**Table of Contents**

** **

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D. C.  20549**

 

**FORM 10-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, 2008**                                                                                                                               |
|                                                                                                                                                                                     |   |   |
| **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.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**(State or other  jurisdiction  of incorporation or organization) | ** ** | **20-0504497** (I.R.S. Employer  Identification No.) |
|------------------------------------------------------------------------------|------------|------------------------------------------------------|

 

**275 North Field Drive**

**Lake Forest, Illinois 60045**

(Address of principal executive offices, including zip code)

 

**(224) 212-2000**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (l) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of l934 during the preceding l2 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90days.     Yes  x  No o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act.

 
| Large  accelerated filerý |   | Accelerated  filero |   | Non-accelerated  filer o   |   | Smaller  reporting companyo |
|--------------------------------|--------|---------------------|--------|----------------------------|--------|-----------------------------|
|                           |   |                |   | (Do not check if a smaller |   |                        |
|                           |   |                |   | reporting company)         |   |                        |

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the ExchangeAct).     Yes  o No  x

 

As of October 31, 2008, Registrant had outstanding 159,596,593shares of common stock, par value $0.01 per share.

 

 

 

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Tableof Contents

 

**Hospira, Inc.**

 

**Quarterly Report 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, 2008 and September 30, 2007 | 3      |
|     |                                                                                                                                             |   |
|     | Condensed Consolidated  Statements of Cash Flows (Unaudited) – Nine Months Ended September 30,  2008 and September 30, 2007       | 4      |
|     |                                                                                                                                             |   |
|     | Condensed Consolidated  Balance Sheets (Unaudited) – September 30, 2008 and December 31,  2007                                    | 5      |
|     |                                                                                                                                             |   |
|     | Condensed  Consolidated Statement of Changes in Shareholders’ Equity (Unaudited) – Nine  Months Ended September 30, 2008          | 6      |
|     |                                                                                                                                             |   |
|     | Notes to  Condensed Consolidated Financial Statements (Unaudited)                                                                                | 7      |
|     |                                                                                                                                             |   |
| Item 2.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                      | 19     |
|     |                                                                                                                                             |   |
| Item 3.  | Quantitative  and Qualitative Disclosures About Market Risk                                                                                      | 29     |
|     |                                                                                                                                             |   |
| Item 4.  | Controls and  Procedures                                                                                                                         | 29     |
|     |                                                                                                                                             |   |
|     | **Part II  – Other Information**                                                                                                       |   |
|     |                                                                                                                                             |   |
| Item 1.  | Legal Proceedings                                                                                                                                | 30     |
|     |                                                                                                                                             |   |
| Item 1A. | Risk Factors                                                                                                                                     | 30     |
|     |                                                                                                                                             |   |
| Item 2.  | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                     | 31     |
|     |                                                                                                                                             |   |
| Item 6.  | Exhibits                                                                                                                                         | 31     |

 

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**PART  I.  FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**Hospira, Inc.**

 

**Condensed Consolidated Statements ofIncome**

 

**(Unaudited)**

 

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

* *
| ** **                                    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                     |       | $                                                        | 925.5      |                                                    | $          | 838.0 |   | $ | 2,715.8 |   | $ | 2,490.1 |   |
| Cost of products sold                         |       | 595.5                                                    |       | 543.5                                                   |       | 1,742.4 |   | 1,654.8 |   |
| Gross Profit                                  |       | 330.0                                                    |       | 294.5                                                   |       | 973.4 |   | 835.3 |   |
|                                          |       |                                                     |       |                                                    |       |   |   |   |   |
| Research and development                      |       | 51.7                                                     |       | 51.4                                                    |       | 160.1 |   | 147.5 |   |
| Acquired in-process research and  development |       | —                                                   |       | —                                                  |       | 0.5 |   | 84.8 |   |
| Selling, general and administrative           |       | 145.6                                                    |       | 136.5                                                   |       | 450.7 |   | 414.4 |   |
| Income From Operations                        |       | 132.7                                                    |       | 106.6                                                   |       | 362.1 |   | 188.6 |   |
|                                          |       |                                                     |       |                                                    |       |   |   |   |   |
| Interest expense                              |       | 27.6                                                     |       | 34.7                                                    |       | 87.2 |   | 102.5 |   |
| Other income, net                             |       | (2.4                                                     | )          | (6.2                                                    | )          | (6.5 | ) | (12.0 | ) |
| Income Before Income Taxes                    |       | 107.5                                                    |       | 78.1                                                    |       | 281.4 |   | 98.1 |   |
|                                          |       |                                                     |       |                                                    |       |   |   |   |   |
| Income tax expense                            |       | 25.7                                                     |       | 18.7                                                    |       | 65.1 |   | 37.4 |   |
| Net Income                                    |       | $                                                        | 81.8       |                                                    | $          | 59.4 |   | $ | 216.3 |   | $ | 60.7 |   |
|                                          |       |                                                     |       |                                                    |       |   |   |   |   |
| Earnings Per Common Share:                    |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                         |       | $                                                        | 0.51       |                                                    | $          | 0.38 |   | $ | 1.36 |   | $ | 0.39 |   |
| Diluted                                       |       | $                                                        | 0.51       |                                                    | $          | 0.37 |   | $ | 1.34 |   | $ | 0.38 |   |
| Weighted Average Common Shares Outstanding:   |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                         |       | 159.4                                                    |       | 157.1                                                   |       | 159.1 |   | 156.6 |   |
| Diluted                                       |       | 161.6                                                    |       | 160.1                                                   |       | 161.4 |   | 159.5 |   |

 

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

 

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**Hospira, Inc.**

 

**Condensed Consolidated Statements ofCash Flows**

 

**(Unaudited)**

 

***(dollars in millions)***

** **
| ** **                                                                         | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| Cash Flow From Operating Activities:                                               |       |                                                    |       |   |   |
| Net income                                                                         |       | $                                                       | 216.3      |   | $ | 60.7 |   |
| Adjustments to reconcile net income to net  cash from operating activities-        |       |                                                    |       |   |   |
| Depreciation                                                                       |       | 141.2                                                   |       | 136.2 |   |
| Amortization of intangibles                                                        |       | 51.1                                                    |       | 37.1 |   |
| Write-off of acquired in-process research  and development                         |       | 0.5                                                     |       | 84.8 |   |
| Step-up value of acquired inventories sold                                         |       | —                                                  |       | 53.1 |   |
| Stock-based compensation expense                                                   |       | 33.2                                                    |       | 31.6 |   |
| Net gains on sales of assets                                                       |       | (3.0                                                    | )          | (2.9 | ) |
| Changes in assets and liabilities-                                                 |       |                                                    |       |   |   |
| Trade receivables                                                                  |       | (75.8                                                   | )          | (42.3 | ) |
| Inventories                                                                        |       | (107.6                                                  | )          | (3.4 | ) |
| Prepaid expenses and other assets                                                  |       | 4.1                                                     |       | 5.4 |   |
| Trade accounts payable                                                             |       | 7.3                                                     |       | 4.8 |   |
| Other liabilities                                                                  |       | 37.1                                                    |       | (31.0 | ) |
| Other, net                                                                         |       | 24.2                                                    |       | 20.4 |   |
| Net Cash Provided by Operating Activities                                          |       | 328.6                                                   |       | 354.5 |   |
| Cash Flow From Investing Activities:                                               |       |                                                    |       |   |   |
| Capital expenditures (including instruments  placed with or leased to customers)   |       | (126.9                                                  | )          | (128.7 | ) |
| Acquisitions, net of cash acquired,  including payments for deferred consideration |       | (22.2                                                   | )          | (1,963.2 | ) |
| Purchases of intangibles and other  investments                                    |       | (49.6                                                   | )          | — |   |
| (Purchases) Sales of marketable securities                                         |       | (24.5                                                   | )          | 0.6 |   |
| Settlements of foreign currency contracts                                          |       | —                                                  |       | (55.7 | ) |
| Proceeds from dispositions of product  rights                                      |       | —                                                  |       | 13.8 |   |
| Proceeds from disposal of facilities                                               |       | 0.8                                                     |       | — |   |
| Net Cash Used in Investing Activities                                              |       | (222.4                                                  | )          | (2,133.2 | ) |
| Cash Flow From Financing Activities:                                               |       |                                                    |       |   |   |
| Issuance of long-term debt, net of fees  paid                                      |       | —                                                  |       | 3,336.2 |   |
| Repayment of long-term debt                                                        |       | (90.1                                                   | )          | (1,700.1 | ) |
| Other borrowings, net                                                              |       | 8.5                                                     |       | (0.3 | ) |
| Excess tax benefit from stock-based  compensation arrangements                     |       | 1.0                                                     |       | 0.9 |   |
| Proceeds from stock options exercised                                              |       | 27.4                                                    |       | 40.4 |   |
| Net Cash (Used in) Provided by Financing  Activities                               |       | (53.2                                                   | )          | 1,677.1 |   |
| Effect of exchange rate changes on cash and  cash equivalents                      |       | (6.7                                                    | )          | 16.0 |   |
| Net change in cash and cash equivalents                                            |       | 46.3                                                    |       | (85.6 | ) |
| Cash and cash equivalents at beginning of  period                                  |       | 241.1                                                   |       | 322.0 |   |
| Cash and cash equivalents at end of period                                         |       | $                                                       | 287.4      |   | $ | 236.4 |   |
|                                                                               |       |                                                    |       |   |   |
| Supplemental Cash Flow Information:                                                |       |                                                    |       |   |   |
| Cash paid during the period-                                                       |       |                                                    |       |   |   |
| Interest                                                                           |       | $                                                       | 96.6       |   | $ | 57.7 |   |
| Income taxes, net                                                                  |       | $                                                       | 8.6        |   | $ | 57.6 |   |

 

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

 

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**Hospira, Inc.**

 

**Condensed Consolidated Balance Sheets**

 

**(Unaudited)**

 

***(dollars inmillions)***

*** ***
| ** **                                                             | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                             | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| **Assets**                                                             |       |                   |       |                  |       |
| Current Assets:                                                        |       |                   |       |                  |       |
| Cash and cash equivalents                                              |       | $                      | 287.4      |                  | $          | 241.1 |   |
| Trade receivables, less allowances of $12.6  in 2008 and $14.1 in 2007 |       | 618.7                  |       | 559.0                 |       |
| Inventories                                                            |       | 854.8                  |       | 766.6                 |       |
| Deferred income taxes                                                  |       | 156.7                  |       | 176.7                 |       |
| Prepaid expenses                                                       |       | 29.0                   |       | 23.8                  |       |
| Other receivables                                                      |       | 71.7                   |       | 73.8                  |       |
| Total Current Assets                                                   |       | 2,018.3                |       | 1,841.0               |       |
| Property and equipment, net                                            |       | 1,226.4                |       | 1,276.9               |       |
| Intangible assets, net                                                 |       | 473.3                  |       | 554.0                 |       |
| Goodwill                                                               |       | 1,181.4                |       | 1,240.9               |       |
| Deferred income taxes                                                  |       | 65.9                   |       | 79.4                  |       |
| Investments                                                            |       | 47.6                   |       | 23.7                  |       |
| Other assets                                                           |       | 54.3                   |       | 68.8                  |       |
| Total Assets                                                           |       | $                      | 5,067.2    |                  | $          | 5,084.7 |   |
| **Liabilities and Shareholders’ Equity**                          |       |                   |       |                  |       |
| Current Liabilities:                                                   |       |                   |       |                  |       |
| Short-term borrowings                                                  |       | $                      | 328.8      |                  | $          | 58.5 |   |
| Trade accounts payable                                                 |       | 193.3                  |       | 190.3                 |       |
| Salaries, wages and commissions                                        |       | 141.6                  |       | 143.6                 |       |
| Deferred income taxes                                                  |       | —                 |       | 8.4                   |       |
| Other accrued liabilities                                              |       | 305.6                  |       | 393.5                 |       |
| Total Current Liabilities                                              |       | 969.3                  |       | 794.3                 |       |
| Long-term debt                                                         |       | 1,832.6                |       | 2,184.4               |       |
| Deferred income taxes                                                  |       | 32.7                   |       | 50.7                  |       |
| Post-retirement obligations and other  long-term liabilities           |       | 335.0                  |       | 310.1                 |       |
| Commitments and Contingencies                                          |       |                   |       |                  |       |
| Total Shareholders’ Equity                                        |       | 1,897.6                |       | 1,745.2               |       |
| Total Liabilities and Shareholders’ Equity                        |       | $                      | 5,067.2    |                  | $          | 5,084.7 |   |

 

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

 

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**Hospira,Inc.**

** **

**Condensed Consolidated Statement ofChanges in Shareholders’ Equity**

** **

**(Unaudited)**

** **

***(dollars and shares in millions)***

** **
| ** **                                                     | ** ** | **Common Stock** | ** ** | **Treasury** | ** ** | **Additional  Paid–in** | ** ** | **Retained** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | ** **             | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|--------------|------------|------------------------------|------------|--------------|------------|---------------------------------------|------------|------------------------|------------|
| ** **                                                     | ** ** | **Shares**            | ** ** | **Amount**   | ** ** | **Stock**                    | ** ** | **Capital**  | ** ** | **Earnings**                          | ** ** | **Income (Loss)** | ** ** | **Total** | ** ** |
| **Balances  at December 31, 2007**                             |       | 158.6                 |       | $            | 1.7        |                         | $          | (299.8       | )          | $                                     | 1,160.2    |                   | $          | 815.5 |   | $ | 67.6 |   | $ | 1,745.2 |   |
| Net income                                                     |       | —                |       | —       |       | —                       |       | —       |       | 216.3                                 |       | —                 |       | 216.3 |   |
|                                                           |       |                  |       |         |       |                         |       |         |       |                                  |       |                   |       |   |   |
| Other  comprehensive loss                                      |       | —                |       | —       |       | —                       |       | —       |       | —                                |       | (128.8                 | )          | (128.8 | ) |
|                                                           |       |                  |       |         |       |                         |       |         |       |                                  |       |                   |       |   |   |
| Changes in  shareholders' equity related to incentive programs |       | 1.0                   |       | —       |       | —                       |       | 64.9         |       | —                                |       | —                 |       | 64.9 |   |
| **Balances  at September 30, 2008**                            |       | 159.6                 |       | $            | 1.7        |                         | $          | (299.8       | )          | $                                     | 1,225.1    |                   | $          | 1,031.8 |   | $ | (61.2 | ) | $ | 1,897.6 |   |

 

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

 

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**Hospira,Inc.**

** **

**Notes to Condensed Consolidated Financial Statements**

** **

**(Unaudited)**

 

**Note 1– Basis of Presentation and Accounting Policies**

** **

The accompanyingunaudited condensed consolidated financial statements have been preparedpursuant to the rules and regulations of the Securities and Exchange Commission(“SEC”) and, therefore, do not include all information and footnote disclosuresnormally included in audited financial statements in conformitywith accounting principles generally accepted in the United States (GAAP). However, in the opinion ofmanagement, all adjustments, consisting only of normal recurring adjustments,unless otherwise noted herein, necessary to present fairly the results ofoperations, financial position and cash flows have been made. These condensedconsolidated financial statements should be read in conjunction with theconsolidated financial statements and notes thereto included in the Hospira,Inc. (“Hospira”) Annual Report on Form 10-K for the year endedDecember 31, 2007. The results of operations for any interim period arenot necessarily indicative of the results of operations to be expected for thefull year.

