UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C.  20549

 

FORM 10-Q

(Mark One)

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

OR

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

For the transition period from              to             

 

Commission File No. 1-2189

 

ABBOTT LABORATORIES

 

 

100 Abbott Park Road
Abbott Park, Illinois 60064-6400

 

Telephone:  (847) 937-6l00

 

 

Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of l934 during the preceding 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  xNo  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.  (Check one):

Large Accelerated Filer  x            Accelerated Filer  o            Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  oNo  x

As of June 30, 2006, Abbott Laboratories had 1,527,807,035 common shares without par value outstanding.

 

 

 

 

 

 

 

 

 

 

PART  I.  FINANCIAL INFORMATION

Abbott Laboratories and Subsidiaries

Condensed Consolidated Financial Statements

(Unaudited)

 

Abbott Laboratories and Subsidiaries

Condensed Consolidated Statement of Earnings

(Unaudited)

(dollars and shares in thousands except per share data)

		Three Months Ended						Six Months Ended
		June 30						June 30
		2006			2005			2006			2005
Net Sales		$	5,501,124		$	5,523,800		$	10,684,583		$	10,906,479
Cost of products sold		2,388,613			2,631,835			4,558,317			5,154,366
Research and development		556,337			445,258			1,041,479			881,914
Acquired in-process and collaborations research and development		493,000			—			493,000			—
Selling, general and administrative		1,520,397			1,351,792			2,984,812			2,639,413
Total Operating Cost and Expenses		4,958,347			4,428,885			9,077,608			8,675,693
Operating Earnings		542,777			1,094,915			1,606,975			2,230,786
Net interest expense		81,683			43,244			116,202			85,514
(Income) from TAP Pharmaceutical Products Inc. joint venture		(134,503		)	(107,153		)	(235,814		)	(189,998		)
Net foreign exchange loss		8,017			9,568			7,407			6,522
Other (income) expense, net		(69,556		)	2,786			(72,973		)	4,422
Earnings Before Taxes		657,136			1,146,470			1,792,153			2,324,326
Taxes on Earnings		44,892			269,418			315,026			609,386
Net Earnings		$	612,244		$	877,052		$	1,477,127		$	1,714,940
Basic Earnings Per Common Share		$	0.40		$	0.56		$	0.97		$	1.10
Diluted Earnings Per Common Share		$	0.40		$	0.56		$	0.96		$	1.09
Cash Dividends Declared Per Common Share		$	0.295		$	0.275		$	0.59		$	0.55
Average Number of Common Shares Outstanding Used for Basic Earnings Per Common Share		1,524,589			1,552,823			1,527,681			1,555,077
Dilutive Common Stock Options and Awards		7,048			16,083			7,441			14,678
Average Number of Common Shares Outstanding Plus Dilutive Common Stock Options and Awards		1,531,637			1,568,906			1,535,122			1,569,755
Outstanding Common Stock Options Having No Dilutive Effect		96,071			22,469			86,456			22,469

 

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

 

2

Abbott Laboratories and Subsidiaries

Condensed Consolidated Statement of Cash Flows

(Unaudited)

(dollars in thousands)

		Six Months Ended
		June 30
		2006			2005
Cash Flow From (Used in) Operating Activities:
Net earnings		$	1,477,127		$	1,714,940
Adjustments to reconcile earnings to net cash from operating activities —
Depreciation		494,862			436,130
Amortization of intangibles		271,341			241,727
Share-based compensation		210,957			15,286
Acquired in-process research and development		452,000			—
Trade receivables		311,014			245,285
Inventories		189,214			(3,250		)
Other, net		(717,858		)	(318,177		)
Net Cash From Operating Activities		2,688,657			2,331,941
Cash Flow From (Used in) Investing Activities:
Acquisition of businesses		(4,321,016		)	—
Investment in Boston Scientific common stock, note receivable and derivative financial instruments		(2,095,780		)	—
Acquisitions of property and equipment		(671,358		)	(633,852		)
Other investment securities transactions		8,205			746,540
Other		(32,537		)	11,629
Net Cash (Used in) From Investing Activities		(7,112,486		)	124,317
Cash Flow From (Used in) Financing Activities:
(Repayments) of commercial paper		—			(820,000		)
Proceeds from issuance of long-term debt		4,000,000			—
(Repayments) of long-term debt		(501,189		)	(150,000		)
Other borrowing transactions, net		167,373			12,857
Purchases of common shares		(754,502		)	(602,227		)
Proceeds from stock options exercised, including tax benefit		155,946			189,843
Dividends paid		(873,616		)	(832,319		)
Net Cash From (Used in) Financing Activities		2,194,012			(2,201,846		)
Effect of exchange rate changes on cash and cash equivalents		59,880			(99,142		)
Net cash provided by operating activities of discontinued operations		67,152			66,316
Net (Decrease) Increase in Cash and Cash Equivalents		(2,102,785		)	221,586
Cash and Cash Equivalents, Beginning of Year		2,893,687			1,225,628
Cash and Cash Equivalents, End of Period		$	790,902		$	1,447,214

 

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

 

3

Abbott Laboratories and Subsidiaries

Condensed Consolidated Balance Sheet

(Unaudited)

(dollars in thousands)

