UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x                              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

Commission File Number: 1-31946

HOSPIRA, INC.

(Exact name of registrant as specified in its charter)

 

275 North Field Drive
Lake Forest, Illinois 60045

(Address of principal executive offices, including zip code)

(224) 212-2000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act: Common Stock: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x  No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o  No x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

 

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

The aggregate market value of registrant’s common stock held by non-affiliates of the registrant on June 30, 2006 (the last business day of the registrant’s most recently completed second fiscal quarter), was approximately $6,738 million.

Registrant had 155,954,485 shares of common stock outstanding as of January 31, 2007.

INCORPORATION OF DOCUMENTS BY REFERENCE

Certain sections of the registrant’s Proxy Statement to be filed in connection with the 2007 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K where indicated.

HOSPIRA, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS

 

FORWARD-LOOKING STATEMENTS

This annual report contains forward-looking statements within the meaning of the federal securities laws. Hospira intends that these forward-looking statements be covered by the safe harbor provisions for forward-looking statements in the federal securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may,” “will,” “should,” “anticipate,” “estimate,” “expect,” “plan,” “believe,” “predict,” “potential,” “project,” “intend,” “could” or similar expressions. In particular, statements regarding Hospira’s plans, strategies, prospects and expectations regarding its business and industry are forward-looking statements. You should be aware that these statements and any other forward-looking statements in this document only reflect Hospira’s expectations and are not guarantees of performance. These statements involve risks, uncertainties and assumptions. Many of these risks, uncertainties and assumptions are beyond Hospira’s control, and may cause actual results and performance to differ materially from its expectations. Important factors that could cause Hospira’s actual results to be materially different from its expectations include (i) the risks and uncertainties described in “Item 1A. Risk Factors” and (ii) the factors described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Accordingly, you should not place undue reliance on the forward-looking statements contained in this annual report. These forward-looking statements speak only as of the date on which the statements were made. Hospira undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

PART I

Item 1. Business

Overview

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

In 2006, Hospira’s net sales were $2.69 billion, on which it earned net income of $237.7 million. The United States is the largest market for Hospira’s products and accounted for approximately 83% of 2006 sales. Sales outside the United States accounted for the remaining 17% of sales.

Hospira has two reportable segments, U.S. and International, through which its products are sold. For financial information relating to Hospira’s segments and the geographic areas, see Note 11 to the financial statements included in Item 8 of this document. As each reportable segment produces and sells similar products and services, unless the context requires otherwise, the disclosure in Items 1 and 1A relates to both reportable segments.

General Development of Business

Hospira was incorporated in Delaware on September 16, 2003 as a wholly owned subsidiary of Abbott Laboratories. Hospira’s business first began operation as part of Abbott in the 1930s. As part of a plan to spin off its core hospital products business, Abbott transferred the assets and liabilities relating to Hospira’s business to Hospira and, on April 30, 2004, distributed Hospira’s common stock to Abbott’s shareholders. On that date, Hospira began operating as an independent company, and on May 3, 2004,

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Hospira’s common stock began trading on the New York Stock Exchange under the symbol “HSP.” The transfer of assets and liabilities to Hospira, and distribution of Hospira common stock as described above, are sometimes referred to in this document as the “spin-off,” and April 30, 2004 is sometimes referred to as the “spin-off date.” As Hospira’s business was conducted by Abbott before the spin-off, references in this annual report to Hospira’s historical assets, liabilities, products, businesses or activities before the spin-off date are generally intended to refer to the historical assets, liabilities, products, businesses or activities of Hospira’s business as it was conducted as a part of Abbott.

Under the terms of the spin-off, the legal title to certain assets and operations relating to Hospira’s business outside the United States were transferred from Abbott over the two-year period after the spin-off. These transfers were completed during 2006.

On September 20, 2006, Hospira entered into an agreement to acquire Mayne Pharma Limited, an Australian-based specialty injectable pharmaceutical company listed on the Australian Stock Exchange, for approximately $2.0 billion in cash. The acquisition was completed on February 2, 2007. Hospira financed the acquisition through approximately $120 million of cash on hand and $1.925 billion of borrowings under new credit facilities. Hospira’s financial statements included in this report do not include the financial results of Mayne Pharma for any of the periods or at any of the dates presented. Unless the context shall require otherwise, this Item 1 describes Hospira’s business conducted through December 31, 2006, without regard to the Mayne Pharma acquisition. A more detailed description of Mayne Pharma’s business is included in this Item 1 under “—Mayne Pharma.”

Products

Hospira offers the following types of products and services:

 

Specialty Injectable Pharmaceuticals

Hospira’s specialty injectable pharmaceutical products primarily consist of generic injectable pharmaceuticals, which provide customers with a lower-cost alternative to branded products whose patents have expired. As of December 31, 2006, Hospira had approximately 130 generic injectable products in

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more than 600 dosages and formulations. These drugs’ therapeutic areas include analgesia, anesthesia, anti-infective, cardiovascular, oncology and other. All of Hospira’s generic injectable pharmaceuticals include unit-of-use bar-code labels that can be used to support medication management efforts. Hospira procures the active pharmaceutical ingredients in these products from third-party suppliers. During 2006, Hospira launched several new generic injectable pharmaceutical products, including ampicillin sulbactam, carboplatin, ciprofloxacin, foscarnet, ondansetron and propofol.

Hospira believes that novel drug delivery formulations and formats are key points of product differentiation for generic injectable pharmaceuticals. Hospira offers a wide variety of drug delivery options, and believes that its products assist its customers’ efforts to enhance safety, increase productivity and reduce waste. Hospira’s drug delivery formats include standard offerings in ampoules and flip-top vials, which clinicians can use with standard syringes. Hospira’s proprietary drug delivery options include Carpuject® and iSecureTM prefilled syringes, Ansyr® prefilled needleless emergency syringe systems, First Choice® ready-to-use premixed formulations and the ADD-Vantage® system for preparing drug solutions from prepackaged drug powders or concentrates.

Hospira’s specialty injectable pharmaceutical product portfolio also includes Precedex® (dexmedetomidine HCl), a proprietary sedative that is used in the intensive care setting. Precedex® is a registered trademark of Orion Corporation and is licensed to Hospira by Orion.

Medication Delivery Systems

The subgroups of the medication delivery systems market that Hospira serves are (1) medication management systems, which include electronic drug delivery pumps, safety software, administration sets and accessories, and related services; and (2) infusion therapy solutions and products that are used to deliver I.V. fluids and medications to patients.

Medication Management Systems.   Medication management systems include electronic drug delivery pumps, safety software and administration sets that are used to deliver I.V. fluids and medications. Hospira also offers services relating to these products. Worldwide, Hospira estimates that more than 400,000 of its electronic drug delivery pumps were in use as of December 31, 2006.

Hospira’s electronic delivery pumps include its next-generation patient-controlled analgesia device, the LifeCare PCA®; the Plum A+® general infusion pump; the Plum A+®3 (triple-channel) infusion system; the GemStar® ambulatory infusion pump; and the OmniFlow® 4000 Plus multi-channel pump. In late 2006, Hospira launched the Symbiq™ infusion system, designed for ease of use, which can be sold with built-in Hospira MedNet® safety software.  Hospira also offers disposable administration sets designed to fit the specific drug delivery pumps. Consulting services and software maintenance agreements are also offered.

Hospira believes that electronic drug delivery pumps with enhanced systems capabilities have become a key contributor in efforts to improve medication management programs and decrease the incidence of medication errors. Some of Hospira’s pumps use bar coding to read drug labels that are compatible with other Hospira products, reducing the opportunity for drug infusion errors. Hospira offers the Hospira MedNet® safety software system, which has been designed to enable hospitals to customize intravenous drug dosage limits and track drug delivery to prevent medication errors. Through its drug library and programmable drug dosage limits, the system can help ensure that medication is infused within hospital-defined dose guidelines and best practices. The wireless network version of the Hospira MedNet® system establishes real-time send-and-receive capability and can interface with hospital and pharmacy information systems. Hospira continues to work with information technology companies to integrate the Hospira MedNet® system with other systems.

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The Hospira MedNet® system is available in the Symbiq™ infusion system, and also for the Plum A+® infusion pump, the Plum A+®3 (triple-channel) infusion system and the LifeCare PCA® patient-controlled analgesia device, which  together represent the majority of Hospira’s line of electronic drug delivery pumps. Hospira believes that the Hospira MedNet® system had penetrated approximately 42% of the compatible Plum A+® and patient-controlled analgesia installed base by December 31, 2006.

Infusion Therapy Solutions and Supplies.   Hospira offers infusion therapy solutions and supplies that include I.V. solutions for general use, I.V. nutrition products, and solutions for the washing and cleansing of wounds or surgical sites. All of Hospira’s injectable I.V. solutions include unit-of-use bar-code labels that can be used to support medication management efforts. Hospira’s line of infusion therapy supplies includes administration sets used in gravity I.V. administration, I.V. catheters and safety devices that are used to facilitate delivery of I.V. fluids and medications without the use of needles. During 2006, Hospira launched the VisIV™ next-generation non-PVC, non-DEHP I.V. container, an I.V. bag with advanced safety and environmentally friendly features.

Hospira offers needlestick safety products and programs to support its customers’ needlestick prevention initiatives. LifeShield® CLAVE® and MicroCLAVE® connectors are one-piece valves that directly connect syringes filled with medications to a patient’s I.V. line without the use of needles. ICU Medical, Inc.’s (“ICU Medical”) CLAVE® connectors are a component of administration sets sold by Hospira to its customers in the United States and select markets outside the United States.

Injectable Pharmaceutical Contract Manufacturing

Through its One 2 One® manufacturing services group, Hospira provides contract manufacturing services for formulation development, filling and finishing of injectable drugs worldwide. Hospira works with its proprietary pharmaceutical and biotechnology customers to develop stable injectable forms of their drugs, and Hospira fills and finishes those and other drugs into containers and packaging selected by the customer. The customer then sells the finished products under its own label. Hospira’s One 2 One® manufacturing services group does not manufacture active pharmaceutical ingredients, but offers a wide range of filling and finishing services, including solutions preparation, sterile filling, lyophilization (freeze drying), terminal sterilization and packaging, and has expertise in formulation development, analytical development and regulatory services. Client companies can choose from a variety of delivery systems that include vials, flexible containers, prefilled syringes and proprietary drug delivery systems such as ADD-Vantage®. One 2 One® serves numerous customers, including many of the largest global proprietary pharmaceutical companies.

Other

Other sales include critical care devices and the SEDLine® brain-function monitoring system. Critical care devices are used to monitor vital signs as well as specific physiologic functions of key organ systems. Hospira provides hemodynamic monitoring systems that are used to monitor cardiac function and blood flow in critically ill patients. Hospira’s critical care devices include its Transpac® disposable blood-pressure-sensing devices, SafesetÔ Blood Sampling System, and various catheter systems.

Customers, Sales and Distribution

The United States accounted for approximately 83% of Hospira’s 2006 net sales. Hospira’s primary customers in the United States include hospitals, integrated delivery networks and alternate site facilities. A substantial portion of Hospira’s products is sold to group purchasing organization (“GPO”) member hospitals and through wholesalers and distributors. Sales through the four largest wholesalers that supply products to many end-users accounted for approximately 41% of total net sales during 2006. As end-users of Hospira’s products have multiple ways to access Hospira’s products, including through more than one

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wholesaler or distributor, and, in some cases, from Hospira directly, Hospira believes that it is not dependent on any single wholesaler or distributor for distribution of its products. Hospira has pricing agreements for specified products with the major GPOs in the United States, including AmeriNet, Inc.; Broadlane Healthcare Corporation; Consorta, Inc.; HealthTrust Purchasing Group; MedAssets Inc.; Novation, LLC; PACT, LLC; and Premier Purchasing Partners, LP. The scope of products included in these agreements varies by GPO.

Hospira’s sales organization includes sales professionals, who sell across its major product lines, as well as product specialists who detail and promote its medication delivery systems, and sales personnel who market and sell Precedex® and select other products. Hospira also has extensive experience contracting with, marketing to and servicing members of the major GPOs.

In the United States, Hospira’s products are primarily distributed through a network of five distribution facilities as well as through external distributors. The U.S. distribution facilities Hospira operates are located in Atlanta, Georgia; Dallas, Texas; King of Prussia, Pennsylvania; Los Angeles, California; and Pleasant Prairie, Wisconsin.

Sales in markets outside the United States comprised approximately 17% of 2006 net sales. Hospira manages its international operations through four international regional hubs in Amsterdam, The Netherlands; Montreal, Canada; Mexico City, Mexico; and Osaka, Japan. Hospira has direct commercial infrastructure in some countries and operates through distributors in others. Under the terms of the spin-off, the legal title to certain assets and operations relating to Hospira’s business outside the United States were transferred from Abbott over the two-year period after the spin-off. These transfers were completed during 2006.

Hospira’s primary customers in markets outside the United States are hospitals and wholesalers that Hospira serves through its own sales force and its distributors. The majority of Hospira’s business outside the United States is conducted through contracting with individual hospitals or through regional or national tenders whereby Hospira submits bids to sell its products.

Hospira believes that backlogged orders do not represent a material portion of its sales or provide a meaningful indication of future sales.