 

In 2008, Hospira re-aligned its segment presentationto better reflect how the business is currently managed. Hospira has threereportable segments: Americas; Europe, Middle East and Africa (“EMEA”) and AsiaPacific (“APAC”). Prior year segment disclosure has been reclassified toconform to the current year presentation.

 

OnFebruary 2, 2007, Hospira acquired all the outstanding ordinary shares of MaynePharma Limited (“Mayne Pharma”), an Australian public company listed on theAustralian Stock Exchange. The results of operations of Mayne Pharma areincluded in Hospira’s results for periods as of that date, which has affectedcomparability of the financial statements for the periods presented in thisreport. For a more detaileddescription of Hospira’s acquisition of Mayne Pharma, see Note 2 to Hospira’sconsolidated financial statements included in Hospira’s Annual Report on Form10-K for the year ended December 31, 2007.

 

For comparative purposes, Hospira made certainreclassifications to prior period amounts. The reclassifications did not affectnet income or shareholders’ equity.

 

*Recently Issued Accounting Standards*

* *

In April 2008, theFinancial Accounting Standards Board (“FASB”) issued FASB Staff Position No.FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP142-3”). FSP 142-3 amends the factors that should be considered in developingrenewal or extension assumptions used to determine the useful life of arecognized intangible asset under FASB Statement No. 142, “Goodwill and OtherIntangible Assets.” This provision of FSP 142-3 will be effective for financialstatements issued for fiscal years beginning after December 15, 2008. Earlyadoption is prohibited. Since this guidance will be applied prospectively, onadoption, there will be no impact to Hospira’s consolidated financial position,results of operations or cash flows.

 

In March 2008, theFASB issued Statement of Financial Accounting Standards (“SFAS”) No. 161, “DisclosuresAbout Derivative Instruments and Hedging Activities – an amendment of FASBStatement No. 133” (“SFAS No. 161”). SFAS No. 161 expands the disclosurerequirements for derivative instruments and hedging activities. The provisionswill be effective for financial statements issued for fiscal years beginningafter November 15, 2008. SFAS No. 161 only requires additionaldisclosures, hence the adoption will not impact Hospira’s consolidatedfinancial position, results of operations or cash flows.

 

In December 2007,the FASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements – an amendment of ARB No. 51” (“SFAS No. 160”). SFAS No.160 states that accounting and reporting for minority interests will berecharacterized as noncontrolling interests and classified as a component ofequity. SFAS No. 160 also establishes reporting requirements that providesufficient disclosures that clearly identify and distinguish between theinterests of the parent and the interests of the noncontrolling owners. SFASNo. 160 applies to all entities that prepare consolidated financial statements,except not-for-profit organizations, but will affect only those entities thathave an outstanding noncontrolling interest in one or more subsidiaries or thatdeconsolidate a subsidiary. SFAS No. 160 is effective for financial statementsissued for fiscal years beginning after December 15, 2008. Hospira doesnot anticipate that the impact from the adoption of SFAS No. 160 will besignificant to the consolidated financial position, results of operations orcash flows.

 

In December 2007, the FASB ratified Emerging Issues Task Force (“EITF”)Issue No. 07-1, “Accounting for Collaborative Arrangements” (“EITF 07-1”). EITF07-1 provides guidance on how to determine whether an arrangement constitutes acollaborative arrangement, how costs incurred and revenue generated on sales tothird parties should be reported by the participants in a collaborativearrangement, how payments made between participants in a collaborativearrangement should be characterized, and what participants should disclose inthe notes to the financial statements about a collaborative arrangement. EITF07-1 is effective for financial statements issued for fiscal years beginningafter December 15, 2008. Hospira is currently evaluating the potentialimpact of EITF 07-1 on the financial statements.

 

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In December 2007,the FASB issued SFAS No. 141 (revised 2007), “Business Combinations”(“SFAS No. 141R”). SFAS No. 141R establishes principles and requirements forthe reporting entity in a business combination, including recognition andmeasurement in the financial statements of the identifiable assets acquired,the liabilities assumed, and any noncontrolling interest in the acquiree. Thisstatement also establishes disclosure requirements to enable financialstatement users to evaluate the nature and financial effects of the businesscombination. SFAS No. 141R is effective for business combinations that close inyears beginning on or after December 15, 2008. Since this guidance will beapplied prospectively, on adoption, there will be no impact to Hospira’sconsolidated financial position, results of operations or cash flows.

 

In September 2006,the FASB issued SFAS No. 158, “Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans – an amendment of FASB Statements No.87, 88, 106, and 132(R)” (“SFAS No. 158”). One provision of SFAS No. 158 requires the measurement of Hospira’s definedbenefit plan’s assets and its obligations to determine the funded status bemade as of the end of the fiscal year. Therefore,the actuarial valuation measurement date will be changed from November 30 toDecember 31, 2008, so all plans will have a year end measurement date. Thisprovision of SFAS No. 158 is effective for fiscal years ending after December15, 2008. The adoption of this provision of SFAS No. 158 will not besignificant to the financial statements.

 

*Adoption of New Accounting Standards*

* *

Hospira adoptedthe required provisions of SFAS No. 157, “Fair Value Measurements” (“SFASNo. 157”) on January 1, 2008. SFAS No. 157 clarifies the principle that fairvalue should be based on the assumptions market participants would use whenpricing an asset or liability and establishes a fair value hierarchy thatprioritizes the information used to develop those assumptions. There was noimpact to the condensed consolidated financial statements from the adoption ofSFAS No. 157.

 

FASB StaffPosition No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP157-2”) delays the effective date of the application of SFAS No. 157 to fiscalyears beginning after November 15, 2008, for all nonfinancial assets andnonfinancial liabilities that are recognized or disclosed at fair value in thefinancial statements on a non-recurring basis. Hospira adopted SFAS No. 157with the exception of the application of the statement to non-recurringnonfinancial assets and liabilities. Non-recurring nonfinancial assets andnonfinancial liabilities for which Hospira has not applied the provisions ofSFAS No. 157 primarily include those measured at fair value in goodwill andlong-lived asset impairment testing, those initially measured at fair value ina business combination, and nonfinancial liabilities for exit or disposalactivities.

 

Hospira adoptedthe provisions of SFAS No. 159, “The Fair Value Option for FinancialAssets and Financial Liabilities – Including an amendment of FASB Statement No.115” (“SFAS No. 159”) on January 1, 2008. SFAS No. 159 provides a company withthe option to measure selected financial instruments and certain other items atfair value at specified election dates. At adoption, Hospira had not elected toapply SFAS No. 159 to measure selected financial instruments and certain otheritems at fair value, therefore, there was no impact to the condensedconsolidated financial statements from adoption of SFAS No. 159. Subsequent tothe initial adoption of SFAS No. 159 on January 1, 2008, Hospira has not madeany elections to apply SFAS No. 159 during the nine months ended September 30,2008.

** **

**Note 2 – Acquisitions and Other Investment Activity**

 

In 2008, Hospira acquired a developer of bar code andradio-frequency identification (“RFID”) point-of-care technology. The preliminaryallocation of purchase price resulted in intangible assets of $5.5 million,mostly technology based, that will be amortized over 4 years; acquiredin-process research and development of $0.5 million that was expensed at thedate of acquisition; non-tax deductible goodwill of $8.5 million; and otherassets and (liabilities), net of $(2.0) million. The impact of the acquisitionis not expected to be material to Hospira’s results of operations in 2008. In2008, Hospira also made payments for deferred consideration related toacquisitions made by Mayne Pharma in prior years.

 

Hospira acquired intangible assets, primarily productrights, in the fourth quarter of 2007, for which the payments were made in 2008,and also made other investments. In addition, Hospira purchased $24.5 millionof marketable equity securities in April 2008.

 

**Note 3 – Fair Value Measures**

 

Hospira adoptedthe required provisions of SFAS No. 157 on January 1, 2008, as amended by FSP157-2.

 

SFAS No. 157establishes a fair value hierarchy for disclosure of the inputs used to measurefair values. This hierarchy prioritizes the inputs into three broad levels.Level 1 inputs are quoted prices (unadjusted) in active markets for identicalassets or liabilities. Level 2 inputs are quoted prices for similar assets andliabilities in active markets or inputs that are observable for similar assetsor liabilities, either directly or indirectly through market corroboration, forsubstantially the full term of the financial instrument. Level 3 inputs areunobservable inputs which reflect assumptions developed by management tomeasure assets and liabilities at fair value. 

 

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A financial assetor liability’s classification within the hierarchy is determined based on thelowest level input that is significant to the fair value measurement.

 

The followingtable summarizes the basis used to measure certain assets at fair value on arecurring basis, under the applicable provisions of SFAS No. 157, in thebalance sheet:

 
| ** **                                           | ** ** | **Fair Value Measurements at Reporting Date, Using:** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **Description (dollars in  millions)**               | ** ** | **September 30,  2008**                                                             | ** ** | **Quoted Prices  in Active  Markets for  Identical Items  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant   Unobservable  Inputs  (Level 3)** | ** ** |
| Financial Assets:                                    |       |                                                                                |       |   |   |   |   |   |   |
| Interest rate swap derivative financial  instruments |       | $                                                                                   | 1.6        |   | $ | — |   | $ | 1.6 |   | $ | — |   |
| Available-for-sale marketable securities             |       | 14.9                                                                                |       | 14.9 |   | — |   | — |   |
| Foreign currency forward exchange contracts          |       | 2.2                                                                                 |       | — |   | 2.2 |   | — |   |
|                                                      |            |                                                                                     |            |  |  |  |  |  |  |  |  |  |  |

 

Thefair value of the Level 1 financial assets is based on quoted market prices ofthe identical underlying security in an active market. The fair value of theLevel 2 financial assets is based on market observable inputs to quoted marketprices, benchmark yields and broker/dealer quotes.

 

AtSeptember 30, 2008, the fair value of the marketable equity securitiespurchased in April 2008 was $14.9 million. Hospira assessed the decline of $8.3million in the market value to be temporary and recorded the decline as anunrealized loss on marketable equity securities in accumulated othercomprehensive loss, net of taxes.

 

**Note 4 – Restructuring Costs**

 

*2008 Actions*

* *

In April 2008, Hospira announced a plan toexit manufacturing operations at its Morgan Hill, California plant over thenext two to three years. Hospira expects to incur aggregaterestructuring charges related to these actions in the range of $29 million to$35 million on a pre-tax basis through 2011. Restructuring costs consistprimarily of costs related to severance and certain other employee benefitcosts, accelerated depreciation resulting from the decreased useful lives ofthe buildings and certain equipment, and other exit costs.

 

During the three months andnine months ended September 30, 2008, Hospira recorded in the Americas segmentpre-tax restructuring charges of $2.8 million and $4.9 million, respectively,in cost of products sold and $0.7 million and $1.2 million, respectively, inresearch and development.