		June 30			December 31
		2006			2005
Assets
Current Assets:
Cash and cash equivalents		$	790,902		$	2,893,687
Investment securities		305,938			62,406
Trade receivables, less allowances of $207,641 in 2006 and $203,683 in 2005		3,673,178			3,576,794
Inventories:
Finished products		1,262,161			1,203,557
Work in process		667,620			630,267
Materials		702,489			708,155
Total inventories		2,632,270			2,541,979
Prepaid expenses, deferred income taxes, and other receivables		2,495,497			2,181,260
Assets held for sale		—			129,902
Total Current Assets		9,897,785			11,386,028
Investment Securities		1,774,215			134,013
Property and Equipment, at Cost		14,270,986			12,760,421
Less: accumulated depreciation and amortization		7,473,314			6,757,280
Net Property and Equipment		6,797,672			6,003,141
Intangible Assets, net of amortization		5,896,146			4,741,647
Goodwill		7,624,088			5,219,247
Other Long-term Assets and Investments in Joint Ventures		2,071,361			1,624,201
Assets Held for Sale		—			32,926
		$	34,061,267		$	29,141,203
Liabilities and Shareholders’ Investment
Current Liabilities:
Short-term borrowings		$	309,203		$	212,447
Trade accounts payable		1,036,931			1,032,516
Salaries, dividends payable, and other accruals		4,379,182			3,771,274
Income taxes payable		26,293			488,926
Current portion of long-term debt		1,942,575			1,849,563
Liabilities of operations held for sale		—			60,788
Total Current Liabilities		7,694,184			7,415,514
Post-employment Obligations, Deferred Income Taxes and Other Long-term Liabilities		3,006,882			2,737,852
Long-term Debt		8,174,695			4,571,504
Liabilities of Operations Held for Sale		—			1,062
Commitments and Contingencies
Shareholders’ Investment:
Preferred shares, one dollar par value Authorized — 1,000,000 shares, none issued		—			—
Common shares, without par value Authorized - 2,400,000,000 shares Issued at stated capital amount - Shares: 2006: 1,541,188,223; 2005: 1,553,769,958		3,791,827			3,477,460
Common shares held in treasury, at cost - Shares: 2006: 13,381,188; 2005: 14,534,979		(195,406		)	(212,255		)
Earnings employed in the business		10,270,234			10,404,568
Accumulated other comprehensive income (loss)		1,318,851			745,498
Total Shareholders’ Investment		15,185,506			14,415,271
		$	34,061,267		$	29,141,203

 

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

 

4

Abbott Laboratories and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2006

(Unaudited)

Note 1 — Basis of Presentation

The accompanying unaudited, condensed consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission and, therefore, do not include all information and footnote disclosures normally included in audited financial statements.  However, in the opinion of management, all adjustments necessary to present fairly the results of operations, financial position and cash flows have been made.  It is suggested that these statements be read in conjunction with the financial statements included in Abbott’s Annual Report on Form 10-K for the year ended December 31, 2005.

Note 2 — Supplemental Financial Information

		Three Months Ended						Six Months Ended
(dollars in thousands)		June 30						June 30
		2006			2005			2006			2005
Net Interest Expense:
Interest expense		$	110,663		$	59,990		$	183,634		$	117,305
Interest income		(28,980		)	(16,746		)	(67,432		)	(31,791		)
Total		$	81,683		$	43,244		$	116,202		$	85,514

 

The increases in Other (income) expense, net for the second quarter and six months ended June 30, 2006 are primarily due to fair value adjustments to certain derivative financial instruments included with the investment in Boston Scientific common stock.

Other, net in Net Cash From Operating Activities for 2006 and 2005 includes the effects of contributions to the main domestic defined benefit plan of $200 million and $641 million, respectively, and to the post-employment medical and dental plans of $40 million and $140 million, respectively, and changes in income taxes, primarily income tax payments.

(dollars in thousands)		June 30			December 31
		2006			2005
Current Investment Securities:
Time deposits and certificates of deposit		$	56,510		$	62,406
Investment in Boston Scientific common stock		249,428			—
Total		$	305,938		$	62,406
Long-term Investment Securities:
Investment in Boston Scientific common stock		$	814,253		$	—
Other equity securities		113,507			116,447
Note receivable from Boston Scientific, 4% interest		830,826			—
Other		15,629			17,566
Total		$	1,774,215		$	134,013

 

The cost basis of the Boston Scientific shares is $1.326 billion, of which $999 million is classified as available-for-sale securities and $327 million is classified under the cost method of accounting.  The fair value of the available-for-sale shares was $737 million at June 30, 2006, resulting in a charge of $157 million to Accumulated other comprehensive income (loss), net of income taxes of $105 million.  The fair value of the shares recorded under the cost method amounted to $239 million.

The decline in the fair value of the Boston Scientific shares, as noted above, is considered by management to be temporary as these shares have been owned by Abbott for a relatively short period of time and Abbott has both the ability and intent to hold the shares for a period of time to allow for the decline in value to reverse.

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Note 3 — Litigation and Environmental Matters

Abbott has been identified as a potentially responsible party for investigation and cleanup costs at a number of locations in the United States and Puerto Rico under federal and state remediation laws and is investigating potential contamination at a number of company-owned locations.  Abbott has recorded an estimated cleanup cost for each site for which management believes Abbott has a probable loss exposure.  No individual site cleanup exposure is expected to exceed $3 million, and the aggregate cleanup exposure is not expected to exceed $15 million.

There are two patent disputes with third parties who claim Abbott’s products infringe their patents.  In one dispute, Abbott has agreed to arbitrate and is subject to a minimum amount of damages, which Abbott has reserved.  In the second dispute, which Abbott assumed as part of the Guidant acquisition, reserves equal to the expected resolution have been recorded.

There are several civil actions pending brought by individuals or entities that allege generally that Abbott and numerous pharmaceutical companies reported false or misleading pricing information relating to the average wholesale price of certain pharmaceutical products in connection with federal, state and private reimbursement.  Civil actions have also been brought against Abbott, and in some cases other members of the pharmaceutical industry, by state attorneys general seeking to recover alleged damages on behalf of state Medicaid programs.  In May 2006, Abbott was notified that the U.S. Department of Justice intervened in a civil whistle-blower lawsuit alleging that Abbott inflated prices for Medicaid and Medicare reimbursable drugs.  The outcome of these investigations and litigation could include the imposition of fines or penalties.  Abbott is unable to estimate the amount of possible loss, and no loss reserves have been recorded for these exposures.  Many of the products involved in these cases are Hospira products.  Abbott retained liability for losses that result from these cases and investigations to the extent any such losses both relate to the sale of Hospira’s products prior to the spin-off of Hospira and relate to allegations that were made in such pending and future cases and investigations that were the same as allegations existing at the date of the spin-off.

