**FORM10-Q**

 

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D. C.  20549**

 

| **(Mark One)**                                                                                                                                                                             |       |                                                                                                |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                       |       |                                                                                                |
| **ý**                                                                                                                                                                                 | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|                                                                                                                                                                                       |       |                                                                                                |
| **For the  quarterly period ended June 30, 2004**                                                                                                                                     |
|                                                                                                                                                                                       |       |                                                                                                |
| **OR**                                                                                                                                                                                     |
|                                                                                                                                                                                       |       |                                                                                                |
| **o**                                                                                                                                                                                      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                       |       |                                                                                                |
| **For the  transition period from               to              ** |
|                                                                                                                                                                                       |       |                                                                                                |
| **Commission  File No. 1-31946**                                                                                                                                                           |

 

**HOSPIRA,INC.**

 

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

 

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

 

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

 

Indicate by check mark whetherthe registrant (l) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of l934 during thepreceding l2 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.     Yes  ý.  No  o.

 

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

 

As of July 31, 2004,Hospira, Inc. had outstanding 156,052,411 common shares, par value $0.01 pershare.

 

 

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Table of Contents

 

**Hospira,Inc.**

 

**QuarterlyReport on Form 10-Q**

 

**Index**

 
| ** **                                                                                                                            | **Part I – Financial Information** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------|------------|
| ** **                                                                                                                            | ** **                              |
| Item 1. Financial Statements                                                                                                          | ** **                              |
| ** **                                                                                                                            | ** **                              |
| Condensed Consolidated Statements  of Income (Unaudited) – Three and Six Months Ended  June 30, 2004 and June 30, 2003 | 3                                       |
|                                                                                                                                  |                                    |
| Condensed Consolidated Statements  of Cash Flows (Unaudited) – Six Months Ended June 30, 2004 and  June 30, 2003       | 4                                       |
| ** **                                                                                                                            | ** **                              |
| Condensed Consolidated Balance  Sheets (Unaudited) – June 30, 2004 and December 31, 2003                               | 5                                       |
|                                                                                                                                  |                                    |
| Condensed Consolidated Statement  of Changes in Shareholders’ Equity (Unaudited) – Six Months Ended  June 30, 2004     | 6                                       |
|                                                                                                                                  |                                    |
| Notes to Condensed Consolidated  Financial Statements (Unaudited)                                                                     | 7                                       |
|                                                                                                                                  |                                    |
| Item 2. Management’s Discussion  and Analysis of Financial Condition and Results of Operations                                   | 17                                      |
|                                                                                                                                  |                                    |
| Item 3. Quantitative and  Qualitative Disclosures about Market Risk                                                                   | 24                                      |
|                                                                                                                                  |                                    |
| Item 4. Controls and Procedures                                                                                                       | 24                                      |
|                                                                                                                                  |                                    |
| ** **                                                                                                                            | **Part II – Other Information**    | ** ** |
| ** **                                                                                                                            | ** **                              |
| Item 1. Legal Proceedings                                                                                                             | 25                                      |
|                                                                                                                                  |                                    |
| Item 4. Submission of Matters to a  Vote of Security Holders                                                                          | 26                                      |
|                                                                                                                                  |                                    |
| Item 6. Exhibits and Reports on  Form 8-K                                                                                             | 27                                      |

 

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Table ofContents

 

**PART I.  FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**Hospira,Inc.**

 

**CondensedConsolidated Statements of Income**

 

**(Unaudited)**

 

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

 
| ** **                                                  | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| ** **                                                  | ** ** | **2004**                            | ** ** | **2003**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales                                                   |       | $                                   | 617,367    |                              | $          | 597,376 |   | $ | 1,192,565 |   | $ | 1,168,898 |   |
| Net sales to Abbott Laboratories                            |       | 50,025                              |       | 51,935                            |       | 96,045 |   | 113,524 |   |
| Total Net Sales                                             |       | 667,392                             |       | 649,311                           |       | 1,288,610 |   | 1,282,422 |   |
|                                                        |       |                                |       |                              |       |   |   |   |   |
| Cost of products sold                                       |       | 456,765                             |       | 474,409                           |       | 909,644 |   | 933,822 |   |
| Gross Profit                                                |       | 210,627                             |       | 174,902                           |       | 378,966 |   | 348,600 |   |
|                                                        |       |                                |       |                              |       |   |   |   |   |
| Research and development                                    |       | 28,087                              |       | 23,933                            |       | 52,533 |   | 43,298 |   |
| Selling, general and administrative                         |       | 66,931                              |       | 54,247                            |       | 124,441 |   | 111,009 |   |
| Curtailment of post-retirement  medical and dental benefits |       | (64,636                             | )          | —                            |       | (64,636 | ) | — |   |
|                                                        |       |                                |       |                              |       |   |   |   |   |
| Income From Operations                                      |       | 180,245                             |       | 96,722                            |       | 266,628 |   | 194,293 |   |
|                                                        |       |                                |       |                              |       |   |   |   |   |
| Interest expense                                            |       | 2,684                               |       | —                            |       | 2,684 |   | — |   |
| Other expense, net                                          |       | 526                                 |       | 978                               |       | 1,394 |   | 3,343 |   |
| Income Before Income Taxes                                  |       | 177,035                             |       | 95,744                            |       | 262,550 |   | 190,950 |   |
|                                                        |       |                                |       |                              |       |   |   |   |   |
| Income tax expense                                          |       | 51,265                              |       | 28,244                            |       | 71,789 |   | 56,330 |   |
| Net Income                                                  |       | $                                   | 125,770    |                              | $          | 67,500 |   | $ | 190,761 |   | $ | 134,620 |   |
|                                                        |       |                                |       |                              |       |   |   |   |   |
| Earnings Per Common Share                                   |       |                                |       |                              |       |   |   |   |   |
| Basic                                                       |       | $                                   | 0.80       |                              | $          | 0.43 |   | $ | 1.22 |   | $ | 0.86 |   |
| Diluted                                                     |       | $                                   | 0.80       |                              | $          | 0.43 |   | $ | 1.22 |   | $ | 0.86 |   |
|                                                        |       |                                |       |                              |       |   |   |   |   |
| Weighted Average Common Shares Outstanding                  |       |                                |       |                              |       |   |   |   |   |
| Basic                                                       |       | 156,048                             |       | 156,043                           |       | 156,048 |   | 156,043 |   |
| Diluted                                                     |       | 156,551                             |       | 156,043                           |       | 156,551 |   | 156,043 |   |

 

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

 

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Table ofContents

 

**Hospira,Inc.**

 

**CondensedConsolidated Statements of Cash Flows**

 

**(Unaudited)**

 

***(dollars in thousands)***

 
| ** **                                                                        | ** ** | **Six Months Ended June 30** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                          | ** ** | **2003** | ** ** |
| Cash Flow From (Used in) Operating  Activities:                                   |       |                              |       |   |   |
| Net income                                                                        |       | $                                 | 190,761    |   | $ | 134,620 |   |
| Adjustments to reconcile net income to net  cash from operating activities — |       |                              |       |   |   |
| Depreciation                                                                      |       | 67,639                            |       | 63,750 |   |
| Amortization of intangibles                                                       |       | 2,153                             |       | 2,290 |   |
| Curtailment of post-retirement medical and  dental benefits                       |       | (64,636                           | )          | — |   |
| Trade receivables                                                                 |       | (23,808                           | )          | 9,163 |   |
| Inventories                                                                       |       | (37,275                           | )          | (85,062 | ) |
| Prepaid expenses and other assets                                                 |       | (4,458                            | )          | (13,581 | ) |
| Trade accounts payable and other  liabilities                                     |       | 85,020                            |       | (14,212 | ) |
| Other, net                                                                        |       | 4,161                             |       | (6,091 | ) |
| Net Cash From Operating Activities                                                |       | 219,557                           |       | 90,877 |   |
|                                                                              |       |                              |       |   |   |
| Cash Flow (Used in) Investing Activities:                                         |       |                              |       |   |   |
| Acquisitions of property and equipment                                            |       | (108,347                          | )          | (72,122 | ) |
|                                                                              |       |                              |       |   |   |
| Cash Flow From (Used in) From Financing  Activities:                              |       |                              |       |   |   |
| Net transactions with Abbott Laboratories                                         |       | (20,845                           | )          | (18,820 | ) |
| Pre-distribution dividend to Abbott                                               |       | (700,000                          | )          | — |   |
| Issuance of unsecured senior credit  facility                                     |       | 700,000                           |       | — |   |
| Repayment of unsecured senior credit facility                                     |       | (700,000                          | )          | — |   |
| Issuance of senior unsecured notes, net of  fees paid                             |       | 693,425                           |       | — |   |
| Net change in revolving credit facility                                           |       | 25,000                            |       | — |   |
| Proceeds from stock options exercised                                             |       | 103                               |       | — |   |
| Net Cash (Used in) Financing Activities                                           |       | (2,317                            | )          | (18,820 | ) |
|                                                                              |       |                              |       |   |   |
| Effect of exchange rate changes on cash and  cash equivalents                     |       | (13                               | )          | 65 |   |
|                                                                              |       |                              |       |   |   |
| Net change in cash and cash equivalents                                           |       | 108,880                           |       | — |   |
| Cash and cash equivalents at beginning of  period                                 |       | —                            |       | — |   |
| Cash and cash equivalents at end of period                                        |       | $                                 | 108,880    |   | $ | — |   |

 

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

 

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Table ofContents

 

**Hospira,Inc.**

 

**CondensedConsolidated Balance Sheets**

 

**(Unaudited)**

 