 

The following summarizes theMorgan Hill, California restructuring activity for 2008:

 
| ** **                          | ** ** | **Balance at**             | ** ** | **Costs**    | ** ** | ** **   | ** ** | **Non Cash** | ** ** | **Balance at**              | ** ** |
|-------------------------------------|------------|---------------------------------|------------|--------------|------------|--------------|------------|-------------------|------------|----------------------------------|------------|
| **(dollars in millions)** | ** ** | **December 31, 2007** | ** ** | **Incurred** | ** ** | **Payments** | ** ** | **Items**         | ** ** | **September 30, 2008** | ** ** |
| Employee-related benefit costs      |       | $                               | —     |         | $          | 5.2          |       | $                 | (0.1       | )                                | $          | — |   | $ | 5.1 |   |
| Accelerated depreciation            |       | —                          |       | 0.8          |       | —       |       | (0.8              | )          | —                           |       |
| Other                               |       | —                          |       | 0.1          |       | (0.1         | )          | —            |       | —                           |       |
|                                |       | $                               | —     |         | $          | 6.1          |       | $                 | (0.2       | )                                | $          | (0.8 | ) | $ | 5.1 |   |

 

*2006 and 2005 Actions*

* *

In August 2005, Hospira announced plans to close itsmanufacturing plant in Donegal, Ireland. In February 2006, Hospira further announcedplans to close plants in Ashland, Ohio and Montreal, Canada, and also providedthe planned timeline for phasing out production at a leased facility in NorthChicago, Illinois. Hospira expects to incur aggregate restructuring chargesrelated to these actions in the range of $75 million to $95 million on apre-tax basis through 2009. Restructuring costs consist primarily of costsrelated to severance and certain other employee benefit costs, accelerateddepreciation resulting from the decreased useful lives of the buildings andcertain equipment, and other exit costs.

 

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Hospira recorded pre-taxrestructuring charges in the following segments to cost of products sold:

 
| ** **                          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(dollars in millions)** | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Americas(1)                         |       | $                                                        | 1.0        |                                                    | $          | 3.7 |   | $ | 7.7 |   | $ | 15.3 |   |
| EMEA                                |       | —                                                   |       | 0.5                                                     |       | — |   | 0.8 |   |
| APAC                                |       | —                                                   |       | —                                                  |       | — |   | — |   |
| Total pre-tax restructuring charges |       | $                                                        | 1.0   |                                                    | $          | 4.2  |   | $ | 7.7  |   | $ | 16.1  |   |

 

----

(1)          In September 2006, theMontreal, Canada manufacturing plant was sold for $7.8 million, resulting in apre-tax gain of $2.5 million which was recognized in the three months endedSeptember 30, 2008, at the end of the lease-back term and when allenvironmental matters were remediated.

 

To date, Hospira has incurred pre-tax restructuringcharges of $74.2 million related to these actions. Product transfers from theDonegal, Ireland manufacturing plant were completed in 2006. Hospira ceasedproduction at the Ashland, Ohio location during the three months endedSeptember 30, 2007, and is in the process of disposing this location, includingconducting environmental studies. At September 30, 2008, Hospira has $0.5million in other accrued liabilities for environmental clean-up costs relatedto these studies and actions. Hospira completed all product transfers relatingto the Montreal, Canada manufacturing plant during the three months ended June30, 2008. Hospira expects to complete all product transfers relating to theNorth Chicago, Illinois manufacturing plant and exit the leased facility by theend of the second quarter of 2009.

 

The following summarizes the Ashland,Ohio; Montreal, Canada; and North Chicago, Illinois restructuring activity for2008:

 
| ** **                          | ** ** | **Balance at**             | ** ** | **Costs**    | ** ** | ** **   | ** ** | **Non Cash** | ** ** | **Balance at**              | ** ** |
|-------------------------------------|------------|---------------------------------|------------|--------------|------------|--------------|------------|-------------------|------------|----------------------------------|------------|
| **(dollars in millions)** | ** ** | **December 31, 2007** | ** ** | **Incurred** | ** ** | **Payments** | ** ** | **Items**         | ** ** | **September 30, 2008** | ** ** |
| Employee-related benefit costs      |       | $                               | 17.8       |         | $          | 6.9          |       | $                 | (11.4      | )                                | $          | (1.7 | ) | $ | 11.6 |   |
| Accelerated depreciation            |       | —                          |       | 0.6          |       | —       |       | (0.6              | )          | —                           |       |
| Other(1)                            |       | 0.6                             |       | 0.2          |       | (3.3         | )          | 2.5               |       | —                           |       |
|                                |       | $                               | 18.4       |         | $          | 7.7          |       | $                 | (14.7      | )                                | $          | 0.2 |   | $ | 11.6 |   |

 

----

(1)            InSeptember 2006, the Montreal, Canada manufacturing plant was sold for $7.8million, resulting in a pre-tax gain of $2.5 million which was recognized inthe three months ended September 30, 2008 at the end of the lease-back term andwhen all environmental matters were remediated.

 

**Note 5 – Stock-Based Compensation**

** **

Hospira’s 2004 Long-Term Incentive Planprovides for the grant of shares of stock options, stock appreciation rights,stock awards (restricted stock, restricted stock units, performance shares,performance units), and cash-based awards to employees and non-employeedirectors. Costs resulting from share-based payment transactions are recognizedas compensation cost over the vesting period based on the fair value of theinstrument on the date of grant. Stock-based compensation expense, primarilyresulting from stock option awards, of $8.7 million and $8.1 million wasrecognized for the three months ended September 30, 2008 and 2007,respectively. The related income tax benefit recognized was $3.2 million and $2.9million, respectively. Stock-based compensation expense, primarily resultingfrom stock option awards, of $33.2 million and $31.6 million was recognized forthe nine months ended September 30, 2008 and 2007, respectively. The relatedincome tax benefit recognized was $12.3 million and $11.7 million,respectively. Stock-based compensation costs are not allocated for segmentreporting purposes.

 

In March 2008, 2.3 million stock options weregranted to certain employees for the 2008 annual stock options grant. Thesestock options were awarded at the fair market value at the time of grant,generally vest over three years, and have a seven-year term. Theannual stock options grant was awarded in the first quarter of 2008 as comparedto the second quarter in 2007.

 

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The fair values are estimated using the Black-Scholesoption-pricing model based on the weighted average assumptions utilized foroption grants during the periods presented are as follows:

 
| ** **                  | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Volatility                  |       | 28.0                                                     | %          | 34.0                                                    | %          | 28.0 | % | 33.8 | % |
| Expected life (years)       |       | 4.5                                                      |       | 3.5                                                     |       | 4.5 |   | 4.4 |   |
| Risk-free interest rate     |       | 2.8                                                      | %          | 4.3                                                     | %          | 2.3 | % | 4.6 | % |
| Dividend yield              |       | 0.0                                                      | %          | 0.0                                                     | %          | 0.0 | % | 0.0 | % |
| Fair value per stock option |       | $                                                        | 10.72      |                                                    | $          | 11.93 |   | $ | 11.68 |   | $ | 14.00 |   |
|                             |            |                                                          |            |                                                         |            |  |  |  |  |  |  |  |  |

 

In March 2008, approximately 195,000 performanceshare awards were granted to key members of management. The performance shareawards vest at the end of the three-year performance cycle. The 2008performance share award is based on a formula that measures performance usingrelative total shareholder return over the three-year performance cyclecompared to an industry peer group. Based on the actual performance, at interimperiods, and at the end of the performance cycle, the number of performanceshare awards earned, which can range between 0% and 200% of the target awardsgranted, will be satisfied with Hospira common stock.

 

The 2008performance share award fair value was $62.39 per share, measured using a MonteCarlo simulation model. The Monte Carlo simulation model uses multiple inputvariables that determine the probability of satisfying performance measuresstipulated in the performance award grant.

 

The valuation model for the March 2008performance share award used the following assumptions:

 
| **Weighted-Average**         | ** ** | **Risk-Free**          | ** ** | **Expected**            | ** ** |
|------------------------------|------------|------------------------|------------|-------------------------|------------|
| **Expected Volatility** | ** ** | **Interest Rate** | ** ** | **Dividend Yield** | ** ** |
| 27.9%                        |       | 2.0%                   |       | 0.0%                    |       |

 

As of September 30, 2008, there was $50.6million of total unrecognized compensation cost related to non-vestedshare-based compensation arrangements. That cost is expected to be recognizedover a weighted average period of 2.0 years.

 

For a more detailed description of Hospira’sstock-based compensation plan, see Note 14 to Hospira’sconsolidated financial statements included in Hospira’s Annual Report on Form10-K for the year ended December 31, 2007.

 

**Note 6– Post-Retirement Benefits**

** **

Retirementplans consist of defined benefit ("pension"), defined contribution,and post-retirement medical and dental plans. Plans cover certain employeesboth in and outside of the United States.

 

Net costrecognized for the pension and post-retirement medical and dental benefit plansis as follows:

 

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| ** **                                        | ** ** | **Pension Plans**                                   | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                        | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
| **(dollars in millions)**               | ** ** | **2008**                                                 | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost for benefits earned during the  year |       | $                                                        | 0.5        |   | $ | 0.4 |   | $ | 1.5 |   | $ | 1.1 |   |
| Interest cost on projected benefit  obligations   |       | 6.1                                                      |       | 6.1 |   | 18.5 |   | 18.5 |   |
| Expected return on plans’ assets             |       | (7.1                                                     | )          | (7.1 | ) | (21.5 | ) | (21.3 | ) |
| Net amortization                                  |       | 0.8                                                      |       | 1.2 |   | 2.5 |   | 3.5 |   |
| Settlement of benefits(1)                         |       | 1.7                                                      |       | — |   | 1.7 |   | — |   |
| Net cost                                          |       | $                                                        | 2.0        |   | $ | 0.6 |   | $ | 2.7 |   | $ | 1.8 |   |

 
| ** **                                        | ** ** | **Medical and Dental Plans**              | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                        | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
| **(dollars in millions)**               | ** ** | **2008**                                                 | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost for benefits earned during the  year |       | $                                                        | 0.1        |   | $ | — |   | $ | 0.3 |   | $ | — |   |
| Interest cost on projected benefit  obligations   |       | 0.9                                                      |       | 0.7 |   | 2.8 |   | 2.1 |   |
| Net amortization                                  |       | 0.9                                                      |       | 0.2 |   | 1.5 |   | 0.6 |   |
| Curtailment of benefits(2)                        |       | —                                                   |       | (0.8 | ) | — |   | (0.8 | ) |
| Net cost                                          |       | $                                                        | 1.9        |   | $ | 0.1 |   | $ | 4.6 |   | $ | 1.9 |   |

 

----

(1)          Relates to the shutdownof the Montreal, Canada manufacturing plant.

(2)          Relates to the shutdownof the Ashland, Ohio manufacturing plant.

 

During the three months ended September 30, 2008,Hospira made a discretionary funding contribution of $5.5 million to the mainU.S. pension plan. Based on Federal laws andregulations, Hospira is not required to make any contributions and does notexpect to make any discretionary contributions to its pension plans for theremainder of 2008 or 2009.

 

Certain Hospira employees participate in the Hospira401(k) Retirement Savings Plan. Hospira’s contributions to this definedcontribution plan for the three months ended September 30, 2008 and 2007 were $9.0million and $10.0 million, respectively. For the nine months ended September30, 2008 and 2007 contributions were $27.7 million and $26.8 million,respectively.

 

**Note 7 – Income Taxes**

** **

Taxes on income reflect theestimated annual effective rates and are less than the statutory U.S. federalincome tax rate principally due to the benefit of tax exemptions, of varyingdurations, in several non-U.S. taxing jurisdictions.

 

Hospira began operations as anew taxpayer on May 1, 2004, and the U.S. federal tax returns for 2004 and 2005are currently under examination by the Internal Revenue Service (“IRS”). Hospiraexpects the audit fieldwork and the issuance of the initial IRS audit report tobe completed within the next 3 months, with final IRS approval within 12 months.However, the ultimate resolution of the 2004 – 2005 IRS audit isdependent on a number of factors and procedures that can not be predicted atthis time. In addition, certaintax statutes are also expected to close within the next 12 months. Accordingly,it is reasonably possible that a change in unrecognized tax benefits will occurwithin the next 12 months; however, quantification of a range can not be madeat this time.

 

Hospira remains open to taxexamination in all major tax-paying jurisdictions, including Australia, Canada,Italy, United Kingdom and the United States. Pre-acquisition audit orprocedural tax adjustments reducing tax liabilities for acquired entities arerecorded as adjustments to goodwill as applicable.

 

**Note 8 – Earnings per Share**

** **

Basic earnings per share are computed by dividing netincome by the number of weighted average common shares outstanding during thereporting period.  Diluted earnings pershare are calculated to give effect to all potentially dilutive common sharesthat were outstanding during the reporting period. The following table showsthe effect of stock-based awards on the weighted average number of sharesoutstanding used in calculating diluted earnings per share:

 

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| ** **                                                    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(shares in millions)**                            | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Weighted average basic common shares  outstanding             |       | 159.4                                                    |       | 157.1                                                   |       | 159.1 |   | 156.6 |   |
| Incremental shares outstanding related to  stock-based awards |       | 2.2                                                      |       | 3.0                                                     |       | 2.3 |   | 2.9 |   |
| Weighted average dilutive common shares  outstanding          |       | 161.6                                                    |       | 160.1                                                   |       | 161.4 |   | 159.5 |   |

 

Thenumber of outstanding options to purchase Hospira stock for which the exerciseprice of the options exceeded the market average stock price was 5.6 million and5.4 million for the three and nine months ended September 30, 2008,respectively, and 5.2 million and 2.6 million for the three and nine monthsended September 30, 2007, respectively. Accordingly, these options are excludedfrom the diluted earnings per share calculation for these periods.