Within the next year, legal proceedings may occur that may result in a change in the estimated reserves recorded by Abbott.  For its legal proceedings and environmental exposures, excluding the cases and investigations discussed in the third paragraph of this footnote, Abbott estimates the range of possible loss to be from approximately $175 million to $370 million.  The recorded reserve balance at June 30, 2006 for these proceedings and exposures was approximately $205 million.  The increase in the reserve and range of possible loss compared to those amounts at March 31, 2006 is primarily due to loss contingencies acquired with the Guidant businesses in April 2006.  These reserves represent management’s best estimate of probable loss, except for one which is recorded at the minimum, as defined by Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies.”

While it is not feasible to predict the outcome of all such proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on Abbott’s financial position, cash flows, or results of operations, except for the cases and investigations discussed in the third paragraph of this footnote, the resolution of which could be material to cash flows or results of operations for a quarter.

Note 4 — Comprehensive Income, net of tax

(dollars in thousands)

		Three Months Ended						Six Months Ended
		June 30						June 30
		2006			2005			2006			2005
Foreign currency gain (loss) translation adjustments		$	637,659		$	(405,899	)	$	735,385		$	(465,586	)
Unrealized (losses) gain on marketable equity securities, net of income taxes of $(107,700) and $(106,000) for the three months and six months ended June 30, 2006, respectively		(161,519		)	4,137			(158,972		)	(12,523		)
Net adjustments for derivative financial instruments designated as cash flow hedges		(19,816		)	23,883			(3,060		)	48,560
Other comprehensive income (loss), net of tax		456,324			(377,879		)	573,353			(429,549		)
Net Earnings		612,244			877,052			1,477,127			1,714,940
Comprehensive Income		$	1,068,568		$	499,173		$	2,050,480		$	1,285,391
Supplemental Comprehensive Income Information, net of tax:
Cumulative foreign currency translation (gain) adjustments								$	(1,496,560	)	$	(1,249,315	)
Minimum pension liability adjustments								8,931			355,103
Cumulative unrealized losses (gains) on marketable equity securities								150,525			(5,178		)
Cumulative losses on derivative financial instruments designated as cash flow hedges								18,253			5,207

 

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Note 5 — Post-Employment Benefits

(dollars in millions)

Retirement plans consist of defined benefit, defined contribution, and medical and dental plans.  Net cost for the six months ended June 30 for Abbott’s major defined benefit plans and post-employment medical and dental benefit plans is as follows:

		Defined Benefit Plans						Medical and Dental Plans
		2006			2005			2006			2005
Service cost — benefits earned during the period		$	109.4		$	106.0		$	26.2		$	21.5
Interest cost on projected benefit obligations		138.9			132.1			39.0			31.5
Expected return on plans’ assets		(187.7		)	(181.2		)	(7.8		)	(4.4		)
Net amortization		41.2			32.9			10.6			4.2
Net cost		$	101.8		$	89.8		$	68.0		$	52.8

 

Abbott funds its domestic defined benefit plans according to IRS funding limitations.  In the first quarters of 2006 and 2005, $200 and $641, respectively, was contributed to the main domestic defined benefit plan and $40 and $140, respectively, was contributed to the post-employment medical and dental benefit plans.

Note 6 — Taxes on Earnings

Taxes on earnings reflect the estimated annual effective rates and the effect of discrete tax events that occurred in the second quarter of 2006.  For the six months ended June 30, 2006, 6.2 percentage points of tax benefit was attributed to discrete items, primarily the tax benefit on acquired in-process and collaborations research and development.  The first six months 2005 includes additional income tax expense of approximately $52 million for remittances of foreign earnings of approximately $600 million in connection with the American Jobs Creation Act of 2004.  The effective tax rates, excluding the effect of the income taxes on the remittances of foreign earnings and the discrete items, are less than the statutory U.S. federal income tax rate principally due to the domestic dividend exclusion and the benefit of lower statutory tax rates and tax exemptions in several taxing jurisdictions.

Note 7 — Segment Information
(dollars in millions)

Revenue Segments— Abbott’s principal business is the discovery, development, manufacture and sale of a broad line of health care products.  Abbott’s products are generally sold directly to retailers, wholesalers, hospitals, health care facilities, laboratories, physicians’ offices and government agencies throughout the world.  Effective with the acquisition of Guidant’s vascular intervention and endovascular solutions businesses on April 21, 2006, Abbott’s base vascular business and Guidant’s vascular intervention and endovascular solutions businesses are reported as the Vascular Products segment.  Effective January 1, 2006, Abbott’s segments were reorganized to reflect the shift of nutritional products from Abbott’s International division to a newly formed division, Abbott Nutrition International.  As a result of this reorganization, total assets of approximately $850 have been transferred from the International division to the Abbott Nutrition International Products division.  For segment reporting purposes, Abbott’s Ross Products division and the Abbott Nutrition International division are aggregated and reported as the Nutritional Products segment and the U.S. and international pharmaceutical products divisions are aggregated and reported as the Pharmaceutical Products segment.  Abbott’s reportable segments are as follows:

Pharmaceutical Products— Worldwide sales of a broad line of pharmaceuticals.  For segment reporting purposes, two pharmaceutical divisions are aggregated and reported as the Pharmaceutical Products segment.