Product Development

Hospira’s development programs are concentrated in the areas of specialty injectable pharmaceuticals and medication management systems. Hospira also maintains an active development program to support its injectable pharmaceutical contract manufacturing relationships. Hospira primarily engages in programs to bring new products to market that are unique or that enhance the effectiveness, ease of use, productivity, safety and reliability of existing product lines, and that expand the use of Hospira’s products in new markets or new applications. Hospira operates product development facilities located in Clayton, North Carolina; Lake County, Illinois; McPherson, Kansas; Morgan Hill, California; and San Diego, California.

Hospira is actively working to develop and commercialize biosimilar products, which are sometimes referred to as “generic” versions of biopharmaceuticals or biologics. Biosimilar products are large-protein molecules derived from genetically modified cell lines. In 2006, Hospira entered into collaboration agreements with STADA Arzneimittel AG and BIOCEUTICALS Arzneimittel AG relating to the development, manufacturing and distribution of a biosimilar version of erythropoietin. Therapeutic erythropoietin is used primarily in the treatment of anemia in dialysis and in certain oncology applications. During 2006, Hospira acquired BresaGen Limited, a biotechnology company based in Adelaide, South Australia. BresaGen provides protein and peptide manufacturing and cell line development capabilities, which Hospira believes are important competencies to support its biosimilar efforts.

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Hospira’s key programs in the area of medication management systems include the development of advanced infusion platforms and systems, including its Hospira MedNet® safety software system, and systems that emphasize ease of use for clinicians, including its SymbiqTM infusion pump. Hospira has entered into alliances with several leading information technology companies to develop interfaces that enable the Hospira MedNet® system to be used with a variety of hospital information systems and to improve cost efficiencies in patient management. Hospira expects to continue entering into strategic alliances as part of its “open system architecture” strategy for the Hospira MedNet® system.

Hospira’s research and development expenses were $161.6 million in 2006, $138.8 million in 2005 and $119.6 million in 2004.

Manufacturing

As of December 31, 2006, Hospira operated 14 manufacturing facilities globally. Hospira’s principal manufacturing facilities are identified in Item 2 of this report.

Hospira closed its Donegal, Ireland facility in late 2006, and expects to close the Ashland, Ohio facility later in 2007 and the Montreal, Canada facility by the first half of 2008. Hospira expects to phase out production at the North Chicago, Illinois facility, which is leased from Abbott under a 10-year lease expiring in 2014, on an accelerated time frame with most of the phase-out occurring by early 2010. Production of the primary products at these facilities is moving to other Hospira facilities and/or being outsourced to third-party suppliers. During 2006, Hospira began a $60 million expansion of manufacturing capacity at the McPherson, Kansas facility, in part to accommodate some of the production from the North Chicago facility.

Hospira’s two largest facilities, located in Rocky Mount, North Carolina and Austin, Texas account for a significant portion of Hospira’s manufacturing output. While Hospira has not experienced a significant interruption of manufacturing at those facilities, such an interruption could materially and adversely affect Hospira’s ability to manufacture and sell its products.

Raw Materials and Components

While Hospira produces some raw materials and components at its manufacturing sites, the majority of raw materials and components that it uses are sourced externally on a global basis. Hospira procures the active pharmaceutical ingredients in its drug products from third-party suppliers.

Although many of the raw materials and components Hospira uses to produce its products are readily available from multiple suppliers, Hospira relies on supply from a single source for many raw materials and components. For example, Hospira relies on proprietary components available exclusively from ICU Medical. ICU Medical’s CLAVE® and MicroCLAVE® connector products are components of administration sets that represented approximately 14% of Hospira’s 2006 sales. Hospira also purchases a significant portion of its critical care products from ICU Medical, pursuant to its long-term manufacturing, commercialization and development agreement with ICU Medical entered into during 2005. In addition, Hospira purchases some of its raw materials and components from single suppliers for reasons of quality assurance, sole-source availability, cost effectiveness or constraints resulting from regulatory requirements.

In order to manage risk, Hospira continually evaluates alternate-source suppliers, although it does not typically pursue regulatory qualification of alternative sources due to the strength of its existing supplier relationships, the reliability of its current supplier base, and the time and expense associated with the regulatory process. Although a change in suppliers could require significant effort or investment by Hospira in circumstances where the items supplied are integral to the performance of its products or incorporate unique technology, Hospira does not believe that the loss of any existing supply arrangement

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(other than its CLAVE® supply arrangement with ICU Medical, which continues through 2014) would have a material adverse effect on its business.

Quality Assurance

Hospira has developed and implemented quality systems and concepts throughout its organization. Hospira is actively involved in setting quality policies and managing internal and external quality performance. Its quality assurance department provides quality leadership and supervises its quality systems. An active audit program, utilizing both internal and external auditors, monitors compliance with applicable regulations, standards and internal policies. In addition, Hospira’s facilities are subject to periodic inspection by the U.S. Food and Drug Administration (the “FDA”) and other regulatory authorities. In the past, Hospira’s business has received notices alleging violations of applicable regulations and standards, and Hospira has developed definitive action plans, implemented remedial programs and modified its practices to address these issues. These matters have not materially impacted Hospira’s ability to market and sell its products.

Competition

Hospira’s industry is highly competitive. Hospira competes with many companies, both public and private, that range from small, highly focused companies to large diversified healthcare manufacturers. Hospira believes that the most effective competitors in its industry are focused on product quality and performance, breadth of product offering, manufacturing efficiency and the ability to develop and deliver cost-effective products that help hospitals provide high quality care in an environment that requires increasing levels of efficiency and productivity.

Hospira’s most significant competitors in specialty injectable pharmaceuticals include Abraxis BioScience, Inc., Baxter International Inc. and Teva Pharmaceuticals, as well as divisions of several multinational pharmaceutical companies. Local manufacturers of specialty injectable pharmaceuticals also compete with Hospira on a country-by-country basis. Hospira’s most significant competitors in medication delivery systems include Baxter, Becton, Dickinson and Company, B. Braun Melsungen AG, Cardinal Healthcare Inc., Fresenius Medical Care AG and Terumo Medical Corporation. Baxter, Cardinal and Patheon, Inc. are significant competitors of Hospira’s contract manufacturing business. Edwards Lifesciences Corporation is a significant competitor in critical care monitoring devices.

Hospira believes that it is one of the leading competitors, in terms of U.S. market share, in each of its major product lines, and believes that its size, scale, customer relationships and breadth of product line are significant contributors to its market positions. Hospira believes that it must continue to invest significantly in, and successfully execute, its research and product development activities, optimize its manufacturing efficiency and productivity, increase its international presence and successfully integrate Mayne Pharma’s business into its operations to further its competitive position. Particularly, within its specialty injectable product line, Hospira seeks to maximize its opportunity to establish a “first-to-market” position for its generic injectable drugs and, within its medication delivery systems product line, Hospira seeks to differentiate its products through technological innovation and an integrated approach to drug delivery. These efforts will depend heavily on the success of Hospira’s research and development programs.

Patents, Trademarks and Other Intellectual Property

When possible, Hospira seeks patent and trademark protection for its products. Hospira owns, or has licenses under, a substantial number of patents, patent applications, trademarks and trademark applications. However, Hospira does not consider any one or more of these patents, patent applications, trademarks and trademark applications to be material in relation to its business as a whole.

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Employees

As of December 31, 2006, Hospira had approximately 13,000 employees. Approximately 8,000 employees were in the United States. Upon the completion of the Mayne Pharma acquisition, Hospira had approximately 15,000 employees. Employees at the Ashland, Ohio manufacturing facility, and a significant portion of Hospira’s employees outside of the United States, are members of works councils or trade unions.

Hospira believes that it generally has a good relationship with its employees and the works councils and unions that represent them.

Governmental Regulation and Other Matters

Laws and regulations that significantly affect Hospira’s business and operations are described below. Hospira believes that it is in material compliance with applicable laws and regulations, including those described below.

Food and Drug Laws

Most of Hospira’s products and facilities are subject to regulation by the FDA and national and supranational regulatory authorities outside the United States, including Health Canada (Health Products and Foods Branch) and the European Agency for the Evaluation of Medicinal Products for Human Use. Hospira’s marketed drugs and devices are subject to regulation with respect to, among other matters, manufacturing, post-marketing studies in humans, advertising and promotional activities and materials, product labeling, and post-marketing surveillance and reporting of adverse events.

All aspects of the manufacturing of regulated products are subject to substantial governmental oversight. Facilities used for the production, packaging, labeling, storage and distribution of drugs and medical devices must be registered with the FDA and other regulatory authorities. All manufacturing activities for these products must be conducted in compliance with relevant good manufacturing practices. Hospira’s manufacturing facilities are subject to periodic and for-cause inspections to verify compliance with good manufacturing practices. New manufacturing facilities or the expansion of existing facilities will require inspection and approval by the FDA and other regulatory authorities before products produced at that site can enter commercial distribution. If, upon inspection, the FDA or another regulatory agency finds that a manufacturer has failed to comply with good manufacturing practices, it may take various enforcement actions, including, but not limited to, issuing a warning letter or similar correspondence, mandating a product recall, seizing violative product, imposing civil penalties, and referring the matter to a law enforcement authority for criminal prosecution. See “Item 1A. Risk Factors—Hospira and its suppliers and customers are subject to various governmental regulations and it could be costly to comply with these regulations and to develop compliant products and processes.”

Hospira’s sales and marketing activities for regulated products, particularly prescription drugs and certain medical devices, are also highly regulated. Regulatory authorities have the power to mandate the discontinuance of promotional materials, practices and programs if they include information that is beyond the scope of the indications included in the approved or cleared labeling or is not in compliance with specific regulatory requirements.

Some of Hospira’s drug products are considered controlled substances and are subject to additional regulation by the U.S. Drug Enforcement Administration (“DEA”) and various state and international authorities. These drugs, which have varying degrees of potential for abuse, require specialized controls for production, storage and distribution to prevent theft and diversion. Violation of controlled substance statutes and regulations may result in substantial civil and criminal penalties.

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Hospira has begun investing in the development of biosimilar products, which are generic and/or similar versions of currently marketed biologic pharmaceuticals. In November 2005, the European Medicines Agency implemented guidelines directed at the approval pathway for all generic biologic pharmaceuticals in the European Union. In the United States, there is no specific regulatory pathway for abbreviated approval of the majority of biologic pharmaceuticals. For historical reasons, some biologic pharmaceuticals, such as human insulin and human growth hormones, are approved under the Food Drug and Cosmetic Act (the “FDCA”), while most other biologic pharmaceuticals are approved under the Public Health Services Act (the “PHS”). The Drug Price Competition and Patent Term Restoration Act of 1984, which is generally known as the Hatch-Waxman Act, amended the FDCA and established an abbreviated approval pathway for generic versions of referenced drug products approved under FDCA. Although the FDA has been willing to recognize an abbreviated approval pathway for generic versions of biologic pharmaceuticals approved under the FDCA, the FDA has been unwilling to recognize an abbreviated approval pathway for generic versions of biologic pharmaceuticals approved under the PHS. Without a similar “Hatch-Waxman” abbreviated approval pathway in the PHS, it is unlikely the FDA will approve a generic, or off-patent, version of a referenced biologic pharmaceutical without independent clinical studies that support the products’ safety and effectiveness.

Healthcare Fraud and Abuse Laws

As a manufacturer and distributor of prescription drugs and medical products to hospitals and other healthcare providers, Hospira and its customers are subject to the federal anti-kickback statute, which applies to Medicare, Medicaid, and other federal and state programs. This statute prohibits the solicitation, offer, payment or receipt of remuneration in return for referrals or purchase, or in return for recommending or arranging for the referral or purchase, of goods covered by the programs. The anti-kickback law provides a number of exceptions or “safe harbors” for particular types of transactions. Hospira believes that its arrangements with its customers are in material compliance with the anti-kickback statute and relevant safe harbors. While Hospira generally does not file claims for reimbursement from government payors, the federal government has asserted theories of liability against manufacturers under the Federal False Claims Act, which prohibits the submission of false claims to Medicare, Medicaid, and other state and federal programs. Hospira believes that its arrangements with and actions in regard to its claims-filing customers are in material compliance with the Federal False Claims Act. Many states have similar fraud and abuse laws, and Hospira believes that it is in material compliance with those laws. If it were determined that Hospira was not in compliance with those laws, however, Hospira could be subject to criminal and/or civil liability, exclusion from participation in Medicare, Medicaid and other state and federal programs, or other material adverse effects.

Environmental Laws

Hospira’s manufacturing operations are subject to many requirements under environmental laws. In the United States, the U.S. Environmental Protection Agency and similar state agencies administer laws which restrict the emission of pollutants into the air, the discharge of pollutants into bodies of water and the disposal of hazardous substances. Violations of these laws can result in significant civil and criminal penalties, and incarceration. The failure to obtain a permit for certain activities may be a violation of environmental law and subject the owner and operator to civil and criminal sanctions. Most environmental agencies also have the power to shut down an operation if it is operating in violation of environmental law. U.S. laws also typically allow citizens to bring private enforcement actions in some situations. Outside the United States, the environmental laws and their enforcement vary, and can be more burdensome. For example, in some European countries, there are environmental taxes and laws requiring manufacturers to take back used products at the end of their useful life. This does not currently have a significant impact on Hospira’s products, but such laws are expanding rapidly in Europe. Hospira has management systems in place that are intended to minimize the potential for violation of these laws.