 

**Note 9 – Inventories and Property andEquipment, Net**

** **

Inventories consist of the following:

 
| ** **                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(dollars in millions)** | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Finished products                   |       | $                      | 513.5      |                  | $          | 465.4 |   |
| Work in process                     |       | 156.1                  |       | 128.2                 |       |
| Materials                           |       | 185.2                  |       | 173.0                 |       |
| Total inventories                   |       | $                      | 854.8      |                  | $          | 766.6 |   |

 

Property and equipment, net consists of the following:

 
| ** **                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(dollars in millions)** | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Property and equipment, at cost     |       | $                      | 2,580.1    |                  | $          | 2,620.2 |   |
| Accumulated depreciation            |       | (1,353.7               | )          | (1,343.3              | )          |
| Total property and equipment, net   |       | $                      | 1,226.4    |                  | $          | 1,276.9 |   |

 

**Note 10 – Goodwill and IntangibleAssets, Net**

 

The following summarizesgoodwill and intangible assets, net activity:

 
| ** **                          | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** | **Currency**                | ** ** | ** **                       | ** ** |
|-------------------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|-----------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **Balance at**             | ** ** | ** **       | ** ** | ** **       | ** ** | **Translation Effect** | ** ** | **Balance at**              | ** ** |
| **(dollars in millions)** | ** ** | **December 31, 2007** | ** ** | **Acquisitions** | ** ** | **Amortization** | ** ** | **and Other**          | ** ** | **September 30, 2008** | ** ** |
| Goodwill                            |       | $                               | 1,240.9    |             | $          | 8.5              |       | $                           | —     |                             | $          | (68.0 | ) | $ | 1,181.4 |   |
| Intangible assets, net              |       | 554.0                           |       | 6.5              |       | (51.1            | )          | (36.1                       | )          | 473.3                            |       |
|                                     |            |                                 |            |                  |            |                  |            |                             |            |                                  |            |  |  |  |  |  |

 

The additions to goodwill andintangible assets, net are primarily related to the acquisition in the Americassegment further described in Note 2. Currency translation effect and otherincludes a $35.3 million reduction in goodwill in the APAC segment related toMayne Pharma deferred tax liabilities for pre-acquisition tax returnsettlements and the adjusted tax basis of certain acquired Mayne Pharma assets.There were no reductions from goodwill relating to impairments or disposal of allor a portion of a business.

 

Goodwill is not amortized, butis tested for impairment at least annually on September 30, or more frequentlyif an event occurs or circumstances change that would reduce the fair value ofa reporting unit below its carrying value. Asof the latest assessment, no impairment was indicated.

 

Intangible assets have definitelives and are amortized on a straight-line basis over their estimated usefullives (3 to 12 years, weighted average 10 years). Intangible asset amortizationexpense was $16.7 million and $14.2 million for the three months endedSeptember 30, 2008 and 2007, respectively. Intangible asset amortizationexpense was $51.1 million and $37.1 million for the nine

 

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months ended September 30, 2008and 2007, respectively. Intangible asset amortization is estimated at $17.0million for the remainder of 2008, $68.4 million for 2009 and 2010, $65.8million for 2011, and $54.2 million for 2012.

 

Hospira acquired productrights, in the fourth quarter of 2007, for which the payments were made in2008.

 

Additionally, intangibleassets, net consist of the following:

 
| ** **                          | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(dollars in millions)** | ** ** | **Gross  Carrying  Amount**      | ** ** | **Accumulated  Amortization**   | ** ** | **Intangible  Assets, Net** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Intangible  Assets, Net** | ** ** |
| Product rights                      |       | $                                | 525.9      |                            | $          | (85.3 | ) | $ | 440.6 |   | $ | 565.4 |   | $ | (46.2 | ) | $ | 519.2 |   |
| Customer relationships              |       | 32.8                             |       | (7.3                            | )          | 25.5 |   | 36.0 |   | (4.2 | ) | 31.8 |   |
| Technology                          |       | 10.3                             |       | (3.1                            | )          | 7.2 |   | 4.8 |   | (1.8 | ) | 3.0 |   |
|                                |       | $                                | 569.0      |                            | $          | (95.7 | ) | $ | 473.3 |   | $ | 606.2 |   | $ | (52.2 | ) | $ | 554.0 |   |

 

**Note 11 – Short-term Borrowingsand Long-term Debt**

** **

For a more detailed description of Hospira’sshort-term borrowings and long-term debt, see Note 10 to Hospira’sconsolidated financial statements included in Hospira’s Annual Report on Form10-K for the year ended December 31, 2007.

 

Under the $500.0 million three-year term loanfacility due 2010, Hospira was required to repay $12.5 million in principal atthe end of each quarter in 2007, $50.0 million in principal at the end of eachquarter in 2008 and $62.5 million for the three remaining payments in 2009 andthe final payment in 2010. Hospira is permitted to prepay amounts borrowedunder the facility from time to time without penalty. Prepayments are proratedagainst future payments under the facility reducing the future obligations.Principal prepayments made in 2007 of $359.7 million and an additional $67.4million in the nine months ended September 30, 2008, reduced the amountsrequired to be repaid to $1.7 million at the end of the fourth quarter of 2008and $2.1 million for the three remaining payments in 2009 and the final paymentin 2010. As of September 30, 2008, prepayments and required payments of $490.0million in principal have been paid and of the remaining $10.0 million inprincipal, $7.9 million is due within one year.

 

In June 2008, Hospira entered into interestrate swap contracts whereby $300.0 million of the $400.0 million, 5.90% fixedrate ten-year senior unsecured notes due in June 2014 were effectivelyconverted from fixed to floating rate debt. Hospira records the interest rateswap contracts at fair value and offsets the carrying amount of the fixed-ratedebt by the same amount. Changes in fair value are offset against the carryingamount of the fixed-rate debt through earnings and the ineffective portion ofthe derivative’s change in fair value will be immediately recognized inearnings. In September 2008, Hospira terminated one interest rate swap contractwith a notional amount of $75.0 million thereby reducing the notional portioneffectively converted from fixed to floating rate debt from $300.0 million to$225.0 million.

 

Additionally, in September 2008, Hospiraterminated one interest rate swap contract with a notional amount of $100.0million, which had effectively converted the related portion of the $300.0million, 4.95% fixed-rate five-year senior unsecured notes due 2009, tovariable rate debt. This reduced the notional portion effectively convertedfrom fixed to floating rate debt from $300.0 million to $200.0 million.

 

As a result of these interest rate swapcontract terminations, Hospira received $2.5 million in cash, excluding accruedinterest. The corresponding gains related to the basis adjustment of the debtassociated with the terminated swap contracts were deferred and are beingamortized as a reduction of interest expense over the remaining term of thenotes. The cash flows from these contracts are reported as operating activitiesin the Condensed Consolidated Statements of Cash Flows. There are no penaltiesassociated with the termination of the interest rate swap agreements.

 

In October 2008, Hospira terminated allremaining interest rate swap contracts with a total notional amount of $425.0million, which had effectively converted the related portion of the fixed-ratesenior unsecured notes due 2014 and 2009, to variable rate debt. As a result ofthe swap terminations, Hospira received $6.7 million in cash, excluding accruedinterest. The corresponding gains related to the basis adjustment of the debtassociated with the terminated swap contracts will be deferred and amortized asa reduction of interest expense over the remaining term of the notes. The cashflows from these contracts will be reported as operating activities in theCondensed Consolidated Statements of Cash Flows. There are no penaltiesassociated with the termination of the interest rate swap agreements.

 

Hospira has a five-year $375.0 millionunsecured revolving credit facility (the “Revolver”). The Revolver is availablefor working capital and other requirements. As of September 30, 2008, Hospirahad no amounts outstanding under the Revolver.

 

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Certain of our borrowing agreements contain covenantsthat require compliance, for example, a maximum leverage ratio and a minimuminterest coverage ratio. As of September 30, 2008, Hospira was incompliance with all applicable covenants.

 

**Note**** 12****– Litigation**

** **

Hospira is involved invarious claims and legal proceedings, as well as product liability claims andproceedings related to Hospira’s business, including in some instances whenHospira operated as part of Abbott Laboratories (“Abbott”).

 

Various state and federalagencies, including the U.S. Department of Justice and various state attorneysgeneral, are investigating a number of pharmaceutical companies, includingAbbott, for allegedly engaging in improper marketing and pricing practices withrespect to certain Medicare and Medicaid reimbursable products, includingpractices relating to average wholesale 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.  In addition, Abbott is a defendantin a number of purported class actions on behalf of individuals or entities,including healthcare insurers and other third-party payors, that allegegenerally that Abbott and numerous other pharmaceutical companies reportedfalse or misleading pricing information in connection with federal, state andprivate reimbursement for certain drugs.  Many of the products involved inthese investigations and lawsuits are Hospira products.  Hospira iscooperating with the authorities in these investigations. There may beadditional investigations or lawsuits, or additional claims in the existinginvestigations or lawsuits, initiated with respect to these matters in thefuture.  Hospira cannot be certain that it will not be named as a subjector defendant in these investigations or lawsuits. Hospira is a named defendantin one such lawsuit: *State of Hawaii v.Abbott Laboratories, Inc., et al.*, Case No. 06-1-0720-04,pending in the Circuit Court of the First Circuit, Hawaii, filed April, 2006.Hospira denies all material allegations asserted against it. 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 other losses that may result from theseinvestigations and lawsuits related to Hospira’s products, including any lossesassociated with post-spin-off activities. These investigations and lawsuitscould result in changes to Hospira’s business practices or pricing policies,civil or criminal monetary damages, penalties or fines, imprisonment and/orexclusion of Hospira products from participation in federal and statehealthcare programs, including Medicare, Medicaid and Veterans’ Administrationhealth programs, any of which could have a material adverse effect on itsbusiness, profitability and financial condition. The previously reported case, *The State of Texas ex rel. Ven-A-Care of the FloridaKeys, Inc. v. Abbott Laboratories Inc*. in which Hospira was added as a defendant in August 2004 hasbeen settled.  Hospira has agreed toprovide additional price reporting to Texas in the future.

 

Hospira has been named asa defendant in a lawsuit alleging generally that the spin-off of Hospira fromAbbott resulted in a mass termination of employees so as to interfere with thefuture attainment of benefits in violation of the Employee Retirement SecurityAct of 1974 (“ERISA”). 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.*Plaintiffs generally seek reinstatement in Abbott benefit plans, disgorgementof profits and attorneys fees. On November 18, 2005, the complaint wasamended to assert an additional claim against Abbott and Hospira for breach offiduciary duty under ERISA.  Hospira has been dismissed as a defendantwith respect to the fiduciary duty claim. By Order dated December 30,2005, the Court granted class action status to the lawsuit. As to the soleclaim against Hospira in the original complaint, the court certified a classdefined as:  “all employees of Abbott who were participants in the AbbottBenefit Plans and whose employment with Abbott was terminated between August 22,2003 and April 30, 2004, as a result of the spin-off of the HPD/creationof Hospira announced by Abbott on August 22, 2003, and who were eligiblefor retirement under the Abbott Benefit Plans on the date of theirterminations.” In July 2008, the court denied defendants’ motions forsummary judgment. Hospira denies all material allegations asserted against itin the complaint. In the third quarter of 2008, Hospira received notice fromAbbott requesting that Hospira indemnify Abbott for all liabilities that Abbottmay incur in connection with this litigation. Hospira denies any obligation toindemnify Abbott for the claims asserted against Abbott in this litigation.

 

On August 12, 2005, Retractable Technologies, Inc. (“RTI”)filed a lawsuit against Abbott alleging breach of contract and fraud inconnection 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 in U.S. District Court for the Eastern Districtof Texas. RTI purported to terminate the contract for breach in 2003. Thelawsuit alleges that Abbott misled RTI and breached the Agreement in connectionwith Abbott’s marketing efforts. RTI seeks unspecified monetary damages as wellas punitive damages. Hospira has conditionally agreed to defend and indemnifyAbbott in connection with this lawsuit, which involves a contract carried outby Abbott’s former Hospital Products Division. Abbott denies all materialallegations in the complaint. Abbott intends to pursue claims against RTI forbreach of the Agreement. Hospira is entitled, pursuant to its agreements withAbbott, to any amounts recovered due to RTI’s breach of the Agreement. On February 9,2007, the court ruled that RTI could not be compelled to arbitrate its claims.On June 2, 2008, the Fifth Circuit Court of Appeals upheld that decisionin a 2-1 ruling. The case will now proceed in the U.S. District Court for theEastern District.

 

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Hospira’s litigationexposure, including product liability claims, are evaluated each reportingperiod. Hospira’s reserves, which are not significant at September 30,2008 and December 31, 2007, are the best estimate of loss, as defined bySFAS No. 5, “Accounting for Contingencies.” Based upon informationthat is currently available, management believes that the likelihood of amaterial loss in excess of recorded amounts is remote.

 

Additional legalproceedings may occur that may result in a change in the estimated reservesrecorded by Hospira. It is not feasible to predict the outcome of suchproceedings with certainty and there can be no assurance that their ultimatedisposition will not have a material adverse effect on Hospira’s financialposition, cash flows, or results of operations.

 

**Note 13****– Shareholders’ Equity**

 

*Common Stock*

* *

Hospira is authorized to issue400.0 million shares of common stock, par value $0.01 per share, and50.0 million shares of preferred stock, par value $0.01 per share. As of September 30,2008 and December 31, 2007, 167.2 million and 166.2 million common shareswere issued and 159.6 million and 158.6 million common shares wereoutstanding, respectively.

 

*Treasury Stock*

* *

Hospira hasrepurchased 7.6 million shares for $299.8 million in the aggregate under the2006 board authorization, all of which were purchased during 2006. Hospira doesnot expect to repurchase any shares in 2008 under this program.