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Diagnostic Products— Worldwide sales of diagnostic systems and tests for blood banks, hospitals, consumers, commercial laboratories and alternate-care testing sites.  For segment reporting purposes, four diagnostic divisions are aggregated and reported as the Diagnostic Products segment.

Nutritional Products— Worldwide sales of a broad line of adult and pediatric nutritional products.  For segment reporting purposes, two nutritional divisions are aggregated and reported as the Nutritional Products segment.

Vascular Products— Worldwide sales of coronary, endovascular and vessel closure products.

Abbott’s underlying accounting records are maintained on a legal entity basis for government and public reporting requirements.  Segment disclosures are on a performance basis consistent with internal management reporting.  Intersegment transfers of inventory are recorded at standard cost and are not a measure of segment operating earnings.  The cost of some corporate functions and the cost of certain employee benefits are charged to segments at predetermined rates that approximate cost.  Remaining costs, if any, are not allocated to segments.  For acquisitions prior to 2006, substantially all intangible assets and related amortization are not allocated to segments.  The following segment information has been prepared in accordance with the internal accounting policies of Abbott, as described above, and are not presented in accordance with generally accepted accounting principles applied to the consolidated financial statements.

		Net Sales to External Customers												Operating Earnings
		Three Months Ended						Six Months Ended						Three Months Ended						Six Months Ended
		June 30						June 30						June 30						June 30
		2006			2005			2006			2005			2006			2005			2006			2005
Pharmaceuticals (a)		$	3,013		$	3,342		$	5,907		$	6,645		$	1,066		$	999		$	2,081		$	2,009
Diagnostics		1,007			958			1,925			1,844			127			130			182			227
Nutritionals		1,049			949			2,191			1,945			265			210			652			503
Vascular (b)		259			61			342			116			(52		)	(33		)	(90		)	(79		)
Total Reportable Segments		5,328			5,310			10,365			10,550			1,406			1,306			2,825			2,660
Other		173			214			320			356
Net Sales		$	5,501		$	5,524		$	10,685		$	10,906
Corporate functions and benefit plans costs														92			88			170			136
Non-reportable segments														(14		)	(10		)	(41		)	(9		)
Net interest expense														82			43			116			86
Acquired in-process and collaborations research and development														493			—			493			—
(Income) from TAP Pharmaceutical Products Inc. joint venture														(135		)	(107		)	(236		)	(190		)
Share-based compensation (c)														65			7			211			15
Other, net														166			139			320			298
Consolidated Earnings Before Taxes														$	657		$	1,146		$	1,792		$	2,324

(a)    The decreases in Pharmaceutical Product segment sales are due primarily to the effects of the amendment to the Boehringer Ingelheim distribution agreement.

(b)    The increase in Vascular Product segment sales is primarily due to the acquisition of Guidant’s vascular intervention and endovascular solutions businesses on April 21, 2006.  These results include approximately ten weeks of domestic sales and only approximately five weeks of international sales due to Abbott’s policy of recording the results of international operations on a one-month lag.

(c)    Approximately 40 to 45 percent of the annual cost of share-based awards will typically be recognized in the first quarter due to the timing of the granting of share-based awards.

 

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Note 8 — Business Combination and Related Transactions

In order to expand Abbott’s presence in the growing vascular market, Abbott acquired Guidant’s vascular intervention and endovascular solutions businesses for approximately $4.1 billion, in cash, in connection with Boston Scientific’s acquisition of Guidant.  These businesses were acquired on April 21, 2006 and the financial results of the acquired operations are included in these financial statements beginning on that date.  In addition, Abbott will also pay to Boston Scientific $250 million each upon government approvals to market the XIENCE drug-eluting stent in the U.S. and in Japan.  Each $250 million payment will result in the recording of additional goodwill.  The preliminary allocation of the acquisition cost is shown in the table below (in millions of dollars).  These allocations will be finalized when appraisals are completed.

Goodwill		$	1,807
Acquired intangible assets, primarily product rights for marketed products, customer relationships and technology		1,249
Acquired in-process research and development		452
Acquired net tangible assets		620
Total preliminary allocation of acquisition cost		$	4,128

 

The acquisition cost has been allocated to the acquired net assets based on preliminary appraisals of the estimated fair values on the date of acquisition.  Acquired intangible assets are expected to be amortized over 3 to 14 years (average of approximately 9 years).  Acquired in-process research and development was charged to income in the second quarter of 2006.  The net tangible assets acquired consist primarily of property and equipment of approximately $540 million, trade accounts receivable of approximately $250 million and inventories of approximately $120 million, net of assumed liabilities, primarily trade accounts payable, litigation reserves and other liabilities.

In order to facilitate Boston Scientific’s acquisition of Guidant, Abbott also acquired 64.6 million shares of Boston Scientific common stock directly from Boston Scientific and loaned $900 million to a wholly-owned subsidiary of Boston Scientific.  Abbott is required to dispose of the shares by October 2008.  Unless the shares trade above an average of $30 per share for twenty consecutive trading days, Abbott cannot dispose of any shares until October 2006.  Sales of the shares are limited to approximately 5.4 million shares per month until October 2007.  The amount recorded upon the acquisition of the shares includes a discount to market, based on an appraisal, to reflect the value of the restrictions on sale.  On the date of acquisition, half of the shares were recorded as available for sale in accordance with SFAS No. 115 and the remainder under the cost method in accordance with APB No. 18.  The loan, which is due in April 2011, is guaranteed by Boston Scientific and bears a favorable effective interest rate of 4 percent, which is reflected in the valuation of the note receivable.  In connection with the acquisition of the shares, Boston Scientific is entitled to certain after-tax gains upon Abbott’s sale of the shares.  Abbott would retain any gains on the sale of the Boston Scientific shares up to a sales price of $23.83; Boston Scientific would receive any after-tax gains on the sale of the shares for the portion of the sales price in excess of  $23.83 but lower than $26.00; and Boston Scientific would receive one-half of any after-tax gain for the portion of the sales price in excess of $25.99.  Based on an appraisal, Abbott recorded approximately $114 million for this gain-sharing derivative financial instrument liability.  In addition, Boston Scientific agreed to reimburse Abbott for certain borrowing costs on debt incurred to acquire the Boston Scientific shares.  After Abbott incurs the first $10 million of interest expense on debt incurred to acquire the shares, Boston Scientific will reimburse Abbott for the next $60 million of interest expense.  Reimbursement for the incremental interest expense will be in the form of additional common stock of Boston Scientific, payable 18 months after the acquisition.  Abbott recorded approximately $55 million for this interest derivative financial instrument asset.  The effect of recording the shares, the loan to Boston Scientific and the derivative financial instruments at fair value on the date of acquisition resulted in the recording of additional goodwill of approximately $204 million.  The financial assets and liability acquired from Boston Scientific were valued and recorded at acquisition as follows (in millions of dollars):