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Other environmental laws address the contamination of land and groundwater, and require the clean-up of such contamination. These laws may apply not only to the owner or operator of an on-going business, but also to the owner of land contaminated by a prior owner or operator. In addition, if a parcel is contaminated by the release of a hazardous substance, such as through its historic use as a disposal site, any person or company that has contributed to that contamination, whether or not they have a legal interest in the land, may be subject to a requirement to clean up the parcel. Hospira has been involved with a number of sites at which clean-up has been required, some as the sole owner and responsible party, and some as a contributor in conjunction with other parties. The resulting costs tend to be in the form of legal expenses, contributions to the cost of the investigation or clean-up of the contaminated sites, or settlement payments to reimburse the government for past remedial work.

Safety and Health Laws

In the United States, the Occupational Safety and Health Act sets forth requirements for conditions of the workplace. Hospira’s operations are subject to many of these requirements, particularly in connection with Hospira’s employees’ use of equipment and chemicals at manufacturing sites that pose a potential health or safety hazard. Violation of these laws can result in civil and criminal penalties.

Transportation Laws

Hospira’s operations include transporting materials defined as “hazardous” over land, over sea and through the air. All of these activities are regulated under laws administered by the U.S. Department of Transportation and similar agencies outside the United States. They include complex requirements for packing, labeling and recordkeeping, and the failure to comply can result in civil and criminal sanctions.

Customs Laws

The import and export of many goods across national borders are heavily regulated, especially in the United States. As the importer and exporter of many shipments each year, Hospira must comply with all customs regulations and pay fees and duties on certain shipments. Failure to comply can result in significant financial penalties and criminal sanctions.

Other Laws

The laws of some states and foreign countries regulate the safety of Hospira’s products in the marketplace to a greater extent than FDA requirements. For example, under California’s Safe Drinking Water and Toxic Enforcement Act of 1986, also known as “Proposition 65,” the state has established a list of chemicals considered to be hazardous. If, as a result of the sale in California of a product containing a listed chemical, a person is exposed to the chemical, the seller of that product must provide that person with a warning. Monetary penalties for non-compliance can be substantial, although there are no criminal sanctions.

Hospira is also subject to a variety of state and foreign compliance, disclosure and anti-fraud laws, non-compliance with which can result in significant financial penalties and criminal sanctions. As Hospira operates internationally, Hospira is subject to U.S. regulations that apply to international operations, including trade laws, the Foreign Corrupt Practices Act and anti-boycott laws.

Spin-Off from Abbott

Hospira became an independent public company pursuant to a spin-off from Abbott Laboratories on April 30, 2004. At that time, Hospira and Abbott entered into various agreements, including agreements that defined the parties’ rights and obligations regarding the spin-off, transitional agreements to support Hospira’s business and commercial infrastructure, and lease agreements. The parties also agreed that legal

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title to certain assets and liabilities used in Hospira’s international operations would be transferred to Hospira over the two years after the spin-off. During 2006, Hospira and Abbott completed the transitional agreements and all of the transfers of such international assets and liabilities. Some commercial agreements relating to the supply of products among the parties remain in place through 2008, and the lease of the North Chicago, Illinois manufacturing facility remains in force through 2014.

Except as otherwise agreed by the parties, Hospira assumed all liabilities of Abbott and its subsidiaries to the extent relating to, arising out of or resulting from any matter occurring or existing prior to the spin-off to the extent such liabilities relate to, arise out of or result from Hospira’s business and assets. The liabilities that Hospira assumed include, among other things, liabilities for any claims or legal proceedings related to products that had been part of Hospira’s business, but were discontinued prior to the spin-off. However, Hospira did not assume certain liabilities of Abbott or its subsidiaries relating to allegations in pending or future investigations and lawsuits that Hospira’s business engaged in improper marketing and pricing practices as described in “Item 3. Legal Proceedings—Marketing and Pricing Cases.”  In addition, Abbott is liable generally for all pre-spin-off U.S. federal income taxes, foreign taxes and certain state taxes attributable to Hospira’s business. Hospira generally is liable for all other taxes attributable to its business.

Hospira generally assumed all employment-related obligations and liabilities for all U.S. employees who transferred employment to Hospira in connection with the spin-off, including salaries and vacation, except as otherwise agreed by the parties. Abbott generally retained responsibility for all employment-related obligations and liabilities for U.S. non-union employees who terminated their employment or retired prior to the spin-off or who otherwise did not transfer employment to Hospira in connection with the spin-off, except as otherwise provided in the agreement. Abbott retained liabilities for post-retirement medical, dental and life insurance benefits for U.S. non-union employees who were retired at the time of the spin-off and for those U.S. non-union employees who were eligible to retire as of the time of the spin-off (commencing on or after their retirement with Hospira), for other medical and dental claims which were incurred by employees of Hospira’s business prior to the spin-off, and for certain deferred compensation and supplemental pension obligations, subject in all cases to the terms of the spin-off and the applicable Abbott plans. Hospira assumed and is liable for the pension and other benefits of Hospira’s current and former union employees at its Ashland, Ohio site. Hospira’s obligations with respect to employees outside the United States are governed in accordance with the terms of applicable local plans and local law.

Mayne Pharma

Business Overview

Mayne Pharma is an international specialty injectable pharmaceutical company, and has a portfolio of generic injectable products focused primarily on the treatment of cancer. Therapeutic areas of its products include anti-cancer agents, anti-infective, pain management and other areas. Mayne Pharma also provides contract manufacturing services, and produces and sells oral pharmaceutical products. Mayne Pharma has a direct commercial presence in 20 countries and indirect distribution in over 45 countries. Mayne Pharma had AUD788.9 million of revenues during its fiscal year ended June 30, 2006, as reported under Australian International Financial Reporting Standards (“AIFRS”). References to “AUD” in this report are to Australian dollars. The exchange rate on the closing date of the acquisition was $1.00 to AUD0.775.

On November 21, 2005, Mayne Pharma was established as an independent company listed on the Australian Stock Exchange, upon its demerger from Mayne Group Limited, an Australian health-care company (now Symbion Health Limited). Hospira completed its purchase of Mayne Pharma on February 2, 2007.

References in this subsection to the “2006 fiscal year” refer to Mayne’s fiscal year ended June 30, 2006.

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Products

Mayne Pharma’s key injectable pharmaceutical products in the 2006 fiscal year were:

·       paclitaxel, a drug for the treatment of ovarian, breast and non-small cell lung cancer;

·       pamidronate, an oncology drug used to treat a condition involving excess calcium in the blood, which may be associated with certain types of cancer;

·       irinotecan, a drug for the treatment of cancer of the colon or rectum;

·       MVI®, injectable multivitamins for nutrition; and

·       carboplatin, a drug for the treatment of ovarian cancer.

Mayne Pharma received marketing authorization in September 2006 for its oxaliplatin product from the United Kingdom Medicines and Healthcare Products Regulatory Agency, which followed a ruling from the United Kingdom High Court, which found in favor of Mayne Pharma in regard to certain patents for its oxaliplatin product. An appeal of the court decision was withdrawn by the innovator in January 2007. Mayne Pharma also has received marketing authorization in other territories, including Germany, France, Sweden and Australia. Oxaliplatin is one of the largest anti-cancer pharmaceutical products in the world by sales.

Commercial Operations

Mayne Pharma has operations in three regions: Europe, Middle East and Africa (“EMEA”), Asia Pacific and the Americas. Mayne Pharma’s primary customers are hospital pharmacists and oncologists. The major distribution channels for Mayne Pharma’s injectable products are hospitals and clinics as well as distributors, group purchasing organizations and governments through tender and bid processes.

As reported under AIFRS, EMEA operations generated AUD391.0 million of sales revenue in the 2006 fiscal year. In Europe, Mayne Pharma has a direct presence in 13 countries, including France, Germany, Italy, Spain and the United Kingdom. Mayne Pharma has distribution arrangements in over 40 other countries across the EMEA.

As reported under AIFRS, Mayne Pharma’s Asia Pacific operations generated AUD194.4 million of sales revenue in the 2006 fiscal year. Mayne Pharma has a direct presence in Australia, Hong Kong, Malaysia, New Zealand and Singapore. Mayne Pharma operates through joint ventures or distributors in several other countries across the region.

As reported under AIFRS, Mayne Pharma’s Americas operations generated AUD203.5 million of sales revenue for the 2006 fiscal year. Mayne Pharma has a direct presence in the United States and Canada.

Research and Development

Mayne Pharma’s research and development activities are focused on oncology and related drugs, and it aims to develop generic products that have one or more characteristics that make it difficult for competitors to develop competing products. Mayne Pharma’s research and development activities are conducted primarily at Mayne Pharma’s facility in Mulgrave, Victoria, Australia. Mayne Pharma also has established relationships with research and development partners in low-cost and generic-friendly environments, such as India. In recent years, Mayne Pharma has also entered into a number of product in-licensing agreements, involving the sale of products under license from third parties, to expand its product portfolio.

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Manufacturing Facilities

Mayne Pharma’s principal manufacturing facilities are identified in Item 2 of this report. Mayne Pharma’s primary injectable drug manufacturing facility is its Mulgrave facility. Products produced at the Mulgrave facility generated a majority of its 2006 fiscal year revenue. A significant disruption to its operations at this site, even on a short-term basis, could materially hinder Mayne Pharma’s ability to produce and ship products on a timely basis.

Raw Materials

Mayne Pharma produces the active pharmaceutical ingredient for paclitaxel at its Boulder, Colorado facility and sources the active pharmaceutical ingredients for its other products from third parties. Mayne Pharma has established relationships with a number of FDA-approved suppliers of active pharmaceutical ingredients and works very closely with them to ensure continuity of supply while maintaining material quality and reliability.

Competition

EMEA.   Generic penetration rates in the EMEA region vary due to wide variations in the structure of health care systems (including purchasing practices) and government policies regarding the use of generic products and pricing, which all lead to differing levels of customer acceptance. Because the European market is fragmented, with different policies and levels of generic penetration in each country, the competition for generic pharmaceuticals is less intense than in the United States, which is a largely homogenous market with a higher level of generic drug usage. In Europe, competitors tend to vary by country and are often smaller than those in the United States, although some consolidation and geographic expansion is now occurring. Teva is the only company that competes with Mayne Pharma in the generic oncology market across the EMEA region. Mayne Pharma’s other key competitors vary from country to country.

Asia Pacific.   In Australia, generic penetration is growing primarily due to changes in government support. Australian laws have been introduced to allow for easier compulsory substitution of generic for branded pharmaceuticals, as a response to pressure to reduce costs, which is believed to have resulted in an increased acceptance of generic pharmaceutical products. Competitors include the Sandoz division of Novartis, a number of smaller competitors and the innovator companies.

In the Asian region, Mayne Pharma sells its products primarily to public and private hospitals. Mayne Pharma’s competition in the Asian region tends to be with the innovator companies rather than local generic competitors.

United States and Canada.   As significantly higher levels of expertise and investment are required for injectable oncology pharmaceutical product manufacturing than for oral dose pharmaceutical manufacturing, there are relatively few companies that compete in this market when compared to the larger oral generics market. Mayne Pharma’s main competitors include Abraxis BioScience, Bedford Laboratories (a division of Boehringer Ingelheim) and Teva.

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Internet Information

Copies of Hospira’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through the Investor Relations section of Hospira’s Web site (www.hospira.com) as soon as reasonably practicable after Hospira electronically files the material with, or furnishes it to, the Securities and Exchange Commission.

Hospira’s corporate governance guidelines, code of business conduct and the charters of its audit, compensation and governance and public policy committees are all available in the Investor Relations section of Hospira’s Web site (www.hospira.com) or by sending a request to: Corporate Governance Materials Request, Hospira General Counsel and Secretary, Hospira, Inc., 275 North Field Drive, Dept. NLEG, Bldg. H1, Lake Forest, Illinois 60045.

Item 1A. Risk Factors

Hospira’s business, financial condition, results of operations and cash flows are subject to various risks and uncertainties, including those described below. These risks and uncertainties may cause (1) Hospira’s sales and results of operations to fluctuate significantly; (2) Hospira’s past performance to not be indicative of future performance; and (3) Hospira’s actual performance to differ materially from Hospira’s expectations or projections. The risks described below apply to Hospira’s business after giving effect to the Mayne Pharma acquisition and may not be the only risks Hospira faces. Additional risks that Hospira does not yet know of or that Hospira currently thinks are immaterial may also impair its business operations.

Risks Relating to the Mayne Pharma Acquisition and Related Transactions

The integration of Mayne Pharma into Hospira’s operations will present significant challenges.

On February 2, 2007, Hospira completed its acquisition of Mayne Pharma Limited. Hospira will face significant challenges in combining its operations and product lines with Mayne Pharma in a timely and efficient manner. The Mayne Pharma acquisition was the largest in Hospira’s history, and successful integration will be important to Hospira’s future success. In connection with the integration, Hospira will identify and eliminate duplicative functions, retain other key functions and personnel, terminate various contractual arrangements and transition its management structure to the new combined company. This integration will be complex and time-consuming, may divert management away from day-to-day operations and may disrupt ordinary operations. If Hospira does not identify the right functions to be eliminated or retained, it may not realize the expected cost savings and synergies from the acquisition. Hospira may not be able to retain key personnel to efficiently operate the business. Integration of Mayne Pharma will also require Hospira to modify its operational and financial systems and cause Mayne Pharma’s internal control over financial reporting to comply with the Sarbanes-Oxley Act of 2002. The integration will result in significant additional expenses, currently estimated to be approximately $95 million to $110 million over the two year period following the acquisition. The substantial majority of such expenses will be incurred in cash. Hospira may incur greater-than-expected costs in connection with the integration if it experiences difficulties or encounters issues not currently known to it. As Hospira and Mayne Pharma offer some similar products in the same markets, Hospira may not be able to retain all historical sales of those products.