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

 
| ** **                                                                                                 | ** ** | **June 30  2004** | ** ** | **December 31  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| **Assets**                                                                                                 |       |                   |       |                       |       |
| Current Assets:                                                                                            |       |                   |       |                       |       |
| Cash and cash equivalents                                                                                  |       | $                      | 108,880    |                       | $          | — |   |
| Trade receivables, less allowances of  $17,128 in 2004 and $16,876 in 2003                                 |       | 319,835                |       | 315,646                    |       |
| Inventories:                                                                                               |       |                   |       |                       |       |
| Finished products                                                                                          |       | 357,954                |       | 316,109                    |       |
| Work in process                                                                                            |       | 83,598                 |       | 124,594                    |       |
| Materials                                                                                                  |       | 134,088                |       | 168,588                    |       |
| Total inventories                                                                                          |       | 575,640                |       | 609,291                    |       |
| Prepaid expenses, deferred income taxes and  other receivables                                             |       | 194,339                |       | 150,496                    |       |
| Total Current Assets                                                                                       |       | 1,198,694              |       | 1,075,433                  |       |
| Property and equipment, at cost                                                                            |       | 2,064,314              |       | 2,009,202                  |       |
| Less: accumulated depreciation and  amortization                                                           |       | 1,166,848              |       | 1,153,925                  |       |
| Net Property and Equipment                                                                                 |       | 897,466                |       | 855,277                    |       |
| Intangible assets, net of amortization                                                                     |       | 3,182                  |       | 5,335                      |       |
| Goodwill                                                                                                   |       | 80,973                 |       | 80,973                     |       |
| Deferred income taxes and other assets                                                                     |       | 81,459                 |       | 233,145                    |       |
| Total Assets                                                                                               |       | $                      | 2,261,774  |                       | $          | 2,250,163 |   |
| **Liabilities and Shareholders’ Equity**                                                              | ** ** | ** **             | ** ** | ** **                 | ** ** |
| Current Liabilities:                                                                                       |       |                   |       |                       |       |
| Short-term borrowings                                                                                      |       | $                      | 25,000     |                       | $          | — |   |
| Trade accounts payable                                                                                     |       | 110,820                |       | 105,613                    |       |
| Salaries payable and other accruals                                                                        |       | 303,103                |       | 253,988                    |       |
| Due to Abbott, net                                                                                         |       | 95,805                 |       | —                     |       |
| Total Current Liabilities                                                                                  |       | 534,728                |       | 359,601                    |       |
| Due to Abbott, net                                                                                         |       | 63,262                 |       | —                     |       |
| Long-term debt                                                                                             |       | 699,698                |       | —                     |       |
| Post-retirement obligations and other  long-term liabilities                                               |       | 123,154                |       | 437,098                    |       |
| Commitments and Contingencies                                                                              |       |                   |       |                       |       |
| Shareholders’ Equity:                                                                                 |       |                   |       |                       |       |
| Common stock, par value $0.01-authorized:  400,000,000 shares;  issued and outstanding: 156,052,372 shares |       | 1,560                  |       | —                     |       |
| Preferred stock, par value  $0.01-authorized: 50,000,000 shares;  issued and outstanding: 0 shares         |       | —                 |       | —                     |       |
| Unearned compensation                                                                                      |       | (250                   | )          | —                     |       |
| Additional paid-in capital                                                                                 |       | 766,018                |       | —                     |       |
| Retained earnings (for the period  subsequent to April 30, 2004)                                      |       | 92,531                 |       | —                     |       |
| Accumulated other comprehensive (loss)                                                                     |       | (18,927                | )          | (27,479                    | )          |
| Net investment in Hospira, Inc. by Abbott  Laboratories                                                    |       | —                 |       | 1,480,943                  |       |
| Total Shareholders’ Equity                                                                            |       | 840,932                |       | 1,453,464                  |       |
| Total Liabilities and Shareholders’ Equity                                                            |       | $                      | 2,261,774  |                       | $          | 2,250,163 |   |

 

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

 

5

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Table ofContents

 

**Hospira,Inc.**

 

**CondensedConsolidated Statement of Changes in Shareholders’ Equity**

 

**(Unaudited)**

 

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

 
| ** **                                                                | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **     | ** ** | **Net**          | ** ** | ** **       | ** ** | ** **        | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------|------------|------------------|------------|-------------------|------------|-------------------|------------|----------------|------------|------------------|------------|------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **     | ** ** | **Investment**   | ** ** | ** **       | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                                | ** ** | ** **       | ** ** | ** **        | ** ** | **Accumulated**   | ** ** | ** **     | ** ** | **in Hospira,**  | ** ** | ** **       | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                                | ** ** | ** **       | ** ** | ** **        | ** ** | **Other**         | ** ** | **Additional** | ** ** | **Inc. by**      | ** ** | ** **       | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                                | ** ** | **Common Stock** | ** ** | **Comprehensive** | ** ** | **Paid-in**       | ** ** | **Abbott**     | ** ** | **Unearned**     | ** ** | **Retained**     | ** ** | ** **        | ** ** |
| ** **                                                                | ** ** | **Shares**       | ** ** | **Amount**        | ** ** | **Income (Loss)** | ** ** | **Capital**    | ** ** | **Laboratories** | ** ** | **Compensation** | ** ** | **Earnings******* | ** ** | **Total**  | ** ** |
| Balances at January 1, 2004                                          |       | —           |       | $                 | —     |              | $          | (27,479        | )          | $                | —     |             | $          | 1,480,943         |       | $          | —     |   | $ | — |   | $ | 1,453,464 |   |
|                                                                      |       |             |       |              |       |              |       |           |       |             |       |             |       |              |       |       |       |
| Net income                                                                |       | —           |       | —            |       | —            |       | —         |       | 98,230           |       | —           |       | 92,531            |       | 190,761    |       |
|                                                                      |       |             |       |              |       |              |       |           |       |             |       |             |       |              |       |       |       |
| Other comprehensive loss                                                  |       | —           |       | —            |       | (39,923           | )          | —         |       | —           |       | —           |       | —            |       | (39,923    | )          |
|                                                                      |       |             |       |              |       |              |       |           |       |             |       |             |       |              |       |       |       |
| Net transactions with Abbott                                              |       | —           |       | —            |       | 48,475            |       | —         |       | (116,974         | )          | —           |       | —            |       | (68,499    | )          |
|                                                                      |       |             |       |              |       |              |       |           |       |             |       |             |       |              |       |       |       |
| Pre-distribution dividend to Abbott                                       |       | —           |       | —            |       | —            |       | —         |       | (700,000         | )          | —           |       | —            |       | (700,000   | )          |
|                                                                      |       |             |       |              |       |              |       |           |       |             |       |             |       |              |       |       |       |
| Elimination of reporting lag for  international operations                |       | —           |       | —            |       | —            |       | —         |       | 5,041            |       | —           |       | —            |       | 5,041      |       |
|                                                                      |       |             |       |              |       |              |       |           |       |             |       |             |       |              |       |       |       |
| Issuance of common stock in connection with  the distribution             |       | 156,043          |       | 1,560             |       | —            |       | 765,680        |       | (767,240         | )          | —           |       | —            |       | —     |       |
|                                                                      |       |             |       |              |       |              |       |           |       |             |       |             |       |              |       |       |       |
| Changes in shareholders’ equity related to  incentive stock programs |       | 9                |       | —            |       | —            |       | 338            |       | —           |       | (250             | )          | —            |       | 88         |       |
|                                                                      |       |             |       |              |       |              |       |           |       |             |       |             |       |              |       |       |       |
| Balances at June 30, 2004                                            |       | 156,052          |       | $                 | 1,560      |              | $          | (18,927        | )          | $                | 766,018    |             | $          | —            |       | $          | (250       | ) | $ | 92,531 |   | $ | 840,932 |   |
|                                                                           |            |                  |            |                   |            |                   |            |                |            |                  |            |                  |            |                   |            |            |            |  |  |  |  |  |  |  |  |  |

 

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* For the period subsequent toApril 30, 2004.

 

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

 

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Table ofContents

 

**Hospira,Inc.**

 

**Notes toCondensed Consolidated Financial Statements**

 

**June 30,2004**

 

**(Unaudited)**

 

**Note 1 –Background and Basis of Presentation**

 

Thesecondensed consolidated financial statements have been prepared pursuant torules and regulations of the Securities and Exchange Commission (“SEC”) and,therefore, do not include all information and footnote disclosures normallyincluded in audited financial statements. 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 statementsshould be read in conjunction with the combined financial statements and notesthereto for the year ended December 31, 2003, included in Hospira’sinformation statement included as an exhibit to Hospira’s registrationstatement on Form 10, which the SEC declared effective on April 13,2004.  The results of operations for anyinterim period are not necessarily indicative of the results of operations tobe expected for the full year.

 

Hospira wasincorporated in Delaware as a wholly owned subsidiary of AbbottLaboratories (“Abbott”) on September 16, 2003, as part of a previouslyannounced plan by Abbott to create a separate company relating to themanufacture and sale of hospital products, including specialty injectablepharmaceuticals, medication delivery systems and injectable pharmaceuticalcontract manufacturing.  Hospira iscomprised of most of Abbott’s Hospital Products segment and a portion ofAbbott’s International segment.

 

On April 30, 2004 (the“distribution date”), Abbott transferred the assets and liabilities comprisingthe hospital products business to Hospira, except as noted below, and distributed all of the shares ofHospira’s common stock to Abbott shareholders in the form of a dividend of oneshare of Hospira’s common stock, and the associated preferred stock purchaseright, for every ten Abbott common shares. Abbott has received a ruling from the Internal Revenue Service (“IRS”)that the transfer of the hospital products business to Hospira and thesubsequent distribution of all of the common stock of Hospira to Abbottshareholders qualifies as a tax-free distribution for U.S. federal income taxpurposes, except with respect to the distribution of cash in lieu of fractionalshares. 

 

Inconnection with the distribution, Hospira and Abbott entered into a series ofagreements, such as a separation and distribution agreement, transitionservices agreement, an employee benefit agreement, a tax sharing agreement andother related agreements, which govern the ongoing relationship between the twocompanies.

 

While thelegal transfer of certain operations and assets (net of liabilities) outsidethe United States will occur over a two year period after the distributiondate, these operations and assets are used in the conduct of Hospira’sinternational business and Hospira is subject to the risks and entitled to thebenefits generated by the operations and assets. Hospira will be dependent onAbbott’s international infrastructure for up to two years following thedistribution date. 

 

Prior tothe distribution, certain operations outside the United States had beenincluded in the consolidated financial statements on the basis of fiscal yearsending November 30 in order to facilitate timely consolidation. This onemonth reporting lag was eliminated as of April 30, 2004 as it was nolonger required to achieve a timely consolidation. The April 2004 netincome from these international operations of approximately $5 million wasrecorded as an adjustment to Net Investment in Hospira, Inc. by AbbottLaboratories in April 2004.

 

Theaccompanying unaudited interim condensed consolidated financial statementsreflect Hospira’s operations as a separate, stand-alone entity subsequent toApril 30, 2004, combined with the historical operations of Hospira when itoperated as part of Abbott prior to becoming a separate, stand-alone entity.For the period prior to April 30, 2004, during which Hospira operated aspart of Abbott, Abbott provided Hospira with various services, includingfinance, legal, internal audit, public affairs, human resources and otherservices. The historical financial statements include expense allocationsrelated to these services and Hospira considers these allocations to bereasonable reflections of the utilization of services provided. Intercompanyaccounts with Abbott have been combined with invested capital and reported inthe consolidated financial statements as Net Investment in Hospira, Inc. byAbbott Laboratories for periods prior to April 30, 2004.  

 

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The financialinformation in these financial statements does not include all the expensesthat would have been incurred had Hospira been a separate, stand-alone entityand does not reflect Hospira’s results of operations, financial position andcash flows had Hospira been a stand-alone entity prior to April 30, 2004.Because a direct ownership relationship did not exist among all the variousunits comprising Hospira, Net Investment in Hospira, Inc. by AbbottLaboratories is shown in lieu of shareholders’ equity in the consolidatedfinancial statements prior to April 30, 2004.

