FORM 10-Q

 

SECURITIES AND 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 September 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. 1-2189

 

ABBOTT LABORATORIES

 

An Illinois Corporation		I.R.S. Employer Identification
		No. 36-0698440

 

100 Abbott Park Road

Abbott Park, Illinois 60064-6400

Telephone: (847) 937-6l00

 

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

 

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

 

As of September 30, 2004, Abbott Laboratories had 1,557,392,303 common shares without par value outstanding.

 

 

PART  I.  FINANCIAL INFORMATION

 

Abbott Laboratories and Subsidiaries

 

Condensed Consolidated Financial Statements

 

(Unaudited)

 

 

Abbott Laboratories and Subsidiaries

 

Condensed Consolidated Statement of Earnings

 

(Unaudited)

 

(dollars and shares in thousands except per share data)

 

		Three Months Ended September 30								Nine Months Ended September 30
		2004				2003				2004				2003
Net Sales		$	4,681,669			$	4,247,855			$		14,025,573		$	12,383,055
Cost of products sold		2,114,919				1,928,796				6,257,063				5,577,094
Research and development		391,698				409,270				1,232,786				1,174,752
Acquired in-process research and development		8,100				61,240				232,006				100,240
Selling, general and administrative		1,144,416				1,027,774				3,534,584				3,598,856
Total Operating Cost and Expenses		3,659,133				3,427,080				11,256,439				10,450,942
Operating Earnings		1,022,536				820,775				2,769,134				1,932,113
Net interest expense		36,706				36,266				107,043				112,008
(Income) from TAP Pharmaceutical Products Inc. joint venture		(84,582			)	(142,821			)	(306,486			)	(407,451		)
Net foreign exchange loss		3,915				5,636				24,541				50,562
Other (income) expense, net		439				(7,240			)	(25,920			)	(32,146		)
Earnings from Continuing Operations Before Taxes		1,066,058				928,934				2,969,956				2,209,140
Taxes on earnings from Continuing Operations		261,979				231,459				768,725				598,661
Earnings from Continuing Operations		804,079				697,475				2,201,231				1,610,479
Earnings from Discontinued Operations, net of taxes		—				63,742				60,015				198,362
Net Earnings		$		804,079		$		761,217		$	2,261,246			$	1,808,841
Basic Earnings Per Common Share —
Continuing Operations		$		0.52		$		0.45		$	1.41			$	1.03
Discontinued Operations		0.00				0.04				0.04				0.13
Net Earnings		$		0.52		$		0.49		$	1.45			$	1.16
Diluted Earnings Per Common Share —
Continuing Operations		$		0.51		$		0.44		$	1.40			$	1.02
Discontinued Operations		0.00				0.04				0.04				0.13
Net Earnings		$		0.51		$		0.48		$	1.44			$	1.15
Cash Dividends Declared Per Common Share		$		0.26		$		0.245		$	0.78			$	0.735
Average Number of Common Shares Outstanding Used for Basic Earnings Per Common Share		1,559,980				1,562,898				1,561,080				1,562,476
Dilutive Common Stock Options		9,023				9,207				9,567				8,480
Average Number of Common Shares Outstanding Plus Dilutive Common Stock Options		1,569,003				1,572,105				1,570,647				1,570,956
Outstanding Common Stock Options Having No Dilutive Effect		78,832				59,836				57,950				59,207

 

The accompanying notes to condensed consolidated financial statements are an integral part of this statement.

 

2

 

Abbott Laboratories and Subsidiaries

 

Condensed Consolidated Statement of Cash Flows

 

(Unaudited)

(dollars in thousands)

 