Boston Scientific common stock		$	1,326
Note receivable		829
Derivative financial instruments, net		(59		)
Total		$	2,096

 

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Note 9 — Incentive Stock Programs

In the first six months of 2006, Abbott granted 23,587,971 stock options, 1,842,056 replacement stock options, 1,047,100 (net of forfeitures of 100,000 shares) restricted stock awards and 674,797 (net of forfeitures of 11,100 shares) restricted stock units under the programs.  The purchase price of shares under option must be at least equal to the fair market value of the common stock on the date of grant, and the maximum term of an option is 10 years.  Options granted in 2006 vest equally over three years except for replacement options, which vest in six months.  Most options granted before January 1, 2005 included a replacement feature.  When an employee tenders mature shares to Abbott upon exercise of a stock option, a replacement stock option is granted equal to the amount of shares tendered.  Replacement options are granted at the then current market price for a term that expires on the date of the underlying option grant.  Upon a change in control of Abbott, all outstanding stock options become fully exercisable, and all terms and conditions of all restricted stock awards are deemed satisfied.  Restricted stock awards granted in 2006 have a 5 year term, with no more than one-third of the award vesting in any one year upon Abbott reaching a minimum return on equity target.  Restricted stock units granted in 2006 vest over three years and upon vesting, the recipient receives one share of Abbott stock for each vested restricted stock unit.  Restricted stock awards and settlement of vested restricted stock units are issued out of treasury shares.  Abbott issues new shares for exercises of stock options.  Abbott does not have a policy of purchasing its shares relating to its share-based programs.  At June 30, 2006, approximately 26 million shares were reserved for future grants.

The number of restricted stock awards and units outstanding and their weighted-average grant-date fair value at January 1, 2006 and June 30, 2006 was 2,381,800 ($50.09) and 3,680,245 ($45.41), respectively.  The number of restricted stock awards and units, and their weighted-average grant-date fair value, granted, vested and lapsed during the six months ended June 30, 2006 were 1,832,997 ($43.95), 415,452 ($49.95) and 119,100 ($44.03), respectively.  The fair value of restricted stock awards and units vested in the six months ended June 30, 2006 and 2005 was $24,941,000 and $6,691,000, respectively.

		Options Outstanding							Exercisable Options
		Shares		Weighted Average Exercise Price			Weighted Average Remaining Life (Years)		Shares		Weighted Average Exercise Price			Weighted Average Remaining Life (Years)
January 1, 2006		141,122,811		$	42.69		6.3		98,328,158		$	42.77		5.4
Granted		25,430,027		44.03
Exercised (total intrinsic value was $73,317,000)		(6,780,703	)	32.24
Lapsed		(4,472,793	)	46.85
June 30, 2006		155,299,342		$	43.24		6.5		110,803,443		$	42.83		5.4

 

The aggregate intrinsic value of options outstanding and exercisable at June 30, 2006 was $387 million and $367 million, respectively.  The total unrecognized compensation cost related to all share-based compensation plans at June 30, 2006 amounted to approximately $303 million and is expected to be recognized over the next three years.

On January 1, 2006, Abbott adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” which requires that the fair value of share-based awards be recorded in the results of operations.  Abbott used the modified prospective method of adoption.  Under this method, prior years’ financial results do not include the impact of recording stock options using fair value.  Under the revised standard, awards issued after 2005 and the remainder of any unrecognized cost for grants issued prior to 2006 are charged to expense.  Total non-cash compensation expense charged against income in the second quarter and first six months of 2006 for share-based plans totaled approximately $65 million and $211 million, respectively, and the tax benefit recognized was approximately $15 million and $50 million, respectively.  Approximately 40 to 45 percent of the annual net cost of share-based awards will typically be recognized in the first quarter due to the timing of the granting of share-based awards.  Compensation cost capitalized as part of inventory is not significant.  Through December 31, 2005, Abbott measured compensation cost using the intrinsic value-based method of accounting for stock options and replacement options granted to employees.