 

**Note 2 – Income Tax Expense**

 

Taxes on income reflect the estimated annualeffective rates, excluding the effect of significant unusual items, primarilycurtailment of post-retirement medical and dental benefits, and are determinedon a separate-return basis through April 30, 2004, at which time Hospirabecame a separate stand-alone taxpayer. The effective tax rates are less than the statutory U.S. federal incometax rate principally due to the benefit of tax exemptions, of varyingdurations, in several taxing jurisdictions. Abbott has retained responsibilityfor all tax liabilities prior to the distribution date. 

 

**Note 3 - Earnings per Share**

 

Basic earnings per share are computed by dividingnet income by the number of weighted average shares of common sharesoutstanding during the reporting period. Diluted earnings per share are calculated to give effect to allpotentially dilutive common shares that were outstanding during the reportingperiod.  For periods ended April 30,2004 and prior, basic and diluted earnings per share are computed using thenumber of shares of Hospira common stock outstanding on April 30, 2004,the date on which the Hospira common stock was distributed to the shareholdersof Abbott.  On the distribution date,outstanding Abbott awards for non-retirement eligible Hospira employees werecancelled and replaced by new awards for Hospira common stock.  The new awards maintained both thepre-conversion aggregate intrinsic value of each award and the ratio of theexercise price per share to the market value per share.  Abbott awards granted to Hospira employeeswho were retirement eligible on the distribution date remain options topurchase Abbott stock and have no impact on Hospira share dilution.  The following table shows the effect of stock options on the weightedaverage number of shares outstanding used in calculating diluted earnings pershare:

 

*(shares in thousands)*

 
| ** **                                           | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| ** **                                           | ** ** | **2004**                            | ** ** | **2003**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| Weighted average common shares outstanding           |       | 156,048                             |       | 156,043                           |       | 156,048 |   | 156,043 |   |
| Assumed exercise of stock options                    |       | 503                                 |       | —                            |       | 503 |   | — |   |
| Weighted average dilutive common shares  outstanding |       | 156,551                             |       | 156,043                           |       | 156,551 |   | 156,043 |   |

 

For the three and six months ended June 30,2004, there were outstanding options to purchase 4.9 million shares of Hospirastock, for which the exercise price of the options exceeded the average stockprice.  Accordingly, these options areexcluded from the diluted earnings per share calculation for these periods.

 

**Note**** ****4 – Litigation**

 

Hospira’sproduct liability claim exposures are evaluated each reporting period.Hospira’s reserves, which are immaterial at June 30, 2004, are the bestestimate of loss, as defined by Statement of Financial Accounting Standards(SFAS) No. 5, “Accounting for Contingencies.”

 

Abbott isinvolved in various claims and legal proceedings, including product liabilityclaims and proceedings related to Hospira’s business, for which Hospira isrequired to indemnify 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 civil investigations that areseeking to identify the practices and determine whether those practicesviolated any laws, including federal and state false claims acts, or constitutedfraud in connection with the Medicare and/or Medicaid reimbursement paid tothird parties.  In addition, Abbott is adefendant in a number of purported class actions on behalf of individuals orentities, including

 

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health care insurers and otherthird-party payors, that allege generally that Abbott and numerous otherpharmaceutical companies reported false or misleading pricing information inconnection with federal, state and private reimbursement for certaindrugs.  Many of the products involved inthese investigations and lawsuits are Hospira products.  Hospira is cooperating with the authoritiesin these investigations. There may be additional investigations or lawsuits, oradditional claims in the existing investigations or lawsuits, initiated withrespect to these matters in the future. Hospira cannot be certain that it will not be named as a subject or defendantin these investigations or lawsuits. Hospira has been added as a defendant in one AWP proceeding, *The State of Texas ex rel. Ven-A-Care of the FloridaKeys, Inc. v. Abbott Laboratories Inc., Hospira, Inc., B. Braun Medical Inc.and Baxter Healthcare Corporation,*Case No. GV401286, pending in theDistrict Court of Travis County, Texas. The lawsuit alleges generally that the defendants made falserepresentations of prices and costs for drugs directly and indirectly to theTexas Medicaid Program.  Abbott willindemnify Hospira for liabilities associated with pending or future AWPinvestigations and lawsuits only to the extent that they are of the same natureas the lawsuits and investigations that existed against Abbott as of thedistribution date and relate to the sale of Hospira products prior to thespin-off.  Hospira will assume any otherlosses that may result from these investigations and lawsuits.  Based upon information that iscurrently available, management believes that the likelihood of a material lossis remote. In accordance with SFAS No. 5, no loss reserves have beenrecorded for these exposures.  Theseinvestigations and lawsuits could result in changes to Hospira’s businesspractices or pricing policies, civil or criminal monetary damages, penalties orfines, imprisonment and/or exclusion of Hospira products from participation infederal and state healthcare programs, including Medicare, Medicaid andVeterans’ Administration health programs, any of which, because of ourobligation to indemnify Abbott or because we may be named as defendantsourselves, could have a material adverse effect on our business, profitabilityand financial condition.

 

Additional legal proceedings may occur that mayresult in a change in the estimated reserves recorded by Hospira. It is notfeasible to predict the outcome of such proceedings with certainty and therecan be no assurance that their ultimate disposition will not have a materialadverse effect on Hospira’s financial position, cash flows, or results ofoperations.

 

**Note 5 - Intangible Assets**

 

The grossamount of intangible assets, primarily product rights, was $25 million at bothJune 30, 2004 and December 31, 2003, and accumulated amortization was$22 million and  $20 million,respectively. Estimated annual amortization for intangible assets is $4 millionfor 2004 and $1 million for 2005. Intangible assets are amortized on astraight-line basis over five to nine years (average 5.7 years). 

 

**Note 6  - Post-Retirement Benefits**

 

Retirement plans consist of defined benefit(“pension”), defined contribution, and post-retirement medical and dentalplans.   The pension and post-retirementmedical and dental plans cover U.S. union and non-union employees as well asemployees at various international locations. In connection with the distribution, Hospira and Abbott entered into anEmployee Benefits Agreement, which provided that Abbott retain liabilities forpension benefits for U.S. non-union and international employees who wereretired as of the distribution date and liabilities for post-retirement medicaland dental benefits for U.S. non-union employees who were retired or eligibleto retire as of the distribution date.

 

***Benefit Plan Changes***

 

As a result of itsevaluation of its benefit programs, Hospira announced a series of benefit planchanges in the second quarter of 2004. These changes include the enhancement of the 401(k) defined contributionplan, the freezing of the U.S. non-union pension plan and the discontinuationof the U.S. non-union post-retirement medical and dental plan. The discontinuationof the U.S. non-union post-retirement medical and dental plan was effective May1, 2004.  Effective December 31,2004, the U.S. non-union pension plan will be frozen.  Eligible employees covered by the plan willcontinue to earn benefits based on pay and years of service throughDecember 31, 2004 and will be entitled to all benefits earned when theyretire.  Beginning January 1, 2005,all U.S. non-union employees will be eligible to receive an additionalcompany-matching contribution to the 401(k) plan and employees that are age 40and above, as of December 31, 2004, will be eligible to receive anadditional annual company-matching contribution for five years beginning in2005.

 

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

 

Net cost recognized for the three and six months endedJune 30 for the major pension plans and post-retirement medical and dentalbenefit plans, is as follows:

 

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*(dollars in millions)*

 
| ** **                                                | ** ** | **Pension Plans**                    | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                | ** ** | **Three Months Ended  June 30** | ** ** | **Six Months Ended  June 30** | ** ** |
| ** **                                                | ** ** | **2004 (1)**                         | ** ** | **2003 (2)** | ** ** | **2004 (1)** | ** ** | **2003 (2)** | ** ** |
|                                                      | * *   | * *                             | * *   | * * | * * | * * | * * | * * | * * |
| Service cost — benefits earned during  the year |       | $                                    | 7.0        |   | $ | 8.4 |   | $ | 14.8 |   | $ | 16.4 |   |
| Interest cost on projected benefit  obligations           |       | 8.2                                  |       | 10.3 |   | 19.2 |   | 21.6 |   |
| Expected return on plans’ assets                     |       | (8.9                                 | )          | (14.0 | ) | (21.7 | ) | (27.9 | ) |
| Net amortization                                          |       | 1.4                                  |       | — |   | 2.7 |   | 0.1 |   |
| Curtailment of benefits (3)                               |       | 1.5                                  |       | — |   | 1.5 |   | — |   |
|                                                      |       |                                 |       |   |   |   |   |   |   |
| Net pension cost                                          |       | $                                    | 9.2        |   | $ | 4.7 |   | $ | 16.5 |   | $ | 10.2 |   |

 

----

Notes

(1)          The net pension cost forthe three and six months ended June 30, 2004 include costs of $2.5 and$9.7 million, respectively, allocated from Abbott through the distribution datefor all Hospira employees, including U.S. non-union employees who were retiredas of the distribution.  Subsequent tothe distribution, Abbott retained net pension costs for U.S. non-unionemployees who were retired as of the distribution date.

(2)          The net pension cost forthe three and six months ended June 30, 2003 include costs allocated fromAbbott for all  Hospira employees,including U.S. employees who were retired as of the distribution date.

(3)          The curtailment chargerepresents previously unrecognized losses and prior service costs for whichrecognition is accelerated due to the freezing of the pension plan.

 

*(dollars in millions)*

 
| ** **                                                | ** ** | **Medical and Dental Plans**         | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                | ** ** | **Three Months Ended  June 30** | ** ** | **Six Months Ended  June 30** | ** ** |
| ** **                                                | ** ** | **2004 (1)(4)**                      | ** ** | **2003 (2)** | ** ** | **2004 (1)(4)** | ** ** | **2003 (2)** | ** ** |
| * *                                                  | * *   | * *                             | * *   | * * | * * | * * | * * | * * | * * |
| Service cost — benefits earned during  the year |       | $                                    | 1.5        |   | $ | 2.1 |   | $ | 5.9 |   | $ | 6.1 |   |
| Interest cost on projected benefit  obligations           |       | 2.2                                  |       | 3.3 |   | 7.8 |   | 9.7 |   |
| Net amortization                                          |       | 0.4                                  |       | (0.2 | ) | 1.2 |   | 0.9 |   |
| Curtailment of benefits (3)                               |       | (64.6                                | )          | — |   | (64.6 | ) | — |   |
|                                                      |       |                                 |       |   |   |   |   |   |   |
| Net medical and dental cost                               |       | $                                    | (60.5      | ) | $ | 5.2 |   | $ | (49.7 | ) | $ | 16.7 |   |

 

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Notes

(1)          The netmedical and dental cost for the three and six months ended June 30, 2004include costs of $3.6 million and $14.4 million, respectively, allocated fromAbbott for periods prior to the distribution date for all U.S. Hospiraemployees, including employees who were retired or retirement eligible as ofthe distribution date. Subsequent to the distribution, Abbott retainedpost-retirement medical and dental costs for Hospira U.S. non-union employeeswho were retired or eligible to retire as of the distribution date.