		Nine Months Ended September 30
		2004			2003
Cash Flow From (Used in) Operating Activities:
Net earnings		$	2,261,246		$	1,808,841
Less: Earnings from discontinued operations, net of taxes		60,015			198,362
Earnings from continuing operations		2,201,231			1,610,479
Adjustments to reconcile earnings from continuing operations to net cash from operating activities of continuing operations -
Depreciation		625,466			547,584
Amortization of intangibles		329,874			253,314
Acquired in-process research and development		232,006			100,240
Trade receivables		(32,769		)	162,248
Inventories		(239,488		)	(19,568		)
Other, net		357,972			202,712
Net Cash From Operating Activities of Continuing Operations		3,474,292			2,857,009
Cash Flow From (Used in) Investing Activities of Continuing Operations:
Acquisitions of businesses and technologies		(1,965,351		)	(463,886		)
Acquisitions of property and equipment		(933,708		)	(807,530		)
Investment securities transactions		(658,046		)	248,804
Other		13,385			64,393
Net Cash (Used in) Investing Activities of Continuing Operations		(3,543,720		)	(958,219		)
Cash Flow From (Used in) Financing Activities of Continuing Operations:
Proceeds from (repayments of) commercial paper, net		688,000			(839,850		)
Proceeds from issuance of long-term debt		1,500,000			—
Repayment of long-term debt		(1,650,000		)	—
Other borrowing transactions, net		136,682			913,018
Common share transactions, net		(405,349		)	(48,770		)
Dividends paid		(1,194,820		)	(1,132,665		)
Net Cash (Used in) Financing Activities of Continuing Operations		(925,487		)	(1,108,267		)
Effect of exchange rate changes on cash and cash equivalents		(20,366		)	69,841
Discontinued Operations:
Net cash provided by discontinued operations		131,048			117,123
Financing activities of discontinued operations		700,000			—
Net cash provided by discontinued operations		831,048			117,123
Net (Decrease) Increase in Cash and Cash Equivalents		(184,233		)	977,487
Cash and Cash Equivalents, Beginning of Year		995,124			704,450
Cash and Cash Equivalents, End of Period		$	810,891		$	1,681,937

 

The accompanying notes to condensed consolidated financial statements are an integral part of this statement.

 

3

 

Abbott Laboratories and Subsidiaries

 

Condensed Consolidated Balance Sheet

 

(Unaudited)

 

(dollars in thousands)

 

		September 30 2004			December 31 2003
Assets
Current Assets:
Cash and cash equivalents		$	810,891		$	995,124
Investment securities		1,100,402			291,297
Trade receivables, less allowances of $238,965 in 2004 and $259,514 in 2003		2,945,894			3,313,377
Inventories:
Finished products		1,229,353			1,467,441
Work in process		599,764			545,977
Materials		541,074			725,021
Total inventories		2,370,191			2,738,439
Prepaid expenses, deferred income taxes, and other receivables		2,770,094			2,952,178
Assets held for sale		218,531			—
Total Current Assets		10,216,003			10,290,415
Investment Securities Maturing after One Year		222,155			406,357
Property and Equipment, at Cost		11,963,172			13,290,747
Less: accumulated depreciation and amortization		6,265,567			7,008,941
Net Property and Equipment		5,697,605			6,281,806
Intangible Assets, net of amortization		4,998,480			4,089,882
Goodwill		5,216,582			4,449,408
Deferred Income Taxes, Investment in Joint Ventures and Other Assets		1,147,869			1,197,474
Assets Held for Sale		65,532			—
		$	27,564,226		$	26,715,342
Liabilities and Shareholders’ Investment
Current Liabilities:
Short-term borrowings		$	1,696,716		$	828,092
Trade accounts payable		1,597,801			1,754,367
Salaries, dividends payable, and other accruals		3,254,718			3,188,975
Income taxes payable		508,367			158,836
Current portion of long-term debt		156,483			1,709,265
Liabilities of operations held for sale		81,372			—
Total Current Liabilities		7,295,457			7,639,535
Post-employment Obligations and Other Long-term Liabilities		2,583,398			2,551,220
Long-Term Debt		4,728,470			3,452,329
Liabilities of Operations Held for Sale		1,557			—
Shareholders’ Investment:
Preferred shares, one dollar par value Authorized – 1,000,000 shares, none issued		—			—
Common shares, without par value Authorized - 2,400,000,000 shares Issued at stated capital amount - Shares: 2004: 1,572,601,329; 2003: 1,580,247,227		3,164,832			3,034,054
Common shares held in treasury, at cost - Shares: 2004: 15,209,026; 2003: 15,729,296		(222,098		)	(229,696		)
Unearned compensation – restricted stock awards		(55,048		)	(56,336		)
Earnings employed in the business		9,483,232			9,691,484
Accumulated other comprehensive income		584,426			632,752
Total Shareholders’ Investment		12,955,344			13,072,258
		$	27,564,226		$	26,715,342

 

The accompanying notes to condensed consolidated financial statements are an integral part of this statement.

