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ABT > SEC Filings for ABT > Form 10-K on 21-Feb-2014All Recent SEC Filings

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Form 10-K for ABBOTT LABORATORIES


21-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Financial Review

Abbott's revenues are derived primarily from the sale of a broad line of health care products under short-term receivable arrangements. Patent protection and licenses, technological and performance features, and inclusion of Abbott's products under a contract most impact which products are sold; price controls, competition and rebates most impact the net selling prices of products; and foreign currency translation impacts the measurement of net sales and costs. Abbott's primary products are nutritional products, branded generic pharmaceuticals, diagnostic testing products and vascular products. Sales in international markets comprise approximately 70 percent of consolidated net sales.

In October 2011, Abbott announced a plan to separate into two publicly traded companies, one in diversified medical products and the other in research-based pharmaceuticals. To accomplish the separation, Abbott created a new company, AbbVie Inc. ("AbbVie") for its research-based pharmaceuticals business which consists primarily of Abbott's historical Proprietary Pharmaceutical Products segment. On January 1, 2013, Abbott distributed all of the outstanding shares of AbbVie to Abbott's shareholders and AbbVie became an independent company trading under the symbol "ABBV". The historical operating results of the research-based proprietary pharmaceuticals business prior to separation are excluded from Earnings from Continuing Operations and are presented on the Earnings from Discontinued Operations line in Abbott's Consolidated Statement of Earnings. The assets, liabilities, and cash flows of the research-based proprietary pharmaceuticals business are included in Abbott's Consolidated Balance Sheet and its Consolidated Statements of Cash Flows for periods prior to January 1, 2013.

Sales growth and margin improvement in the nutritional and diagnostics businesses and the challenging economic and fiscal environment in many countries around the world have impacted Abbott's sales, costs and financial position over the last three years. Sales in emerging markets increased 11 percent per year in 2013 and 2012, excluding foreign exchange, despite the slowdown in several emerging economies and a weakening of key emerging market currencies in 2013. (Emerging markets include all countries except the United States, Western Europe, Japan, Canada, and Australia.)

In Abbott's worldwide nutritional products business, sales over the last three years were positively impacted by demographics such as an aging population and an increasing rate of chronic disease in developed markets and the rise of a middle class in many emerging markets, as well as by numerous new product introductions that leveraged Abbott's strong brands. At the same time, manufacturing and distribution process changes and other cost reductions drove margin improvements across the business. Operating margins for this business increased from 13.2 percent in 2011 to 18.7 percent in 2013.

In 2013 sales growth in International Pediatric Nutrition was affected by a product recall initiated in August 2013 in China and two other markets for certain pediatric nutritional products supplied to Abbott by a third-party manufacturer. While there were no health issues associated with the recalled products, and the supplier subsequently determined that the products had been safe for consumption, the recall created significant disruption in these markets. As a result, International Pediatric Nutrition sales were significantly lower than Abbott's previous expectations for this business for the second half of 2013. While Abbott initiated investments in the third quarter of 2013 in these markets to rebuild consumer confidence, Abbott expects the recall to continue to have a negative impact on sales in the first half of 2014.

In Abbott's worldwide diagnostics business, margin improvement continued to be a key focus in 2013. Operating margins increased from 19.2 percent of sales in 2011 to 22.2 percent in 2013 as the business continued to execute on efficiency initiatives in the manufacturing and supply chain functions. In addition to continued margin improvement, unit growth across geographical regions positively impacted worldwide


diagnostic sales. Worldwide sales for this business increased 8.3 percent in 2013 and 7.3 percent in 2012, excluding foreign exchange.

In the Established Pharmaceutical Products segment, macroeconomic and market pressures in certain emerging markets impacted this business in 2013. Nevertheless, sales in this segment's 14 key emerging markets increased 6.3 percent in 2013 excluding the effect of foreign exchange. However, the growth in emerging markets was largely offset by declines in developed markets where austerity measures have continued to impact performance.