(2)          The netmedical and dental cost for the three and six months ended June 30, 2003include costs allocated from Abbott for all U.S. Hospira employees, includingemployees who were retired or eligible to retire as of the distribution date.

(3)          Thecurtailment gain results from the discontinuation of benefits for U.S.non-union employees that were not retired or eligible to retire as of thedistribution date.

(4)          In May2004, the Financial Accounting Standards Board issued Staff Position FAS No.106-2, “Accounting and Disclosure Requirements Related to the MedicarePrescription Drug, Improvement and Modernization Act of 2003,” which provides

 

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guidance toemployers who determine the prescription drug benefits available under theirplan are actuarially equivalent to Medicare Part D and therefore qualify for asubsidy.  As a result of the adoption ofthis new standard by Hospira in the second quarter, the projected benefitobligation related to benefits attributed to past services for the U.S. union planwas reduced by approximately $5.3 million, and the net cost recognized for thesecond quarter was reduced by $0.1 million.

 

Hospira’semployees also participated through the distribution date in the Abbott StockRetirement Plan that is Abbott’s principal defined contribution plan, andthereafter in the Hospira 401(k) Retirement Savings Plan.  Hospira’s contributions to these definedcontribution plans for the three months ended June 30, 2004 and 2003 were$4.8 million and $4.4 million, respectively. For the six months endedJune 30, 2004 and 2003, contributions were $9.6 million and $9.2 million,respectively.

 

***Changes in BenefitObligations as of Distribution Date***

 

As required underthe Employee Benefits Agreement, the projected and accumulated benefit obligationsand corresponding unrecognized actuarial losses, unrecognized prior servicecost and unrecognized transition obligation were re-measured as of thedistribution date.  The allocation of thebenefit obligations was based on the employees retained by Abbott and Hospiraon the date of distribution as discussed above. The weighted average actuarial assumptions used for the April 30,2004 re-measurements remained consistent with those as of December 31,2003, except for the discount rate, which was increased from 6.0% to 6.25%

 

Summarizedinformation about the changes in benefit obligations and plan assets related tothe distribution, for Hospira’s U.S. and international plans as of thedistribution date is as follows:

 

*(dollarsin millions)*

 
| ** **                                                                 | ** ** | **Pension  Plans** | ** ** | **Medical and Dental  Plans** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| ** **                                                                 | ** ** | ** **         | ** ** | ** **                    | ** ** |
| Amounts retained by Abbott:                                                |       |               |       |                          |       |
| Projected benefit obligation retained by  Abbott                           |       | $                  | 464.5      |                          | $          | 265.0 |   |
| Assets retained by Abbott Trusts                                           |       | (445.1             | )          | —                        |       |
| Unrecognized actuarial losses and prior  service costs retained by Abbott  |       | (150.3             | )          | (57.6                         | )          |
| Net (prepaid) accrued balance retained by  Abbott                          |       | $                  | (130.9     | )                             | $          | 207.4 |   |
|                                                                       |       |               |       |                          |       |
| Amounts retained by Hospira:                                               |       |               |       |                          |       |
| Projected benefit obligation retained by  Hospira                          |       | $                  | 426.2      |  (1)                     | $          | 116.5 |  (2) |
| Assets retained by Hospira Trusts                                          |       | (263.3             | )          | —                        |       |
| Unrecognized actuarial losses and prior  service costs retained by Hospira |       | (145.1             | )(1)       | (30.9                         | )(2)       |
| Net accrued balance retained by Hospira                                    |       | $                  | 17.8       |                          | $          | 85.6 |   |

 

----

(1)          Due tobenefit plan changes, the pension plans projected benefit obligation andunrecognized actuarial losses and prior service costs were subsequently reducedby $95.5 and $97.1 million, respectively. 

(2)          Due tobenefit plan changes, the medical and dental plans projected benefit obligationand unrecognized actuarial losses and prior service costs were subsequentlyreduced by $84.3 and $19.7 million, respectively. The net impact is $64.6million related to the U.S. non-union post-retirement medical and dental plans,which was recognized as a curtailment gain as noted above. The remaining netaccrued balance relates to Hospira’s union medical and dental plan.

 

As a result ofAbbott’s retention of the benefit obligations for the retirees as of thedistribution date, Hospira’s additional minimum pension liability was reducedby $76.8 million to $41.0 million.  Therelated accumulated other comprehensive loss was reduced by $47.3 million, with$23.2 million retained by Hospira, net of taxes. 

 

***Changes in PlanAssets and Cash Funding***

 

Plan assets forthe primary U.S. pension plan of $215.1 million were transferred to theAbbott/Hospira Transitional Annuity Retirement Trust from the Abbott pensiontrust in the third quarter. The amount of the transfer was determined inaccordance with the assumptions dictated in ERISA section 4044 and theEmployee Benefits Agreement. 

 

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In accordance withthe Employee Benefits Agreement, Abbott is required to make a payment toHospira in an amount that will cause the accumulated benefit obligation fundedratio of the Hospira plan to be equivalent to that of the Abbott plan as of thedistribution date.  Hospira received suchpayment, in the amount of $45 million, in the third quarter.  The amount is recorded in Due to Abbott, Netas of June 30, 2004.  Hospira plans toconduct an asset/liability study in order to determine the appropriate level offunding for the Hospira plan.  

 

**Note7 – Debt**

 

The following debtwas incurred either as a result of or since the distribution from Abbott.  Hospira did not have debt prior toApril 28, 2004.  

 

***$700 Million Short-term Senior Unsecured Credit Facility***

 

On April 28,2004, Abbott and Hospira entered into a $700 million, short-term seniorunsecured credit facility (“Senior Facility”). The borrowing bore interest at arate of LIBOR plus .875% and was repayable on or before April 27, 2005.The proceeds of the Senior Facility borrowing were retained by Abbott.  On the distribution date, Abbott was relievedof all obligations under the Senior Facility and Hospira became solelyresponsible for repayment of the principal and for payment of interest and feeson this debt.  As of June 30, 2004,all amounts under the Senior Facility have been repaid with proceeds from thesenior unsecured notes together with cash on hand.

 

***$375 Million Unsecured Revolving Credit Facility***

 

On April 30,2004, Hospira entered into an unsecured revolving credit facility of $375million (“Revolver”) that is available for working capital and otherrequirements.  The Revolver allowsHospira to borrow funds on an unsecured basis at variable interest rates asshort-term cash needs dictate. Borrowings under the Revolver initially bear interest at LIBOR plus .575%,plus a utilization fee of .125% if borrowings under the Revolver exceed $125million.  Interest and the annualfacility fee under the Revolver are subject to increase or decrease if there isa change in Hospira’s credit rating (currently BBB by Standard &Poor’s).  The maximum interest rate isLIBOR plus 1.25%. The commitment is subject to an annual facility fee,initially .175% with a maximum fee of .375%, and expires in April 2009.  As of June 30, 2004, Hospira hasborrowed $25 million under the Revolver. 

 

***$700 Million Senior Unsecured Notes***

 

On June 15,2004, Hospira completed an underwritten offering of a consolidated $700 millionaggregate principal amount consisting of $300 million five-year seniorunsecured notes at a price of 99.947 percent of par value and $400 millionten-year senior unsecured notes at a price of 99.731 percent of par value.  The $300 million five-year notes bearinterest at a rate of 4.95 percent per annum and mature on June 15, 2009and the $400 million ten-year notes bear interest at a rate of 5.90 percent perannum and mature on June 15, 2014. The proceeds from this offering, together with cash on hand, were usedto repay all amounts outstanding under the Senior Facility.  

 

The Revolver andSenior Unsecured Notes contain, among other provisions, covenants with whichHospira must comply while the underlying agreements are outstanding.  Such covenants include obligations not toallow liens on properties or assets, merge or consolidate with any othercorporation, or sell or lease all or substantially all of Hospira’s assets, aswell as compliance with certain financial covenants, including interestcoverage ratio, leverage ratio and minimum consolidated net worth.

 

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Hospira’s debt asof June 30, 2004 consists of the following (dollars in millions):

 
| ** **                                        | ** ** | **June 30,  2004** | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|
|                                              |       |                    |       |
| Short-term borrowings:                            |       |                    |       |
| $375 million unsecured revolving credit  facility |       | $                       | 25         |   |
|                                              |       |                    |       |
| Total short-term borrowings                       |       | 25                      |       |
|                                              |       |                    |       |
| Long –term debt:                             |       |                    |       |
| Senior unsecured notes due 2009                   |       | 300                     |       |
| Senior unsecured notes due 2014                   |       | 400                     |       |
|                                              |       |                    |       |
| Total long-term debt                              |       | 700                     |       |
|                                              |       |                    |       |
| Unamortized debt discount                         |       | (1                      | )          |
|                                              |       |                    |       |
| Long-term debt                                    |       | 699                     |       |
|                                              |       |                    |       |
| Total debt                                        |       | $                       | 724        |   |

 

**Note 8 - Comprehensive Income, net oftax**

 

*(dollars in millions)*

 
| ** **                                                   | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| ** **                                                   | ** ** | **2004**                            | ** ** | **2003**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                         |       |                                |       |                              |       |   |   |   |   |
| Foreign currency translation (losses) gains                  |       | $                                   | (7.1       | )                                 | $          | 19.7 |   | $ | (39.4 | ) | $ | 35.3 |   |
| Minimum pension liability adjustment                         |       | 47.3                                |       | —                            |       | 47.3 |   | — |   |
| Unrealized (losses) gains on marketable  equity securities   |       | (0.5                                | )          | 2.7                               |       | 0.7 |   | 3.0 |   |
| Other comprehensive income                                   |       | 39.7                                |       | 22.4                              |       | 8.6 |   | 38.3 |   |
| Less effect of distribution from Abbott                      |       | (48.5                               | )          | —                            |       | (48.5 | ) | — |   |
| Adjusted other comprehensive (loss) income                   |       | (8.8                                | )          | 22.4                              |       | (39.9 | ) | 38.3 |   |
| Net Income                                                   |       | 125.8                               |       | 67.5                              |       | 190.8 |   | 134.6 |   |
| Comprehensive Income                                         |       | $                                   | 117.0      |                              | $          | 89.9 |   | $ | 150.9 |   | $ | 172.9 |   |
|                                                         |       |                                |       |                              |       |   |   |   |   |
| ** **                                                   | ** ** | **June 30,  2004**             | ** ** | **December 31,  2003**       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Supplemental Comprehensive Income  Information:              |       |                                |       |                              |       |   |   |   |   |
|                                                         |       |                                |       |                              |       |   |   |   |   |
| Cumulative foreign currency translation  gains               |       | $                                   | 1.5        |                              | $          | 40.9 |   |   |   |   |   |
| Cumulative minimum pension liability  adjustments            |       | (23.2                               | )          | (70.5                             | )          |   |   |   |   |
| Cumulative unrealized gains on marketable  equity securities |       | 2.8                                 |       | 2.1                               |       |   |   |   |   |
|                                                         |       | $                                   | (18.9      | )                                 | $          | (27.5 | ) |   |   |   |   |

 

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**Note 9 - Segment Information**

 

Hospira’sprincipal business is the development, manufacture and sale of a broad line ofhospital products including specialty injectable pharmaceuticals and medicationdelivery systems, and the provision of injectable pharmaceutical contractmanufacturing services. Hospira has two reportable segments: U.S. andinternational. 