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Had compensation cost been determined using the fair value-based accounting method in 2005, pro forma net income (in millions) and earnings per share (EPS) amounts would have been as follows:

		Three Months Ended June 30			Six Months Ended June 30
Net earnings, as reported		$	877		$	1,715
Compensation cost under fair value-based accounting method, net of taxes of $21 and $47, respectively		(45		)	(135		)
Net earnings, pro forma		$	832		$	1,580
Basic EPS, as reported		$	0.56		$	1.10
Basic EPS, pro forma		0.54			1.02
Diluted EPS, as reported		0.56			1.09
Diluted EPS, pro forma		0.53			1.01

 

The weighted average fair value of an option granted in 2006 and 2005 was $11.72 and $12.17, respectively.  The fair value of an option grant was estimated using the Black-Scholes option-pricing model with the following assumptions:

		2006		2005
Risk-free interest rate		4.6	%	3.8	%
Average life of options (years)		6.1		5.4
Volatility		28.0	%	29.0	%
Dividend yield		2.7	%	2.2	%

 

The risk-free interest rate is based on the rates available at the time of the grant for zero-coupon U.S. government issues with a remaining term equal to the option’s expected life.  The average life of an option granted in 2006 is based on both historical and projected exercise and lapsing data.  Prior to 2006, the average life of an option granted was based on historical experience.  Expected volatility for 2006 option grants is based on implied volatilities from traded options on Abbott’s stock and historical volatility of Abbott’s stock over the expected life of the option.  Expected volatility for options granted prior to 2006 was based on historical volatility over a period prior to the option grant equal to the option’s expected life.   Dividend yield is based on the option’s exercise price and annual dividend rate at the time of grant.

Note 10 — Equity Method Investment
(dollars in millions)

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

		Three Months Ended June 30						Six Months Ended June 30
		2006			2005			2006			2005
Net sales		$	882.3		$	841.2		$	1,667.0		$	1,601.9
Cost of sales		203.8			237.2			413.2			460.0
Income before taxes		423.6			337.5			742.7			598.4
Net earnings		269.0			214.3			471.6			380.0

 

						June 30			December 31
						2006			2005
Current assets						$	1,177.7		$	1,339.1 8
Total assets						1,307.4			1,470.2
Current liabilities						931.8			1,082.2
Total liabilities						989.6			1,136.2

 

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Note 11 — Goodwill and Intangible Assets
(dollars in millions)

Abbott recorded total goodwill of approximately $2,011 related to the acquisition of Guidant’s vascular intervention and endovascular solutions businesses in the second quarter of 2006.  Foreign currency translation adjustments and other adjustments increased (decreased) goodwill in the first six months of 2006 and 2005 by approximately $394 and $(232), respectively.  There were no reductions of goodwill relating to impairments or disposal of all or a portion of a business.

The gross amount of amortizable intangible assets, primarily product rights and technology, was $8,184 as of June 30, 2006 and $6,776 as of December 31, 2005, and accumulated amortization was $2,306 as of June 30, 2006 and $2,053 as of December 31, 2005.  Intangible assets with indefinite lives are not significant.  The estimated annual amortization expense for intangible assets is $589 in 2006, $635 in 2007, $622 in 2008, $621 in 2009, and $623 in 2010.   These amounts include the estimated amortization of intangible assets acquired in 2006 and are subject to change when appraisals are completed.  Intangible assets are expected to be amortized over 3 to 25 years (average 12 years).

Note 12 — Restructuring Plans

In 2005, Abbott management approved plans to realign its global manufacturing operations and selected international commercial operations.  An additional $22 million was subsequently recorded in the first six months of 2006 relating to these restructurings, primarily for accelerated depreciation.  The following summarizes the activity for restructurings (dollars in millions):

		Employee- Related and Other			Asset Impairments			Total
2005 restructuring charges		$	191.7		$	63.8		$	255.5
Payments and impairments		(36.9		)	(63.8		)	(100.7		)
Accrued balance at December 31, 2005		154.8			—			154.8
Payments and other adjustments		(52.4		)	—			(52.4		)
Accrued balance at June 30, 2006		$	102.4		$	—		$	102.4

 

 

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FINANCIAL REVIEW

Results of Operations

The following table details sales by reportable segment for the second quarter and first six months:
(dollars in millions)

		Three Months Ended June 30										Six Months Ended June 30
		Net Sales to External Customers						Absolute Percentage Change (a)		Percentage Change Excluding BI Products (b)		Net Sales to External Customers						Absolute Percentage Change (a)		Percentage Change Excluding BI Products (b)
		2006			2005							2006			2005
Pharmaceuticals		$	3,013		$	3,342		(9.9	)	9.3		$	5,907		$	6,645		(11.1	)	5.4
Diagnostics		1,007			958			5.2		5.2		1,925			1,844			4.4		4.4
Nutritionals		1,049			949			10.5		10.5		2,191			1,945			12.7		12.7
Vascular		259			61			323.0		323.0		342			116			195.7		195.7
Total Reportable Segments		5,328			5,310			0.3		12.8		10,365			10,550			(1.8	)	9.0
Other		173			214			(19.1	)	(19.1	)	320			356			(10.3	)	(10.3	)
Net Sales		$	5,501		$	5,524		(0.4	)	11.4		$	10,685		$	10,906		(2.0	)	8.3
Total U.S.		$	2,750		$	3,025		(9.1	)	12.7		$	5,433		$	5,993		(9.4	)	9.7
Total International		$	2,751		$	2,499		10.1		10.1		$	5,252		$	4,913		6.9		6.9

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

(b)    The Pharmaceutical Products segment has an agreement with Boehringer Ingelheim (BI) to co-promote and distribute three of its products in the U.S. In 2005, Abbott and BI amended the agreement.  Effective January 1, 2006, Abbott no longer distributes or records sales for distribution activities for the BI products.  Abbott continued to co-promote one product, Micardis, through March 31, 2006, and receives residual commissions on BI’s sales of the products.