*** ***

**Note 14****–****Comprehensive (Loss)Income and Accumulated Other Comprehensive (Loss) Income, net of taxes**

 

Comprehensive (loss)income, net of taxes consists of the following:

 
| ** **                                                                                                                                                                                                                                                                              | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(dollars in millions)**                                                                                                                                                                                                                                                     | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Foreign currency translation adjustments                                                                                                                                                                                                                                                |       | $                                                        | (229.7     | )                                                       | $          | 63.9 |   | $ | (123.8 | ) | $ | 116.1 |   |
| Pension liability adjustments, net of taxes  $(0.4) million and $(0.5) million for the three months ended  September 30, 2008 and 2007, respectively, and $(1.5) million and $(1.6)  million for the nine months ended September 30, 2008 and 2007,  respectively             |       | 0.7                                                      |       | 0.8                                                     |       | 2.6 |   | 2.4 |   |
| Unrealized losses on marketable equity  securities, net of taxes $(1.6) million and $1.9 million for the three months  ended September 30, 2008 and 2007, respectively, and $0 million and $2.2  million for the nine months ended September 30, 2008 and 2007,  respectively |       | (1.9                                                     | )          | (3.4                                                    | )          | (8.0 | ) | (3.9 | ) |
| Unrealized gains (losses) on cash flow  hedges, net of taxes $(0.3) million and $0.4 million for the three months ended  September 30, 2008 and 2007, respectively, and $(0.3) million and $1.1  million for the nine months ended September 30, 2008 and 2007,  respectively |       | 0.4                                                      |       | (0.6                                                    | )          | 0.4 |   | (1.8 | ) |
| Other comprehensive (loss) income                                                                                                                                                                                                                                                       |       | (230.5                                                   | )          | 60.7                                                    |       | (128.8 | ) | 112.8 |   |
| Net Income                                                                                                                                                                                                                                                                              |       | 81.8                                                     |       | 59.4                                                    |       | 216.3 |   | 60.7 |   |
| Comprehensive (Loss) Income                                                                                                                                                                                                                                                             |       | $                                                        | (148.7     | )                                                       | $          | 120.1 |   | $ | 87.5 |   | $ | 173.5 |   |

 

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Accumulated othercomprehensive (loss) income, net of taxes consists of the following:

 
| ** **                                                                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(dollars in millions)**                                                                                 | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Cumulative foreign currency translation  adjustments                                                                |       | $                      | 5.9        |                  | $          | 129.7 |   |
| Cumulative retirement plans unrealized  losses, net of taxes $37.1 million and $38.7 million, respectively          |       | (57.4                  | )          | (60.0                 | )          |
| Cumulative unrealized losses on marketable  equity securities, net of taxes $0 million and $0 million, respectively |       | (8.3                   | )          | (0.3                  | )          |
| Cumulative unrealized losses on cash flow  hedges, net of taxes $0.8 million and $1.1 million, respectively         |       | (1.4                   | )          | (1.8                  | )          |
| Accumulated Other Comprehensive (Loss)  Income                                                                      |       | $                      | (61.2      | )                     | $          | 67.6 |   |

 

**Note 15****–****Segment Information**

** **

Hospira conducts operations worldwide and is managedin three reportable segments: Americas, EMEA and APAC. The Americas segmentincludes the United States, Canada and Latin America; the EMEA segment includesEurope, the Middle East and Africa; and the APAC segment includes Asia, Japan,Australia and New Zealand. In all segments, Hospira sells a broad line ofhospital products, including specialty injectable and other pharmaceuticals andmedication management systems and other devices. Specialty Injectables includegeneric injectables and proprietary specialty injectables. OtherPharmaceuticals include large volume IV solutions, nutritionals and contractmanufacturing services (including former “Sales to Abbott”). MedicationManagement Systems include infusion pumps, related software, services andadministration sets. Other Devices include gravity administration sets,critical care products and other device products. In 2008, Hospira re-alignedits segment presentation to better reflect how the business is currentlymanaged. Previously, Hospira operated in two reportable segments: U.S. andInternational. Prior year segment disclosure has been reclassified to conformto the current year presentation.

 

Hospira’s underlyingaccounting records are maintained on a legal entity basis for government andpublic reporting requirements. Segment disclosures are on a performance basisconsistent with internal management reporting. For internal managementreporting, intersegment transfers of inventory are recorded at standard costand are not a measure of segment income from operations. The costs of certaincorporate functions, stock-based compensation, interest expense, and otherincome, net that benefit the entire organization are not allocated to segments.The following segment information has been prepared in accordance with theinternal accounting policies of Hospira, as described above.

 

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| ** **                             | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                             | ** ** | **Net Sales**                                       | ** ** | **Income from Operations** | ** ** |
| **(dollars in millions)**    | ** ** | **2008**                                                 | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Americas                               |       | $                                                        | 705.7      |   | $ | 644.7 |   | $ | 151.1 |   | $ | 127.2 |   |
| EMEA                                   |       | 146.6                                                    |       | 133.8 |   | 4.4 |   | 1.8 |   |
| APAC                                   |       | 73.2                                                     |       | 59.5 |   | 6.4 |   | 5.6 |   |
|                                   |       |                                                     |       |   |   |   |   |   |   |
| Total reportable segments              |       | $                                                        | 925.5      |   | $ | 838.0 |   | 161.9 |   | 134.6 |   |
|                                   |       |                                                     |       |   |   |   |   |   |   |
| Corporate functions                    |       |                                                     |       |   |   | (20.5 | ) | (19.9 | ) |
| Stock-based compensation               |       |                                                     |       |   |   | (8.7 | ) | (8.1 | ) |
| Income from operations                 |       |                                                     |       |   |   | 132.7 |   | 106.6 |   |
| Interest expense and other income, net |       |                                                     |       |   |   | (25.2 | ) | (28.5 | ) |
|                                   |       |                                                     |       |   |   |   |   |   |   |
| Income before income taxes             |       |                                                     |       |   |   | $ | 107.5 |   | $ | 78.1 |   |

 
| ** **                             | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                             | ** ** | **Net Sales**                                      | ** ** | **Income from Operations** | ** ** |
| **(dollars in millions)**    | ** ** | **2008**                                                | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Americas                               |       | $                                                       | 2,057.1    |   | $ | 1,930.4 |   | $ | 426.0 |   | $ | 301.4 |   |
| EMEA                                   |       | 456.0                                                   |       | 396.5 |   | 10.7 |   | (15.4 | ) |
| APAC                                   |       | 202.7                                                   |       | 163.2 |   | 13.6 |   | (8.4 | ) |
|                                   |       |                                                    |       |   |   |   |   |   |   |
| Total reportable segments              |       | $                                                       | 2,715.8    |   | $ | 2,490.1 |   | 450.3 |   | 277.6 |   |
|                                   |       |                                                    |       |   |   |   |   |   |   |
| Corporate functions                    |       |                                                    |       |   |   | (55.0 | ) | (57.4 | ) |
| Stock-based compensation               |       |                                                    |       |   |   | (33.2 | ) | (31.6 | ) |
| Income from operations                 |       |                                                    |       |   |   | 362.1 |   | 188.6 |   |
| Interest expense and other income, net |       |                                                    |       |   |   | (80.7 | ) | (90.5 | ) |
|                                   |       |                                                    |       |   |   |   |   |   |   |
| Income before income taxes             |       |                                                    |       |   |   | $ | 281.4 |   | $ | 98.1 |   |

 
| ** **                          | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                          | ** ** | **Depreciation and Amortization**              | ** ** | **Additions to Long-Term Assets** | ** ** |
| **(dollars in millions)** | ** ** | **2008**                                                 | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Americas                            |       | $                                                        | 39.4       |   | $ | 38.9 |   | $ | 32.2 |   | $ | 37.8 |   |
| EMEA                                |       | 14.6                                                     |       | 10.3 |   | 6.1 |   | 0.8 |   |
| APAC                                |       | 10.0                                                     |       | 11.1 |   | 2.5 |   | 2.1 |   |
|                                |       |                                                     |       |   |   |   |   |   |   |
| Total reportable segments           |       | $                                                        | 64.0       |   | $ | 60.3 |   | $ | 40.8 |   | $ | 40.7 |   |

 
| ** **                          | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **Depreciation and Amortization**             | ** ** | **Additions to Long-Term Assets** | ** ** |
| **(dollars in millions)** | ** ** | **2008**                                                | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Americas                            |       | $                                                       | 121.4      |   | $ | 116.0 |   | $ | 104.9 |   | $ | 113.1 |   |
| EMEA                                |       | 39.4                                                    |       | 28.5 |   | 13.7 |   | 5.3 |   |
| APAC                                |       | 31.5                                                    |       | 28.8 |   | 7.2 |   | 5.8 |   |
|                                |       |                                                    |       |   |   |   |   |   |   |
| Total reportable segments           |       | $                                                       | 192.3      |   | $ | 173.3 |   | $ | 125.8 |   | $ | 124.2 |   |

 
| ** **                          | ** ** | **Goodwill**           | ** ** | **Total Assets** | ** ** |
|-------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| **(dollars in millions)** | ** ** | **2008**               | ** ** | **2007**              | ** ** | **2008** | ** ** | **2007** | ** ** |
| Americas                            |       | $                      | 757.5      |                  | $          | 749.0 |   | $ | 3,324.7 |   | $ | 3,203.9 |   |
| EMEA                                |       | 245.5                  |       | 263.8                 |       | 1,031.3 |   | 1,090.3 |   |
| APAC                                |       | 178.4                  |       | 228.1                 |       | 711.2 |   | 790.5 |   |
|                                |       |                   |       |                  |       |   |   |   |   |
| Total reportable segments           |       | $                      | 1,181.4    |                  | $          | 1,240.9 |   | $ | 5,067.2 |   | $ | 5,084.7 |   |

 

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

** **

**Forward-LookingStatements**

 

This report containsforward-looking statements within the meaning of the federal securities laws.Hospira intends that these forward-looking statements be covered by the safeharbor provisions for forward-looking words such as “may,” “will,” “should,” “anticipate,”“estimate,” “expect,” “plan,” “believe,” “predict,” “potential,” “project,” “intend,”“could,” or similar expressions. In particular, statements regarding Hospira’splans, strategies, prospects and expectations regarding its business andindustry are forward-looking statements. Investors should be aware that thesestatements and any other forward-looking statements in this document onlyreflect Hospira’s expectations and are not guarantees of performance. Thesestatements involve risks, uncertainties and assumptions. Many of these risks,uncertainties and assumptions are beyond Hospira’s control, and may causeactual results and performance to differ materially from expectations.Important factors that could cause Hospira’s actual results to be materiallydifferent from its expectations include (i) the risks and uncertainties describedin “Item 1A. Risk Factors” in Hospira’s Annual Report on Form 10-K for theyear ended December 31, 2007 (the “2007 Form 10-K”) as updated byPart II. Item 1A. in this Form 10-Q, and (ii) the factors described in “Item7. Management’s Discussion and Analysis of Financial Condition and Results ofOperations” in the 2007 Form 10-K, and the factors described in “Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations” in each report on Form 10-Q for the three month periods ended March 31,2008 and June 30, 2008, as updated by this Item 2. Accordingly, one shouldnot place undue reliance on the forward-looking statements contained in thisreport. These forward-looking statements speak only as of the date on which thestatements were made. Hospira undertakes no obligation to update or revisepublicly any forward-looking statements, whether as a result of newinformation, future events or otherwise.

 

**Overview**

 

Hospira is a globalspecialty pharmaceutical and medication delivery company that develops,manufactures and markets products that help improve the safety, cost andproductivity of patient care. Hospira’s portfolio includes one of the industry’sbroadest lines of generic acute-care and oncology injectables, as well asintegrated infusion therapy and medication management solutions. Hospira’sbroad portfolio of products is used by hospitals and alternate site providers,such as clinics, home healthcare providers and long-term care facilities. In February 2007,Hospira acquired Mayne Pharma Limited (“Mayne Pharma”) to increase its globalpresence in specialty generic injectable pharmaceuticals.

 

In 2008, Hospirare-aligned its segment presentation to better reflect how the business iscurrently managed. Hospira has three reportable segments: Americas; Europe,Middle East and Africa (“EMEA”); and Asia Pacific (“APAC”). Prior year segmentdisclosure has been reclassified to conform to the current year presentation.

 

**MaynePharma Acquisition**

** **

On February 2, 2007,Hospira completed its acquisition of Mayne Pharma for $2,055.0 million. Theresults of operations of Mayne Pharma are included in Hospira’s results forperiods as of that date, which has affected comparability of the financialstatements for the periods presented in this report and will affectcomparability in future periods. Hospira financed the acquisition and relatedexpenses through borrowing approximately $1,925.0 million, and the remainderwas funded with cash on hand. Net sales of Mayne Pharma products, which areprincipally specialty injectable pharmaceutical products, are reported withineach of Hospira’s reportable segments.

 

In connection with theacquisition, during the nine months ended September 30, 2007, Hospirarecorded $137.9 million of charges relating to purchase accounting, including$84.8 million of acquired in-process research and development, all of which wasrecorded in the first quarter, and $53.1 million of inventory step-up charges,of which $21.4 million was expensed in the first quarter and $31.7 million wasexpensed in the second quarter. Hospira also recorded $518.2 million ofintangible assets in connection with the acquisition, which will be amortizedover their estimated useful lives (which have a weighted average life of 10years).