 

Hospira’s underlying accounting records aremaintained on a legal entity basis for government and public reportingrequirements. Segment disclosures are on a performance basis consistent withinternal management reporting. Certain immaterial reclassifications have beenmade to the basis of presentation to reflect changes in internal managementreporting.  Intersegment transfers ofinventory are recorded at standard cost and are not a measure of segment incomefrom operations. The costs of some corporate functions are sold to segments atpredetermined rates that approximate cost. Remaining costs, if any, are notallocated.  The following segmentinformation has been preparedin accordance with the internal accounting policies of Hospira, as describedabove.

 

*(dollars in millions)*

 
| ** **                 | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|----------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| ** **                 | ** ** | **Net Sales**                       | ** ** | **Income from  Operations**       | ** ** | **Net Sales** | ** ** | **Income from  Operations** | ** ** |
| ** **                 | ** ** | **2004**                            | ** ** | **2003**                          | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                 | ** ** | ** **                          | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. (1)                   |       | $                                   | 555        |                              | $          | 546 |   | $ | 160 |   | $ | 79 |   | $ | 1,077 |   | $ | 1,085 |   | $ | 239 |   | $ | 170 |   |
| International              |       | 112                                 |       | 103                               |       | 34 |   | 27 |   | 212 |   | 197 |   | 52 |   | 43 |   |
| Total reportable segments  |       | $                                   | 667        |                              | $          | 649 |   | 194 |   | 106 |   | $ | 1,289 |   | $ | 1,282 |   | 291 |   | 213 |   |
| Corporate functions        |       |                                |       |                              |       | (13 | ) | (10 | ) |   |   |   |   | (24 | ) | (19 | ) |
| Income from Operations     |       |                                |       |                              |       | 181 |   | 96 |   |   |   |   |   | 267 |   | 194 |   |
| Other                      |       |                                |       |                              |       | (4 | ) | — |   |   |   |   |   | (4 | ) | (3 | ) |
| Income before income taxes |       |                                |       |                              |       | $ | 177 |   | $ | 96 |   |   |   |   |   | $ | 263 |   | $ | 191 |   |

 

----

(1)  2004 Incomefrom operations includes curtailment benefit of $65 million.

 

**Note 10 – Incentive Stock Programs**

 

Certain employees of Abbott who becameHospira employees following the distribution held stock option awards grantedunder Abbott incentive stock programs. For employees who were retirement eligible at distribution date, theseawards remain options to purchase Abbott stock and all terms of the optionsremain the same.  For those employees whowere not retirement eligible at the distribution date, the awards werecancelled and replaced by new awards (“converted options”) for Hospira commonstock at the time of distribution. Approximately 7.5 million options were issued as replacements for thecancelled Abbott awards. The converted options maintain both the pre-conversionaggregate intrinsic value of each award and the ratio of the exercise price pershare to the market value per share.  Allother terms of the converted options remain the same.

 

In May 2004, Hospira awarded a Founders Grantof 8.4 million options to substantially all employees in the United States andcertain international employees, at the fair market value at the time ofgrant.  These options generally vest insix months and have a five- year term for all employees except for thosegranted to corporate officers, which vest over three years and have a ten-yearterm.

 

Hospira measures compensation cost using theintrinsic value-based method of accounting for stock options. In accordancewith this intrinsic value method, no compensation expense is recognized forHospira’s stock option plans. If the fair value method of accounting was usedfor the Abbott options, converted Hospira options, and Hospira Foundersoptions, net income and earnings per share (EPS) in the periods during 2004 and2003 would have been as follows:

 

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*(dollars in millions)*

 
| ** **                                                               | ** ** | **Three Months Ended  June 30** | ** ** | **Six Months Ended  June 30** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                               | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Income, as reported                                                  |       | $                                    | 125.8      |                               | $          | 67.5 |   | $ | 190.8 |   | $ | 134.6 |   |
| Hospira stock-based compensation, net of  tax (1)                        |       | 12.0                                 |       | —                             |       | 12.0 |   | — |   |
| Pro-forma net income including Hospira  stock-based compensation expense |       | 113.8                                |       | 67.5                               |       | 178.8 |   | 134.6 |   |
| Abbott stock-based compensation, net of tax  (2)                         |       | 1.7                                  |       | 5.4                                |       | 7.1 |   | 10.9 |   |
| Pro-forma net income including all  stock-based compensation expense     |       | $                                    | 112.1      |                               | $          | 62.1 |   | $ | 171.7 |   | $ | 123.7 |   |
|                                                                     |       |                                 |       |                               |       |   |   |   |   |
| Basic EPS, as reported                                                   |       | $                                    | 0.80       |                               | $          | 0.43 |   | $ | 1.22 |   | $ | 0.86 |   |
| Basic EPS, pro forma                                                     |       | $                                    | 0.72       |                               | $          | 0.40 |   | $ | 1.10 |   | $ | 0.79 |   |
| Diluted EPS, as reported                                                 |       | $                                    | 0.80       |                               | $          | 0.43 |   | $ | 1.22 |   | $ | 0.86 |   |
| Diluted EPS, pro forma                                                   |       | $                                    | 0.72       |                               | $          | 0.40 |   | $ | 1.10 |   | $ | 0.79 |   |

 

----

Notes

(1)          For the three and six months ended June 30, 2004, the Hospira proforma stock-based compensation expense, determined using the fair value methodfor stock-based awards, net of tax, includes $10.0 million for the Foundersoptions, granted in May 2004, as well as $2.0 million for the convertedoptions.

(2)          Hospira is reflecting the Abbott stock-based compensation for itsemployees, whether or not those awards were cancelled and replaced by Hospiraawards at the time of distribution, in the pro forma net income for the periodsprior to the distribution. Subsequent to the distribution, only Hospiraconverted options and the corresponding unvested portion will impact pro formaincome. 

 

The weighted average fair value for theHospira options granted in the three and six months ended June 30, 2004was $6.61. The weighted average fair value for the Abbott options granted inthe three and six months ended June 30, 2004 and 2003 was $11.79 and$8.73, respectively. The fair value was estimated using the Black-Scholes option-pricingmodel based on the weighted average market price at the grant date and theweighted average assumptions specific to the underlying options. The historicalAbbott assumptions relate to Abbott stock and are therefore based on Abbott’svaluation assumptions. The assumptions utilized for option grants during theperiods presented are as follows:

 
| ** **                                                           | ** ** | **Three Months Ended  June 30** | ** ** | **Six Months Ended  June 30** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                           | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Hospira Stock Options Black-Scholes  assumptions (weighted average): |       |                                 |       |                               |       |   |   |   |   |
| Volatility                                                           |       | 32.0                                 | %          | N/A                                |       | 32.0 | % | N/A |   |
| Expected Life (years)                                                |       | 2.9                                  |       | N/A                                |       | 2.9 |   | N/A |   |
| Risk-free interest rate                                              |       | 2.9                                  | %          | N/A                                |       | 2.9 | % | N/A |   |
| Dividend yield                                                       |       | 0.0                                  | %          | N/A                                |       | 0.0 | % | N/A |   |
|                                                                 |       |                                 |       |                               |       |   |   |   |   |
| Abbott Stock Options Black-Scholes  assumptions (weighted average):  |       |                                 |       |                               |       |   |   |   |   |
| Volatility                                                           |       | 32.0                                 | %          | 32.0                               | %          | 32.0 | % | 32.0 | % |
| Expected Life (years)                                                |       | 5.4                                  |       | 5.4                                |       | 5.4 |   | 5.4 |   |
| Risk-free interest rate                                              |       | 2.9                                  | %          | 2.7                                | %          | 2.9 | % | 2.7 | % |
| Dividend yield                                                       |       | 2.2                                  | %          | 2.8                                | %          | 2.2 | % | 2.8 |   |

 

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**Note11 – Relationship with Abbott**

 

Hospira operated as part ofAbbott prior to April 30, 2004, during which time Abbott provided variousservices to Hospira, which included, for example, administration oftreasury, payroll and benefits, accounts payable, public and investorrelations, internal audit, telecommunications, computing services, corporateincome tax and selected legal services. The cost of these services wasallocated to Hospira utilizing various allocation methods including relativesales, headcount, square footage and number of transactions. Managementbelieves that the methods used to allocate expenses to Hospira were reasonable.In connection with the distribution, Hospira and Abbott entered intoagreements pursuant to which Hospira and Abbott will provide to the other, onan interim, transitional basis, various services, including, for example,internal audit, treasury administration, employee benefits administration andquality assurance services. The agreed-upon charges for such services aregenerally intended to allow the servicing party to recover all out-of-pocketcosts plus a mark up.  The servicesgenerally commenced on the distribution date and will terminate no later than24 months following the distribution date. The receiving party mayterminate the provision of such services upon prior written notice. The cost of these various services wasapproximately $5 million and $10 million for the second quarter and six monthsended June 30, 2004 and $6 million and $12 million for the second quarterand six months ended June 30, 2003. 

 

Both Hospira and Abbott have provided and willcontinue to provide manufacturing services to the other. Prior to April 30,2004, under Abbott’s and Hospira’s internal reporting practices, these serviceswere provided at cost to the purchasing entity and Hospira’s sales to Abbottincluded the value of the bulk material. Subsequent to the distribution date,for manufacturing services provided to Abbott, Hospira records as revenue itscosts plus a third-party manufacturing profit and, for certain products,Hospira receives the bulk material from Abbott and the mark up is on thevalue-added portion only.  Inventory thatHospira purchases from Abbott is at Abbott’s cost plus a third-partymanufacturing profit. Sales to Abbott amounted to approximately $50 million and$96 million for thesecond quarter and six months ended June 30, 2004 and $52 million and $114million for the second quarter and six months ended June 30, 2003. Productpurchases from Abbott were approximately $20 million and $40 million for the second quarter and six monthsended June 30, 2004 and $22 million and $42 million for the second quarterand six months ended June 30, 2003.  