 

4

 

Abbott Laboratories and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements

 

September 30, 2004

 

(Unaudited)

 

Note 1 – Basis of Presentation

 

The accompanying unaudited, condensed consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission and, therefore, do not include all information and footnote disclosures normally included in audited financial statements.  However, in the opinion of management, all adjustments necessary to present fairly the results of operations, financial position and cash flows have been made.  It is suggested that these statements be read in conjunction with the financial statements included in Abbott’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

Note 2 – Spin-off of Hospira

 

On April 12, 2004, Abbott’s board of directors declared a special dividend distribution of all of the outstanding shares of common stock of Hospira, Inc.  For every 10 Abbott common shares held at the close of business on April 22, 2004, Abbott shareholders received one share of Hospira stock on April 30, 2004.  All of the shares of Hospira’s common stock were distributed to Abbott shareholders on a pro-rata basis. Abbott has received a ruling from the Internal Revenue Service that the spin-off qualifies as a tax-free distribution to Abbott and its U.S. shareholders for U.S. federal income tax purposes.  Cash, which will generally be taxable to the recipient, was issued in lieu of fractional shares.  Hospira included the operations relating to the manufacture and sale of hospital products including specialty injectable pharmaceuticals, medication delivery systems and critical care devices and injectable pharmaceutical contract manufacturing.  Hospira included Abbott’s Hospital Products segment, after that segment’s reorganization on January 1, 2004, and portions of Abbott’s International segment.  The income and cash flows of Hospira and the direct transaction costs of the spin-off have been presented as discontinued operations in the Condensed Consolidated Statement of Earnings and Statement of Cash Flows.   Prior years’ balance sheets have not been adjusted to reflect the effect of the spin-off.

 

The legal transfer of certain operations and assets (net of liabilities) outside the United States will occur after the distribution date.  These operations and assets are used in the conduct of Hospira’s international business and Hospira is subject to the risks and entitled to the benefits generated by these operations and assets.  These assets and liabilities have been presented as available for sale in the condensed consolidated balance sheet as of September 30, 2004.  The assets and liabilities held for sale consist primarily of inventories, trade accounts receivable, property and equipment and trade accounts payable, salaries and other accruals.

 

In April 2004, Abbott borrowed and Hospira assumed $700 million of debt, the proceeds of which were retained by Abbott to reduce short-term borrowings.  Hospira is solely responsible for repayment of the principal and for payment of interest on this debt.  Abbott has retained liabilities for taxes on income prior to the spin-off, post-employment medical benefits for most of Hospira’s U.S. retired employees and U.S. retirement eligible employees, certain potential liabilities, if any, related to alleged improper pricing practices in connection with federal, state and private reimbursement for certain drugs, and the defined benefit retirement plan liabilities and plan assets for most of Hospira’s retired employees.   In connection with the spin-off, Abbott’s defined benefit, medical and dental and employee stock option programs have been adjusted.  See footnotes 7 and 11 for further details.

 

5

 

Summarized financial information for discontinued operations is as follows:

(dollars in thousands)

 

		Three Months Ended September 30			Nine Months Ended September 30
		2003			2004			2003
Net sales		$	598,026		$	793,129		$	1,766,924
Earnings before taxes		91,707			90,444			282,657
Taxes on earnings		27,965			30,429			84,295
Net earnings		63,742			60,015			198,362

 

The financial information above includes the operations of Hospira through April 30, 2004, the date of the spin-off.  As a consequence, the results for the nine months ended September 30, 2004 include only four months of the operations of Hospira.  The results of the discontinued operations also include direct transaction costs of approximately $36 million and approximately $3 million in the nine months ended September 30, 2004 and 2003, respectively.

 

The following is a summary of the assets and liabilities transferred to Hospira on April 30, 2004:

(dollars in millions)

 

Trade receivables, net		$		235
Inventories		481
Prepaid expenses, deferred income taxes, and other receivables		269
Net property and equipment		841
Goodwill		81
Deferred income taxes and other assets		91
Total Assets		$	1,998
Short-term borrowings		$	700
Trade accounts payable, salaries and other accruals		346
Post-employment obligations and other long-term liabilities		185
Total Liabilities		$	1,231
Net Assets Transferred to Hospira		$	767

 

Note 3 – Supplemental Financial Information

(dollars in thousands)

 