Over the last three years in the vascular business, Abbott continued to build its Xience drug-eluting stent franchise with the receipt of approval to market Xience Xpedition in various countries, including Japanese approval in the third quarter of 2013 and U.S. approval in the fourth quarter of 2012. Xience Pro received CE Mark approval in the second quarter of 2012. Abbott's market share also benefited from the U.S. launches of Xience nano and Xience PRIME in 2011, and the Japanese launches of Xience PRIME small vessel DES in 2013 and Xience PRIME in April 2012. Xience, which includes Xience V, PRIME, nano, Pro, and Xpedition, ended 2013 as the market-leading drug eluting stent globally. In 2013, ABSORB and MitraClip also contributed to sales growth. In 2011, the third party distributor of the Promus product began transitioning away from the product and that supply agreement ended in 2012. The effect of the winding down of the agreement continued into the first quarter of 2013.

Abbott's short- and long-term debt totaled $6.6 billion at December 31, 2013. At December 31, 2013, Abbott's long-term debt rating was A+ by Standard and Poor's Corporation and A1 by Moody's Investors Service. In the fourth quarter of 2012, Abbott extinguished $7.7 billion of long-term debt and incurred a charge of $1.35 billion related to the early repayment, net of gains from the unwinding of interest rate swaps related to the debt. In October 2013 Abbott announced a 57 percent increase in Abbott's quarterly dividend to $0.22 per share from $0.14 per share, effective with the dividend paid in February 2014.

In 2014, Abbott will focus on several key initiatives. In the nutritional business, Abbott will continue to build its product portfolio with the introduction of new science-based products, expand in high-growth emerging markets and implement additional margin improvement initiatives. In the established pharmaceuticals business, Abbott will continue to focus on obtaining additional product approvals across numerous countries and expanding its presence in emerging markets. In the diagnostics business, Abbott will focus on the development of next-generation instrument platforms and other advanced technologies, expansion in emerging markets, and further improvements in the segment's operating margin. In the vascular business, Abbott will continue to focus on marketing products in the Xience and endovascular franchises, and increasing MitraClip sales, as well as further clinical development of ABSORB, its bioresorbable vascular scaffold (BVS) device and a further penetration of ABSORB in numerous countries. In Abbott's other segments, Abbott will focus on developing differentiated technologies in higher growth markets.

Critical Accounting Policies

Sales Rebates - In 2013, approximately 49 percent of Abbott's consolidated gross revenues were subject to various forms of rebates and allowances that Abbott recorded as reductions of revenues at the time of sale. Most of these rebates and allowances are in the Established Pharmaceuticals and Nutritional Products segments. Abbott provides rebates to state agencies that administer the Special Supplemental Nutrition Program for Women, Infants, and Children (WIC), wholesalers, group purchasing organizations, and other government agencies and private entities. Rebate amounts are usually based upon the volume of purchases using contractual or statutory prices for a product. Factors used in the rebate calculations include the identification of which products have been sold subject to a rebate, which customer or government agency price terms apply, and the estimated lag time between sale and payment of a rebate. Using historical trends, adjusted for current changes, Abbott estimates the amount of the rebate that will be paid, and records the liability as a reduction of gross sales when Abbott records its sale of the product.


Settlement of the rebate generally occurs from one to six months after sale. Abbott regularly analyzes the historical rebate trends and makes adjustments to reserves for changes in trends and terms of rebate programs. Rebates and chargebacks charged against gross sales in 2013, 2012 and 2011 amounted to approximately $2.0 billion, $1.9 billion and $1.7 billion, respectively, or 16.1 percent, 16.0 percent and 16.8 percent, respectively, based on gross sales of approximately $12.5 billion, $11.8 billion and $10.1 billion, respectively, subject to rebate. A one-percentage point increase in the percentage of rebates to related gross sales would decrease net sales by approximately $125 million in 2013. Abbott considers a one-percentage point increase to be a reasonably likely increase in the percentage of rebates to related gross sales. Other allowances charged against gross sales were approximately $150 million, $149 million and $117 million for cash discounts in 2013, 2012 and 2011, respectively, and $208 million, $199 million and $170 million for returns in 2013, 2012 and 2011, respectively. Cash discounts are known within 15 to 30 days of sale, and therefore can be reliably estimated. Returns can be reliably estimated because Abbott's historical returns are low, and because sales returns terms and other sales terms have remained relatively unchanged for several periods.