 

Hospira will purchase certain internationaloperations and assets (net of liabilities) from Abbott over a period of time ofup to two years after the distribution date as Hospira establishes its businessinfrastructure outside the United States and obtains regulatory approval forthe transfer of marketing authorizations for Hospira products.  Hospira is obligated to purchase thoseinternational net assets from Abbott for the net book value of such assets atthe time of purchase.  As of June 30,2004, the net book value of the assets to be purchased was approximately $236million, of which $63 million is recorded as long-term. The net book value isprimarily comprised of accounts receivable of $105 million, inventory of $92million, equipment of $60 million and other, net of $(21) million, primarilyaccounts payable and other accrued liabilities. Each amount has been includedin the corresponding balance sheet line item.

 

All charges between Hospira and Abbott are includedin Due to Abbott, Net on the balance sheet. 

 

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**Item 2.  Management’s Discussion And Analysis OfFinancial Condition And Results Of Operations**

 

**Overview**

 

Hospirais a global specialty pharmaceutical and medication delivery company that isfocused on products that improve the safety and efficacy of patient care in theacute care setting.  Hospira is a globalleader in the development, manufacture and marketing of specialty injectablepharmaceuticals and medication delivery systems that deliver drugs andintravenous (I.V.) fluids. Hospira is also a leading provider of contractmanufacturing services to pharmaceutical and biotechnology companies forformulation development, filling and finishing of injectablepharmaceuticals.  Hospira’s broadportfolio of products is used by hospitals, alternate site clinics, homehealthcare providers and long-term care facilities.

 

**Spin-off from Abbott Laboratories**

 

In August 2003, Abbott announced a plan to createa separate publicly traded company consisting of its existing core hospitalproducts business.  On April 12,2004, Abbott announced its board of directors had declared a special dividenddistribution of all of the outstanding shares of common stock of Hospira, Inc.,the global hospital products company to be spun off by Abbott.  The special dividend distribution was paid onApril 30, 2004.  For every tenAbbott common shares held, Abbott shareholders received one share of Hospiracommon stock.  All of the shares ofHospira’s common stock were distributed to Abbott shareholders in a tax-freedistribution on a pro-rata basis. Abbott has received a ruling from theInternal Revenue Service that the distribution qualifies as a tax-freedistribution for U.S. federal income tax purposes,except with respect to the distribution of cash in lieu of fractional shares.

 

While thelegal transfer of certain operations and assets (net of liabilities) outsidethe United States will occur after the distribution date, these operations andassets will be used in the conduct of Hospira’s international business andHospira will be subject to the risks and entitled to the benefits generated bythe operations and assets commencing immediately after the distribution date.Hospira will be dependent on Abbott’s international infrastructure for up totwo years after the distribution date. 

 

**2004 Second Quarter Highlights**

 

•                  Began trading as HSP on the New York Stock Exchange onMay 3, 2004.

 

•                  Amended our existing medication management (pump)agreement with Consorta to enable its members to sign multi-year agreementswith Hospira that extend beyond the current contract’s August 31, 2007 enddate.

 

•                  Launched a new generic injectable drug, deferoxaminemesylate, adding to our position as a leading provider of generic injectablepharmaceuticals in the United States.

 

•                  Completed the process started earlier this year withNovation on our pharmacy contract, and secured its renewal. The contractrepresents over $200 million in potential annual sales for our genericinjectable drugs.

 

•                  Acquired a 100,000 square-foot manufacturing facilityin Clayton, N.C., providing Hospira with additional capacity in emulsiontechnology.

 

•                  Proceeded on schedule with transition plans,including selection of the site for Hospira’s research and developmentfacility, initiation of the build-out of a new IT infrastructure, andestablishment of Hospira’s international leadership structure.

 

**Results of operations for the threemonths ended June 30, 2004 compared to June 30, 2003**

 

*Net Sales*

 

Net sales increased 2.8 percent in the secondquarter 2004 compared to the second quarter 2003, of which 0.7 percent relatesto the impact of the weaker U.S. dollar. The remaining increase resulted primarily from volume increases,partially offset by lower prices on certain products. 

 

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Acomparison of product line sales is as follows: 

 
| ** **                                        | ** ** | **Three Month Period Ended June 30** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|
| **(dollars in millions)**                         | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **Percent  Change vs.  Prior Year*** | ** ** |
| U.S. —                                       |       |                                      |       |   |   |   |   |
| Specialty Injectable Pharmaceuticals              |       | $                                         | 221        |   | $ | 218 |   | 1.4 |   |
| Medication Delivery Systems                       |       | 192                                       |       | 184 |   | 4.9 |   |
| Injectable Pharmaceutical Contract  Manufacturing |       | 46                                        |       | 44 |   | 3.9 |   |
| Sales to Abbott Laboratories                      |       | 34                                        |       | 42 | ** ** | (19.5) |   |
| Other                                             |       | 62                                        |       | 58 |   | 6.3 |   |
|                                              |       |                                      |       |   |   |   |   |
| Total U.S.                                        |       | 555                                       |       | 546 |   | 1.7 |   |
|                                              |       |                                      |       |   |   |   |   |
| International—                               |       |                                      |       |   |   |   |   |
| Sales to Third Parties                            |       | 96                                        |       | 93 |   | 2.7 |   |
| Sales to Abbott Laboratories                      |       | 16                                        |       | 10 |   | 64.2 |   |
|                                              |       |                                      |       |   |   |   |   |
| Total International Sales                         |       | 112                                       |       | 103 |   | 8.6 |   |
|                                              |       |                                      |       |   |   |   |   |
| Consolidated Net Sales                            |       | $                                         | 667        |   | $ | 649 |   | 2.8 |   |

 

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* Percent change computed based on unrounded numbers

 

The sales increase inMedication Delivery Systems was due to increased placements, including therelated sales of disposable sets and syringes, of Hospira’s newer technologyPlum A+ ®, Gemstar ® and Lifecare PCA ®3 pumps; coupled with increased sales ofinfusion therapy products.  Sales toAbbott prior to the distribution were recorded at cost, while after thedistribution they were recorded at Hospira’s cost plus a markup, and areimpacted by Abbott’s unit volume requirements. The decrease in Sales to Abbott is primarily due to the exclusion of thecost of the bulk drug subsequent to the distribution for two significantproducts manufactured for Abbott, while 2003 included the cost of these bulkdrugs.  This reflects thepost-distribution arrangement between Hospira and Abbott under which Abbotttransfers the bulk drug to Hospira for processing and Hospira’s sales includeonly the value added plus a markup.  Thesales reduction due to this change was partially offset by the markup onproduct sold to Abbott after the distribution. Other U.S. sales primarily include sales to non-hospital customers andsales of critical care products.  Thesales increase in 2004 was due to the launch of the generic drug, deferoxaminemesylate, to the non-hospital customer base. In addition, 2003 Other U.S. sales was negatively impacted by a productrecall.  The sales increase was partiallyoffset by the divestiture of the product rights for paclitaxel in 2003 and adecline in critical care products. International sales to Abbott in 2004 increased primarily due to volumerelated to an additional product manufactured for Abbott subsequent to thedistribution, coupled with the impact of the markup on products sold to Abbottafter the distribution.

 

*Gross Profit*

 

Gross profitincreased approximately $35.7 million, or 20.4%, for the quarter endedJune 30, 2004, compared with the same period in 2003. Gross profit marginincreased to 31.6% for the second quarter of 2004, from 26.9% for the secondquarter of 2003. The increased margin is primarily the result of product miximprovement; lower costs, primarily freight and distribution; the impact in2003 of a product recall; and the markup on sales to Abbott in 2004, comparedto 2003 when sales were recorded at cost. Slightly lower prices partiallyoffset the margin improvements.

 

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*Research and Development*

 

Researchand development expenses increased approximately $4.2 million, or 17.4%, forthe quarter ended June 30, 2004, compared with the same period in 2003.The increase was due to spending associated with new product developmentprimarily related to our medication management systems.  Research and development expenses increased to4.2% of net sales for the quarter ended June 30, 2004, compared with 3.7%of net sales for the same period in 2003. 

 

*Selling, General and Administrative*

 

Selling,general and administrative expenses increased approximately $12.7 million, or23.4%, for the quarter ended June 30, 2004, compared with the same periodin 2003. The increase was primarily due to additional costs relating tobecoming a separate stand-alone company. These costs include the establishment of corporate functions, legal andother professional services, insurance, information technology and costsrelating to establishing business infrastructure outside the United States.Selling, general and administrative expenses increased to 10.0% of net salesfor the quarter ended June 30, 2004, compared with 8.4% of net sales forthe same period in 2003.

 

*Curtailment of Post-retirement Medical and Dental Benefits*

 

In thesecond quarter of 2004, Hospira evaluated its retirement benefit programs andannounced a series of benefit plan changes which included the discontinuationof the U.S. non-union post-retirement medical and dental plan. The effect ofthe discontinuation of the post-retirement medical and dental plan was anon-cash pre-tax benefit of $64.6 million resulting from the reversal of therelated liability. 

 

*Interest and Other Expense (Income), Net*

 

Interest and other expenses, net increasedapproximately $2.2 million for the quarter ended June 30, 2004, comparedwith the same period in 2003. The increase was primarily due to interestrelating to short-term borrowings and the issuance of the senior unsecurednotes to repay the senior unsecured credit facility that Hospira incurred aspart of the distribution. 

 

*Income Tax Expense*

 

Theeffective tax rate was 29% for the quarter ended June 30, 2004 compared to29.5% for the same period in 2003. Hospira estimates its 2004 annual effectivetax rate to be 24%, excluding the effect of significant unusual items.  The effective tax rates are less than thestatutory U.S. federal income tax rate principally due to the benefit of taxexemptions, of varying durations, in several taxing jurisdictions.  The effective tax rate in the second quarterof 2004 includes the impact of a significant unusual item, the curtailment ofthe post-retirement medical and dental plan noted above.  Excluding the effect of the curtailment, theeffective rate in the second quarter of 2004 was lower than the rate in thesame period in 2003 primarily due to a greater portion of income derived fromoperations in jurisdictions with tax exemptions. 

 

**Results of operations for the sixmonths ended June 30, 2004 compared to June 30, 2003**

 

*Net Sales*

 

Net sales increased 0.5 percent in the six monthsended June 30, 2004 compared to the six months ended June 30,2003.  This increase reflects the impactof the weaker U.S. dollar of 1.1 percent, as well as increased volumes,partially offset by lower prices on certain products.