		Three Months Ended September 30							Nine Months Ended September 30
		2004				2003			2004			2003
Net Interest Expense:
Interest expense		$	49,891			$	47,219		$	143,252		$	143,473
Interest income		(13,185			)	(10,953		)	(36,209		)	(31,465		)
Total		$		36,706		$	36,266		$	107,043		$	112,008

 

6

 

Note 4 – Taxes on Earnings

 

Taxes on earnings reflect the estimated annual effective rates, and for 2004 include the effects of the charges for acquired in-process research and development and for other non-tax deductible items.  For 2003, the tax rate includes the effects of the settlement of the Ross enteral nutrition investigation and the charges for acquired in-process research and development.  The effective tax rates, excluding the effect of these 2004 and 2003 charges, are less than the statutory U.S. federal income tax rate principally due to the domestic dividend exclusion and the benefit of lower statutory tax rates and tax exemptions in several taxing jurisdictions.

 

Note 5 – Litigation and Environmental Matters

 

Abbott is involved in various claims and legal proceedings including a number of antitrust suits and investigations in connection with the pricing of prescription pharmaceuticals. These suits and investigations allege that various pharmaceutical manufacturers conspired to fix prices for prescription pharmaceuticals and/or to discriminate in pricing to retail pharmacies by providing discounts to mail-order pharmacies, institutional pharmacies and HMOs in violation of state and federal antitrust laws. The suits were brought on behalf of retail pharmacies and name certain pharmaceutical manufacturers, including Abbott, as defendants. The cases seek treble damages, civil penalties, and injunctive and other relief.  Abbott filed a response to each of the complaints denying all substantive allegations.

 

There are several lawsuits pending in connection with the sales of Hytrin. These suits allege that Abbott violated state or federal antitrust laws and, in some cases, unfair competition laws by signing patent settlement agreements with Geneva Pharmaceuticals, Inc. and Zenith Laboratories, Inc. in 1998. Those agreements related to pending patent infringement lawsuits between Abbott and the two companies. Some of the suits also allege that Abbott violated various state or federal laws by filing frivolous patent infringement lawsuits to protect Hytrin from generic competition. The cases seek treble damages, civil penalties and other relief. Abbott has filed or intends to file a response to each of the complaints denying all substantive allegations.

 

Abbott has been identified as a potentially responsible party for investigation and cleanup costs at a number of locations in the United States and Puerto Rico under federal and state remediation laws and is investigating potential contamination at a number of company-owned locations. Abbott has recorded an estimated cleanup cost for each site for which management believes Abbott has a probable loss exposure. No individual site cleanup exposure is expected to exceed $3 million, and the aggregate cleanup exposure is not expected to exceed $20 million.

 

Within the next year, legal proceedings may occur that may result in a change in the estimated reserves recorded by Abbott.  For its legal proceedings and environmental exposures discussed in this note and in Note 6, Abbott estimates the range of possible loss to be from approximately $130 million to $225 million. Abbott has recorded reserves of approximately $160 million for these proceedings and exposures.  These reserves represent management’s best estimate of probable loss, except for one which is recorded at the minimum, as defined by Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies.”

 

While it is not feasible to predict the outcome of all such proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on Abbott’s financial position, cash flows, or results of operations.

 

Note 6 – TAP Pharmaceutical Products Inc.

 

TAP Pharmaceutical Products Inc. (TAP) and Abbott have been named as defendants in several lawsuits alleging violations of various state or federal laws in connection with TAP’s marketing and pricing of Lupron. During the third quarter of 2004, TAP reached an agreement in principle with plaintiffs to settle the allegations and dismiss Abbott from the cases.  The settlement is subject to court approval.  Abbott reversed the reserve it had recorded for this matter and TAP recorded the expected settlement amount.  Abbott’s portion of this settlement is included in the reserve amounts and range in Note 5 above.

 

7

 

Within the next year, legal proceedings may occur that may result in a change in the estimated reserves recorded by TAP and Abbott. While it is not feasible to predict the outcome of such pending claims, proceedings, and investigations with certainty, management is of the opinion that their ultimate disposition should not have a material adverse effect on Abbott’s financial position, cash flows, or results of operations.