The failure to successfully integrate Mayne Pharma’s business into Hospira’s business and manage the challenges presented by the integration process may prevent Hospira from achieving the anticipated potential benefits of the acquisition, may lead to significant costs and may harm Hospira’s future profitability.

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Hospira has incurred significant indebtedness in order to finance the Mayne Pharma acquisition, which may limit its operating flexibility.

To finance the Mayne Pharma acquisition, Hospira has incurred additional borrowings of approximately $1.9 billion in the aggregate under a one-year bridge loan facility and a three-year term loan facility. As a result, as of February 1, 2007, Hospira had approximately $2.6 billion of debt.

This significant indebtedness will require Hospira to dedicate a substantial portion of its cash flow from operations to payments on its debt, thereby reducing the availability of cash flow to fund capital expenditures, to pursue other acquisitions or investments in new technologies and for general corporate purposes. During 2006, Hospira incurred approximately $31.0 million in interest expense. In 2007, interest expense is expected to increase to approximately $130 million to $140 million, assuming Hospira maintains its existing credit ratings and is able to refinance amounts due under the bridge loan facility in market conditions similar to current market conditions. Hospira will also be required to make minimum principal payments under the term loan facility of $50 million in 2007, $200 million in 2008 and $250 million in 2009. These amounts will be reduced if Hospira prepays the principal in earlier periods.

In addition, this significant indebtedness will:

·       increase Hospira’s vulnerability to general adverse economic conditions, including increases in interest rates; and

·       limit Hospira’s flexibility in planning for, or reacting to, changes in or challenges relating to its business and industry.

The terms of the loan agreements contain restrictions on Hospira’s ability to, among other things:

·       incur additional indebtedness;

·       create or incur liens;

·       sell all or substantially all of its assets; and

·       consolidate or merge with another entity.

Hospira must also maintain a minimum interest coverage ratio and is subject to a maximum leverage ratio throughout the life of the loan facilities. If Hospira does not comply with the covenants and restrictions under the agreements governing its indebtedness, Hospira would be in default under the agreements and, if the lenders do not waive such default, the lenders may accelerate the amounts borrowed. If the loans are accelerated, Hospira may be unable to repay the amounts due to the lenders or obtain additional or replacement financing on favorable terms or at all, which would have a material adverse effect on Hospira’s financial condition.

Hospira’s credit rating has been downgraded by Standard and Poor’s and future downgrades are possible. A further downgrade will increase Hospira’s cost of borrowing.

As a result of the Mayne Pharma acquisition, Hospira’s credit rating was downgraded from BBB+ to BBB by Standard & Poor’s. While Moody’s maintained Hospira’s credit rating at Baa3, which is the lowest investment grade rating, the rating outlook was changed from stable to negative. It is possible that Hospira’s credit ratings could be further downgraded and fall below investment grade from both agencies. The credit ratings assigned to Hospira’s indebtedness affect its ability to obtain new financing and the cost of financing and credit. The amount of interest payable under Hospira’s loan facilities depends on Hospira’s credit ratings. If Hospira’s credit ratings were to be further downgraded, its borrowing costs would increase, and its access to unsecured debt markets could be limited.

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Ratings are not recommendations to buy, sell or hold securities and are subject to revision or withdrawal at any time by the rating agencies. Each rating should be evaluated independently of any other rating.

Hospira may not be able to refinance amounts borrowed under its bridge loan facility on favorable terms or at all.

Hospira owes approximately $1.425 billion under the bridge loan facility entered into to finance the Mayne Pharma acquisition. The bridge loan facility matures in January 2008. Hospira intends to refinance the bridge loan facility before it matures through the sale of long-term bonds. Hospira’s ability to refinance the bridge loan facility in a timely manner and at favorable terms depends on several factors, including Hospira’s credit ratings, general economic conditions, capital markets and interest rate levels.

Hospira may not be able to refinance the bridge loan facility. If Hospira is able to refinance the bridge loan facility, the terms of the refinancing may not be as favorable as the terms of the bridge loan facility. If Hospira does not maintain investment grade credit ratings, it may be more difficult to refinance the bridge loan facility, the cost of borrowing would increase substantially and Hospira would become subject to more stringent covenants and restrictions on its business. If Hospira fails to refinance the credit facility on favorable terms or at all, such failure could have a material adverse effect on its business and financial condition.

Hospira will incur substantial charges relating to the Mayne Pharma acquisition.

In addition to integration-related expenses, Hospira will also incur other charges in connection with the Mayne Pharma acquisition. These will include purchase accounting charges, such as the write-off of in-process research and development and the write-up of inventory, as well as the amortization of intangible assets. These charges will negatively affect Hospira’s results of operations.

Risks Related to Hospira’s Business and Industries

Hospira faces significant competition and may not be able to compete effectively.

The healthcare industry is highly competitive. Hospira competes with many companies ranging from small start-up enterprises to multinational companies that are larger than Hospira and have access to greater financial, marketing, technical and other resources than Hospira. Hospira’s present or future products could be rendered obsolete or uneconomical by technological advances by competitors or by the introduction of competing products by one or more of its competitors. Hospira faces strong competition from one or more large competitors in each of its major product lines. To remain competitive and bolster its competitive position, Hospira believes that it must successfully execute various strategic plans, including expanding its research and development initiatives, increasing its international presence and lowering its operating costs. These initiatives may result in significant expenditures and ultimately may not be successful.

Many of Hospira’s products are not protected by patents or other proprietary rights and are therefore not entitled to market exclusivity. In the absence of patent protection, the introduction of competing products is limited primarily by market considerations and the need to obtain necessary regulatory approvals, which may not keep competitors from providing competitive products.

Hospira’s failure to compete effectively could cause it to lose market share to its competitors and/or have a material adverse effect on its sales and profitability.

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If Hospira does not introduce new products in a timely manner, its products may become obsolete over time, customers may not buy its products, and its sales and profitability may decline.

Demand for Hospira’s products may change in ways Hospira may not anticipate because of evolving customer needs, the introduction by others of new products and technologies, and evolving industry standards. A key component to Hospira’s strategy is effective execution of its research and development activities, in part to increase the breadth of Hospira’s specialty injectable product portfolio and to develop new and improved medication delivery systems products. Without the timely introduction of new products and enhancements, Hospira’s products may become obsolete over time, in which case its sales and operating results would suffer.

If Hospira does not continue to develop generic injectable pharmaceuticals in a timely manner, its competitors may develop generic injectable pharmaceutical product portfolios that are more competitive than Hospira’s, and Hospira could find it more difficult to renew or expand GPO pricing agreements or to obtain new agreements. The ability to launch a generic pharmaceutical product at or before generic market formation is important to that product’s profitability. Prices for generic products typically decline, sometimes dramatically, following market formation, as additional companies receive approvals to market that product and competition intensifies. If a company can be “first to market,” such that the branded drug is the only other competition for a period of time, higher levels of sales and profitability can be achieved. With increasing competition in the generic product market, the timeliness with which Hospira can market new generic products will increase in importance. If Hospira is unable to bring its generic products to market on a timely basis, and secure “first to market” positions, its sales and profitability could be harmed.

Hospira faces similar risks if it does not introduce new versions or upgrades to its medication management systems. Innovations generally require a substantial investment in product development before Hospira can determine their commercial viability, and Hospira may not have the financial resources necessary to fund these innovations. Even if Hospira succeeds in creating new product candidates from these innovations, such innovations may still fail to result in commercially successful products. It may take more time and effort for Hospira to sell and implement newer-technology medication management systems to its customers.

The success of Hospira’s new product offerings and enhancements will depend on several factors, including Hospira’s ability to:

·       properly anticipate and satisfy customer needs, including increasing demand for lower-cost products that help improve safety and productivity;

·       innovate, develop, manufacture and implement new products and technologies in an economical and timely manner;

·       differentiate its offerings from competitors’ offerings;

·       achieve positive clinical outcomes for new products;

·       meet safety and efficacy requirements and other regulatory requirements of government agencies;

·       avoid infringing the proprietary rights of third parties; and

·       obtain favorable pricing on such products.

Even if Hospira is able to successfully develop new products or enhancements or new generations of its existing products, these new products or enhancements or new generations of its existing products may not produce sales in excess of the costs of development, and they may be quickly rendered obsolete by changing customer preferences or the introduction by competitors of products embodying new technologies or features. Finally, innovations may not be accepted quickly in the marketplace because of,

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among other things, entrenched patterns of clinical practice, the need for regulatory clearance and uncertainty over third-party reimbursement.

Failure to effectively manage efforts under product collaboration agreements may harm Hospira’s business and profitability.

In many cases, Hospira collaborates with other companies for the development, regulatory approval, manufacturing and marketing of new products. For example, during 2006, Hospira entered into collaboration agreements relating to the long-term development and commercialization of biosimilar products, which Hospira views as an important long-term opportunity for its specialty injectable pharmaceutical product line. Hospira’s ability to benefit from these arrangements will depend on its ability to successfully manage these arrangements and the performance of the other parties to these arrangements. Hospira and the other parties to these arrangements may not efficiently work together, leading to higher-than-anticipated costs and/or delays in important activities under the arrangements. The other parties to these arrangements may not devote the resources that Hospira requires for the arrangement to be successful. These arrangements are often governed by complex agreements that may be subject to differing interpretations by the parties, which may result in disputes. These factors are often beyond the control of Hospira, and could harm Hospira’s sales, product development efforts and profitability.

Hospira is subject to the cost-containment efforts of hospital buying groups, wholesalers, distributors, third-party payors and government organizations.

Many existing and potential customers for Hospira’s products have combined to form GPOs, and integrated delivery networks (“IDNs”) in an effort to lower costs. GPOs and IDNs negotiate pricing arrangements with medical supply manufacturers and distributors, and these negotiated prices are made available to a GPO’s or an IDN’s affiliated hospitals and other members. Failure to negotiate advantageous pricing and purchasing arrangements could cause Hospira to lose market share to its competitors and/or have a material adverse effect on its sales and profitability.

Hospira also relies significantly on drug wholesalers to assist in the distribution of its generic injectable pharmaceutical products. In general, drug wholesalers have been attempting to implement, and unilaterally enforce, a fee-for-service model for the distribution of such products. One drug wholesaler continues to unilaterally invoice Hospira for higher fees that it alleges are due for the distribution of Hospira’s generic injectable pharmaceutical products, which Hospira denies are payable. While Hospira has contracts in place with its major drug wholesalers, if Hospira is required to pay fees not contemplated by its existing agreements, Hospira will incur additional costs to distribute its products, which may harm Hospira’s profitability.

Hospira’s products and services are sold to hospitals and alternate site providers, such as clinics, home healthcare providers and long-term care facilities, all of which receive reimbursement for the healthcare services provided to their patients from third-party payors, such as government programs, private insurance plans and managed-care programs. These third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement for medical products and services. Levels of reimbursement, if any, may be decreased in the future, and future legislation, regulation or reimbursement policies of third-party payors may otherwise adversely affect the demand for and price levels of Hospira’s products, which could have a material adverse effect on its sales and profitability.

In markets outside the United States, Hospira’s business has experienced downward pressure on product pricing as a result of the concentrated buying power of governments as principal customers and the use of bid-and-tender sales methods whereby Hospira is required to submit a bid for the sale of its

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products. Hospira’s failure to offer acceptable prices to these customers could have a material adverse effect on its sales and profitability in these markets.

If Hospira is unable to maintain its GPO pricing agreements, sales of its products could decline.

A small number of GPOs influence a majority of sales to Hospira’s hospital customers. GPOs negotiate pricing agreements with providers of medical products, and these negotiated prices are made available to members of GPOs. If Hospira does not have a pricing agreement with a GPO, it may be more difficult for Hospira to sell its products to the GPO’s members.

Hospira has pricing agreements covering certain products with the major GPOs in the United States, including AmeriNet, Inc.; Broadlane Healthcare Corporation; Consorta, Inc.; HealthTrust Purchasing Group; MedAssets Inc.; Novation, LLC; PACT, LLC; and Premier Purchasing Partners, LP. It will be important for Hospira to continue to maintain pricing arrangements with major GPOs. In order to maintain these relationships, Hospira must offer a reliable supply of high-quality, regulatory-compliant products. Hospira also needs to maintain a broad product line and be price-competitive. Several GPO contracts are up for renewal or extension each year. If Hospira is unable to renew or extend one or more of those contracts, and cannot replace lost business, Hospira’s sales and profitability will decline. There has been consolidation among major GPOs, and further consolidation may occur. The effect of consolidation is uncertain, and consolidation may impair Hospira’s ability to contract with GPOs in the future.

The GPOs also have a variety of business relationships with Hospira’s competitors and may decide to enter into pricing agreements for, or otherwise prefer, products other than Hospira’s. While GPOs negotiate incentives for members to purchase specified products from a given manufacturer or distributor, GPO pricing agreements allow customers to choose between the products covered by the arrangement and another manufacturer’s products, whether or not purchased under a negotiated pricing agreement. As a result, Hospira may face competition for its products even within the context of its GPO pricing agreements.