 

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Acomparison of product line sales is as follows: 

 
| ** **                                        | ** ** | **Six Month Period Ended June 30** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------|------------|
| **(dollars in millions)**                         | ** ** | **2004**                                | ** ** | **2003** | ** ** | **Percent  Change vs.  Prior Year*** | ** ** |
| U.S. —                                       |       |                                    |       |   |   |   |   |
| Specialty Injectable Pharmaceuticals              |       | $                                       | 426        |   | $ | 426 |   | 0.1 |   |
| Medication Delivery Systems                       |       | 379                                     |       | 361 |   | 5.1 |   |
| Injectable Pharmaceutical Contract  Manufacturing |       | 84                                      |       | 81 |   | 4.0 |   |
| Sales to Abbott Laboratories                      |       | 71                                      |       | 94 | ** ** | (25.1) |   |
| Other                                             |       | 117                                     |       | 123 |   | (6.3) |   |
|                                              |       |                                    |       |   |   |   |   |
| Total U.S.                                        |       | 1,077                                   |       | 1,085 |   | (0.9) |   |
|                                              |       |                                    |       |   |   |   |   |
| International—                               |       |                                    |       |   |   |   |   |
| Sales to Third Parties                            |       | 187                                     |       | 177 |   | 5.4 |   |
| Sales to Abbott Laboratories                      |       | 25                                      |       | 20 |   | 31.1 |   |
|                                              |       |                                    |       |   |   |   |   |
| Total International Sales                         |       | 212                                     |       | 197 |   | 8.0 |   |
|                                              |       |                                    |       |   |   |   |   |
| Consolidated Net Sales                            |       | $                                       | 1,289      |   | $ | 1,282 |   | 0.5 |   |

 

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* Percent change computed based on unrounded numbers

 

The sales increase inMedication Delivery Systems was due to increased placements, including therelated sales of disposable sets and syringes, of Hospira’s newer technologyPlum A+ ®, Gemstar ® and Lifecare PCA ®3 pumps; coupled with increased sales ofinfusion therapy products.  Sales toAbbott prior to the distribution were recorded at cost, while after thedistribution they were recorded at Hospira’s cost plus a markup, and areimpacted by Abbott’s unit volume requirements. The decrease in Sales to Abbott is primarily due to the exclusion of thecost of the bulk drug subsequent to the distribution for two significantproducts manufactured for Abbott, while 2003 included the cost of these bulkdrugs.  This reflects thepost-distribution arrangement between Hospira and Abbott under which Abbotttransfers the bulk drug to Hospira and Hospira’s sales include only the valueadded plus a markup.  The sales reductiondue to this change was partially offset by the markup on product sold to Abbottafter the distribution.  Other U.S. salesprimarily include sales to non-hospital customers and sales of critical careproducts.  The decrease in Other U.S.sales was primarily due to the divestiture of the product rights for paclitaxelin 2003, a decline in critical care products, and the wind-down of the homeinfusion product line in 2003, partially offset by the launch of the genericdrug, deferoxamine mesylate, to the non-hospital customer base.  In addition, 2003 Other U.S. sales wasnegatively impacted by a product recall. International sales to Abbott in 2004 increased primarily due to volumerelated to an additional product manufactured for Abbott subsequent to thedistribution, coupled with the impact of the markup on products sold to Abbottafter the distribution.

 

*Gross Profit*

 

Grossprofit increased approximately $30.4 million, or 8.7%, for the six months endedJune 30, 2004, compared with the same period in 2003. Gross profit marginincreased to 29.4% for the first six months of 2004, from 27.2% for the firstsix months of 2003. The increased margin is primarily the result of product miximprovement; the impact in 2003 of a product recall; lower costs, primarilyfreight and distribution; and the markup on sales to Abbott in 2004.  Slightly lower prices partially offset themargin improvements.

 

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*Research and Development*

 

Researchand development expenses increased approximately $9.2 million, or 21.3%, forthe six months ended June 30, 2004, compared with the same period in 2003.The increase was due to spending associated with new product developmentprimarily related to our medication management systems and genericpharmaceutical development. Research and development expenses increased to 4.1%of net sales for the six months ended June 30, 2004, compared with 3.4% ofnet sales for the same period in 2003.

 

*Selling, General and Administrative*

 

Selling, general and administrative expenses increasedapproximately $13.4 million, or 12.1%, for the six months ended June 30,2004, compared with the same period in 2003. The increase was primarily due toadditional costs relating to becoming a separate stand-alone company.  These costs include the establishment ofcorporate functions, legal and other professional services, insurance,information technology and costs relating to establishing businessinfrastructure outside the United States. Selling, general and administrativeexpenses increased to 9.7% of net sales for the six months ended June 30,2004, compared with 8.7% of net sales for the same period in 2003.

 

*Curtailment of Post-retirement Medical and Dental Benefits*

 

In thesecond quarter of 2004, Hospira evaluated its retirement benefit programs andannounced a series of benefit plan changes which included the discontinuationof the U.S. non-union post-retirement medical and dental plan. The effect ofthe discontinuation of the post-retirement medical and dental plan was anon-cash pre-tax benefit of $64.6 million. 

 

*Interest and Other Expense (Income), Net*

 

Interest and other expenses, net increasedapproximately $0.7 million for the six months ended June 30, 2004,compared with the same period in 2003. The increase was primarily due tointerest relating to short-term borrowings and the issuance of the seniorunsecured notes to repay the senior unsecured credit facility that Hospiraincurred as part of the distribution, offset by losses in 2003 of an equityinvestment retained by Abbott.

 

*Income Tax Expense*

 

Theeffective tax rate for the six months ended June 30, 2004 was 27.3%,compared to 29.5% for the same period in 2003. Hospira estimates its 2004annual effective tax rate to be 24%, excluding the effect of significantunusual items.  The effective tax ratesare less than the statutory U.S. federal income tax rate principally due to thebenefit of tax exemptions, of varying durations, in several taxingjurisdictions.  The effective tax ratefor the six months ended June 30, 2004 includes the impact of asignificant unusual item, the curtailment of the post-retirement medical anddental plan noted above.  Excluding theeffect of the curtailment, the effective rate for the first six months of 2004was lower than the rate in the same period in 2003 primarily due to a greaterportion of income derived from operations in jurisdictions with tax exemptions.

 

**Coststo Operate as an Independent Company**

 

As part of becoming an independent company, Hospirawill incur additional non-recurring transitional expenses to establishcorporate headquarters, international infrastructure and independent computersystems. These costs are estimated to total approximately $100 million ofpretax expense over the 24-month period subsequent to the spin-off from Abbott.As of June 30, 2004, Hospira has incurred approximately $5 million ofthese costs.

 

**Liquidity and Capital Resources atJune 30, 2004 compared with December 31, 2003**

 

Prior to the distribution, aspart of Abbott, Hospira did not hold cash, and the related transactions withAbbott were reflected in the condensed consolidated statement of cash flows inthe financing section as “Net transactions with Abbott Laboratories.”  Subsequent to the distribution, Hospira hascash and cash equivalents, which primarily include demand deposits with banksor other financial institutions.  

 

Net Cash From Operating Activities, whichcontinues to be Hospira’s primary source of funds to finance operating needsand capital expenditures, was $220 million for the six-month period endedJune 30, 2004.  The cash inflow isdue primarily to operating income and increased accounts payable and otherliabilities.

 

Net Cash Used in Investing Activities of $108million included payments for upgrading and expanding manufacturing andadministrative support facilities, and for equipment placed withcustomers.  

 

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Net Cash Used in Financing Activities of $2million consisted primarily of net transactions with Abbott previous to andrelated to the distribution, net transactions with Abbott related tointernational net asset activity for the entire six month period, and theissuance and payment of short term and long-term debt, net of discount andfinancing fees.  Operational transactionswith Abbott after the distribution are included in operating cash flows.

 

At June 30, 2004,Hospira’s working capital of approximately $664 million compared to workingcapital of approximately $716 million at December 31, 2003.  The decrease in working capital in 2004 wasmainly due to the current portion of “Due to Abbott, Net”, which is primarily related to the liability forthe international net assets to be purchased from Abbott; increases in accountspayable and accrued liabilities; borrowings under the revolving creditfacility; and decreases in inventory, offset by an increase in cash and cashequivalents and current deferred income taxes.  The increase in cash is due primarily to two months of cash flow fromoperations being retained by Hospira that prior to the distribution would havebeen remitted to Abbott.

 

Hospira expects annual Net CashFrom Operating Activities to be between $300 and $350 million.  Annual capital expenditures are expected tobe between $250 million and $275 million, including transition-relatedcapital expenditures, such as the construction of a new research anddevelopment facility. 

 

Hospira believes that currentcash and cash equivalents, cash generated from operations, and funds availablefrom our revolving credit facility will be sufficient to finance ouroperations, including product development, transition costs, international netasset acquisitions, and capital expenditures.

 

On June 15, 2004, Hospira completed anunderwritten offering of a consolidated $700 million aggregate principal amountconsisting of $300 million five-year senior unsecured notes and $400 millionten-year senior unsecured notes.  The$300 million five-year notes bear interest at a rate of 4.95 percent per annumand mature on June 15, 2009 and the $400 million ten-year notes bearinterest at a rate of 5.90 percent per annum and mature on June 15,2014.  The proceeds from this offering,together with cash on hand, were used to repay all amounts outstanding underthe $700 million, short-term senior unsecured credit facility (“SeniorFacility”).  

 

On April 28, 2004, Abbott and Hospiraentered into the Senior Facility.  Theproceeds of the Senior Facility were retained by Abbott.  On the distribution date, Abbott was relievedof all obligations under the Senior Facility and Hospira became solelyresponsible for repayment of the principal and for payment of interest and feeson this debt.  As of June 30, 2004,all amounts under the Senior Facility have been repaid with proceeds from thesenior unsecured notes together with cash on hand.  

 

Hospira’s credit facility, enteredinto on April 30, 2004, consists of an unsecured revolving credit facilityof $375 million (“Revolver”) that is available for working capital and otherrequirements.  The Revolver allowsHospira to borrow funds on an unsecured basis at variable interest rates asshort-term cash needs dictate.  Thecommitment is subject to an annual facility fee, and expires inApril 2009. As of June 30, 2004, Hospira has borrowed $25 millionunder the Revolver.

 

The Revolver andSenior Unsecured Notes contain, among other provisions, covenants with whichHospira must comply while the underlying agreements are outstanding.  Such covenants include obligations not toallow liens on properties or assets, merge or consolidate with any othercorporation, or sell or lease all or substantially all of Hospira’s assets, aswell as compliance with certain financial covenants, including interestcoverage ratio, leverage ratio and minimum consolidated net worth.

 

Hospira will purchase certain internationaloperations and assets, and assume the corresponding liabilities, from Abbottover a two-year period after the distribution date as Hospira establishes itsbusiness infrastructure outside the United States and obtains regulatoryapproval for the transfer of the marketing authorizations for Hospira products.The purchase price will be equal to the net book value of those assets andliabilities at the time of such purchase. Accordingly, the net book value willbe affected by normal operations, exchange rates and other business factors.  As of June 30, 2004, the net book valueof those assets and liabilities was approximately $236 million. Hospirapays Abbott interest on a portion of this purchase price at local prevailingshort-term rates in connection with Hospira’s use of these assets during thatperiod. Hospira expects to fund these net asset purchases from operating cashflow.