 

Note 7 – Post-Employment Benefits

 

Retirement plans consist of defined benefit, defined contribution, and medical and dental plans. In the second quarter of 2004, as a result of the spin-off, Abbott remeasured most of its defined benefit and medical and dental plan assets and liabilities and adjusted the net cost for the period subsequent to the spin-off.   Net cost recognized in continuing operations for the nine months ended September 30 for Abbott’s major defined benefit plans and post-employment medical and dental benefit plans is as follows:  (dollars in millions)

 

		Defined Benefit Plans						Medical and Dental Plans
		2004			2003			2004			2003
Service cost — benefits earned during the year		$	129.0		$	119.0		$	21.1		$	24.2
Interest cost on projected benefit obligations		173.3			149.4			41.3			36.6
Expected return on plans’ assets		(196.1		)	(170.1		)	—			—
Net amortization		18.8			4.6			3.4			3.7
Net cost		$	125.0		$	102.9		$	65.8		$	64.5

 

As a result of the April 30, 2004 remeasurement of the assets and liabilities of Abbott’s main domestic defined benefit plan, in connection with the spin-off, Abbott recorded an additional minimum pension liability adjustment of approximately $80 million.  This resulted in a charge to Accumulated other comprehensive income in the second quarter 2004 of approximately $50 million, net of income taxes.

 

In the second quarter 2004, Abbott reflected the requirements of Financial Accounting Standards Board Staff Position No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.”  As a result, the projected benefit obligations related to benefits attributed to past service were reduced by approximately $210 million, and the net cost recognized in the nine months ended September 30, 2004 was reduced by approximately $25 million.

 

As a result of the spin-off of Hospira and the assumption by Hospira of certain defined benefit and medical and dental plan liabilities and assets, Abbott transferred to Hospira net accrued benefit costs and plans’ assets as of April 30, 2004 as follows:

(dollars in millions)

 

		Defined Benefit Plans			Medical and Dental Plans
Projected benefit obligations		$	(426	)	$	(117	)
Plans’ assets		263			—
Net unrecognized actuarial (gains) losses and prior service cost		145			31
Net accrued balance transferred to Hospira		$	(18	)	$	(86	)

 

As a result of the spin-off, Abbott transferred to Hospira a minimum pension liability adjustment and a charge to Accumulated other comprehensive income, net of income taxes, of approximately $41 million and $23 million, respectively.

 

Abbott funds its domestic defined benefit plans according to IRS funding limitations.  In the first nine months of 2004, $295 million was contributed to the main domestic defined benefit plan.  In addition, Abbott transferred approximately $45 million to Hospira in the third quarter 2004 in accordance with the employee benefit agreement governing the assumption by Hospira of certain defined benefit plan assets and liabilities.

 

8

 

Note 8 – Comprehensive Income, net of tax

(dollars in thousands)

 

		Three Months Ended September 30						Nine Months Ended September 30
		2004			2003			2004			2003
Foreign currency translation adjustments		$	(106,327	)	$	(486,984	)	$	30,985		$	495,660
Minimum pension liability adjustments		—			—			(50,121		)	—
Unrealized gains (losses) on marketable equity securities		(3,101		)	19,102			(38,728		)	53,770
Net gains on derivative instruments designated as cash flow hedges		2,554			38,141			14,575			9,260
Reclassification adjustments for realized (gains)		(4,305		)	(6,169		)	(24,937		)	(17,137		)
Other comprehensive income (loss), net of tax		(111,179		)	(435,910		)	(68,226		)	541,553
Net Earnings		804,079			761,217			2,261,246			1,808,841
Comprehensive Income		$	692,900		$	325,307		$	2,193,020		$	2,350,394
Supplemental Comprehensive Income Information, net of tax:
Cumulative foreign currency translation (income) adjustments								$	(884,747	)	$	(187,418	)
Minimum pension liability adjustments								329,276			203,182
Cumulative unrealized (gains) on marketable equity securities								(28,196		)	(45,641		)
Cumulative (gains) losses on derivative instruments designated as cash flow hedges								(759		)	8,106

 

Note 9 – Segment Information (dollars in millions)

 