Although some of Hospira’s GPO pricing agreements may not be terminated without breach until the end of their contracted term, others may be terminated on 60 or 90 days’ notice. If Hospira is unable to establish or maintain arrangements with key GPOs and customers, or if GPO members alter their preference for Hospira’s products in favor of those of Hospira’s competitors, Hospira’s sales and profitability could decline.

Hospira and its suppliers and customers are subject to various governmental regulations, and it could be costly to comply with these regulations and to develop compliant products and processes.

Hospira’s products are subject to rigorous regulation by the FDA, and numerous other national, supranational, federal and state governmental authorities. The process of obtaining regulatory approvals to market a drug or medical device, particularly from the FDA and certain governmental authorities outside the United States, can be costly and time-consuming, and approvals might not be granted for future products on a timely basis, if at all.

The FDA recently has been experiencing a backlog of generic drug applications, which may delay approvals of new generic drug products. FDA officials are considering plans to propose user fees in connection with applications by generic drug producers like Hospira for approval of new generic drug products. If enacted, user fees would increase Hospira’s product development costs.

Existing regulations may also delay or prevent generic drug producers such as Hospira from offering certain products, such as biosimilar products, in key territories, which could harm Hospira’s ability to grow its business. If a clear regulatory pathway for the approval of biosimilar products is not fully developed in the United States and other jurisdictions, Hospira may not be able to generate future sales of such

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products in those jurisdictions and may not realize the anticipated benefits of its investments in the development, manufacture and sale of such products. Delays in receipt of, or failure to obtain, approvals for product candidates could result in delayed realization of product revenues and in substantial additional costs.

Hospira may not be able to remain in compliance with applicable FDA and other material regulatory requirements once it has obtained clearance or approval for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling, advertising and postmarketing reporting, including adverse event reports and field alerts, some of which are related to manufacturing quality concerns. Hospira may be required by regulatory authorities, or determine on its own, to temporarily cease production and sale of certain products to resolve manufacturing and product quality concerns, which would harm Hospira’s sales, margins and profitability in the affected period(s) and may have a material adverse effect on Hospira’s business.

Many of Hospira’s facilities and procedures and those of its suppliers are subject to ongoing regulation, including periodic inspection by the FDA and other regulatory authorities. For example, manufacturers of pharmaceutical products must comply with detailed regulations governing current good manufacturing practices, including requirements relating to quality control and quality assurance. Hospira must incur expense and spend time and effort in the areas of production, safety, quality control and quality assurance to ensure compliance with these complex regulations. In the past, Hospira’s business has received notices alleging violations of these regulations, and Hospira has modified its practices in response to these notices.

Hospira’s manufacturing facilities and those of its suppliers could be subject to significant adverse regulatory actions in the future. These possible regulatory actions could include warning letters, fines, damages, injunctions, civil penalties, recalls, seizures of its products and criminal prosecution. These actions could result in, among other things, substantial modifications to Hospira’s business practices and operations; refunds, recalls or seizures of its products; a total or partial shutdown of production in one or more of its facilities while Hospira remedies the alleged violation; the inability to obtain future pre-market clearances or approvals; and withdrawals or suspensions of current products from the market.

Any adverse regulatory action, or action taken by Hospira to maintain appropriate regulatory compliance, could disrupt Hospira’s business and have a material adverse effect on its sales, profitability and financial condition. Furthermore, adverse regulatory action with respect to any Hospira product, operating procedure or manufacturing facility could materially harm Hospira’s reputation in the marketplace.

The manufacture of Hospira’s products is highly exacting and complex, and if Hospira or its suppliers encounter problems manufacturing, storing or distributing products, Hospira’s business could suffer.

The manufacture of Hospira’s products is highly exacting and complex, due in part to strict regulatory requirements governing the manufacture of drugs and medical devices. Problems may arise during manufacturing, storage or distribution of Hospira’s products for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials and environmental factors. If problems arise during the production, storage or distribution of a batch of product, that batch of product may have to be discarded. This could, among other things, lead to increased costs, lost sales, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. Problems with respect to the manufacture, storage or distribution of its products could materially disrupt Hospira’s business and harm its sales and profitability.

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Hospira is experiencing higher costs to produce its products as a result of rising oil and gas prices.

Hospira uses resins and other petroleum-based materials as raw materials in many of its products. Prices of oil and gas also affect significantly Hospira’s costs for freight and utilities. Oil and gas prices are volatile and fluctuated significantly in 2005 and 2006, and resulted in higher costs to Hospira to produce and distribute its products during certain periods. If costs increase and Hospira is unable to fully recover these costs through price increases or offset these increases through other cost reductions, Hospira could experience lower margins and profitability.

Hospira depends on third parties to supply raw materials and other components and may not be able to obtain sufficient quantities of these materials, which could limit Hospira’s ability to manufacture products on a timely basis and could harm its profitability.

The manufacture of Hospira’s products requires raw materials and other components that must meet stringent FDA and other regulatory requirements. Some of these raw materials and other components are currently available from a limited number of suppliers. For example, the LifeShield® CLAVE® and MicroCLAVE® connector products, which are components of administration sets that represented approximately 14% of Hospira’s 2006 sales, rely on proprietary components that are available exclusively from ICU Medical. CLAVE® and MicroCLAVE® are registered trademarks of ICU Medical. In addition, Hospira purchases from single sources certain compounding material, polyvinyl-chloride resin and laminate film components for Hospira’s production of certain flexible bags that it uses with its intravenous and pre-mixed solutions, as well as rubber components that it uses with some of its injectable pharmaceuticals. Hospira also obtains from single sources certain active pharmaceutical ingredients and finished products. Identifying alternative suppliers and obtaining approval to change or substitute a raw material or component, or the supplier of a finished product, raw material or component, can be time-consuming and expensive, as testing, validation and regulatory approval are necessary.

In the past, Hospira’s business has experienced shortages in some of the raw materials and components of its products. Continuous supply of petroleum-based products is especially risky due to the limited number of capable suppliers, limited production capacity and the effect of natural disasters. If suppliers are unable to deliver sufficient quantities of these materials on a timely basis or if supply is otherwise disrupted, including by suppliers exiting the market, the manufacture and sale of Hospira’s products may be disrupted, and its sales and profitability could be materially adversely affected.

Hospira’s cost-reduction activities have resulted in significant charges and cash expenditures. These activities may disrupt Hospira’s business and may not result in the intended cost savings.

Hospira’s strategy, in part, relies on the establishment of a low-cost operating infrastructure. In order to realize potential savings on future manufacturing and other operating costs, since 2005, Hospira has taken various actions to dispose of, or close, certain manufacturing facilities. These actions included the sale of its Salt Lake City manufacturing facility to ICU Medical and an agreement to purchase critical care products produced there from ICU Medical; the closure of its Donegal, Ireland facility; the planned closures of its Ashland, Ohio and Montreal, Canada manufacturing facilities; and the planned accelerated production phase-out at its North Chicago, Illinois manufacturing facility, which is leased from Abbott. These actions have resulted in, and are expected to continue to result in, significant charges to Hospira’s income and cash expenditures. Future cost reduction activities, if taken, may result in additional charges and cash expenditures, which may be material.

Hospira expects to relocate some of the production at the affected facilities to other Hospira facilities. Relocation of production to other facilities is a complex process requiring, among other things, re-registration of products and modification of the other facilities to accommodate the production. If Hospira does not successfully manage such relocation, its manufacturing operations and business could be

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disrupted and it may incur more costs than anticipated in connection with these activities. Manufacturing at other Hospira facilities, or outsourcing manufacturing to third parties, may not result in the cost savings that Hospira expects. If Hospira does not realize expected savings from its cost-reduction efforts, its profitability may be harmed.

Hospira’s manufacturing capacity could limit its ability to expand its business without significant capital investment.

Although Hospira believes that it has adequate manufacturing capacity for its primary products, it may need to invest substantial capital resources to expand its manufacturing capacity if demand for its products increases significantly or if it is successful in obtaining significant additional customers for its injectable pharmaceuticals contract manufacturing services business. Hospira may not be able to complete any such expansion projects in a timely manner or on a cost-effective basis, and may not realize the desired benefits of any such expansion.

As a result of cost-reduction efforts, Hospira has announced the planned closing of, or has sold, certain of its facilities. While Hospira believes it will have available manufacturing capacity to absorb, or the ability to outsource, the production at these facilities, there may be less available capacity at Hospira’s facilities. If Hospira experiences an interruption in manufacturing at any of its primary manufacturing facilities, it may not be able to produce sufficient products for its customers. As a result, Hospira’s sales, margins and profitability may be materially harmed.

Hospira relies on the performance of its information technology systems, the failure of which could have an adverse effect on Hospira’s business and performance.

Hospira operates in a highly regulated industry that requires the continued operation of sophisticated information technology systems and network infrastructure. These systems are vulnerable to interruption by fire, power loss, system malfunction and other such events, which are beyond Hospira’s control. Systems interruptions could reduce Hospira’s ability to manufacture its products, and could have a material adverse effect on Hospira’s operations and financial performance. Integration of Hospira’s systems with Mayne Pharma’s systems may increase the chance of systems interruptions. The level of Hospira’s protection and disaster-recovery capability varies from site to site, and there can be no guarantee that any such plans, to the extent they are in place, will be totally effective.

Hospira may continue to acquire other businesses, license rights to technologies or products from third parties, or form alliances, which may not be successful.

As part of Hospira’s business strategy, it may continue to pursue acquisitions of complementary businesses and technology licensing arrangements. Hospira also may pursue strategic alliances to expand its product offerings and geographic presence. Hospira may not identify or complete these transactions in a timely manner, on a cost-effective basis or at all, and may not realize the expected benefits of any acquisition, license arrangement or strategic alliance. Other companies, including those with substantially greater financial and sales and marketing resources, may compete with Hospira for these strategic opportunities. Further, if Hospira is successful in securing such opportunities, the products and technologies that Hospira acquires may not be successful or may require significantly greater resources and investments than originally anticipated. In addition, Hospira may enter markets in which it has no or limited prior experience.

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Hospira conducts sales activity outside of the United States and is subject to additional business risks that may cause its sales and profitability to decline.

Because Hospira’s products are sold outside the United States, its business is subject to risks associated with doing business internationally. In 2006, Hospira’s business derived $468.0 million, or 17% of its net sales, from sales of products outside of the United States. With the acquisition of Mayne Pharma, which derives a substantial majority of its revenues outside the United States, a significantly higher percentage of sales will be generated outside the United States in 2007 and beyond. Hospira may continue to pursue growth opportunities in sales of products outside the United States, which could expose Hospira to greater risks. The risks associated with Hospira’s operations outside the United States include:

·       changes in medical reimbursement policies and programs;

·       multiple regulatory requirements that are subject to change, which may delay or deter Hospira’s international product commercialization efforts;

·       differing local product preferences and product requirements;

·       fluctuations in foreign currency exchange rates;

·       trade protection measures and import or export licensing requirements;

·       difficulty in establishing, staffing and managing international operations;

·       differing labor regulations;

·       complying with U.S. regulations that apply to international operations, including trade laws, the Foreign Corrupt Practices Act and anti-boycott laws;

·       potentially negative consequences from changes in tax laws;

·       political and economic instability; and

·       diminished protection of intellectual property in some countries outside of the United States.

Hospira operates through distributors in many countries outside the United States. Its success will depend on the efforts and performance of such distributors, which is beyond Hospira’s control. The acquisition of Mayne Pharma will increase the dependence of the international business on the performance of distributors. These risks could have a material adverse effect on Hospira’s ability to distribute and sell its products in markets outside the United States and on Hospira’s profitability.

Hospira is subject to healthcare fraud and abuse regulations that could result in significant liability and require Hospira to change its business practices and restrict its operations in the future.

Hospira’s industry is subject to various national, supranational, federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback and false claims laws. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in national, federal and state healthcare programs, including Medicare, Medicaid, and Veterans’ Administration health programs and health programs outside the United States. These laws and regulations are broad in scope and are subject to evolving interpretations, which could require Hospira to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt Hospira’s business and result in a material adverse effect on Hospira’s sales, profitability and financial condition.

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State and federal investigations and existing and future lawsuits relating to the alleged reporting of false or misleading pricing information in connection with Medicare and Medicaid programs could have a material adverse effect on Hospira’s business, profitability and financial condition.

Various state and federal agencies, including the U.S. Department of Justice and various state attorneys general, are investigating a number of pharmaceutical companies, including Abbott, for allegedly engaging in improper marketing and pricing practices with respect to certain Medicare- and Medicaid-reimbursable products, including practices relating to average wholesale price (“AWP”). These are civil investigations that are seeking to identify the practices and determine whether those practices violated any laws, including federal and state false claims acts, or constituted fraud in connection with the Medicare and/or Medicaid reimbursement paid to third parties. In addition, Abbott is a defendant in a number of purported class actions on behalf of individuals or entities, including healthcare insurers and other third-party payors, that allege generally that Abbott and numerous other pharmaceutical companies reported false or misleading pricing information in connection with federal, state and private reimbursement for certain drugs. Since the spin-off, Hospira has been named as a defendant in some of these suits, as further described in “Item 3. Legal Proceedings—Marketing and Pricing Cases.” Hospira’s products are involved in these investigations and lawsuits. There may be additional investigations or lawsuits, or additional claims in existing investigations or lawsuits, initiated with respect to these matters in the future. Hospira may be named as a subject or defendant in more of these investigations or lawsuits. Abbott will indemnify Hospira for liabilities associated with pending or future AWP investigations and lawsuits only to the extent that they are of the same nature as the lawsuits and investigations that existed against Abbott as of the spin-off date and relate to the sale of Hospira products prior to the spin-off. Hospira will assume any other losses that may result from these investigations and lawsuits related to Hospira’s products. Hospira has not established any reserves related to these matters, and Hospira does not currently believe insurance coverage will be available for any resulting losses.