Management analyzes the adequacy of ending rebate accrual balances each quarter. In the domestic nutritional business, management uses both internal and external data available to estimate the level of inventory in the distribution channel. Management has access to several large customers' inventory management data, and for other customers, utilizes data from a third party that measures time on the retail shelf. These sources allow management to make reliable estimates of inventory in the distribution channel. Except for a transition period before or after a change in the supplier for the WIC business in a state, inventory in the distribution channel does not vary substantially. Management also estimates the states' processing lag time based on claims data. In addition, internal processing time is a factor in estimating the accrual. In the WIC business, the state where the sale is made, which is the determining factor for the applicable price, is reliably determinable. Estimates are required for the amount of WIC sales within each state where Abbott has the WIC business. External data sources utilized for that estimate are participant data from the U.S. Department of Agriculture (USDA), which administers the WIC program, participant data from some of the states, and internally administered market research. The USDA has been making its data available for many years. Internal data includes historical redemption rates and pricing data. At December 31, 2013, Abbott had WIC business in 23 states.

Historically, adjustments to prior years' rebate accruals have not been material to net income. Abbott employs various techniques to verify the accuracy of claims submitted to it, and where possible, works with the organizations submitting claims to gain insight into changes that might affect the rebate amounts. For government agency programs, the calculation of a rebate involves interpretations of relevant regulations, which are subject to challenge or change in interpretation.

Income Taxes - Abbott operates in numerous countries where its income tax returns are subject to audits and adjustments. Because Abbott operates globally, the nature of the audit items are often very complex, and the objectives of the government auditors can result in a tax on the same income in more than one country. Abbott employs internal and external tax professionals to minimize audit adjustment amounts where possible. In accordance with the accounting rules relating to the measurement of tax contingencies, in order to recognize an uncertain tax benefit, the taxpayer must be more likely than not of sustaining the position, and the measurement of the benefit is calculated as the largest amount that is more than 50 percent likely to be realized upon resolution of the benefit. Application of these rules requires a significant amount of judgment. In the U.S., Abbott's federal income tax returns through 2010 are settled except for three items, and the income tax returns for years after 2010 are open. Abbott does not record deferred income taxes on earnings reinvested indefinitely in foreign subsidiaries.

Pension and Post-Employment Benefits - Abbott offers pension benefits and post-employment health care to many of its employees. Abbott engages outside actuaries to assist in the determination of the obligations and costs under these programs. Abbott must develop long-term assumptions, the most significant of which are the health care cost trend rates, discount rates and the expected return on plan


assets. The discount rates used to measure liabilities were determined based on high-quality fixed income securities that match the duration of the expected retiree benefits. The health care cost trend rates represent Abbott's expected annual rates of change in the cost of health care benefits and is a forward projection of health care costs as of the measurement date. A difference between the assumed rates and the actual rates, which will not be known for decades, can be significant in relation to the obligations and the annual cost recorded for these programs. Low interest rates have significantly increased actuarial losses for these plans. At December 31, 2013, pretax net actuarial losses and prior service costs and (credits) recognized in Accumulated other comprehensive income
(loss) for Abbott's defined benefit plans and medical and dental plans were losses of $1.8 billion and $82 million, respectively. Actuarial losses and gains are amortized over the remaining service attribution periods of the employees under the corridor method, in accordance with the rules for accounting for post-employment benefits. Differences between the expected long-term return on plan assets and the actual annual return are amortized over a five-year period. Note 12 to the consolidated financial statements describes the impact of a one-percentage point change in the health care cost trend rate; however, there can be no certainty that a change would be limited to only one percentage point.

Valuation of Intangible Assets - Abbott has acquired and continues to acquire significant intangible assets that Abbott records at fair value. Transactions involving the purchase or sale of intangible assets occur with some frequency between companies in the health care field and valuations are usually based on a discounted cash flow analysis. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. Abbott engages independent valuation experts who review Abbott's critical assumptions and calculations for acquisitions of significant intangibles. Abbott reviews definite-lived intangible assets for impairment each quarter using an undiscounted net cash flows approach. If the undiscounted cash flows of an intangible asset are less than the carrying value of an intangible asset, the intangible asset is written down to its fair value, which is usually the discounted cash flow amount. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest group level for which cash flows are identifiable. Goodwill and indefinite-lived intangible assets, which relate to in-process research and development acquired in a business combination, are reviewed for impairment annually or when an event that could result in an impairment occurs. At December 31, 2013, goodwill amounted to $9.8 billion and intangibles amounted to $5.7 billion, and amortization expense for intangible assets amounted to $791 million in 2013, $795 million in 2012 and $884 million in 2011. There were no impairments of goodwill in 2013, 2012 or 2011. In 2012 and 2011, Abbott recorded impairment charges of $69 million and $125 million, respectively, for certain research and development assets due to changes in the projected development and regulatory timelines for the projects.