Revenue Segments— Abbott’s principal business is the discovery, development, manufacture and sale of a broad line of health care products.  Abbott’s products are generally sold directly to retailers, wholesalers, hospitals, health care facilities, laboratories, physicians’ offices and government agencies throughout the world.  Effective January 1, 2004, Abbott’s segments were reorganized to reflect the shift of certain hospital pharmaceutical products from the Hospital Products segment to the Pharmaceutical Products segment, and the separation of the vascular and spinal product businesses into separate segments.  On April 30, 2004, Abbott spun-off its core hospital products business which included all of the Hospital Products segment, after its reorganization on January 1, 2004, and a portion of the International segment.  In addition, as of January 1, 2004, the Diagnostic Products segment was reorganized into four separate divisions.  For segment reporting purposes, these divisions are aggregated and reported as the Diagnostic Products segment.  The segment information below has been adjusted to reflect the reorganizations and the spin-off of Abbott’s core hospital products business.  Abbott’s reportable segments are as follows:

 

Pharmaceutical Products— U.S. sales of a broad line of pharmaceuticals.

 

Diagnostic Products— Worldwide sales of diagnostic systems and tests for blood banks, hospitals, consumers, commercial laboratories and alternate-care testing sites.

 

Ross Products— U.S. sales of a broad line of adult and pediatric nutritional products, pediatric pharmaceuticals and consumer products.

 

International— Non-U.S. sales of all of Abbott’s pharmaceutical and nutritional products. Products sold by International are manufactured by domestic segments and by international manufacturing locations.

 

9

 

Abbott’s underlying accounting records are maintained on a legal entity basis for government and public reporting requirements. Segment disclosures are on a performance basis consistent with internal management reporting. Intersegment transfers of inventory are recorded at standard cost and are not a measure of segment operating earnings. The cost of some corporate functions and certain employee benefits are sold to segments at predetermined rates that approximate cost. Remaining costs, if any, are not allocated to segments. Intangible assets and related amortization from business acquisitions are not allocated to segments. The following segment information has been prepared in accordance with the internal accounting policies of Abbott, as described above, and are not presented in accordance with generally accepted accounting principles applied to the consolidated financial statements.

 

		Net Sales to External Customers												Operating Earnings
		Three Months Ended September 30						Nine Months Ended September 30						Three Months Ended September 30						Nine Months Ended September 30
		2004			2003			2004			2003			2004			2003			2004			2003
Pharmaceutical		$	1,678		$	1,502		$	4,882		$	4,221		$	611		$	509		$	1,700		$	1,397
Diagnostics (worldwide)		845			756			2,452			2,235			112			80			264			190
Ross		531			519			1,717			1,597			136			145			574			558
International		1,425			1,273			4,451			3,841			424			272			1,217			887
Total Reportable Segments		4,479			4,050			13,502			11,894			1,283			1,006			3,755			3,032
Other		203			198			524			489
Net Sales		$	4,682		$	4,248		$	14,026		$	12,383
Corporate functions and benefit plans costs														62			57			216			140
Non-reportable segments														55			(6		)	144			28
Net interest expense														37			36			107			112
Acquired in-process research and development														8			61			232			100
(Income) from TAP Pharmaceutical Products Inc. joint venture														(85		)	(143		)	(306		)	(407		)
Net foreign exchange loss														4			6			25			51
Other, net (a)														136			66			367			799
Consolidated Earnings from Continuing Operations Before Taxes														$	1,066		$	929		$	2,970		$	2,209

 

(a)          Other, net for 2004 includes acquisition related charges, primarily related to the TheraSense acquisition.  Other, net for the nine months 2003 includes charges of $622 for the settlement of the Ross enteral nutrition investigation.

 

Note 10 – Business Combinations and Technology Acquisitions

 

In April 2004, Abbott acquired TheraSense, Inc., a leader in the development, manufacturing and marketing of blood glucose self-monitoring systems, for approximately $1.2 billion in cash.  In the second quarter 2004, Abbott also acquired certain other product technologies for approximately $352 million.  These acquisitions resulted in a charge of $164 million for acquired in-process research and development, intangible assets of approximately $903 million, non-tax deductible goodwill of approximately $708 million and deferred income taxes of approximately $241 million.  Acquired intangible assets, primarily product technology, are amortized over 9 to 17 years (average of approximately 13 years).  In January 2004, Abbott acquired i-STAT Corporation, a manufacturer of point-of-care diagnostic products for blood analysis, for approximately $394 million in cash.  This acquisition resulted in a charge of approximately $60 million for acquired in-process research and development, intangible assets of approximately $263 million, non-tax deductible goodwill of approximately $126 million and deferred income taxes of approximately $105 million.  Acquired intangible assets, primarily product technology, are amortized over 7 to 18 years (average of approximately 17 years).