 

In connection with theintegration of Mayne Pharma into its operations, Hospira reported that itexpected to incur approximately $95 million to $110 million of cashexpenditures for the two-year period after the closing, of which $60 million to$75 million to be recorded as expense, with the remainder related to purchaseaccounting items and capital projects. These expenses relate to theclosure of facilities, termination of lease agreements and employee-relatedbenefit arrangements during the two-year period after the closing. Approximately$4.8 million and $22.4 million of integration expenses were recorded during thethree and nine months ended September 30, 2008, respectively.Approximately $7.9 million and $31.6 million of integration expenses wererecorded during the three and nine months ended September 30, 2007,respectively. To date, approximately $108.7 million of cash expenditures have been made,of which $66.6 million of expenses have been incurred. Although theremaining expenditures are expected to be completed by the end of 2008, Hospira nowexpects to incur cash expenditures slightly above the high end of the range dueto the impact of changes in foreign exchange rates and additional capitalexpenditures. In addition to integration expenses, Hospira recorded otheracquisition-related expenses of $7.9 million in the three months ended March 31,2007.

 

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**Critical Accounting Policies**

** **

The preparation offinancial statements in accordance with generally accepted accountingprinciples in the United States (GAAP) requires management to make estimatesand judgments that affect the reported amounts of assets, liabilities, revenuesand expenses. A summary of Hospira’s significant accounting policies isincluded in Note 1 to the company’s consolidated financial statements, whichare included in Hospira’s Annual Report on Form 10-K for the year ended December 31,2007. Certain of Hospira’s accounting policies are considered critical, asthese policies require significant, difficult or complex judgments bymanagement, often employing the use of estimates about the effects of mattersthat are inherently uncertain. Such policies are summarized in “Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations” in the 2007 Form 10-K.

 

**Recently Issued Accounting Standards**

** **

In April 2008, the Financial Accounting Standards Board (“FASB”)issued FASB Staff Position No. FAS 142-3, “Determination of the UsefulLife of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors thatshould be considered in developing renewal or extension assumptions used todetermine the useful life of a recognized intangible asset under FASB StatementNo. 142, “Goodwill and Other Intangible Assets.” This provision of FSP142-3 will be effective for financial statements issued for fiscal yearsbeginning after December 15, 2008. Early adoption is prohibited. Since thisguidance will be applied prospectively, on adoption, there will be no impact toHospira’s consolidated financial position, results of operations or cash flows.

 

In March 2008, the FASB issued Statement of Financial AccountingStandards (“SFAS”) No. 161, “Disclosures About Derivative Instruments andHedging Activities – an amendment of FASB Statement No. 133” (“SFAS No. 161”).SFAS No. 161 expands the disclosure requirements for derivativeinstruments and hedging activities. The provisions will be effective forfinancial statements issued for fiscal years beginning after November 15,2008. SFAS No. 161 only requires additional disclosures, hence theadoption will not impact Hospira’s consolidated financial position, results ofoperations or cash flows.

 

In December 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements — an amendment of ARB No. 51”(“SFAS No. 160”). SFAS No. 160 states that accounting and reportingfor minority interests will be recharacterized as noncontrolling interests andclassified as a component of equity. SFAS No. 160 also establishesreporting requirements that provide sufficient disclosures that clearlyidentify and distinguish between the interests of the parent and the interestsof the noncontrolling owners. SFAS No. 160 applies to all entities thatprepare consolidated financial statements, except not-for-profit organizations,but will affect only those entities that have an outstanding noncontrollinginterest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS No. 160is effective for financial statements issued for fiscal years beginning after December 15,2008. Hospira does not anticipate that the impact from the adoption of SFAS No. 160will be significant to the consolidated financial position, results ofoperations or cash flows.

 

In December 2007, the FASB ratified EmergingIssues Task Force (“EITF”) Issue No. 07-1, “Accounting for CollaborativeArrangements” (“EITF 07-1”). EITF 07-1 provides guidance on how to determinewhether an arrangement constitutes a collaborative arrangement, how costsincurred and revenue generated on sales to third parties should be reported bythe participants in a collaborative arrangement, how payments made betweenparticipants in a collaborative arrangement should be characterized, and whatparticipants should disclose in the notes to the financial statements about acollaborative arrangement. EITF 07-1 is effective for financial statementsissued for fiscal years beginning after December 15, 2008. Hospira iscurrently evaluating the potential impact of EITF 07-1 on the financialstatements.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “BusinessCombinations” (“SFAS No. 141R”). SFAS No. 141R establishes principlesand requirements for the reporting entity in a business combination, includingrecognition and measurement in the financial statements of the identifiableassets acquired, the liabilities assumed, and any noncontrolling interest inthe acquiree. This statement also establishes disclosure requirements to enablefinancial statement users to evaluate the nature and financial effects of thebusiness combination. SFAS No. 141R is effective for business combinationsthat close in years beginning on or after December 15, 2008. Since thisguidance will be applied prospectively, on adoption, there will be no impact toHospira’sconsolidated financial position, results of operations or cash flows.

 

In September 2006,the FASB issued SFASNo. 158, “Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plans – an amendment of FASBStatements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”). Oneprovision of SFAS No. 158 requiresthe measurement of Hospira’s defined benefit plan’s assets and its obligationsto determine the funded status be made as of the end of the fiscal year. Therefore, the actuarial valuation measurement datewill be changed from November 30 to December 31, 2008, so all planswill have a year end measurement date. This provision of SFAS No. 158 iseffective for fiscal years ending after December 15, 2008. The adoption of this provision of SFAS No. 158will not be significant to the financial statements.

 

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**Adoption of New Accounting Standards**

** **

Hospira adopted the required provisions of SFAS No. 157, “Fair ValueMeasurements” (“SFAS No. 157”) on January 1, 2008. SFAS No. 157clarifies the principle that fair value should be based on the assumptionsmarket participants would use when pricing an asset or liability andestablishes a fair value hierarchy that prioritizes the information used todevelop those assumptions. There was no impact to the condensed consolidatedfinancial statements from the adoption of SFAS No. 157.

 

SFAS No. 157 establishes a fair value hierarchy for disclosure of theinputs used to measure fair values. This hierarchy prioritizes the inputs intothree broad levels. Level 1 inputs are quoted prices (unadjusted) in activemarkets for identical assets or liabilities. Level 2 inputs are quoted pricesfor similar assets and liabilities in active markets or inputs that areobservable for similar assets or liabilities, either directly or indirectlythrough market corroboration, for substantially the full term of the financialinstrument. Level 3 inputs are unobservable inputs which reflect assumptionsdeveloped by management to measure assets and liabilities at fair value. Afinancial asset or liability’s classification within the hierarchy isdetermined based on the lowest level input that is significant to the fairvalue measurement.

 

The fair value of the Level 1 financialassets is based on quoted market prices of the identical underlying security inan active market. The fair value of the Level 2 financial assets is based onmarket observable inputs to quoted market prices, benchmark yields andbroker/dealer quotes.

 

FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157”(“FSP 157-2”) delays the effective date of the application of SFAS No. 157to fiscal years beginning after November 15, 2008, for all nonfinancialassets and nonfinancial liabilities that are recognized or disclosed at fairvalue in the financial statements on a non-recurring basis. Hospira adoptedSFAS No. 157 with the exception of the application of the statement tonon-recurring nonfinancial assets and liabilities. Non-recurring nonfinancialassets and nonfinancial liabilities for which Hospira has not applied theprovisions of SFAS No. 157 primarily include those measured at fair valuein goodwill and long-lived asset impairment testing, those initially measuredat fair value in a business combination, and nonfinancial liabilities for exitor disposal activities.

 

Hospira adopted the provisions of SFAS No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities – Including an amendment of FASBStatement No. 115” (“SFAS No. 159”) on January 1, 2008. SFAS No. 159provides a company with the option to measure selected financial instrumentsand certain other items at fair value at specified election dates. At adoption,Hospira had not elected to apply SFAS No. 159 to measure selectedfinancial instruments and certain other items at fair value, therefore, therewas no impact to the condensed consolidated financial statements from adoptionof SFAS No. 159. Subsequent to the initial adoption of SFAS No. 159on January 1, 2008, Hospira has not made any elections to apply SFAS No. 159during the nine months ended September 30, 2008.

 

**Results ofoperations for the three months ended September 30, 2008 compared to September 30,2007**

** **

*Net Sales*

* *

Net sales increased 10.4%or 8.8%, excluding the impact of changes in foreign exchange rates, in the threemonths ended September 30, 2008 compared to the three months ended September 30,2007.

 

A comparison of product line net sales is as follows:

 

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**Hospira, Inc.**

**Net Sales by Product Line**

**(Unaudited)**

***(dollars in millions)***

 
| ** **                    | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|
| ** **                    | ** ** | **2008**                                                 | ** ** | **2007** | ** ** | **Percent  Change vs.  Prior Year** | ** ** |
| Americas—                |       |                                                     |       |   |   |   |   |
| Pharmaceuticals               |       |                                                     |       |   |   |   |   |
| Specialty Injectables         |       | $                                                        | 341.1      |   | $ | 299.9 |   | 13.7 | % |
| Other Pharma                  |       | 129.8                                                    |       | 131.3 |   | (1.1 | )% |
|                          |       | 470.9                                                    |       | 431.2 |   | 9.2 | % |
| Devices                       |       |                                                     |       |   |   |   |   |
| Medication Management Systems |       | 138.5                                                    |       | 123.0 |   | 12.6 | % |
| Other Devices                 |       | 96.3                                                     |       | 90.5 |   | 6.4 | % |
|                          |       | 234.8                                                    |       | 213.5 |   | 10.0 | % |
| Total Americas                |       | 705.7                                                    |       | 644.7 |   | 9.5 | % |
|                          |       |                                                     |       |   |   |   |   |
| EMEA—                    |       |                                                     |       |   |   |   |   |
| Pharmaceuticals               |       |                                                     |       |   |   |   |   |
| Specialty Injectables         |       | 67.5                                                     |       | 65.0 |   | 3.8 | % |
| Other Pharma                  |       | 41.3                                                     |       | 37.8 |   | 9.3 | % |
|                          |       | 108.8                                                    |       | 102.8 |   | 5.8 | % |
| Devices                       |       |                                                     |       |   |   |   |   |
| Medication Management Systems |       | 19.6                                                     |       | 16.1 |   | 21.7 | % |
| Other Devices                 |       | 18.2                                                     |       | 14.9 |   | 22.1 | % |
|                          |       | 37.8                                                     |       | 31.0 |   | 21.9 | % |
| Total EMEA                    |       | 146.6                                                    |       | 133.8 |   | 9.6 | % |
|                          |       |                                                     |       |   |   |   |   |
| APAC—                    |       |                                                     |       |   |   |   |   |
| Pharmaceuticals               |       |                                                     |       |   |   |   |   |
| Specialty Injectables         |       | 57.3                                                     |       | 45.7 |   | 25.4 | % |
| Other Pharma                  |       | 4.5                                                      |       | 4.2 |   | 7.1 | % |
|                          |       | 61.8                                                     |       | 49.9 |   | 23.8 | % |
| Devices                       |       |                                                     |       |   |   |   |   |
| Medication Management Systems |       | 4.8                                                      |       | 4.0 |   | 20.0 | % |
| Other Devices                 |       | 6.6                                                      |       | 5.6 |   | 17.9 | % |
|                          |       | 11.4                                                     |       | 9.6 |   | 18.8 | % |
| Total APAC                    |       | 73.2                                                     |       | 59.5 |   | 23.0 | % |
|                          |       |                                                     |       |   |   |   |   |
| Net Sales                     |       | $                                                        | 925.5      |   | $ | 838.0 |   | 10.4 | % |

 

Specialty Injectablesinclude generic injectables and proprietary specialty injectables. OtherPharmaceuticals include large volume IV solutions, nutritionals and contractmanufacturing services (including former “Sales to Abbott”). MedicationManagement Systems include infusion pumps, related software, services andadministration sets. Other Devices include gravity administration sets,critical care products and other device products.

 

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Americas

 

Netsales in the Americas segment increased 9.5%, or 9.2% excluding the impact ofchanges in foreign exchange rates. The growth in net sales of SpecialtyInjectable Pharmaceuticals was due to increased volumes from Group PurchasingOrganization (“GPO”) pharmacy contract awards, new product introductions, andthe impact of competitor supply issues. Other Pharma net sales decreased due tolower demand from certain contract manufacturing customers, partially offset byincreased large volume IV solutions sales. Net sales in Medication ManagementSystems increased due to strong demand, particularly for Symbiq®,Hospira’s newest general infusion system. Other Device net sales increased dueto volume growth in gravity administration sets.

 

EMEA

 

Netsales in the EMEA segment increased 9.6%, or 3.4% excluding the impact ofchanges in foreign exchange rates. Excluding the changes in foreign exchangerates, Specialty Injectable Pharmaceuticals sales declined, primarily due toexpected oncology price decreases, partially offset by higher anesthesiaproduct volume, and sales of newly launched biogenerics. Net sales inMedication Management Systems increased due to higher sales volume ofambulatory infusion systems.

 

APAC

 

Netsales in the APAC segment increased 23.0%, or 17.3% excluding the impact ofchanges in foreign exchange rates. The majority of the increase wasattributed to growth in Specialty Injectables due to volume growth inanti-infectives and oncology products. The remaining increase was due to volumegrowth in Medication Management Systems, Other Pharma and Devices.