Litigation - Abbott accounts for litigation losses in accordance with FASB Accounting Standards Codification No. 450, "Contingencies." Under ASC No. 450, 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 becomes known. Accordingly, Abbott is often initially unable to develop a best estimate of loss, and therefore the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Abbott estimates the range of possible loss to be from approximately $70 million to $90 million for its legal proceedings and environmental exposures. Accruals of approximately $80 million have been recorded at December 31, 2013 for these proceedings and exposures. These accruals represent management's best estimate of probable loss, as defined by FASB ASC No. 450, "Contingencies."


Results of Operations

Sales

    The following table details the components of sales growth by reportable
segment for the last two years:


                                              Total           Components of % Change
                                             % Change      Price      Volume     Exchange
Total Net Sales
2013 vs. 2012                                      1.6        (0.8 )      4.5         (2.1 )
2012 vs. 2011                                      0.4        (0.4 )      4.0         (3.2 )
Total U.S.
2013 vs. 2012                                     (0.8 )      (1.0 )      0.2            -
2012 vs. 2011                                      0.7         0.8       (0.1 )          -
Total International
2013 vs. 2012                                      2.7        (0.8 )      6.5         (3.0 )
2012 vs. 2011                                      0.3        (0.9 )      5.7         (4.5 )
Established Pharmaceutical Products
Segment
2013 vs. 2012                                     (2.9 )      (0.4 )      1.1         (3.6 )
2012 vs. 2011                                     (4.4 )      (1.3 )      3.4         (6.5 )
Nutritional Products Segment
2013 vs. 2012                                      4.3         3.2        2.2         (1.1 )
2012 vs. 2011                                      7.9         4.5        4.4         (1.0 )
Diagnostic Products Segment
2013 vs. 2012                                      5.9        (2.5 )     10.8         (2.4 )
2012 vs. 2011                                      4.0        (1.4 )      8.7         (3.3 )
Vascular Products Segment
2013 vs. 2012                                     (1.9 )      (6.2 )      6.2         (1.9 )
2012 vs. 2011                                     (7.9 )      (5.2 )     (0.4 )       (2.3 )

The increases in Total Net Sales in 2013 and 2012 reflect unit growth, partially offset by the impact of unfavorable foreign exchange. The price declines related to Vascular Products sales in 2013 and 2012 primarily reflect pricing pressure on drug eluting stents and other coronary products as a result of market competition in major markets.


A comparison of significant product and product group sales is as follows. Percent changes are versus the prior year and are based on unrounded numbers.

                                                             Percent               Percent
                                                   2013      Change      2012      Change
                                                            (dollars in millions)
Total Established Pharmaceuticals
Key Emerging Markets                              $ 2,358           1   $ 2,324           4
Other Markets                                       2,616          (7 )   2,797         (10 )
Nutritionals -
International Pediatric Nutritionals                2,257           9     2,075           8
U.S. Pediatric Nutritionals                         1,508           -     1,505          14
International Adult Nutritionals                    1,601           8     1,489           4
U.S. Adult Nutritionals                             1,374          (1 )   1,392           6
Diagnostics -
Immunochemistry                                     3,458           5     3,279           4
Vascular Products (1) -
Drug Eluting Stents (DES) and Bioresorbable
Vascular Scaffold (BVS) products                    1,563          (2 )   1,599           3
Other Coronary Products                               579          (3 )     598          (1 )
Endovascular                                          475           5       452           1


--------------------------------------------------------------------------------
    (1)


Other Coronary Products include primarily guidewires and balloon catheters. Endovascular includes vessel closure, carotid stents and other peripheral products.

Excluding the unfavorable effect of exchange, total Established Pharmaceutical Products sales increased 0.7 percent in 2013 and 2.1 percent in 2012. The Established Pharmaceutical Products segment is focused on 14 key emerging markets including India, Russia, China and Brazil. Excluding the effect of exchange, sales in these 14 key emerging markets increased 6.3 percent in 2013 and 12.8 percent in 2012 as macroeconomic and market pressures in various emerging markets negatively affected 2013 growth. Excluding the effect of exchange, sales in Established Pharmaceuticals' other markets decreased 4 percent in 2013 and 5.6 percent in 2012. These declines in the Other Markets category reflect unfavorable market conditions, including the continued effects of European austerity measures and 2012 Japanese pricing actions.