 

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In the third quarter 2003, Abbott acquired ZonePerfect, a marketer of healthy and nutritious products for active people, for approximately $160 million in cash.  In addition, Abbott acquired Integrated Vascular Systems, Inc., a developer of a novel vessel closure technology, for approximately $65 million in cash.  These acquisitions resulted in a charge of approximately $61 million for acquired in-process research and development, intangible assets of approximately $105 million and non-deductible goodwill of approximately $90 million.  Acquired intangible assets, primarily trademarks and product technology, are amortized over 12 to 20 years (average of approximately 15 years).

 

In the second quarter 2003, Abbott acquired Spinal Concepts Inc., a marketer of spinal fixation products used in the treatment of spinal disorders, diseases and injuries for approximately $166 million, in cash, plus additional milestone payments of up to $40 million if agreed upon targets are met.  Abbott also acquired the assets of JOMED’s coronary and peripheral interventional business line for approximately $68 million in cash.  These acquisitions resulted in a charge of $39 million for acquired in-process research and development, intangible assets of approximately $117 million and non-tax deductible goodwill of approximately $92 million.  Acquired intangible assets, primarily product technology, are amortized over 10 to 16 years (average of approximately 13 years).

 

Had these acquisitions taken place on January 1 of the previous year, consolidated sales and income would not have been significantly different from reported amounts.

 

Note 11 – Incentive Stock Programs

 

Abbott measures compensation cost using the intrinsic value-based method of accounting for stock options and replacement stock options granted to employees.  Had compensation cost been determined using a fair market value-based accounting method, pro forma net earnings (in millions) and earnings per share (EPS) amounts would have been as follows:

 

		Three Months Ended September 30						Nine Months Ended September 30
		2004			2003			2004			2003
Net earnings, as reported		$	804		$	761		$	2,261		$	1,809
Compensation cost under fair value-based accounting method, net of taxes		(53		)	(57		)	(152		)	(168		)
Net earnings, pro forma		$	751		$	704		$	2,109		$	1,641
Diluted EPS from continuing operations, as reported		$	0.51		$	0.44		$	1.40		$	1.02
Diluted EPS from continuing operations, pro forma		0.48			0.41			1.32			0.93
Basic EPS, as reported		0.52			0.49			1.45			1.16
Basic EPS, pro forma		0.48			0.45			1.35			1.05
Diluted EPS, as reported		0.51			0.48			1.44			1.15
Diluted EPS, pro forma		0.48			0.45			1.35			1.05

 

Hospira optionees who were eligible to retire as of the spin-off date are retired from Abbott for purposes of their outstanding options.  Approximately 4.8 million Abbott options held by Hospira optionees who were not eligible to retire were cancelled and were replaced by Hospira.  Pro forma compensation expense for the nine months ended September 30, 2004 reflects the cancellation of the options.  Abbott options were adjusted for the effects of the spin-off on the value of the options resulting in the issuance of an additional 8.2 million Abbott options.

 

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Note 12 – Equity Method Investments

(dollars in millions)

 

Abbott’s 50 percent-owned joint venture, TAP Pharmaceutical Products Inc. (TAP), is accounted for under the equity method of accounting.  Abbott’s income from the TAP joint venture is recognized net of consolidating adjustments. Summarized financial information for TAP is as follows:

 

		Three Months Ended September 30						Nine Months Ended September 30
		2004			2003			2004			2003
Net Sales		$	912.8		$	945.7		$	2,680.6		$	2,952.4
Cost of Sales		269.1			258.8			775.5			788.7
Income Before Taxes		266.4			446.3			965.3			1,273.3
Net Income		169.2			285.6			613.0			814.9

 

		September 30 2004			December 31 2003
Current Assets		$	1,501.5		$	1,451.6
Total Assets		1,756.2			1,718.1
Current Liabilities		1,247.2			965.8
Total Liabilities		1,298.7			1,037.2

 

Note 13 – Long-term Debt and Interest Rate Hedge Contracts

 

Under a registration statement filed with the Securities and Exchange Commission in September 2003, Abbott issued $1.5 billion of long-term debt in the first quarter of 2004 that matures in 2009 through 2014 with interest rates ranging from 3.5 percent to 4.35 percent.  Proceeds from this debt were used to fund the acquisition of TheraSense in the second quarter of 2004 and to pay down domestic commercial paper borrowings.  In connection with these borrowings, Abbott entered into interest rate hedge contracts totaling $1.5 billion to manage its exposure to changes in the fair value of the $1.5 billion of debt.  These contracts are designated as fair value hedges of the variability of the fair value of fixed-rate debt due to changes in the long-term bench-mark interest rates.  The effect of the hedge is to change the fixed interest rate to a variable rate.