 

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**Contractual Obligations**

 

Hospira has no material exposures to off-balance sheet arrangements, nospecial purpose entities, and no activities that include non-exchange-tradedcontracts accounted for at fair value. The following table summarizes Hospira’s estimated contractualobligations as of June 30, 2004 (dollars in millions):

 

 
| ** **                                                                  | ** ** | **Payment Due By  Period** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                  | ** ** | **Total**                  | ** ** | **2004** | ** ** | **2005-2006** | ** ** | **2007-2008** | ** ** | **2009 and  Thereafter** | ** ** |
|                                                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Short-term borrowings                                                       |       | $                          | 25.0       |   | $ | 25.0 |   | $ | — |   | $ | — |   | $ | — |   |
| Long-term debt                                                              |       | 700.0                      |       | — |   | — |   | — |   | 700.0 |   |
| Lease obligations                                                           |       | 163.7                      |       | 8.9 |   | 37.9 |   | 30.3 |   | 86.6 |   |
| Purchase commitments(1)                                                     |       | 274.0                      |       | 233.1 |   | 40.9 |   | — |   | — |   |
| Other long-term  liabilities reflected on the consolidated balance sheet(2) |       | 9.7                        |       | — |   | 9.7 |   | — |   | — |   |
| Amounts due to Abbott  for acquisition of certain international net assets  |       | 236.3                      |       | 140.0 |   | 96.3 |   | — |   | — |   |
|                                                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Total                                                                       |       | $                          | 1,408.7    |   | $ | 407.0 |   | $ | 184.8 |   | $ | 30.3 |   | $ | 786.6 |   |

 

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(1)           Purchase commitments consistprimarily of inventory purchases made in the normal course of business to meetoperational requirements.

(2)           Excludes approximately $113 millionof other long-term liabilities related primarily to post-retirement benefitplans.  Hospira plans to conductan asset/liability study in order to determine the appropriate level of fundingfor the primary U.S. Hospira pension plan.  

 

**Legislative Issues**

 

Hospira’s primary markets are highly competitive andsubject to substantial government regulation. Hospira expects debate tocontinue at both the federal and state levels over the availability, method ofdelivery, reporting requirements and payment for health care products andservices. If additional legislation is enacted, it could have the effect ofreducing prices, or reducing the rate of price increases, for medical productsand services. International operations are also subject to a significant degreeof government regulation. It is not possible to predict the extent to whichHospira or the health care industry in general might be adversely affected bythese factors in the future. 

 

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

 

Under the safe harbor provisions of the PrivateSecurities Litigation Reform Act of 1995, Hospira cautions investors that anyforward-looking statements or projections made by Hospira, including those madein this document, are subject to risks and uncertainties that may cause actualresults to differ materially from those projected. In some cases, thesestatements can be identified by use of 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’s plans, strategies, prospects andexpectations regarding Hospira’s business as an independent public company areforward-looking statements. Please be aware that these statements and any otherforward-looking statements in this document only reflect Hospira’s expectationsand are not guarantees of performance. These statements involve risks,uncertainties and assumptions. Many of these risks, uncertainties andassumptions are beyond Hospira’s control, and may cause actual results andperformance to differ materially from Hospira’s expectations. Economic,competitive, governmental, technological and other factors that may affectHospira’s operations are discussed in the information statement included as anexhibit in Hospira’s registration statement on Form 10 which the Securities andExchange Commission declared effective on April 13, 2004. Accordingly,undue reliance should not be placed on the forward-looking statements containedin this document. These forward-looking statements speak only as of the date onwhich the statements were made. Hospira undertakes no obligation to update orrevise publicly any forward-looking statements, whether as a result of newinformation, future events or otherwise.

 

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

 

There have been no material changes to theinformation provided in the information statement included as an exhibit inHospira’s registration statement on Form 10, which the Securities and ExchangeCommission declared effective on April 13, 2004

 

**Item4.****          ****Controls and Procedures**

 

(a)          *Evaluation of disclosure controlsand procedures. *The Chief Executive Officer, ChristopherB. Begley, and Chief Financial Officer, Terrence C. Kearney, evaluated theeffectiveness of Hospira’s disclosure controls and procedures as of the end ofthe period covered by this report, and concluded that Hospira’s disclosurecontrols and procedures were effective to ensure that information Hospira isrequired to disclose in its filings with the Securities and Exchange Commissionunder the Securities Exchange Act of 1934 is recorded, processed, summarizedand reported, within the time periods specified in the Commission’s rules andforms, and to ensure that information required to be disclosed by Hospira inthe reports that it files under the Exchange Act is accumulated andcommunicated to Hospira’s management, including its principal executive officerand principal financial officer, as appropriate to allow timely decisionsregarding required disclosure.

 

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**PART II.  OTHERINFORMATION**

 

**Item1.****                           LegalProceedings**

 

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 civil investigations that areseeking to identify the practices and determine whether those practicesviolated any laws, including federal and state false claims acts, orconstituted fraud in connection with the Medicare and/or Medicaid reimbursementpaid to third parties.  In addition,Abbott is a defendant in a number of purported class actions on behalf ofindividuals or entities, including health care insurers and other third-partypayors, that allege generally that Abbott and numerous other pharmaceuticalcompanies reported false or misleading pricing information in connection withfederal, state and private reimbursement for certain drugs.  Many of the products involved in theseinvestigations and lawsuits are Hospira products.  Hospira is cooperating with the authoritiesin these investigations. There may be additional investigations or lawsuits, oradditional claims in the existing investigations or lawsuits, initiated withrespect to these matters in the future. Hospira cannot be certain that it will not be named as a subject ordefendant in these investigations or lawsuits. Hospira has been added as a defendant in one AWP proceeding, *The State of Texas ex rel. Ven-A-Care of the FloridaKeys, Inc. v. Abbott Laboratories Inc., Hospira, Inc., B. Braun Medical Inc.and Baxter Healthcare Corporation,*Case No. GV401286, pending in theDistrict Court of Travis County, Texas. The lawsuit alleges generally that the defendants made falserepresentations of prices and costs for drugs directly and indirectly to theTexas Medicaid Program.  Abbott willindemnify Hospira for liabilities associated with pending or future AWPinvestigations and lawsuits only to the extent that they are of the same natureas the lawsuits and investigations that existed against Abbott as of thedistribution date and relate to the sale of Hospira products prior to thespin-off.  Hospira will assume any otherlosses that may result from these investigations and lawsuits.  These investigations and lawsuits couldresult in changes to Hospira’s business practices or pricing policies, civil orcriminal monetary damages, penalties or fines, imprisonment and/or exclusion ofHospira products from participation in federal and state healthcare programs,including Medicare, Medicaid and Veterans’ Administration health programs, anyof which, because of our obligation to indemnify Abbott or because we may benamed as defendants ourselves, could have a material adverse effect on ourbusiness, profitability and financial condition.

 

Additional legal proceedings may occur that mayresult in a change in the estimated reserves recorded by Hospira. It is notfeasible to predict the outcome of such proceedings with certainty and therecan be no assurance that their ultimate disposition will not have a materialadverse effect on Hospira’s financial position, cash flows, or results ofoperations.

 

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**Item4.****           Submission of Mattersto a Vote of Security Holders**

 

In connection with the spin-off,Abbott’s board of directors, acting on behalf of Abbott as the sole stockholderof Hospira, approved the following matters on April 8, 2004:  (i) the registration statement onForm 10, File No. 1-31946, filed by Hospira with the Securities and ExchangeCommission, (ii) the Hospira 2004 Long-Term Stock Incentive Plan, (iii)the entry into change in control agreements by Hospira with certain Hospiraexecutives, (iv) the adoption by Hospira of the Hospira Change in ControlSeverance Pay Plan, and (v) the adoption by Hospira of the Hospira 2004Performance Incentive Plan.

 

On April 12, 2004, Abbott,as the sole stockholder of Hospira, approved by written consent (i) theRestated Certificate of Incorporation as the amended and restated certificateof incorporation for Hospira, effective as of April 30, 2004, and (ii) theissuance of a sufficient number of shares of Hospira common stock to Abbott toeffect the distribution of Hospira common stock to Abbott shareholders.

 

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**Item 6.****          ****Exhibits and Reports on Form8-K**

 

(a)                                  Exhibits

 

 
| **EXHIBIT  NO.** | ** ** | **DESCRIPTION**                                                                                                                                              |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1             |       | Hospira Supplemental Pension Plan.                                                                                                                           |
|             |       |                                                                                                                                                         |
| 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. |

 

(b)                                 Reportson Form 8-K

 

On April 19, 2004, Hospira, Inc. furnished a Current Report onSecurities and Exchange Commission Form 8-K reporting materials that Hospira,Inc. intended to present in meetings with certain potential investors.

 

On April 28, 2004, Hospira, Inc. furnished a Current Report onSecurities and Exchange Commission Form 8-K reporting a revised page 31 tomaterials that Hospira, Inc. intended to present in meetings with certainpotential investors.

 

On May 10, 2004, Hospira, Inc. furnished a Current Report on Securitiesand Exchange Commission Form 8-K reporting that Hospira has granted certainstock options under its 2004 Long Term Stock Incentive Plan.

 

On May 27, 2004, Hospira, Inc. furnished a Current Report on Securitiesand Exchange Commission Form 8-K reporting certain comments on the results of thefirst quarter of 2004 that Hospira, Inc. intended to discuss with certainpotential investors.

 

On June 9, 2004, Hospira, Inc. filed a Current Report onSecurities and Exchange Commission Form 8-K reporting the issuance and sale of$300 million of 4.95% Notes due in 2009 and $400 million of 5.90% Notes due in2014.

 

On July 29, 2004, Hospira, Inc. furnished a Current Report onSecurities and Exchange Commission Form 8-K reporting:  (i) unaudited combined statements of earningsfor the three month periods ended March 31, June 30,September 30 and December 31, 2003; and (ii) unaudited net sales byproduct line for each of the three month periods ended March 31,June 30, September 30 and December 31, 2003.

 

On August 11, 2004, Hospira, Inc. furnished a Current Report onSecurities and Exchange Commission Form 8-K attaching a copy of its PressRelease dated August 10, 2004 on Second Quarter 2004 Results.

 

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SIGNATURE

 

Pursuant to the requirementsof the 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/  Terrence C. Kearney |
|                             |           |   | Terrence C.  Kearney, |
|                             |           |   | Senior Vice  President,  Finance and Chief Financial  Officer |
|                             |           |   |
|                             |           |   |
| Date:  August 12, 2004 |           |   |

 

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