Excluding the unfavorable effect of exchange, total Nutritional Products sales increased 5.4 percent in 2013 and 8.9 percent in 2012. International Pediatric Nutritional sales increased in 2013 and 2012 due primarily to volume growth in developing countries. A supplier's recall of product in August 2013 in certain international markets negatively impacted International Pediatric Nutritional sales in the third and fourth quarters of 2013. While there were no health issues associated with this supplier recall and the supplier subsequently determined that the product had been safe for consumption, this event created significant disruption in these markets. Abbott expects this sales disruption to continue to negatively impact International Pediatric Nutritional growth in the first half of 2014. U.S. Pediatric sales were flat in 2013 due to lower formula share, partially offset by higher shipments of toddler products. U.S. Pediatric Nutritional sales in 2012 reflect market share gains for Similac and unit growth for PediaSure.

The 2013 and 2012 increases in International Adult Nutritional sales are due primarily to volume growth in developing countries and were negatively impacted by the effect of the relatively stronger U.S. dollar. The 1 percent decline in 2013 U.S. Adult Nutritional sales reflects Abbott's exit from certain non-core business lines as part of the business' margin improvement initiative; most of the sales decline


resulting from this exit was offset by higher Ensure revenues. The increase in 2012 U.S. Adult Nutritional sales reflects unit growth for the Ensure and Glucerna products.

Excluding the unfavorable effect of exchange, total Diagnostic Products sales increased 8.3 percent in 2013 and 7.3 percent in 2012. The sales increases reflect unit growth across geographical regions. 2013 and 2012 sales of immunochemistry products, the largest category in this segment, reflect continued execution of Abbott's strategy to deliver integrated solutions to large healthcare customers.

Excluding the unfavorable effect of exchange, total Vascular Products sales were flat in 2013 and decreased 5.6 percent in 2012. In 2013, growth in international markets, driven by continued share gains in key geographies of XIENCE Xpedition and Absorb, was offset by declines in the U.S. market due to the negative impact of pricing pressure and a decline in procedures due to market conditions, as well as the expected decline of certain royalty revenues. In 2012, the decrease in Vascular Products sales was due to pricing pressure, as well as the expected winding down of royalty and supply agreements related to certain third-party products, including Promus. Excluding this royalty and supply agreement revenue in both periods and the unfavorable effect of exchange, Vascular Products sales increased 3.4 percent in 2012.

Abbott has periodically sold product rights to non-strategic products and has recorded the related gains in net sales in accordance with Abbott's revenue recognition policies as discussed in Note 1 to the consolidated financial statements. Related net sales were not significant in 2013, 2012 and 2011.

The expiration of licenses and patent protection can affect the future revenues and operating income of Abbott. There are currently no significant patent or license expirations in the next three years that are expected to affect Abbott.

Operating Earnings

Gross profit margins were 50.4 percent of net sales in 2013, 50.6 percent in 2012 and 49.1 percent in 2011. The gross profit margin in 2013 remained relatively unchanged versus the prior year as improved margins in the Nutritional and Diagnostics Products segments were offset by margin declines in Established Pharmaceuticals and Vascular Products due to pricing pressures and unfavorable product mix as well as the impact of unfavorable foreign exchange across segments. The increase in the gross profit margin in 2012 was impacted by improved gross margins across all reportable segments as a result of cost reduction initiatives, the impact of exchange and favorable product mix.

In the U.S., states receive price rebates from manufacturers of infant formula under the federally subsidized Special Supplemental Nutrition Program for Women, Infants, and Children. There are also rebate programs for pharmaceutical products in numerous countries. These rebate programs continue to have a negative effect on the gross profit margins of the Nutritional and Established Pharmaceutical Products segments.

Research and development expense was $1.452 billion in 2013, $1.544 billion in 2012 and $1.512 billion in 2011 and represented a 6.0 percent decrease in 2013, and a 2.1 percent increase in 2012. The 2013 decrease primarily reflects . . .

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