Agreement. Abbott intends topursue claims against RTI for breach of the Agreement in arbitration or infederal court. Hospira is entitled, pursuant to its agreements with Abbott, toany amounts recovered due to RTI’s breach of the Agreement.

 

Additional legal proceedings may occur that may resultin a change in the estimated reserves recorded by Hospira. It is not feasibleto predict the outcome of such proceedings with certainty and there can be noassurance that their ultimate disposition will not have a material adverseeffect on Hospira’s financial position, cash flows, or results of operations.

 

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**Item 2.****       Changes inSecurities and Use of Proceeds**

 

(c)       Issuer Purchases of EquitySecurities

 

The table below givesinformation on a monthly basis regarding purchases made by Hospira of itscommon stock.

 
| ** **                       | ** ** | ** **        | ** ** | ** **     | ** ** | **Total Number of**  | ** ** | ** **                | ** ** |
|----------------------------------|------------|-------------------|------------|----------------|------------|----------------------|------------|---------------------------|------------|
| ** **                       | ** ** | ** **        | ** ** | ** **     | ** ** | **Shares**           | ** ** | **Maximum Number (or**    | ** ** |
| ** **                       | ** ** | ** **        | ** ** | ** **     | ** ** | **Purchased as**     | ** ** | **Approximate Dollar**    | ** ** |
| ** **                       | ** ** | **Total**         | ** ** | ** **     | ** ** | **Part of Publicly** | ** ** | **Value) of Shares that** | ** ** |
| ** **                       | ** ** | **Number of**     | ** ** | **Average**    | ** ** | **Announced**        | ** ** | **May Yet be Purchased**  | ** ** |
| ** **                       | ** ** | **Shares**        | ** ** | **Price Paid** | ** ** | **Plans or**         | ** ** | **Under the Plans or**    | ** ** |
| **Period**                       | ** ** | **Purchased (1)** | ** ** | **per Share**  | ** ** | **Programs**         | ** ** | **Programs**              | ** ** |
| July 1- July  31, 2005           |       | 20,834            |       | $              | 39.04      |                 | —     |                      | —     |   |
| August 1-  August 31, 2005       |       | 14,789            |       | 38.03          |       | —               |       | —                    |       |
| September 1-  September 30, 2005 |       | 75,487            |       | 40.85          |       | —               |       | —                    |       |
| Total                            |       | 111,110           |       | $              | 40.14      |                 |       |                      |       |   |

 

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| (1) |   | These shares  represent the shares deemed surrendered to Hospira to pay the exercise price  and satisfy tax withholding obligations in connection with the exercise of  employee stock options. |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**Item 6.****   ****Exhibits**

 

(a)           Exhibits

 
| **EXHIBIT   NO.** |   | **DESCRIPTION**                                                                                                                                                                                        |
|-------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|              |   |                                                                                                                                                                                                   |
| 10.1              |   | Hosipra, Inc. Non-Employee Directors’ Fee Plan, as amended October  26, 2005 (incorporated by reference to Exhibit 10.1 to Hospira’s Current  Report on Form 8-K filed on October 28, 2005). |
|              |   |                                                                                                                                                                                                   |
| 12                |   | Computation of Ratio of Earnings to Fixed Charges.                                                                                                                                                     |
|              |   |                                                                                                                                                                                                   |
| 31.1              |   | Certificate of Chief Executive Officer pursuant to Rule 13a-14(a).                                                                                                                                     |
|              |   |                                                                                                                                                                                                   |
| 31.2              |   | Certificate of Chief Financial Officer pursuant to Rule 13a-14(a).                                                                                                                                     |
|              |   |                                                                                                                                                                                                   |
| 32.1              |   | Certificate of Chief Executive Officer pursuant to 18 U.S.C. Section  1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                      |
|              |   |                                                                                                                                                                                                   |
| 32.2              |   | Certificate of Chief Financial Officer pursuant to 18 U.S.C. Section  1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                      |

 

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SIGNATURE

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                          | HOSPIRA,  INC. |
|-------------------------------|----------------|
|                          |           |   |
|                          |           |   |
|                          | By:            |   | /s/  Terrence C. Kearney |
|                          |           |   | Terrence C.  Kearney, |
|                          |           |   | Senior Vice  President,  Finance and Chief Financial  Officer |
|                          |           |   |
|                          |           |   |
| Date:  November 10, 2005 |           |   |

 

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