Worldwide sales for the second quarter and six months 2006 compared to 2005, excluding sales of BI products, reflect primarily unit growth and the acquisition of Guidant’s vascular intervention and endovascular solutions businesses on April 21, 2006 and are partially offset by the negative effect of the relatively stronger U.S. dollar.  The acquired businesses accounted for increases in sales of 268 percent and 142 percent in the Vascular Products segment and 3.0 percent and 1.5 percent in total net sales for the second quarter and six months ended June 30, 2006, respectively.  The results from this acquisition include approximately ten weeks of domestic sales and only approximately five weeks of international sales due to Abbott’s policy of recording the results of international operations on a one-month lag.   The relatively stronger U.S. dollar decreased second quarter and first six months 2006 consolidated net sales 0.9 percent and 1.8 percent, respectively, and decreased Total International sales 2.0 percent and 3.9 percent, respectively, over the second quarter and first six months of 2005.  In addition, the effect of the relatively stronger U.S. dollar decreased second quarter and first six months 2006 sales in the Diagnostic Products segment by 1.7 percent and 3.0 percent, respectively, and sales in the Pharmaceutical Products segment by 0.9 percent and 1.9 percent, respectively.  Sales for the Nutritional Products segment were favorably impacted in 2006 by increased sales volume of international pediatric products and by incremental revenue from a revised agreement for the U.S. promotion of Synagis.

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

		Six Months Ended June 30
					Percentage					Percentage
		2006			Change (a)		2005			Change (a)
Pharmaceuticals —
U.S. Pharmaceutical Operations		$	1,806		9.1		$	1,656		7.4
U.S. Specialty Operations		1,029			10.4		933			8.3
International Other Pharmaceuticals		2,011			9.2		1,842			22.1
International Anti-Infectives		404			(15.6	)	479			9.2
International Hospital Pharmaceuticals		320			2.2		313			12.4
Diagnostics —
Immunochemistry		1,086			(0.6	)	1,092			4.0
Diabetes Care		563			10.1		511			50.9
Nutritionals —
U.S. Pediatric Nutritionals		549			(0.7	)	553			(3.5	)
International Pediatric Nutritionals		435			32.1		329			15.4
U.S. Adult Nutritionals		567			5.1		540			27.2
International Adult Nutritionals		371			6.2		349			11.0

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

Increased sales volume of Humira and Tricor in 2006 favorably impacted U.S. Pharmaceutical Operations.  These increases were partially offset by lower U.S. sales of Biaxin due to generic competition for the immediate-release formulation as well as a weaker flu season.  U.S. sales of Biaxin were $80 million and $173 million in the first six months of 2006 and 2005, respectively.  U.S. Specialty Operations were favorably impacted by increased sales volume and price for Depakote and Kaletra.  Decreased sales volume due to generic competition for clarithromycin unfavorably impacted International Anti-Infectives.  Immunochemistry sales for 2006 were negatively affected 3.5 percent by the relatively stronger U.S. dollar.  Diabetes Care product sales growth in 2005 was favorably impacted by the acquisition of TheraSense in the second quarter of 2004.  The decrease in sales of U.S. pediatric nutritionals in the Nutritional Products segment in 2006 was due to competitive share loss and the decrease in sales of U.S. pediatric nutritionals in 2005 was primarily due to overall infant nutritionals non-WIC category decline and competitive share loss.  International Pediatric Nutritionals sales increased due primarily to volume growth in developing countries.

On January 1, 2006, Abbott adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” which requires that the fair value of share-based awards be recorded in the results of operations.  Abbott used the modified prospective method of adoption.  Under this method, prior years’ financial results do not include the impact of recording stock options using fair value.  Total non-cash compensation expense charged against income in the first six months of 2006 for share-based plans totaled approximately $211 million.  Approximately 40 to 45 percent of the annual net cost of share-based awards will typically be recognized in the first quarter due to the timing of the grants of share-based awards.

The gross profit margin was 56.6 percent for the second quarter 2006, compared to 52.4 percent for the second quarter 2005.  First six months 2006 gross profit margin was 57.3 percent, compared to 52.7 percent for the first six months 2005.  The increases in the gross profit margins were due to favorable product mix, primarily as a result of decreased sales of Boehringer Ingelheim products that have lower margins than for other products in the Pharmaceutical Products segment.  These increases were partially offset by higher intangible asset amortization and other acquisition related costs associated with the acquisition of Guidant’s vascular intervention and endovascular solutions businesses.

Research and development expenses increased 24.9 percent in the second quarter 2006 and 18.1 percent for the first six months 2006 over comparable 2005 periods.   The increases are due to the acquisition of Guidant’s vascular intervention and endovascular solutions businesses, the effect of recording compensation expense relating to share-based awards and increased spending to support pipeline programs, including follow-on indications for Humira, and other late-stage clinical programs in pharmaceuticals, diabetes care and vascular.  The majority of research and development expenditures are concentrated on pharmaceutical products.

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Selling, general and administrative expenses for the second quarter and first six months 2006 increased 12.5 percent and 13.1 percent, respectively, over the comparable 2005 periods.  Both 2006 periods include the effect of recording compensation expense relating to share-based awards and the acquisition of Guidant’s vascular intervention and endovascular solutions businesses.  These items increased selling, general and administrative expenses by 6.1 percentage points and 7.1 percentage points over the second quarter and first six months of 2005.   The remaining increases were due, in part, to increased selling and marketing support for new and existing products, including continued spending for Humira, as well as spending on other marketed pharmaceutical products.

Net interest expense

Net interest expense increased in both the second quarter and first six months of 2006 due to higher interest rates and higher borrowings as a result of the acquisition of Guidant’s vascular intervention and endovascular solutions businesses, and Abbott’s investments in the common stock of Boston Scientific and the note receivable; partially offset by higher interest income.

Other (income) expense, net

The increases in Other (income) expense, net for the second quarter and six months ended June 30, 2006 are primarily due to fair value adjustments to certain derivative financial instruments included with the investment in Boston Scientific common stock.