 

Note 14 – Goodwill and Intangible Assets

(dollars in millions)

 

Abbott recorded goodwill of approximately $834 related to the acquisitions of TheraSense in the second quarter of 2004 and i-STAT in the first quarter of 2004.  Foreign currency translation adjustments increased goodwill in the first nine months of 2004 by approximately $14 and approximately $81 of goodwill was transferred to Hospira.  There were no other reductions of goodwill relating to impairments or disposal of all or a portion of a business.

 

The gross amount of amortizable intangible assets, primarily product rights and technology was $6,363 as of September 30, 2004 and $5,159 as of December 31, 2003, and accumulated amortization was $1,383 as of September 30, 2004 and $1,087 as of December 31, 2003.  Intangible assets with indefinite lives are not significant.  The estimated annual amortization expense for intangible assets is $447 in 2004, $468 in 2005, $466 in 2006, $452 in 2007, and $427 in 2008.  Intangible assets are amortized primarily on a straight-line basis over 4 to 25 years (average 14 years).

 

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FINANCIAL REVIEW

 

Results of Operations

 

The following table details sales by reportable segment for the third quarter and first nine months:

(dollars in millions)

 

		Three Months Ended September 30								Nine Months Ended September 30
		Net Sales to External Customers						Percentage Change (a)		Net Sales to External Customers						Percentage Change (a)
		2004			2003					2004			2003
Pharmaceutical		$	1,678		$	1,502		11.7		$	4,882		$	4,221		15.7
Diagnostics		845			756			11.8		2,452			2,235			9.7
Ross		531			519			2.4		1,717			1,597			7.5
International		1,425			1,273			12.0		4,451			3,841			15.9
Total Reportable Segments		4,479			4,050			10.6		13,502			11,894			13.5
Other		203			198			1.7		524			489			7.1
Net Sales		$	4,682		$	4,248		10.2		$	14,026		$	12,383		13.3
Total U.S.		$	2,645		$	2,406		9.9		$	7,827		$	6,963		12.4
Total International		$	2,037		$	1,842		10.6		$	6,199		$	5,420		14.4

 

(a) Percentage changes are versus the prior year and are based on unrounded numbers.

 

Worldwide sales for the third quarter and nine months ended September 30, 2004 reflect primarily unit growth and the positive effect of the relatively weaker U.S. dollar.  The relatively weaker U.S. dollar increased third quarter and first nine months 2004 consolidated net sales 1.8 percent and 3.5 percent respectively, and increased Total International sales 4.0 percent and 8.0 percent over the third quarter and first nine months of 2003.  In addition, the effect of the relatively weaker U.S. dollar increased third quarter and first nine months 2004 sales in the Diagnostic Products segment by 3.3 percent and 5.7 percent, respectively and International segment sales by 3.9 percent and 8.0 percent, respectively.

 

A comparison of the product group sales by segment for the first nine months ended September 30 is as follows: (dollars in millions)

 

		Nine Months Ended September 30
		2004			Percentage Change (a)		2003			Percentage Change (a)
Pharmaceutical —
Primary Care		$	2,715		23.4		$	2,201		21.2
Specialty		1,449			36.4		1,062			26.4
Hospital Pharmaceuticals		618			2.0		606			5.3
Diagnostics —
Immunochemistry		1,574			2.4		1,537			2.4
Diabetes Care		549			37.2		400			9.4
Ross —
Pediatric Nutritionals		862			6.5		809			7.7
Adult Nutritionals		661			12.3		589			(8.3	)
International —
Other Pharmaceuticals		2,309			21.6		1,899			14.8
Anti-Infectives		586			5.4		556			8.2
Hospital Pharmaceuticals		431			13.1		381			18.5
Pediatric Nutritionals		430			11.6		385			5.2
Adult Nutritionals		483			12.7		429			11.4

 

(a) Percentage changes are versus the prior year and are based on unrounded numbers.

 

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