 

*Gross Profit*

 
| **Three months ended September 30 (dollars in millions)** | ** ** | **2008** | ** ** | **2007** | ** ** | **Percent  change** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|---------------------|------------|
| Gross profit                                                                                 |       | $        | 330.0      |     | $          | 294.5               |       | 12.1 | % |
| As a percent of net sales                                                                    |       | 35.7     | %          | 35.1     | %          |                |       |
|                                                                                              |            |          |            |          |            |                     |            |  |  |

 

Gross profit increased$35.5 million, or 12.1%, for the three months ended September 30, 2008,compared with the same period in 2007.

 

The gross profit increaseis primarily the result of higher sales volume, favorable product mix andimproved manufacturing performance, partially offset by higher freight anddistribution expenses. Gross margin increased to 35.7% for the three monthsended September 30, 2008, from 35.1% for the three months ended September 30,2007.

 

*Research and Development*

 
| **Three months ended September 30 (dollars in millions)** | ** ** | **2008** | ** ** | **2007** | ** ** | **Percent  change** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|---------------------|------------|
| Research and development expense                                                             |       | $        | 51.7       |     | $          | 51.4                |       | 0.6 | % |
| As a percent of net sales                                                                    |       | 5.6      | %          | 6.1      | %          |                |       |
|                                                                                              |            |          |            |          |            |                     |            |  |  |

 

Research and development(“R&D”) expenses increased $0.3 million, or 0.6%, for the three monthsended September 30, 2008, compared with the same period in 2007. Theexpense increase was primarily related to higher spending on productdevelopment related to new compounds in Hospira’s generic injectable drugpipeline and medication management systems projects, partially offset by lowerclinical trial spending.

 

*Selling, General and Administrative*

 
| **Three months ended September 30 (dollars in millions)** | ** ** | **2008** | ** ** | **2007** | ** ** | **Percent  change** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|---------------------|------------|
| Selling, general and administrative expense                                                  |       | $        | 145.6      |     | $          | 136.5               |       | 6.7 | % |
| As a percent of net sales                                                                    |       | 15.7     | %          | 16.3     | %          |                |       |
|                                                                                              |            |          |            |          |            |                     |            |  |  |

 

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Selling, general andadministrative (“SG&A”) expenses increased $9.1 million, or 6.7%, for thethree months ended September 30, 2008, compared with the same period in2007. The expense increase was primarily due to sales and marketing supportwithin the Americas and support costs for new product launches outside the Americas.

 

*Interest Expense and Other Income,Net*

* *

Interest expense was$27.6 million for the three months ended September 30, 2008, compared to$34.7 million in the same period in 2007. The decrease was primarily due tolower debt outstanding in the 2008 period, and lower interest rates on floatingrate notes. Other income, net was $(2.4) million for the three months ended September 30,2008 compared to $(6.2) million for the three months ended September 30,2007. The decrease reflects lower levels of interest income, foreign exchangetransaction gains, and net gains on investments.

 

*IncomeTax Expense*

* *

The effective tax ratewas 23.9% for the three months ended September 30, 2008, compared to 24.0%for the same period in 2007.

 

**Results ofoperations for the nine months ended September 30, 2008 compared to September 30,2007**

 

*Net Sales*

* *

Net sales increased 9.1%,or 6.1% excluding the impact of changes in foreign exchange rates, in the ninemonths ended September 30, 2008 compared to the nine months ended September 30,2007.

 

A comparison of product line net sales is as follows:

 

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**Hospira, Inc.**

**Net Sales by Product Line**

**(Unaudited)**

***(dollars in millions)***

 
| ** **                    | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------|------------|---------------------------------------------------------|------------|
| ** **                    | ** ** | **2008**                                                | ** ** | **2007** | ** ** | **Percent  Change vs.  Prior Year** | ** ** |
| Americas—                |       |                                                    |       |   |   |   |   |
| Pharmaceuticals               |       |                                                    |       |   |   |   |   |
| Specialty Injectables         |       | $                                                       | 981.7      |   | $ | 891.2 |   | 10.2 | % |
| Other Pharma                  |       | 374.4                                                   |       | 393.6 |   | (4.9 | )% |
|                          |       | 1,356.1                                                 |       | 1,284.8 |   | 5.5 | % |
| Devices                       |       |                                                    |       |   |   |   |   |
| Medication Management Systems |       | 418.3                                                   |       | 372.2 |   | 12.4 | % |
| Other Devices                 |       | 282.7                                                   |       | 273.4 |   | 3.4 | % |
|                          |       | 701.0                                                   |       | 645.6 |   | 8.6 | % |
| Total Americas                |       | 2,057.1                                                 |       | 1,930.4 |   | 6.6 | % |
|                          |       |                                                    |       |   |   |   |   |
| EMEA—                    |       |                                                    |       |   |   |   |   |
| Pharmaceuticals               |       |                                                    |       |   |   |   |   |
| Specialty Injectables         |       | 224.2                                                   |       | 184.3 |   | 21.6 | % |
| Other Pharma                  |       | 120.3                                                   |       | 111.3 |   | 8.1 | % |
|                          |       | 344.5                                                   |       | 295.6 |   | 16.5 | % |
| Devices                       |       |                                                    |       |   |   |   |   |
| Medication Management Systems |       | 59.3                                                    |       | 49.8 |   | 19.1 | % |
| Other Devices                 |       | 52.2                                                    |       | 51.1 |   | 2.2 | % |
|                          |       | 111.5                                                   |       | 100.9 |   | 10.5 | % |
| Total EMEA                    |       | 456.0                                                   |       | 396.5 |   | 15.0 | % |
|                          |       |                                                    |       |   |   |   |   |
| APAC—                    |       |                                                    |       |   |   |   |   |
| Pharmaceuticals               |       |                                                    |       |   |   |   |   |
| Specialty Injectables         |       | 155.3                                                   |       | 121.6 |   | 27.7 | % |
| Other Pharma                  |       | 12.1                                                    |       | 10.8 |   | 12.0 | % |
|                          |       | 167.4                                                   |       | 132.4 |   | 26.4 | % |
| Devices                       |       |                                                    |       |   |   |   |   |
| Medication Management Systems |       | 15.5                                                    |       | 12.3 |   | 26.0 | % |
| Other Devices                 |       | 19.8                                                    |       | 18.5 |   | 7.0 | % |
|                          |       | 35.3                                                    |       | 30.8 |   | 14.6 | % |
| Total APAC                    |       | 202.7                                                   |       | 163.2 |   | 24.2 | % |
|                          |       |                                                    |       |   |   |   |   |
| Net Sales                     |       | $                                                       | 2,715.8    |   | $ | 2,490.1 |   | 9.1 | % |

 

Specialty Injectablesinclude generic injectables and proprietary specialty injectables. OtherPharmaceuticals include large volume IV solutions, nutritionals and contractmanufacturing services (including former “Sales to Abbott”). MedicationManagement Systems include infusion pumps, related software, services andadministration sets. Other Devices include gravity administration sets,critical care products and other device products.

 

Net sales for the ninemonths ended September 30, 2008 and 2007 include nine and eight months,respectively, of Mayne Pharma net sales.

 

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Americas

 

Net sales in the Americassegment increased 6.6%, or 5.7% excluding the impact of changes in foreignexchange rates. Net sales of Specialty Injectable Pharmaceuticals increased dueto higher volumes from GPO pharmacy contract awards, new product introductionsand the impact of various competitor supply issues. Other Pharma net salesdecreased due to lower demand from certain contract manufacturing customers,partially offset by increased large volume IV solutions sales. Net sales inMedication Management Systems increased due to strong demand, particularly forSymbiq®, Hospira’s newest general infusion system, as well asimprovements in our implementation processes. Other Devices net sales increaseddue to volume growth in gravityadministration sets.

 

EMEA

 

Netsales in the EMEA segment increased 15.0%, or 4.9% excluding the impact ofchanges in foreign exchange rates. The increase was primarily due to anadditional month of Mayne Pharma net sales in 2008, growth in compounding,higher ambulatory infusion systems sales volume, and sales of newly launchedbiogenerics partially offset by declines in demand from existingcontract manufacturing customers.

 

APAC

 

Netsales in the APAC segment increased 24.2%, or 13.2% excluding the impact ofchanges in foreign exchange rates. The increase was primarily due to anadditional month of Mayne Pharma net sales in 2008, volume growth in SpecialtyInjectable anti-infectives and oncology products and increased volumes inMedication Management Systems.

 

*Gross Profit*

 
| **Nine months ended September 30 (dollars in millions)** | ** ** | **2008** | ** ** | **2007** | ** ** | **Percent  change** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|---------------------|------------|
| Gross profit                                                                                |       | $        | 973.4      |     | $          | 835.3               |       | 16.5 | % |
| As a percent of net sales                                                                   |       | 35.8     | %          | 33.5     | %          |                |       |
|                                                                                             |            |          |            |          |            |                     |            |  |  |

 

Gross profit increased$138.1 million, or 16.5%, for the nine months ended September 30, 2008,compared with the same period in 2007.

 

The gross profit increaseis primarily the result of higher sales volume, including an additional monthof Mayne Pharma gross profit in 2008, variations in foreign exchange rates, improvedmanufacturing performance, andfavorable product mix driven by Medication Management Systems, partiallyoffset by higher freight and distribution expenses. A portion of the increasein gross profit results from the absence in 2008 of purchase accounting chargesfor Mayne Pharma, which in the prior year included inventory step-up charges of$53.1 million. Gross margin increased to 35.8% for the nine months ended September 30,2008, from 33.5% for the nine months ended September 30, 2007.

 

*Research and Development*

 
| **Nine months ended September 30 (dollars in millions)** | ** ** | **2008** | ** ** | **2007** | ** ** | **Percent  change** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|---------------------|------------|
| Research and development expense                                                            |       | $        | 160.1      |     | $          | 147.5               |       | 8.5 | % |
| As a percent of net sales                                                                   |       | 5.9      | %          | 5.9      | %          |                |       |
|                                                                                             |            |          |            |          |            |                     |            |  |  |

 

Research and development(“R&D”) expenses increased $12.6 million, or 8.5%, for the nine monthsended September 30, 2008, compared with the same period in 2007. Theincrease was primarily related to higher spending on product developmentrelated to new compounds in Hospira’s generic injectable drug pipeline and theadditional month of Mayne Pharma partially offset by lower clinical trialspending.

 

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*Acquired In-Process Research and Development*

 

In the three months ended June 30, 2008, as partof the acquisition purchase price allocation further described in Note 2,Hospira expensed $0.5 million to acquired in-process research and developmentrelated to pipeline products.

* *

In the three months ended March 31, 2007, as partof the Mayne Pharma purchase price allocation, Hospira allocated and expensed$84.8 million to acquired in-process research and development related to MaynePharma’s pipeline products.

* *

*Selling, General and Administrative*

 
| **Nine months ended September 30 (dollars in millions)** | ** ** | **2008** | ** ** | **2007** | ** ** | **Percent  change** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|---------------------|------------|
| Selling, general and administrative expense                                                 |       | $        | 450.7      |     | $          | 414.4               |       | 8.8 | % |
| As a percent of net sales                                                                   |       | 16.6     | %          | 16.6     | %          |                |       |
|                                                                                             |            |          |            |          |            |                     |            |  |  |

 

Selling, general andadministrative (“SG&A”) expenses increased $36.3 million, or 8.8%, for thenine months ended September 30, 2008, compared with the same period in2007. The expense increase was primarily due to sales and marketing supportwithin the Americas and support costs for new product launches outside the Americas,and changes in foreign exchange rates.

 

*Interest Expense and Other Income,Net*

* *

Interest expense was$87.2 million for the nine months ended September 30, 2008, compared to$102.5 million in the same period in 2007. The decrease was primarily due tolower debt outstanding in the 2008 period, write-off of debt issue costsincurred in 2007 related to the Mayne Pharma acquisition, and lower interestrates on floating rate notes. Other income, net was $(6.5) million for the ninemonths ended September 30, 2008 compared to $(12.0) million for the ninemonths ended September 30, 2007, due to lower levels of interest income,foreign exchange transaction gains, and net gains on investments.

 

*IncomeTax Expense*

 

The effective tax ratewas 23.1% for the nine months ended September 30, 2008, compared to 38.1%for the same period in 2007. The effective tax rate for 2007 included theimpact of expensing acquired in-process research and development. Excluding theeffect of this item, the 2007 effective tax rate was 20.5%, and the change inthe effective tax rate was due primarily to increased income in higher tax ratejurisdictions.

 

**Liquidityand Capital Resources at September 30, 2008 compared with December 31,2007**

 

Net Cash Provided byOperating Activities continues to be Hospira’s primary source of funds tofinance capital expenditures and repay debt. Other capital resources includecash on hand, borrowing availability under a $375.0 million revolving creditfacility and access to capital markets. Hospira believes that its currentcapital resources, including cash and cash equivalents, cash generated fromoperations, funds available from its revolving credit facility and access tothe credit and capital markets will be sufficient to finance its operations,debt service obligations, capital expenditures, product development andintegration expenditures for the foreseeable future.

 

Beginning on February 2,2007, Hospira’s operating cash flows include operating cash flows generated byMayne Pharma. In connection with the integration of Mayne Pharma into itsoperations, Hospira reported that it expected to incur approximately $95million to $110 million of cash expenditures for the two-year period after theclosing, which reduce operating and investing cash flows. To date,approximately $108.7 million of cash expenditures have been incurred. Althoughthe remaining expenditures are expected to be completed by the end of 2008, Hospira nowexpects to incur cash expenditures slightly above the high end of the range dueto the impact of changes in foreign exchange rates and additional capitalexpenditures. In addition, as a result of the debt incurred to financethe Mayne Pharma acquisition, Hospira must dedicate substantially greater cashto service debt obligations (including interest expense and mandatory principalpayments on the term loan described below) compared to previous periods.