Taxes on Earnings

Taxes on earnings reflect the estimated annual effective rates and the effect of discrete tax events that occurred in the second quarter of 2006.  For the six months ended June 30, 2006, 6.2 percentage points of tax benefit was attributed to discrete items, primarily the tax benefit on acquired in-process and collaborations research and development.  The first six months 2005 includes additional income tax expense of approximately $52 million for remittances of foreign earnings of approximately $600 million in connection with the American Jobs Creation Act of 2004.  The effect of the increased income taxes on the remittance of foreign earnings was to increase the first six months 2005 effective tax rate by approximately 2.2 percentage points.  Abbott estimates that the effective tax rate for the last six months of 2006 will be between 23.5 percent and 24.0 percent.  The effective tax rates, excluding the effect of the income taxes on the remittances of foreign earnings and discrete items, are less than the statutory U.S. federal income tax rate principally due to the domestic dividend exclusion and the benefit of lower statutory tax rates and tax exemptions in several taxing jurisdictions.

TAP Pharmaceutical Products Inc. Joint Venture

 

In August 2006, TAP Pharmaceutical Products Inc. received an approvable letter from the U.S. Food and Drug Administration (FDA) for the investigational compound febuxostat for the management of hyperuricemia in patients with gout.  TAP intends to discuss with the FDA next steps for pursuing approval for febuxostat.  This approvable letter has no impact on Abbott’s previously stated earnings per share guidance for 2006.

Restructurings

In 2005, Abbott management approved plans to realign its global manufacturing operations and selected international commercial operations.  An additional $22 million was subsequently recorded in the first six months of 2006 relating to these restructurings, primarily for accelerated depreciation.  The following summarizes the activity for restructurings (dollars in millions):

		Employee- Related and Other			Asset Impairments			Total
2005 restructuring charges		$	191.7		$	63.8		$	255.5
Payments and impairments		(36.9		)	(63.8		)	(100.7		)
Accrued balance at December 31, 2005		154.8			—			154.8
Payments and other adjustments		(52.4		)	—			(52.4		)
Accrued balance at June 30, 2006		$	102.4		$	—		$	102.4

 

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Business Combinations and Related Transactions

In order to expand Abbott’s presence in the growing vascular market, Abbott acquired Guidant’s vascular intervention and endovascular solutions businesses for approximately $4.1 billion, in cash, in connection with Boston Scientific’s acquisition of Guidant.  These businesses were acquired on April 21, 2006 and the financial results of the acquired operations are included in these financial statements beginning on that date.  In addition, Abbott will also pay to Boston Scientific $250 million each upon government approvals to market the XIENCE drug-eluting stent in the U.S. and in Japan.  Each $250 million payment will result in the recording of additional goodwill.  The preliminary allocation of the acquisition cost is shown in the table below (in millions of dollars).  These allocations will be finalized when appraisals are completed.

Goodwill		$	1,807
Acquired intangible assets, primarily product rights for marketed products, customer relationships and technology		1,249
Acquired in-process research and development		452
Acquired net tangible assets		620
Total preliminary allocation of acquisition cost		$	4,128

 

The acquisition cost has been allocated to the acquired net assets based on preliminary appraisals of the estimated fair values on the date of acquisition.  Acquired intangible assets are expected to be amortized over 3 to 14 years (average of approximately 9 years).  Acquired in-process research and development was charged to income in the second quarter of 2006.  The net tangible assets acquired consist primarily of property and equipment of approximately $540 million, trade accounts receivable of approximately $250 million and inventories of approximately $120 million, net of assumed liabilities, primarily trade accounts payable, litigation reserves and other liabilities.

In order to facilitate Boston Scientific’s acquisition of Guidant, Abbott also acquired 64.6 million shares of Boston Scientific common stock directly from Boston Scientific and loaned $900 million to a wholly-owned subsidiary of Boston Scientific.  Abbott is required to dispose of the shares by October 2008.  Unless the shares trade above an average of $30 per share for twenty consecutive trading days, Abbott cannot dispose of any shares until October 2006.  Sales of the shares are limited to approximately 5.4 million shares per month until October 2007.  The amount recorded upon the acquisition of the shares includes a discount to market, based on an appraisal, to reflect the value of the restrictions on sale.  On the date of acquisition, half of the shares were recorded as available for sale in accordance with SFAS No. 115 and the remainder under the cost method in accordance with APB No. 18.  The loan, which is due in April 2011, is guaranteed by Boston Scientific and bears a favorable effective interest rate of 4 percent, which is reflected in the valuation of the note receivable.  In connection with the acquisition of the shares, Boston Scientific is entitled to certain after-tax gains upon Abbott’s sale of the shares.  Abbott would retain any gains on the sale of the Boston Scientific shares up to a sales price of $23.83; Boston Scientific would receive any after-tax gains on the sale of the shares for the portion of the sales price in excess of  $23.83 but lower than $26.00; and Boston Scientific would receive one-half of any after-tax gain for the portion of the sales price in excess of $25.99.  Based on an appraisal, Abbott recorded approximately $114 million for this gain-sharing derivative financial instrument liability.  In addition, Boston Scientific agreed to reimburse Abbott for certain borrowing costs on debt incurred to acquire the Boston Scientific shares.  After Abbott incurs the first $10 million of interest expense on debt incurred to acquire the shares, Boston Scientific will reimburse Abbott for the next $60 million of interest expense.  Reimbursement for the incremental interest expense will be in the form of additional common stock of Boston Scientific, payable 18 months after the acquisition.  Abbott recorded approximately $55 million for this interest derivative financial instrument asset.  The effect of recording the shares, the loan to Boston Scientific and the derivative financial instruments at fair value on the date of acquisition resulted in the recording of additional goodwill of approximately $204 million.  The financial assets and liability acquired from Boston Scientific were valued and recorded at acquisition as follows (in millions of dollars):

Boston Scientific common stock		$	1,326
Note receivable		829
Derivative financial instruments, net		(59		)
Total		$	2,096

 

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