These investigations and lawsuits could result in changes to Hospira’s business practices or pricing policies, civil or criminal monetary damages, penalties or fines, imprisonment and/or exclusion of Hospira’s products from participation in federal and state healthcare programs, including Medicare, Medicaid and Veterans’ Administration health programs, any of which could have a material adverse effect on Hospira’s business, profitability and financial condition.

Income taxes can have an unpredictable effect on Hospira’s results of operations and result in greater- than-anticipated liabilities.

Hospira is subject to income taxes in a variety of jurisdictions, and its tax structure is subject to review by both domestic and foreign taxation authorities. Because Hospira’s income tax expense for any period depends heavily on the mix of income derived from the various taxing jurisdictions during that period, which is inherently uncertain, its income tax expense and reported net income may fluctuate significantly, and may be materially different than forecasted.

Hospira is the beneficiary of tax exemptions in certain jurisdictions outside the United States, where a portion of its income is sourced. These tax exemptions have a significant impact on reducing Hospira’s overall effective tax rate. If Hospira is unable to maintain these tax exemptions, Hospira’s future profitability may be reduced. Changes in laws or governmental policies can affect the availability of these exemptions.

Significant judgment is required in determining the provision for income taxes and in evaluating tax positions that are subject to audits and adjustments. Reserves are established when, despite Hospira’s belief that the tax return positions are fully supportable, positions taken by Hospira are likely to be challenged based on the applicable tax authority’s determination of the positions. Although Hospira believes its tax provisions and reserves are reasonable, the ultimate tax outcome may differ from the

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amounts recorded in its financial statements and may materially affect its financial results in the period or periods for which such determination is made.

Hospira may incur product liability losses and insurance coverage could be inadequate or unavailable to cover these losses.

Hospira’s business is subject to potential product liability risks that are inherent in the design, development, manufacture and marketing of drugs and medical devices and products. In the ordinary course of business, Hospira is the subject of product liability claims and lawsuits alleging that its products have resulted or could result in an unsafe condition or injury to patients. Product liability claims and lawsuits, safety alerts or product recalls, regardless of their ultimate outcome, could have a material adverse effect on Hospira’s business and reputation and on its ability to attract and retain customers.

Hospira is responsible for all liabilities, including liabilities for claims and lawsuits, related to its business, whether they arose before or after the spin-off, other than certain liabilities relating to allegations that it engaged in improper marketing and pricing practices in connection with federal, state or private reimbursement for its products. As part of Hospira’s risk management policy, Hospira carries third-party product liability insurance coverage, which includes a substantial retention or deductible that provides that Hospira will not receive insurance proceeds until the losses incurred exceed the amount of that retention or deductible. To the extent that any losses are within these retentions or deductibles, Hospira will be responsible for the administration and payment of these losses. Product liability claims in excess of applicable insurance could have a material adverse effect on Hospira’s profitability and financial condition.

If Hospira is unable to protect its intellectual property rights, its business and prospects could be harmed.

Hospira relies on trade secrets, confidentiality agreements, continuing technological innovation and, in some cases, patent, trademark and service mark protection to preserve its competitive position. A failure to protect Hospira’s intellectual property could harm its business and prospects, and its efforts to protect its proprietary rights may not be adequate.

Most of Hospira’s products are not protected by patents or other proprietary rights, and have limited or no market exclusivity. Patent filings by third parties could render Hospira’s intellectual property less valuable. In addition, intellectual property rights may be unavailable or limited in certain countries outside the United States, which could make it easier for competitors to capture market position. Competitors may also harm sales of Hospira’s products by designing products that mirror the capabilities of those products or technology without infringing Hospira’s intellectual property rights. If Hospira does not obtain sufficient international protection for its intellectual property, Hospira’s competitiveness in international markets could be impaired, which could limit its growth and future sales.

If Hospira infringes the intellectual property rights of third parties, Hospira may face legal action, increased costs and delays in marketing new products.

Hospira seeks to launch generic pharmaceutical products either where patent protection of equivalent branded products has expired, where patents have been declared invalid or where products do not infringe the patents of others. To achieve a “first-to-market” position for generic pharmaceutical products, Hospira may take action, such as litigation, to seek to assert that its products do not infringe patents of existing products or that those patents are invalid or unenforceable. These actions may result in increased litigation, which could be costly and time consuming, and which may not be successful. Hospira and Mayne Pharma have made abbreviated new drug applications and certifications (known as “paragraph IV certifications”) that the relevant patents for existing products would not be infringed by a Hospira or Mayne Pharma product, or were invalid or enforceable, in the United States and equivalent filings in Canada. Claims filed by innovators challenging these paragraph IV certifications may delay or prevent the launch of the relevant products and result in additional costs.

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Third parties may claim that Hospira’s products are infringing their intellectual property rights. Claims of intellectual property infringement could be costly and time-consuming and might require Hospira to enter into costly royalty or license agreements, if Hospira is able to obtain royalty or license agreements on acceptable terms or at all. Hospira also may be subject to significant damages or an injunction preventing it from manufacturing, selling or using some of its products in the event of a successful claim of patent or other intellectual property infringement. Any of these adverse consequences could have a material adverse effect on Hospira’s profitability and financial condition.

Hospira has outstanding stock options, which may dilute the ownership of its existing shareholders.

As of December 31, 2006, Hospira had approximately 13.6 million outstanding stock options and the ability to award approximately 10.0 million additional share-based awards under its equity compensation plan. As of December 31, 2006, Hospira’s outstanding option awards had a weighted average exercise price of $32.52, which was below the market price of Hospira’s stock at that time. Exercises of stock options at a price below the market price of Hospira’s stock will dilute the ownership interest of existing shareholders.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The locations and uses of Hospira’s principal manufacturing, administrative, and research and development properties as of December 31, 2006 are as follows:

 

The North Chicago, Illinois lease between Abbott and Hospira expires in 2014; the Montreal, Canada lease expires in 2008; the Lake Forest, Illinois lease expires in 2016; and the Finisklin, Sligo, Ireland lease expires in 2013.

Hospira closed its Donegal, Ireland facility in late 2006. Hospira expects to close the Ashland facility later in 2007 and the Montreal facility by the first half of 2008. Hospira expects to phase out production at the North Chicago facility on an accelerated time frame, with most of the phase-out occurring by early 2010. Production of the primary products at these facilities is expected to move to other Hospira facilities

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and/or be outsourced to third-party suppliers. In 2006, Hospira began a $60 million expansion of manufacturing capacity at the McPherson facility, in part to accommodate some of the production from the North Chicago facility.

Hospira believes that its facilities and equipment are in good operating condition and are well maintained. Hospira believes that it has adequate capacity to meet its current business needs.

The locations of Mayne Pharma’s principal manufacturing facilities as of December 31, 2006 are as follows:

 

Mayne Pharma has a joint venture with Zydus Cadila, an Indian pharmaceutical company, which is constructing a manufacturing facility in India to produce injectable drugs and process active pharmaceutical ingredients.

Item 3. Legal Proceedings

In addition to the litigation described below, additional legal proceedings may occur that may result in a change in estimated reserves recorded by Hospira. It is not possible to predict the outcome of legal proceedings with certainty and their ultimate disposition may have a material adverse effect on Hospira’s financial position, cash flows, or results of operations.

Marketing and Pricing Cases

Various state and federal agencies, including the U.S. Department of Justice and various state attorneys general, are investigating a number of pharmaceutical companies, including Abbott, for allegedly engaging in improper marketing and pricing practices with respect to certain Medicare- and Medicaid-reimbursable products, including practices relating to average wholesale price (“AWP”). These are civil investigations that are seeking to identify the practices and determine whether those practices violated any laws, including federal and state false claims acts, or constituted fraud in connection with the Medicare and/or Medicaid reimbursement paid to third parties. In addition, Abbott is a defendant in a number of purported class actions on behalf of individuals or entities, including healthcare insurers and other third-party payors, that allege generally that Abbott and numerous other pharmaceutical companies reported false or misleading pricing information in connection with federal, state and private reimbursement for certain drugs. Many of the products involved in these investigations and lawsuits are Hospira products. Hospira is cooperating with the authorities in these investigations. There may be additional investigations or lawsuits, or additional claims in the existing investigations or lawsuits, initiated with respect to these matters in the future. Hospira cannot be certain that it will not be named as a subject or defendant in these investigations or lawsuits. Hospira is a named defendant in two such lawsuits: The State of Texas ex rel. Ven-A-Care of the Florida Keys, Inc. v. Abbott Laboratories Inc., Hospira, Inc., B. Braun Medical Inc. and Baxter Healthcare Corporation, Case No. GV401286, pending in the District Court of Travis County, Texas and State of Hawaii v. Abbott Laboratories, Inc., et al.,Case No. 06-1-0720-04, pending in the Circuit Court of the First Circuit, Hawaii. Hospira has been dismissed as a defendant in the case, United States of America ex rel. Ven-A-Care of the Florida Keys, Inc. v. Abbott Laboratories, Inc., et al Case No. 95-1354, pending in the United States District Court for the Southern District of Florida. Abbott will indemnify Hospira for liabilities associated with pending or future AWP investigations and lawsuits only to the extent that they are of the same nature as the lawsuits and investigations that existed against Abbott as of the spin-off date

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and relate to the sale of Hospira products prior to the spin-off. Hospira will assume any other losses that may result from these investigations and lawsuits related to Hospira’s products, including any losses associated with post-spin-off activities. These investigations and lawsuits could result in changes to Hospira’s business practices or pricing policies, civil or criminal monetary damages, penalties or fines, imprisonment and/or exclusion of Hospira products from participation in federal and state healthcare programs, including Medicare, Medicaid and Veterans’ Administration health programs, any of which could have a material adverse effect on its business, profitability and financial condition.

ERISA Litigation

Hospira has been named as a defendant in a lawsuit alleging generally that the spin-off of Hospira from Abbott Laboratories interfered with employee benefits in violation of the Employee Retirement Security Act of 1974 (“ERISA”). The lawsuit was filed on November 8, 2004 in the United States District Court for the Northern District of Illinois, and is captioned:  Myla Nauman, Jane Roller and Michael Loughery v. Abbott Laboratories and Hospira, Inc. On November 18, 2005, the complaint was amended to assert an additional claim against Abbott and Hospira for breach of fiduciary duty under ERISA. Hospira has been dismissed as a defendant with respect to the new fiduciary duty claim. By Order dated December 30, 2005, the Court granted class action status to the lawsuit. The new claim in the amended complaint is not subject to the class certification ruling. As to the sole claim against Hospira in the original complaint, the court certified a class defined as:  “all employees of Abbott who were participants in the Abbott Benefit Plans and whose employment with Abbott was terminated between August 22, 2003 and April 30, 2004, as a result of the spin-off of the HPD/creation of Hospira announced by Abbott on August 22, 2003, and who were eligible for retirement under the Abbott Benefit Plans on the date of their terminations.”  Hospira denies all material allegations asserted against it in the complaint.

Retractable Technologies

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

Item 4. Submission of Matters to a Vote of Security Holders

None.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market for Common Stock

Hospira’s common stock is listed and traded on the New York Stock Exchange under the symbol “HSP.” The following table sets forth the high and low closing prices for Hospira’s common stock on the New York Stock Exchange for each period indicated.

 

As of December 31, 2006, Hospira had approximately 43,600 shareholders of record. Hospira has not paid dividends on its common stock.

Equity Compensation Plan Information

The following table gives information, as of December 31, 2006, about Hospira’s common stock that may be issued upon the exercise of options and other equity awards under the Hospira 2004 Long-Term Stock Incentive Plan, which is the only equity compensation plan pursuant to which Hospira’s equity securities are authorized for issuance.

 

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Issuer Purchases of Equity Securities

The following table gives information on a monthly basis regarding purchases made by Hospira of its common stock during the fourth quarter of 2006.

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

(2)          In February 2006, Hospira’s board of directors authorized the repurchase of up to $400 million of Hospira’s common stock in accordance with Rule 10b-18 under the Securities Exchange Act of 1934. The repurchase of shares commenced in early March 2006. As of December 31, 2006, Hospira purchased 7,584,400 shares for $299.8 million. Because Hospira must dedicate a substantial portion of its cash to servicing debt and integrating Mayne Pharma into its operations, Hospira does not expect to continue repurchasing shares for the foreseeable future.

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Performance Graph

The following graph compares the performance of Hospira common stock for the periods indicated with the performance of the S&P 500 Stock Index and the S&P Health Care Index.

Comparison of Cumulative Total Return

Assumes $100 was invested on May 3, 2004 (the first date Hospira common stock was traded on the New York Stock Exchange) in Hospira common stock and each index. Values are as of the close of the U.S. stock markets on December 31, 2004, 2005 and 2006, and assume dividends are reinvested. No cash dividends have been declared or paid on Hospira common stock. Returns over the indicated period may not be indicative of future returns.

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Item 6. Selected Financial Data

The following table sets forth Hospira’s selected financial information derived from its audited consolidated financial statements as of, and for the years ended, December 31, 2006, 2005, 2004, 2003 and 2002.