 

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*Summary of Cash Flows*

 
| ** **                          | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------|------------|
| **(dollars in millions)** | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| Cash flow provided by (used in):    |       |                                                    |       |   |   |
| Operating activities                |       | $                                                       | 328.6      |   | $ | 354.5 |   |
| Investing activities                |       | (222.4                                                  | )          | (2,133.2 | ) |
| Financing activities                |       | (53.2                                                   | )          | 1,677.1 |   |
|                                     |            |                                                         |            |  |  |  |  |

 

Operating activities for the nine months ended September 30, 2008provided net cash of $328.6 million driven by net income of $216.3 million.Non-cash charges related to depreciation, amortization of intangibles, thewrite-off of acquired in-process research and development, stock-basedcompensation expense and the net gains on the sales of assets totaled $223.0million. Changes in operating assets and liabilities and Other, totaled$(110.7) million driven by higher trade receivables and higher inventories forplanned product launches and increased GPO contract awards.

 

Net Cash Used in Investing Activities of $222.4 million for the ninemonths ended September 30, 2008 includes capital expenditures of $126.9million and $49.6 million of payments for certain intangible assets includingproduct rights, primarily acquired in the prior year but paid in the currentyear, and other investments. Hospira paid $22.2 million for acquisitions anddeferred consideration related to acquisitions made by Mayne Pharma in prioryears. Also, Hospira purchased $24.5 million of marketable equitysecurities and received proceeds of $0.8 million from disposal of facilities.

 

Net Cash Used inFinancing Activities of $53.2 million for the nine months ended September 30,2008 includes prepayments of $67.4 million in addition to the revised required$22.6 million for a total of $90.0 million in principal for the term loan.Financing activities also include net borrowing of $8.5 million and proceedsfrom employee stock option exercises and related tax benefits of $28.4 million.

 

*Debt and Capital*

* *

Underthe $500.0 million three-year term loan facility due 2010, Hospira was requiredto repay $12.5 million in principal at the end of each quarter in 2007, $50.0million in principal at the end of each quarter in 2008 and $62.5 million forthe three remaining payments in 2009 and the final payment in 2010. Hospira ispermitted to prepay amounts borrowed under the facility from time to timewithout penalty. Prepayments are prorated against future payments under thefacility reducing the future obligations. Principal prepayments made in 2007 of$359.7 million and an additional $67.4 million in the nine months ended September 30,2008, reduced the amounts required to be repaid to $1.7 million at the end ofthe fourth quarter of 2008 and $2.1 million for the three remaining payments in2009 and the final payment in 2010. As of September 30, 2008, prepaymentsand required payments of $490.0 million in principal have been paid and of theremaining $10.0 million in principal, $7.9 million is due within one year

 

InJune 2008, Hospira entered into interest rate swap contracts whereby$300.0 million of the $400.0 million, 5.90% fixed rate ten-year seniorunsecured notes due in June 2014 were effectively converted from fixed tofloating rate debt. Hospira records the interest rate swap contracts at fairvalue and offsets the carrying amount of the fixed-rate debt by the sameamount. Changes in fair value are offset against the carrying amount of thefixed-rate debt through earnings and the ineffective portion of the derivative’schange in fair value will be immediately recognized in earnings. In September 2008,Hospira terminated one interest rate swap contract with a notional amount of$75.0 million thereby reducing the notional portion effectively converted fromfixed to floating rate debt from $300.0 million to $225.0 million.

 

Additionally,in September 2008, Hospira terminated one interest rate swap contract witha notional amount of $100.0 million, which had effectively converted therelated portion of the $300.0 million, 4.95% fixed-rate five-year seniorunsecured notes due 2009, to variable rate debt. This reduced the notionalportion effectively converted from fixed to floating rate debt from $300.0million to $200.0 million.

 

Asa result of these interest rate swap contract terminations, Hospira received$2.5 million in cash, excluding accrued interest. The corresponding gainsrelated to the basis adjustment of the debt associated with the terminated swapcontracts were deferred and are being amortized as a reduction of interestexpense over the remaining term of the notes. The cash flows from thesecontracts are reported as operating activities in the Condensed ConsolidatedStatements of Cash Flows. There are no penalties associated with thetermination of the interest rate swap agreements.

 

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InOctober 2008, Hospira terminated all remaining interest rate swapcontracts with a total notional amount of $425.0 million, which had effectivelyconverted the related portion of the fixed-rate senior unsecured notes due 2014and 2009, to variable rate debt. As a result of the swap terminations, Hospirareceived $6.7 million in cash, excluding accrued interest. The correspondinggains related to the basis adjustment of the debt associated with theterminated swap contracts will be deferred and amortized as a reduction ofinterest expense over the remaining term of the notes. The cash flows fromthese contracts will be reported as operating activities in the CondensedConsolidated Statements of Cash Flows. There are no penalties associated withthe termination of the interest rate swap agreements.

 

Hospirahas a five-year $375.0 million unsecured revolving credit facility (the “Revolver”).The Revolver is available for working capital and other requirements. As of September 30,2008, Hospira had no amounts outstanding under the Revolver.

 

Certain of our borrowing agreements contain covenantsthat require compliance, for example, a maximum leverage ratio and a minimuminterest coverage ratio. As of September 30, 2008, Hospira was incompliance with all applicable covenants.

 

**Contractual Obligations**

** **

Pleaserefer to Item 7. in Hospira’s Annual Report on Form 10-K for the yearended December 31, 2007 for a discussion of Hospira’s contractualobligations.

 

Throughthe nine-months ended September 30, 2008, actual returns for the main U.S.pension plan funds are significantly below the expected rate of return of 8.25%due to adverse conditions in the equity markets. Continued actual returnsbelow the long-term expected rate of return would impact the amount and timingof future contributions and funding requirements under the Pension ProtectionAct of 2006. During the three months ended September 30, 2008,Hospira made a discretionary funding contribution of $5.5 million to the mainU.S. pension plan. Based on Federal laws and regulations, Hospira is notrequired to make any contributions and does not expect to make anydiscretionary contributions to its pension plans for the remainder of 2008 or2009.

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

As of September 30, 2008, Hospira had interest rate swaptransactions whereby $200.0 million of the $400.0 million ten-year seniorunsecured notes due in June 2014, and $225.0 million of the$300.0 million five-year senior unsecured notes due in June 2009 wereeffectively converted from fixed to floating rate debt. When converting fromfixed to floating rate debt, a hypothetical one percentage pointincrease/(decrease) in interest rates would increase/(decrease) interestexpense by $4.5 million.

 

There have been no othermaterial changes to the information provided in Item 7A. to Hospira’s AnnualReport on Form 10-K for the year ended December 31, 2007.

 

**Item4.   Controls and Procedures**

 

*Evaluation of disclosure controlsand procedures.*  The Chairman and Chief Executive Officer,Christopher B. Begley, and Senior Vice President, Finance and Chief FinancialOfficer, Thomas E. Werner, evaluated the effectiveness of Hospira’s disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934) as of the end of the period covered bythis report, and concluded that Hospira’s disclosure controls and procedureswere effective.

 

*Changes in internal controls.* There was no change in Hospira’sinternal control over financial reporting that has materially affected, or isreasonably likely to materially affect, Hospira’s internal control overfinancial reporting.

 

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** **

**PART II.  OTHER INFORMATION**

 

**Item1.****                    LegalProceedings**

** **

The disclosure containedin Note 12 to the condensed consolidated financial statements included in Part I.Item 1 hereof is incorporated herein by reference.

 

**Item1A.  Risk Factors**

** **

Pleaserefer to Item 1A. in Hospira’s Annual Report on Form 10-K for the yearended December 31, 2007 for a discussion of risks to which Hospira’sbusiness, financial condition, results of operations and cash flows aresubject. There have been no material changes in our Risk Factors as disclosedin Hospira’s Form 10-K, except for the following:

 

*Adverse market conditions may affect Hospira’s ability tomeet its future liquidity needs.*

* *

Thesecurities and credit markets have been experiencing volatility, and in somecases, have exerted negative pressure on the availability of liquidity andcredit capacity for certain companies.  Our ability to access the creditand capital markets, and the related cost of borrowings, will depend on avariety of factors, including market conditions, the availability of creditgenerally and to our industry, the strength of Hospira’s credit rating, andHospira’s debt to capital levels. In addition, lending institutions, includingthose associated with Hospira’s $375 million revolving credit facility, maysuffer losses due to their lending and other financial relationships,especially because of the general weakening of the national economy andincreased financial instability of many borrowers. As a result, lendersmay become insolvent, which could affect the actual availability of creditunder our revolving credit facility, or our ability to obtain other financingon favorable terms.  If one or more of these events occurred, our sources ofliquidity may prove to be insufficient, and our financial condition or resultsof operations could be adversely affected.

 

*Changes in the funded status or costs of our pension orpost-retirement benefit plans could adversely affect our financial position andresults of operations.*

* *

Thefunded status of our pension and post-retirement benefit plans is subject todevelopments and changes in actuarial and other related assumptions. Decreasesin the valuation of plan assets, particularly with respect to equitysecurities, and a change in the actual rate of return on plan assets can resultin significant changes to the expected return on plan assets in the followingyear and, as a consequence, could result in higher funding requirements and/ornet periodic benefit costs. In addition, changes in assumptions, such asdiscount rates, mortality rates, retirement rates, health care cost trend ratesand other factors, may lead to significant increases in the value of therespective obligations. Assumption changes could affect the reportedfunded status of our plans and, as a result, could result in higher fundingrequirements and/or net periodic benefit costs. All of these factors could havean adverse effect on Hospira’s financial position and results of operations.

 

*Acquisitions have increased our investment balances and adecline in value of those investments may effect our financial position andresults of operations.*

* *

Hospiraregularly reviews its investments, including equity and cost based investments,to determine when a significant event or change in circumstance has occurredthat may have an adverse effect on the fair value of each investment. Hospiraconsiders numerous factors, including factors affecting the investee, factorsaffecting the industry of the investee, and general equity market trends.Hospira also considers the length of time an investment’s market value has beenbelow carrying value and the near-term prospects for recovery to carryingvalue. The recent volatility in the global equity markets and other factorscould adversely impact the fair value of our investments and, as a consequence,could result in a charge for an other than temporary decline in value, whichcould have an adverse effect on Hospira’s financial position and results ofoperations.

 

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**Item 2.       Unregistered Sales of Equity Securitiesand Use of Proceeds**

** **

(c)          Issuer Purchases ofEquity Securities

 

The table below gives information on a monthly basis regardingpurchases made by Hospira of its common stock.

 
| **Period**                               | ** ** | **Total Number  of Shares  Purchased (1)** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number  of Shares  Purchased as  Part of  Publicly  Announced  Plans or  Programs** | ** ** | **Maximum Number  (or Approximate  Dollar Value) of  Shares that May  Yet be Purchased  Under the Plans or  Programs ****(2)** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| July 1-July 31, 2008           |       | 661                                                       |       | $                                                | 38.65      |                                                                                                                 | —     |                                                                                                                                                                                       | $          | 100,233,606 |   |
| August 1-August 31, 2008       |       | 1,756                                                     |       | $                                                | 39.17      |                                                                                                                 | —     |                                                                                                                                                                                       | $          | 100,233,606 |   |
| September 1-September 30, 2008 |       | 4,375                                                     |       | $                                                | 40.36      |                                                                                                                 | —     |                                                                                                                                                                                       | $          | 100,233,606 |   |
| Total                                    |       | 6,792                                                     |       | $                                                | 39.89      |                                                                                                                 | —     |                                                                                                                                                                                       | $          | 100,233,606 |   |

 

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(1)          These shares represent the shares deemedsurrendered to Hospira to pay the exercise price and satisfy minimum statutorytax withholding obligations in connection with the exercise of employee stockoptions.

 

(2)          In February 2006, Hospira’s board ofdirectors authorized the repurchase of up to $400.0 million of Hospira’s commonstock in accordance with Rule 10b-18 under the Securities Exchange Act of1934. The repurchase of shares commenced in early March 2006. As of September 30,2008, Hospira had purchased 7.6 million shares for $299.8 million in theaggregate under the 2006 board authority, all of which were purchased during2006. Hospira does not expect to repurchase any shares in 2008 under thisprogram.

 

**Item 6.       Exhibits**

** **

Alist of exhibits filed herewith or incorporated by reference herein immediatelyprecedes such exhibits and is incorporated herein by reference.

 

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SIGNATURE

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
|   | HOSPIRA, INC. |
|--------|--------------------|
|   |               |
|   | By                 | /s/ THOMAS E. WERNER |
|   |               | Thomas E. Werner, |
|   |               | Senior Vice President, Finance and |
|   |               | Chief Financial Officer |
|   |               | Date: November 5, 2008 |

 

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EXHIBIT INDEX

 
| **Exhibit No.** | ** ** | **Exhibit**                                                                                                                                                                                                         |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                |
| 3.1                  |       | Amended and Restated Bylaws of  Hospira, Inc. (filed as Exhibit 3.1 to Hospira, Inc.’s Current  Report on Form 8-K filed on October 27, 2008, and incorporated  herein by reference). |
|                 |       |                                                                                                                                                                                                                |
| 12.1                 |       | Statement regarding Computation of Ratios.                                                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                |
| 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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