For all periods prior to April 30, 2004, the date of Hospira’s spin-off from Abbott, Hospira operated as a part of Abbott. Hospira’s consolidated financial statements for the year ended December 31, 2004, reflect Hospira’s operations as a separate, stand-alone entity subsequent to the spin-off combined with the historical operations of Hospira when it operated as part of Abbott prior to the spin-off. The historical financial information presented is not indicative of the results of operations or financial position that would have been obtained if Hospira had been an independent company during all periods shown or of future performance as an independent company.

The selected financial information should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Hospira’s audited financial statements included in Item 8.

(1)          Includes post-retirement medical and dental curtailment benefit of $64.6 million in 2004.

(2)          For periods prior to April 30, 2004, basic and diluted earnings per share are computed using the number of shares of Hospira common stock outstanding on April 30, 2004, the date on which the Hospira common stock was distributed to the shareholders of Abbott in connection with the spin-off.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

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

Transition from Abbott

Hospira became a separate public company on April 30, 2004, when it was spun off from Abbott. References to the historical assets, liabilities, products, businesses or activities of Hospira prior to the spin-off are generally intended to refer to the historical assets, liabilities, products, businesses or activities of Hospira’s business as it was conducted as part of Abbott prior to the spin-off. Hospira’s consolidated financial statements for the year ended December 31, 2004 reflect Hospira’s operations as a separate, stand-alone entity subsequent to the spin-off, combined with the historical operations of Hospira when it operated as part of Abbott prior to the spin-off. The financial information in the financial statements included in this annual report does not include all the expenses that would have been incurred, nor does it reflect Hospira’s results of operations, financial position and cash flows, had Hospira been a stand-alone company for all of 2004.

The two-year period after the spin-off was a transition period during which Hospira built its own corporate and international infrastructure and completed its separation from Abbott. From 2004 to 2006, Hospira incurred increased expenses year over year as a result of establishing and operating independent corporate functions; operating, maintaining and supporting information technology systems; and operating internationally on a stand-alone basis. From 2004 to 2006, Hospira also incurred expenses on a non-recurring, transitional basis as a result of the spin-off, including expenses relating to the establishment of new facilities, the build-out of independent information technology systems, and product registration and re-labeling. Hospira incurred $32.4 million of these costs in 2004, $46.0 million in 2005 and $35.0 million in 2006. Hospira does not expect to incur these non-recurring, transitional expenses in future periods.

Under the terms of the spin-off, the legal title to certain assets and operations relating to Hospira’s business outside the United States were transferred from Abbott over the two-year period after the spin-off. These transfers were completed during 2006.  Hospira paid $116.7 million in 2005 and $126.2 million in 2006 to acquire these assets. These transfers were completed during 2006, and Hospira has no further related obligations to Abbott going forward.

Hospira and Abbott entered into various manufacture and supply agreements prior to the spin-off under which Hospira supplied certain products to Abbott that it manufactured prior to the spin-off. These agreements had an initial two-year term (originally scheduled to expire in April 2006), subject to being extended by Abbott for an additional two-year term under substantially similar contractual provisions. Some of these agreements terminated in 2006, resulting in lower sales to Abbott during 2006. Sales to Abbott are expected to continue to decline in 2007.

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Cost-Reduction Activities

As part of its strategy to improve margins and cash flows, beginning in 2005, Hospira has taken a number of actions to reduce operating costs and optimize its manufacturing capabilities and capacity. Expenditures relating to these activities are not included in the transition activities discussed above.

In May 2005, to reduce its costs to produce critical care products, Hospira completed a strategic manufacturing, commercialization and development agreement with ICU Medical and sold its Salt Lake City manufacturing facility and related equipment and inventory to ICU Medical. In connection with these transactions, during 2005, Hospira recorded an impairment charge of $2.4 million and a loss of $13.4 million, which was Hospira’s best estimate of the cost of certain obligations that Hospira was required to reimburse to ICU Medical over the 24-month period after closing. Both the impairment and the loss related to obligations assumed were recorded in cost of products sold. During 2006, Hospira reduced its liability by $6.8 million due to a change in ICU Medical’s strategy for the manufacturing facility that reduced Hospira’s related obligation. For further details regarding the financial impact of these transactions, see Note 2 to the consolidated financial statements included in Item 8.

In August 2005, Hospira announced plans to close its medical device manufacturing plant in Donegal, Ireland. Hospira closed the facility late in 2006. Products produced at the Donegal plant have been moved to Hospira facilities primarily in Costa Rica and the Dominican Republic. At the time of the announcement, Hospira expected to incur $30 million to $40 million of pre-tax charges relating to the plant closure. During 2005 and 2006, Hospira incurred $8.5 million and $21.9 million of these charges, respectively, which are reported in cost of products sold. The costs consist primarily of severance and other employee benefit costs, additional depreciation resulting from the decreased useful lives of the building and certain equipment, and other exit costs. Hospira expects to generate cost savings relating to this activity beginning in 2007. For further details regarding the financial impact of this plant closure, see Note 4 to the consolidated financial statements included in Item 8.

In February 2006, Hospira announced plans to close its plants in Ashland, Ohio and Montreal, Canada over the subsequent 18 to 28 months, respectively, and also provided a timeline for phasing out production at a facility in Abbott Laboratories’ North Chicago, Illinois campus, where it has leased space from its former parent company since the spin-off in April 2004. Hospira intends to transition out of this facility in advance of the lease’s expiration in 2014, with a majority of the product transfers occurring over the four years following the announcement. Hospira will transfer production of the primary products from these facilities to other Hospira facilities and will outsource certain product components to third-party suppliers. The aggregate charges that Hospira will incur related to the plant closings are expected to be in the range of approximately $95 million to $110 million on a pre-tax basis, of which approximately $45 million to $55 million are expected to be reported as restructuring charges. The restructuring costs consist primarily of costs related to severance and other employee benefit costs, additional depreciation resulting from the decreased useful lives of the buildings and certain equipment, and other exit costs. The remaining charges relate to the relocation of production. During 2006, Hospira incurred $21.7 million of restructuring charges, which are recorded in cost of products sold. For further details regarding the financial impact of this plant closure, see Note 4 to the consolidated financial statements included in Item 8.

These cost-reduction activities involve risks and uncertainties as relocating or outsourcing production is a complex process. Hospira may incur more charges than estimated and may not realize the expected cost savings on its planned time frame or at all. See “Item 1A. Risk Factors--Risks Relating to Hospira’s Business and Industry—Hospira’s cost-reduction activities have resulted in significant charges. These activities may disrupt Hospira’s business and may not result in the intended cost savings.”

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Acquisition of Mayne Pharma Limited

On February 2, 2007, Hospira acquired Mayne Pharma Limited (“Mayne Pharma”), an Australia-based specialty injectable pharmaceutical company listed on the Australian Stock Exchange, for approximately $2.0 billion in cash. As Mayne Pharma has strong market positions in Europe and Australia and a significant commercial infrastructure outside the United States, the acquisition is expected to substantially increase Hospira’s international presence. The acquisition is also expected to broaden Hospira’s specialty injectable pharmaceuticals product line.

The results of operations of Mayne Pharma will be included in Hospira’s results for periods on and after February 2, 2007.  In connection with the closing of the acquisition, in 2007, Hospira will incur non-cash charges relating to purchase accounting, including a write-off of in-process research and development and a write-up of inventory. Hospira will also record intangible assets which will be amortized over their useful lives. For the two-year period following the closing, Hospira expects to incur approximately $95 million to $110 million of costs relating to the integration of Mayne Pharma, the substantial majority of which will be in cash.

Hospira borrowed approximately $1.9 billion under a one-year bridge loan facility and a three-year term loan facility, and used approximately $120 million of cash on hand, to finance the acquisition, and as of the closing, had approximately $2.6 billion of total debt. Hospira expects to refinance the borrowings under the bridge loan through the sale of long-term debt securities during 2007. On an ongoing basis, Hospira will incur significantly greater interest expense than it incurred in prior periods, and will be required to dedicate a substantial portion of its cash flow to servicing its debt. Please refer to “Liquidity and Capital Resources—Debt and Capital” later in this Item 7 for further details.

The acquisition of Mayne Pharma is subject to various risks and uncertainties, including risks relating to the integration of Mayne Pharma and risks relating to our incurring substantial indebtedness in connection with the acquisition and the need to refinance the indebtedness. Please see “Item 1A. Risk Factors—Risks Relating to the Mayne Pharma Acquisition and Related Transactions.”

Other Factors

Manufacturing and Quality.   Hospira’s ability to manufacture and sell high-quality, low-cost products in compliance with regulatory requirements is an important factor to the success of its business. Hospira must comply with regulations governing the design, manufacture, marketing and sale of its products, including requirements relating to quality control and quality assurance, and must incur expense, time and effort to ensure compliance with the complex regulations. Hospira must also maintain continuity of supply of raw materials that comply with applicable regulatory requirements. Its business is subject to risks of manufacturing and supply interruptions, and product quality issues, which can lead to product recalls or field actions. Hospira did not experience significant manufacturing or raw material supply interruptions during the periods presented in this report.

Hospira has recalled, and/or conducted field alerts relating to, certain of its products from time to time. While these activities can lead to costs to repair or replace affected products and temporary interruptions in product sales, and can impact reported results of operations in the applicable period, Hospira does not believe that these activities had a material adverse effect on its business or results of operations during the periods presented in this report.

Product Development.   Hospira views investment in research and development as an important driver of sales growth over the longer term. To successfully execute its product development strategy, Hospira must continue to develop cost-competitive products and enhancements that satisfy customer needs, introduce products on a timely basis and successfully market those products. As a part of this strategy, Hospira will also need to identify, and successfully manage, strategic alliances and collaborative arrangements.

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Hospira believes that the ability to grow sales in the specialty injectable pharmaceutical product line will be driven primarily by its ability to launch new generic drug products on a timely basis. Generally, the price and sales volume of a generic drug tend to decline as more competitors enter the market for that particular drug. However, new product launches can offset declines from other portfolio products and generate growth. If a company can be “first to market,” such that the branded drug is the only other competition for a period of time, higher levels of sales and profitability can be achieved. Timely, efficient research and development capabilities and expertise in legal and regulatory matters will be required to be successful in executing a “first to market” strategy. Over the longer term, Hospira views biosimilar products as an important opportunity. In 2006, Hospira invested in biosimilar product development through its collaboration with STADA, under which it made a $21.7 million upfront payment, and its $17.1 million acquisition of BresaGen Limited.

A key component to the product development strategy for medication management systems has been the development and offering of newer-technology drug delivery pumps and related products and services. Hospira expects to achieve sales growth in part due to increased sales of these newer technology products. Hospira believes that the features and functionality offered by these products position it to achieve such growth over the long-term. As a result, Hospira is aggressively competing to upgrade its current customer base as well as to capture competitive business. Because of changes in technology, it may take more time and effort to sell and implement newer-technology products to its customers. Hospira also expects intense competition for existing and potential customers from other competitors. The timing and amount of purchases made by customers cannot be predicted with certainty.

Hospira’s ability to execute on its product development efforts is subject to various risks and uncertainties described in “Item 1A. Risk Factors,” including the ability to timely launch new products and enhancements, the ability to successfully manage collaborative arrangements, actions of competitors and acceptance by customers.

Contract Manufacturing.   Hospira’s contract manufacturing product line has received lower forecasted 2007 volumes from existing customers. In addition, certain drugs being manufactured by Hospira under contract have lost patent protection, which results in lower demand for Hospira’s contract manufacturing services. These factors are expected to negatively impact Hospira’s contract manufacturing product line sales by approximately $50 million. Hospira expects to offset a small portion of this loss through new contracts or volume under other contracts, and expects substantially lower contract manufacturing sales during 2007.

GPO Contracts.   The ability to maintain GPO contracts is an important factor for Hospira to generate sales. Approximately 50% of Hospira’s net sales are made through these contracts. Typically, these contracts cover a portion of Hospira’s product lines, specify the prices for Hospira’s products, and are effective for three to five years. Generally, the contracts are extended or competitively bid prior to contract expiration. In any year, a portion of the various contracts Hospira has with GPO’s expire. While Hospira expects to maintain its business with the GPO’s and has been able to maintain its base business under its GPO contracts during the periods covered by this report, if Hospira is unable to renew or renegotiate any significant GPO contracts in the future, its ability to sell products and its profitability may be harmed.

Share Repurchase.   In February 2006, Hospira’s board of directors approved a $400 million share repurchase program. As of December 31, 2006, Hospira purchased 7,584,400 shares for $299.8 million. Because Hospira must dedicate a substantial portion of its cash to servicing debt and integrating Mayne Pharma into its operations, Hospira does not expect to continue repurchasing shares for the foreseeable future.

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Critical Accounting Policies

Critical accounting policies are those policies that require management to make the most difficult, subjective or complex judgments, often because they must estimate the effects of matters that are inherently uncertain and may change in subsequent periods. Critical accounting policies involve judgments and uncertainties that are sufficiently sensitive to result in materially different results under different assumptions and conditions. Hospira believes its most critical accounting policies are those described below. For a detailed discussion of these and other accounting policies, see Note 1 to the consolidated financial statements.

Revenue Recognition—Hospira recognizes revenues from product sales when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed and determinable, and collectibility is reasonably assured. For other than certain drug delivery pumps and injectable pharmaceutical contract manufacturing, product revenue is recognized when products are delivered to customers and title passes. In certain circumstances, Hospira enters into arrangements in which it provides multiple elements to its customers. In these cases, total revenue is divided among the separate units of accounting (deliverables) based on their relative fair value and is recognized for each deliverable in accordance with the applicable revenue recognition criteria. The recognition of revenue is delayed if there are significant post-delivery obligations, such as installation or customer acceptance.

For drug delivery pumps, revenue is typically derived under one of three types of arrangements: outright sales of the drug delivery pump; placements under lease arrangements; and placements under contracts that include associated disposable set purchases. For lease agreements under which Hospira’s warranty obligation extends through the entire term are accounted for as operating leases. For these, Hospira recognizes revenue over the lease term, which averages five years. For leases under which Hospira’s warranty obligation is limited to approximately one year, Hospira accounts for these as sales-type leases, under which the discounted sales value of the drug delivery pump is recorded as revenue upon placement with the customer. Hospira has contractual arrangements with certain customers whereby it places drug delivery pumps at customer sites, and the customers agree to purchase minimum levels of disposable products (sets) that are used with the pumps. These arrangements do not include any upfront fees or payments. The contractual arrangements generally set forth fixed prices for the purchases of the disposable products, where the prices for the disposables do not change over the term of the arrangement, other than, in some cases, for changes in Consumer Price Index provisions. Title for the pumps is retained by Hospira throughout these arrangements, and the related asset is depreciated over its estimated useful life on a straight-line basis.  In these placement arrangements, revenue is recognized as the disposable products are delivered, in accordance with SFAS No. 48, “Revenue Recognition when Right of Return Exists,” and SAB No. 104, “Revenue Recognition.”

Hospira markets a server-based suite of software applications designed to connect data from a hospital’s drug information library to drug delivery pumps throughout the hospital. The arrangements related to such applications typically include a perpetual software license, software maintenance and implementation services. Hospira recognizes revenue related to these arrangements in accordance with the provisions of Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended. Software license revenue and implementation service revenue are generally recognized upon completion of related obligations or customer acceptance and software maintenance revenue is recognized ratably over the contract period.

Injectable pharmaceutical contract manufacturing involves filling customers’ active pharmaceutical ingredients (“API”) into delivery systems. Under these arrangements, customers’ API is often consigned to Hospira and revenue is recorded for the materials and labor provided by Hospira, plus a profit, upon shipment to the customer.

Upon recognizing revenue from a sale, Hospira records an estimate for certain items that reduce gross sales in arriving at its reported net sales for each period. These items include chargebacks, rebates and

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other items (such as cash discounts and returns). Provisions for chargebacks and rebates represent the most significant and complex of these estimates.

Chargebacks—Hospira sells a significant portion of its specialty injectable pharmaceutical products through wholesalers, which maintain inventories of Hospira products and later sell those products to end customers. In connection with its sales and marketing efforts, Hospira negotiates prices with end customers for certain products under pricing agreements (including, for example, group purchasing organization contracts). Consistent with industry practice, the negotiated end customer prices are typically lower than the prices charged to the wholesalers.

When an end customer purchases a Hospira product that is covered by a pricing agreement from a wholesaler, the end customer pays the wholesaler the price determined under the pricing agreement. The wholesaler is then entitled to charge Hospira back for the difference between the price the wholesaler paid Hospira and the contract price paid by the end customer (a “chargeback”). This process is necessary to enable Hospira to track actual sales to the end customer, which is essential information to run the business effectively. Settlement of chargebacks generally occurs between 30 and 40 days after the sale to wholesalers.

To account for the chargeback, Hospira records the initial sale to a wholesaler at the price invoiced to the wholesaler and at the same time, records a provision equal to the estimated amount the wholesaler will later charge back to Hospira, reducing gross sales and trade receivables. This provision must be estimated because the actual end customer and applicable pricing terms may vary at the time of the sale to the wholesaler. Accordingly, the most significant estimates inherent in the initial chargeback provision relate to the volume of sales to the wholesalers that will be subject to chargeback and the ultimate end customer contract price. These estimates are based primarily on an analysis of Hospira’s product sales and most recent historical average chargeback credits by product, estimated wholesaler inventory levels, current contract pricing, anticipated future contract pricing changes and claims processing lag time. Hospira estimates the levels of inventory at the wholesalers through analysis of wholesaler purchases and inventory data obtained directly from certain of the wholesalers. A one percent decrease in end customer contract prices for sales pending chargeback at December 31, 2006 would decrease net sales and income before income taxes by $1.3 million. A one percent increase in wholesale units sold subject to chargebacks at December 31, 2006 would decrease net sales and income before income taxes by $1.4 million.

Hospira regularly monitors the provision for chargebacks and makes adjustments when it believes the actual chargebacks may differ from estimates. At December 31, 2006 and 2005, chargebacks of $42.9 million and $64.2 million, respectively, were recorded as a reduction in trade receivables. The methodology used to estimate and provide for chargebacks was consistent across all periods presented.

Rebates—Hospira primarily offers rebates to direct customers, customers who purchase from certain wholesalers at end customer contract prices and government agencies, which administer various programs such as Medicaid. Direct rebates are generally rebates paid to direct purchasing customers based on a contracted discount applied to the direct customer’s purchases. Indirect rebates are rebates paid to “indirect customers” that have purchased Hospira products from a wholesaler under a pricing agreement with Hospira. Governmental agency rebates are amounts owed based on legal requirements with public sector benefit providers (such as Medicaid), after the final dispensing of the product by a pharmacy to a benefit plan participant. Rebate amounts are usually based upon the volume of purchases. Hospira estimates the amount of the rebate due at the time of sale, and records the liability and a reduction of gross sales at the same time the product sale is recorded. Settlement of the rebate generally occurs from three to 12 months after sale.

In determining provisions for rebates to direct customers, Hospira considers the volume of eligible purchases by these customers and the rebate terms. In determining rebates on sales through wholesalers, Hospira considers the volume of eligible contract purchases, the rebate terms and the estimated level of inventory at the wholesalers that would be subject to a rebate, which is estimated as described above under

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“Chargebacks.”  Upon receipt of a chargeback, due to the availability of product and customer specific information, Hospira can then establish a specific provision for fees or rebates based on the specific terms of each agreement. Rebates under governmental programs are based on the estimated volume of products sold subject to these programs. Each period the estimates are reviewed and revised, if necessary, in conjunction with a review of contract volumes within the period. Adjustments related to prior period sales have not been material in any period.

Hospira regularly analyzes the historical rebate trends and makes adjustments to recorded reserves for changes in trends and terms of rebate programs. At December 31, 2006 and 2005, accrued rebates of $65.1 million and $83.5 million, respectively, are included in other accrued liabilities. The methodology used to estimate and provide for rebates was consistent across all periods presented.

The following table is an analysis of chargebacks and rebates for 2006 and 2005. In each year, the provisions for chargebacks and rebates relating to prior period sales were not material.

 

Stock-Based Compensation—On January 1, 2006, Hospira adopted SFAS No. 123R, “Share-Based Payment,” which requires, among other changes, that the cost resulting from all share-based payment transactions be recognized as compensation cost over the vesting period based on the fair value of the instrument on the date of grant. Under SFAS No. 123R, Hospira uses the Black-Scholes option valuation model to determine the fair value of stock options. The fair value model includes various assumptions, including the expected volatility and expected life of the awards. These assumptions reflect Hospira’s best estimates, but they involve inherent uncertainties based on market conditions generally outside of Hospira’s control. As a result, if other assumptions had been used, stock-based compensation expense, as calculated and recorded under SFAS No. 123R, could have been materially impacted. Furthermore, if Hospira uses different assumptions in future periods, stock-based compensation expense could be materially impacted in future periods. See Note 14 to the consolidated financial statements included in Item 8 for additional information regarding stock-based compensation.

Pension and Post-Retirement Benefits—Hospira provides pension and post-retirement medical and dental benefits to certain of its employees based both in and outside of the United States. Prior to the spin-off date, Hospira employees participated in Abbott benefit plans that provided pension and post-retirement benefits. For financial reporting purposes, Hospira develops long-term assumptions, the most significant of which are the discount rate, the expected rate of return on plan assets, and healthcare cost trend rate. For these assumptions, management consults with actuaries, monitors plan provisions and demographics, and reviews public market data and general economic information.

The discount rate estimate for the current year is based on a proprietary yield curve developed by third-party actuaries, while prior year estimates used Moody’s Aa corporate bond index, with consideration of differences in duration between the bonds in the index and Hospira’s benefit liabilities. The change in assumption did not have a significant impact on Hospira’s 2006 consolidated financial statements.

The expected rate of return for the pension plan represents the average rate of return to be earned on plan assets over the period the benefits are expected to be paid. The expected rate of return on plan assets

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is developed from the expected future return of each asset class, weighted by the expected allocation of pension assets to that asset class. Hospira considers historical performance for the types of assets in which the plans invest, independent market forecasts, and economic and capital market conditions.

The healthcare cost trend rate for 2006 was 8% for pre-65 and 10% for post-65 years of age employees, with both rates declining to 5% by 2012 and 2011, respectively. A one percentage point increase/(decrease) in the assumed healthcare cost trend rate, with other assumptions held constant, would increase/(decrease) the service and interest component of net post-retirement medical and dental cost for the year ended December 31, 2006 by approximately $1.0/($1.0) million, and would increase/(decrease) the accumulated post-retirement benefit obligation by approximately $6.1/($5.1) million.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”). One provision of SFAS No. 158 requires full recognition of the funded status of Hospira’s defined benefit and post-retirement plans. The incremental effect of the application of this provision is provided in Note 7 of the consolidated financial statements. Another provision of SFAS No. 158 requires the measurement of Hospira’s defined benefit plan’s assets and its obligations to determine the funded status be made as of the end of the fiscal year. Hospira’s current measurement date is November 30. This provision of SFAS No. 158 is effective for fiscal years ending after December 15, 2008. Hospira is currently evaluating the potential impact of this provision of SFAS No. 158 on its financial statements.

Loss Contingencies—Hospira accounts for contingent losses in accordance with SFAS No. 5, “Accounting for Contingencies” (“SFAS No. 5”). Under SFAS No. 5, loss contingency provisions are recorded for probable losses at management’s best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount is recorded. These estimates are often initially developed substantially earlier than the ultimate loss is known, and the estimates are refined each accounting period, as additional information is known. Accordingly, if Hospira is initially unable to develop a best estimate of loss, the minimum amount, which could be zero, is recorded.

Income Taxes—Hospira’s provision for income taxes is based on taxable income, statutory tax rates, and tax planning opportunities available in the various jurisdictions in which Hospira operates. Significant judgment is required in determining the provision for income taxes and in evaluating tax positions that are subject to audits and adjustments. Reserves are established when, despite Hospira’s belief that the tax return positions are fully supportable, certain positions are likely to be challenged based on the applicable tax authority’s determination of the positions. Such reserves are based on management’s judgment, utilizing internal and external tax advisors, and represent the best estimate as to the ultimate outcome of tax audits. The provision for income taxes includes the impact of changes to reserves. Each quarter, Hospira reviews the anticipated mix of income derived from the various taxing jurisdictions and its reserves in accordance with SFAS No. 5. Deferred income taxes are provided for the tax effect of temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements at the enacted statutory rate expected to be in effect when the taxes are paid. Provision for income taxes and foreign withholding taxes are not provided for on undistributed earnings for certain foreign subsidiaries when Hospira intends to reinvest these earnings indefinitely to fund foreign acquisitions or to meet working capital and plant and equipment acquisition needs. See further discussion regarding the impact on undistributed earnings of foreign subsidiaries as a result of the American Jobs Creation Act of 2004 (the “Jobs Act”) in Note 8 to the consolidated financial statements.

Prior to the spin-off date, the provision for income taxes was calculated on a separate return basis. Under the tax sharing agreement executed in conjunction with the spin-off, Abbott will indemnify Hospira for tax liabilities arising for periods prior to the spin-off date. Therefore, no tax liabilities for the periods prior to the spin-off are reflected in the consolidated financial statements.

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Prospectively, Hospira has been providing for income taxes based on its post-separation independent activities. These estimates might change in future periods as Hospira develops its own tax filing history and considers the results of tax authority examinations.

Results of Operations

Net Sales

Net sales increased 2.4% in 2006 compared to 2005. Sales to third parties represented a 2.7% increase in overall sales, driven by favorable volume/mix of 1.5%, which includes the unfavorable impact of the Berlex contract termination of (2.6)%, increased price of 0.9% in the United States, and the impact of exchange of 0.3%. Sales to Abbott had an unfavorable impact of (0.3)% on overall sales, driven primarily by demand, partially offset by increased price. During the first half of 2005, the agreement under which Hospira distributed Berlex imaging agents was terminated, resulting in lower sales from 2004 to 2005 and from 2005 to 2006.

Net sales decreased (0.7)% in 2005 compared to 2004. Sales to third parties represented a (0.3)% decline in overall sales, driven by volume/product mix of (1.9)%, which includes the unfavorable impact of the Berlex contract termination of (4.9)%, partially offset by the impact of exchange of 0.3% and price of 1.3%. Sales to Abbott had an unfavorable impact of (0.4)% on overall sales growth, driven by the exclusion of the bulk drug cost from the pricing for certain products post-spin, partially offset by increased demand.

A comparison of product line sales is as follows: