Hospirais a provider of injectable pharmaceutical drugs and infusion technologies that it develops, manufactures, distributes and markets globally. Through a broad, integrated product portfolio, Hospirais uniquely positioned to Advance Wellness™ by improving patient and caregiver safety while reducing healthcare costs. 31
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Hospira'sportfolio of products includes Specialty Injectable Pharmaceuticals, Medication Management, and Other Pharmaceuticals. Specialty Injectable Pharmaceuticals, which represented approximately 69% of 2013 global Net sales, includes Hospira'sgeneric acute-care and oncology injectable products, biosimilars and the proprietary sedation agent Precedex™. Hospira's Specialty Injectable Pharmaceuticalsportfolio also includes many of its products offered in differentiated delivery formats. Medication Management, which represented approximately 19% of 2013 global Net sales, includes the company's medication management systems and gravity administration sets. Medication management systems are integrated infusion delivery systems that include dedicated administration sets and safety software system offerings that help make the medication delivery process safer and more efficient. Other Pharmaceuticals, which represented approximately 12% of 2013 global Net sales, includes intravenous solutions and One2One™, Hospira'sglobal contract manufacturing services. Hospiraderived 79% of its 2013 global Net sales from the Americas, which includes the U.S., Canadaand Latin America; 13% from Europe, Middle Eastand Africa; and, 8% from Asiapacific, which includes Asia, Japan, Australia and New Zealand. Hospira's Specialty Injectable Pharmaceuticals, including biosimilars, and medication management systems are considered key strategic growth drivers. Through continued global expansion, biosimilar research and development, work with collaborative partners, and Hospira'sDevice Strategy (discussed below), Hospiracontinues to position itself to deliver a broad portfolio of products used by hospitals and other healthcare providers throughout the globe. With an active sales force or manufacturing presence in the U.S., Canada, Latin America, India, Europe, the Middle East, Africa, Asia, Japan, Australia and New Zealand, Hospirais able to serve its product portfolio to approximately 100 markets globally. In addition to portfolio expansion, Hospiraseeks opportunities for continuous improvement (including efficiency, effectiveness and competitiveness to improve its cost base and cash flows) and capacity expansion, both demonstrated through Hospira'sconstruction of a manufacturing facility in Vizag, India, and the anticipated closing of an acquisition, in which Hospirawill acquire Orchid's penem and penicillin API business located in India. Although product development and expansion are areas of significant investment, Hospirarecognizes that its industry is complex, evolving and subject to significant regulation. Hospirahas made substantial investments designed to meet the ever-increasing demands of the highly regulated industry in which it operates. Hospiraworks closely with regulators, including the U.S. FDAand other regulatory bodies, and has undertaken significant initiatives, including its Device Strategy and certain quality matters, to support its products in a highly regulated industry. Hospirabelieves that major global healthcare trends offer the company opportunities. Hospirabelieve that the healthcare needs of growing aging populations in many developed markets and the rapidly increasing cost of healthcare may spur demand for quality healthcare at lower costs. In addition, the phenomenon of increasing middle class populations in many emerging markets is driving the demand for access to quality healthcare at reasonable costs. Hospira'sproducts offer the means to help governments, customers and patients address these trends.
Product Development and Product Launches
Hospira'sproduct development programs are concentrated in the areas of specialty injectable pharmaceuticals and medication management. Hospiramanages its product development programs and related costs through the following four categories: generic pharmaceuticals, biosimilars, proprietary pharmaceuticals and device products. For information related to certain of Hospira'sagreements for biosimilars and proprietary pharmaceuticals see Note 1 and Note 5 to the consolidated financial statements in "Item 8. Financial Statements and Supplementary Data" of this report.
Generic Pharmaceutical Product Development
December 31, 2013, Hospira'sgeneric pharmaceutical pipeline consisted of 73 compounds. Hospiraincludes products in its pipeline if they are approved for development and activity has occurred. In addition, in 2011 Hospiraadopted a global expansion program related to its generic specialty injectable pharmaceutical product line. Execution of this program has involved, and will involve, Hospiraqualifying certain of its on-market products into new countries, and to pursue other on-market generic products that are not currently in Hospira'sportfolio. Through 2013, Hospirahas achieved a cumulative total of over 200 new to country submissions.
A majority of
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Biosimilar Product Development
December 31, 2013, Hospira'sbiosimilar development pipeline, including co-exclusive commercialization rights for biosimilars developed with Celltrion, Inc. and Celltrion Healthcare, Inc.("Celltrion"), consisted of 11 compounds. Updates for certain products in the pipeline includes the following:
• Celltrion completed the development program for infliximab, and Celltrion
received a positive opinion from the
Products for Human Use, recommending the
Hospira'sinfliximab product), and in September 2013, the European Commissionapproved Inflectra™ for multiple indications, specifically, the treatment of inflammatory conditions including
rheumatoid arthritis, ankylosing spondylitis, Crohn's disease, ulcerative
colitis, psoriatic arthritis and psoriasis. This approval is applicable to
countries, and it will be launched throughout
opportunity taking into account any relevant patent protection. Celltrion
is able to commercialize its infliximab product in the same territories;
biosimilar erythropoietin ("EPO") for patients with certain renal
dysfunction who have anemia.
is expected to continue into 2015; and • in
December 2013, Hospirareceived positive results of its Phase I U.S. EPO clinical study which met primary and secondary endpoints. On April 29, 2013, Hospiraand NovaQuest entered into an arrangement for the following biosimilar products: Hospira'sEPO (in the U.S. and Canada), filgrastim (in the U.S.) and pegylated filgrastim (globally). Hospirawill be responsible for development, regulatory approval, commercialization and distribution of those products. NovaQuest will contribute up to $120.0 millionof development funding, and such amounts are recorded as an offset to Research and development expense as incurred as there is substantive and genuine risk of return of the investment inherent in these biosimilar development programs. This agreement is in alignment with Hospira'spre-existing biosimilar strategy to expand its portfolio and capabilities with measured investment and risk. For further information related to the NovaQuest agreement, see Note 5 to the consolidated financial statements in "Item 8. Financial Statements and Supplementary Data" of this report. For the year ended December 31, 2013, in connection with the NovaQuest agreement, Hospirarecognized an offset to R&D expense for development funding of $50.0 million.
Proprietary Pharmaceutical Product Development
During the year ended
• Precedex™ is a proprietary sedative.
development programs to expand the clinical use of this product: • in 2011,
Hospirasubmitted additional clinical data to the FDAto support a new indication to use Precedex™ beyond 24 hours. Hospirahas successfully gained approval for an indication to use
for greater than 24 hours in several non-U.S. markets.
Hospiracontinues to consider clinical pathways available for
its labeled indications; • in 2012,
Hospiracompleted Phase III clinical trials in Japanto support a procedural sedation indication for the use of
Hospirasubmitted the data to the Pharmaceuticals and Medical Devices Agency of Japanin 2012, and in June 2013, Hospirareceived approval for the additional indication; • in March 2013, the FDAgranted pediatric exclusivity for
Hospirareceived a six-month extension to all patents covering Precedex™; and • in March 2013, Hospirareceived FDAapproval for premix
Precedex™ and in
April 2013, Hospiralaunched the new premix versions in the U.S. The U.S. patents specifically covering the premix versions of Precedex™ expire on July 4, 2032(U.S. Patents Nos. 8,242,158; 8,338,470; 8,455,527 and 8,436,033). 33
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• Dyloject™ is a post-operative pain management drug currently awaiting
approval. In 2010,
FDA'scomplete response letter. In December 2013, Hospirareceived a second complete response letter from the FDA. Hospiracontinues to work with the agency, however, the timing of resolution is uncertain.
Device Product Development
May 2013, Hospiraannounced its Device Strategy, an initiative that will be implemented over the next approximately two years that establishes a streamlined and modernized portfolio to address customer needs and position Hospirafor future innovation and growth, while supporting continued advancement of device remediation and improvement efforts. Under this initiative, Hospira'sdevelopment efforts for on-market products will focus on the Plum A+™, Sapphire™ and LifeCare PCA™ platforms. In addition, Hospirawill focus on investment in and development of next-generation pump technology while furthering Hospira'sposition in providing I.V. clinical integration technology, which integrates infusion systems with electronic health records. For further information related to the Device Strategy, see the section captioned "Device Strategy" below.
Research and Development Expense
R&D expense includes costs identifiable to specific development projects, support activities which are essential to all of
Hospira'sR&D operations, and one-time initial and development milestone payments associated with external collaborative arrangements. For the year ended December 31, 2013, 2012 and 2011, specific project costs included EPO Phase III U.S. clinical trial expenses and other project costs which were approximately 10%, 16% and 8% of total R&D expense, respectively net of R&D collaboration arrangement funding reimbursements in 2013 recognized as an offset to R&D expense. As Hospira'sbiosimilar development programs progress, Hospiraexpects that over the next several years, the amount of spending on the biosimilar programs will remain a higher percentage of Hospira'stotal R&D expense. Other than EPO Phase III costs, the costs attributable to a specific project were not individually material to Hospira'sR&D expense line item for the periods presented. Hospira'sR&D expenses were $301.7 million, $303.6 million, and $258.8 millionin 2013, 2012 and 2011, respectively. Hospiramay periodically enter into collaborative arrangements with third parties for the development, license or commercialization of certain products. The timing and terms of such collaborative arrangements can be uncertain and unpredictable. Hospiraexpects that R&D as a percentage of Net sales may range between 8% to 9% over the next two to three years to support Hospira'sstrategy to expand and advance its generic pharmaceutical and biosimilar product portfolio, exclusive of any one-time initial and development milestone payments associated with collaborative arrangements.
Continuous Improvement Activities
Hospiraaims to achieve a culture of continuous improvement that will enhance its efficiency, effectiveness and competitiveness to improve its cost base and cash flow. As part of its strategy, Hospirahas taken a number of actions to reduce operating costs and optimize operations. The net charges related to these actions consist primarily of severance and other employee benefits, impairments, other asset (inventory) charges, manufacturing start-up costs, product validation and registration charges, other exit costs, contract termination costs and gains or losses on disposal of assets.
Facilities Optimization and Capacity Expansion
Hospiracontinued to advance construction on a specialty injectable pharmaceutical manufacturing facility in Vizag, India, which began in 2011. Capital expenditures and related start-up costs are anticipated, with the first commercial production expected by the end of 2014, with production increasing over the course of the next several years. In aggregate, Hospiraestimates Vizag capacity expansion capital expenditures of $375 millionto $450 million. Hospirahas incurred total capital expenditures of $227.2 millionthrough December 31, 2013. For the Vizag, Indiacapacity expansion, capital expenditures were $74.1 million, $73.4 millionand $79.7 millionin 2013, 2012 and 2011, respectively. Capital expenditures in 2014 are expected to be approximately $90 millionwith the remaining amounts to be capitalized in subsequent years. Hospiracurrently purchases certain oncology drugs from Hospira'sjoint venture, ZHOPL, a pharmaceutical company located in Ahmedabad, India. Hospiraand the joint venture continue to advance plans, initiated in 2011 and continuing through 2015, to qualify and validate manufacturing and related activities to support certain other oncology compounds at this location. 34
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For both the joint venture and the Vizag,
Indiafacility capacity expansion activities, Hospiraexpects 2014 and 2015 to be peak years for manufacturing start-up, validation (facility and product-related), registration costs, and unabsorbed production costs. The estimated range of costs in 2014 is expected to be approximately $70 millionto $90 million, subject to timing of applicable regulatory approval and other external factors. For the years ended December 31, 2013, 2012 and 2011, Hospiraincurred charges of $22.5 million, $17.9 millionand $3.8 million, respectively, primarily related to start-up and facility validation activities which are reported in Cost of products sold. Since inception, charges incurred through December 31, 2013were $44.2 million. Hospiraanticipates the amount, timing and recognition of charges and capital expenditures will be affected by various facility construction, product validation and registration timelines throughout the duration of the projects and corresponding regulatory outcomes in connection therewith. As Hospiratransitions from start-up to normalized production levels, Hospiramay incur further unabsorbed costs which will be impacted by the rate of transition and utilization of each production line. Furthermore, Hospiraexpects higher capital expenditures related to modernization and streamlining at its existing facilities. Hospiraanticipates the timing and recognition of charges and capital expenditures will be affected by various facility construction and product validation timelines throughout the duration of the projects as well as quality remediation activities and timelines as discussed in the section captioned "Certain Quality and Product Related Matters" below. In June 2012, as part of its effort to streamline and modernize existing facilities, Hospirainitiated plans to exit a specialty injectable drug packaging and inspection finishing operation at one facility and commence modernization of drug finishing operations, including installing additional automated visual inspection equipment, at other existing facilities. In 2012, as a result, primarily in the Americassegment (includes the United States, Canadaand Latin America), Hospiraincurred equipment and facility impairment charges of $18.6 million. In April 2013, Hospiraterminated its lease contract without incurring significant lease termination charges upon final exit from the operations. In April 2008, Hospiraannounced a plan to exit manufacturing operations at its Morgan Hill, Californiafacility. In March 2011, Hospiracompleted the process of transferring related operations and production of products to other Hospirafacilities or outsourcing certain product components to third-party suppliers. During the year ended December 31, 2011, Hospiraincurred, in the Americassegment, restructuring costs of $0.3 million. Hospiraincurred aggregate restructuring charges related to these actions of $27.8 millionin the Americassegment. In May 2012, Hospirasold the Morgan Hill, Californiafacility for approximately $5 million.
March 2009, Hospiraannounced details of a restructuring and optimization plan ("Project Fuel") that was completed in March 2011. Project Fuel included the following activities: optimizing the product portfolio, evaluating non-strategic assets and streamlining the organizational structure. During 2011, Hospiraincurred restructuring costs and other asset charges of $8.5 million.
From time to time
Hospiraincurs costs to implement restructuring actions for specific initiatives. In 2012, Hospirainitiated plans to discontinue a non-strategic product line. As a result, in the Americassegment, Hospiraincurred equipment impairment charges of $24.1 millionand contract termination charges of $1.6 millionfor the year ended December 31, 2012, which are reported in Restructuring and impairment. In addition, Hospiraincurred other asset (inventory) charges of $5.4 millionrelated to the product line discontinuation for the year ended December 31, 2012, which are reported in Cost of products sold. Additionally, in 2012, Hospirasold a non-strategic product line and recognized a $1.9 milliongain upon disposition reported in Restructuring and impairment. In December 2013, Hospirarecovered $3.4 millionrelated to assets associated with these matters which are reported in Restructuring and impairment. In late 2012 and continuing into 2013, Hospiraincurred costs, primarily in the APAC and EMEA segments, to optimize both commercial organizational structures and exit device products in certain APAC markets. The aggregate costs are reported in Restructuring and impairment and primarily include severance charges of $11.5 millionand contract termination charges of $3.1 million. Of the aggregate costs, $7.7 millionand $6.9 millionwere incurred in 2013 and 2012, respectively. In 2011, Hospiraincurred costs of $7.8 millionto terminate distributor contracts in the Americassegment related to the restructuring of certain Latin Americaoperations and are reported in Restructuring and impairment. 35
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Financial Related Impact
The charges incurred for the above continuous improvement activities collectively were reported in the consolidated statements of (loss) income line items as follows:
$ 22.5 $ 23.3 $ 9.6Restructuring and impairment 7.7 49.3 11.5 Selling, general and administrative - - 1.2 Total net charges $ 30.2 $ 72.6 $ 22.3As Hospiracontinues to consider each continuous improvement activity, the amount, the timing and recognition of charges will be affected by the occurrence of commitments and triggering events as defined under accounting principles generally accepted in the United States("GAAP"), among other factors. For further information regarding the impact of these continuous improvement activities, see Note 3 to the consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data" of this report. For more information about risks related to these matters, see the section captioned " Hospira'scontinuous improvement activities have resulted, and may continue to result, in significant charges and cash expenditures. These activities may disrupt Hospira'sbusiness and may not result in the intended improvement or cost savings" in "Item 1A. Risk Factors" of this report.
Orchid (Penem and Penicillin Active Pharmaceutical Ingredient Business)
August 29, 2012, Hospira, through its wholly-owned subsidiary, Hospira Healthcare India Private Limited("Hospira India"), entered into a definitive agreement (the "Agreement") with Orchid to acquire from Orchid its penem and penicillin API business for $202.5 millionin cash. In March 2013, the Agreement was amended to increase the purchase price to approximately $218 millionto include additional assets to be purchased by Hospirathat are related to the assets previously subject to the original Agreement and to change the purchase price currency from U.S. dollar to Indian rupee, which may result in a higher or lower payment upon close based upon the currency fluctuations between the Indian rupee and the U.S. dollar. As part of the Agreement, Hospirare-characterized $15.0 millionof previous inventory supply advances as an advanced payment of the purchase price to be settled at closing, and is subject to credit risk. For further information on advances to Orchid, see the section captioned "Supplier Advances" in Note 1 to the consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data" of this report. In addition, supplier advances to Orchid made subsequent to the Agreement and outstanding as of closing will be settled as part of the purchase price or provided to Hospirain the form of future product deliveries. The pending acquisition includes a FDAapproved manufacturing facility located in Aurangabad, India, and a research and development facility based in Chennai, India, along with the related assets and employees associated with those operations. Orchid is a current supplier of APIs to Hospiraand will continue to supply cephalosporin APIs following the pending acquisition. Hospiraincurred $4.6 millionand $1.0 millionin 2013 and 2012, respectively, of acquisition and integration-related costs, reported in Selling, general and administrative ("SG&A"). Cumulative acquisition and integration-related costs as of December 31, 2013were $5.6 million. Hospiraexpects to incur additional acquisition and integration-related costs in 2014. The Agreement contains customary covenants between Hospira India and Orchid. The transaction is subject to customary closing conditions and regulatory approvals and it is possible that the Agreement may be further modified by Hospira India and Orchid prior to closing to reflect additional negotiations and regulatory considerations. The customary closing conditions include Orchid transferring the business and related assets to Hospirawith satisfactory release of encumbrances, which may be delayed as Orchid attempts to obtain creditor and other necessary approvals, among other factors. Hospiraexpects to close the transaction in the first half of 2014, but can give no assurance that the transaction will be consummated during that time period, or at all.
For more information about risks related to this matter, see the section captioned "
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In December of 2013,
Hospirasigned an agreement to acquire a Brazilian-based oncology distributor, Evolabis Produtos FarmacÊuticos Ltda., adding approximately 15 on-market oncology products to Hospira'sportfolio in Brazil, accelerating expansion of its injectable pharmaceutical product line around the globe. During early February 2014, Hospiraclosed the transaction. The impacts of this acquisition are not anticipated to be material to Hospira'sresults of operations in 2014. Related Risks Acquisitions and related transactions are subject to various risks and uncertainties, including risks relating to the integration and risks relating to incurring substantial indebtedness in connection with an acquisition. See the section captioned " Hospiramay acquire businesses and assets, license rights to technologies or products from third parties, form alliances, or dispose of businesses and assets, and actions may not result in the expected benefits or may not be completed in a timely or cost-effective manner, or at all." in "Item 1A. Risk Factors" of this report.
Certain Quality and Product Related Matters
Hospiraand its suppliers are subject to extensive, complex and evolving regulations and increasing oversight by the FDAand other domestic and foreign regulatory authorities. Hospira'smanufacturing and other facilities, and those of its suppliers, are subject to periodic inspections to verify compliance with current FDAand other governmental regulatory requirements. This regulatory oversight may lead to, including, but not limited to, inspection observations (commonly called Form 483 observations in the U.S.), untitled letters, warning letters or similar correspondence, voluntary or involuntary product recalls, consent decrees, injunctions to halt manufacture and distribution of products, seizures of violative products, import and export bans or restrictions, monetary sanctions, delays in product approvals, civil penalties, criminal prosecution and other restrictions on operations. Any of these regulatory actions as well as Hospira'sinspections, reviews and commitments may require remediation activities with respect to products, facilities and quality/production policies, procedures and processes.
The following information provides additional detail regarding certain quality and product related matters.
Warning Letter Matters
Warning Letter (
April 2010, Hospirareceived a Warning Letter from the FDA("2010 Warning Letter") in connection with the FDA'sinspections of Hospira'spharmaceutical and device manufacturing facilities located in Clayton, North Carolina, and Rocky Mount, North Carolina. In the 2010 Warning Letter, the FDAcited current good manufacturing practice deficiencies related to particulate in certain emulsion products at the Claytonfacility and the failure to adequately validate the processes used to manufacture products at the Rocky Mountfacility. The 2010 Warning Letter also asserted other inadequacies, including procedures related to the Quality Control unit, investigations and medical reporting obligations. The 2010 Warning Letter does not restrict production or shipment of Hospira'sproducts from these facilities. Since issuing the 2010 Warning Letter, the FDAhas completed multiple follow-up inspections at both the Claytonand Rocky Mountfacilities. At the close of a June 2013inspection at the Claytonfacility, the FDAdid not issue a Form 483, thus, there were no observations from that inspection. In March 2013, the FDAissued a Form 483 listing observations after inspection of the Rocky Mountfacility as a sterile pharmaceutical manufacturer, which identified further areas for remediation and improvement. A number of the observations dealt with matters for which remediation was already underway but not yet complete or were matters previously self-identified for remediation by Hospirathat were scheduled to be addressed in the latter part of Hospira'sremediation and modernization plans. In February 2014, Hospirawas verbally informed by the FDAthat based on information submitted and ongoing commitments made by Hospira, the status of Rocky Mount'spharmaceutical manufacturing has been upgraded to Voluntary Action Indicated ("VAI") status. Under VAI status, Hospirais free to pursue new product approvals and export certifications for pharmaceutical products manufactured at Rocky Mount. In November 2013, the FDAissued a Form 483 listing observations after inspection of the Rocky Mountfacility as a medical device manufacturer. A number of the observations deal with matters for which remediation was intended to be addressed as part of a second phase of implementation of Hospira'sdevice remediation plan at sites that primarily manufacture pharmaceutical products. Hospiraresponded to the specific FDAobservations received in March 2013and November 2013, and expects to continue working cooperatively with the FDAregarding the scope and timing of remediation efforts at the facility. 37
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Warning Letter (
August 2012, Hospirareceived a Warning Letter from the FDArelated to the FDA's April 2012inspection of Hospira'sLa Aurora de Heredia, Costa Ricadevice manufacturing facility and corresponding Form 483 ("2012 Warning Letter"). In the 2012 Warning Letter, the FDAcited current good manufacturing practice deficiencies related to the failure to (i) correct and prevent recurrence of nonconforming product; (ii) implement changes in procedures needed to correct and prevent identified quality problems; (iii) evaluate suppliers on their ability to meet requirements; (iv) establish adequate procedures for acceptance of incoming product; and (v) maintain appropriate device history records. The Costa Ricasite manufactures most of Hospira'sinfusion devices and administration sets. In November 2012, the FDAissued an import alert that prohibits the importation of Symbiq™ infusion pumps into the U.S., and in February 2013, the FDAexpanded the import alert to prohibit the importation into the U.S. of the Plum™, GemStar™, and LifeCare PCA™ infusion pumps which are manufactured in Hospira's Costa Ricafacility. The FDA'simport alert does not restrict the importation of Hospira'sother medication management products, including consumables or Hospira'sother infusion pump accessories. Hospiracannot predict when the FDAimport alert for the above infusion devices will end. The FDAimport alert is not expected to be lifted until at least the re-inspection of the Costa Ricafacility, and perhaps other related facilities, occurs and the FDAis satisfied with the results and until Hospirademonstrates adequate progress on its Device Strategy. Hospiracontinues to support the repair and service of all impacted pumps to existing customers in the United States. Other regulatory agencies have restricted the supply of Hospirainfusion pumps into certain international markets for reasons similar to those cited by the FDAin its August 2012warning letter concerning Hospira's Costa Ricafacility. During 2013, the National Standards Authority of Ireland("NSAI") performed two audits of Hospira's Lake Forestsite. Based on the results of the latest audit, the NSAI has reissued the ISO certifications for the Lake Forestand Costa Ricasites, which allows Hospirato continue to import, tender, sell and distribute consumables or Hospira'sother infusion pump accessories in various international markets. NSAI also communicated to Hospirathat the European Conformity ("CE") certificate for infusion pumps and related software, covering Plum A+™ and Hospira MedNet™ expired and were withdrawn on August 31, 2013. Hospiraintends to file a new submission to regain CE marking for certain infusion devices and related software during 2014. Hospiracannot predict the timing and outcome of obtaining these new CE certificates, which if not received could negatively impact Hospira'songoing sales of device products.
Warning Letters (
May 2013, Hospirareceived a Warning Letter from the FDArelated to the FDA'sinspection of Hospira'sdevice quality systems and governance in Lake Forest, Illinois, in January and February 2013("2013 Device Warning Letter"). The 2013 Device Warning Letter cited current good manufacturing practice deficiencies, including failures related to design controls, corrective and preventive actions, complaint handling, purchasing controls and document controls and other inadequacies, including deviations from the medical device reporting regulation. Hospira's Lake Forestsite does not manufacture any device products but performs certain portions of Hospira'squality system procedures which support all of Hospira'sdevice products and operations. Also in May 2013, Hospirareceived a Warning Letter from the FDArelated to the FDA'sinspection of Hospira'spharmaceutical manufacturing facility in Irungattukottai, India("IKKT facility") in October 2012("2013 Pharmaceutical Warning Letter"). The 2013 Pharmaceutical Warning Letter cited current good manufacturing practice deficiencies, including failure to establish and follow appropriate written procedures, including validation of all aseptic and sterilization processes, and failure to appropriately maintain manufacturing facilities. In December 2013, the FDAcompleted a follow-up inspection of Hospira'sIKKT facility. At the close of the inspection, the FDAissued a Form 483 listing observations related primarily to processes and procedures, and Hospiradoes not anticipate any impact to product supply from this plant as a result of the Form 483. Hospiraresponded to the specific FDAobservations in January 2014, having already completed a majority of the identified corrective actions and expects to continue working cooperatively with the FDAregarding the scope and timing of remediation efforts at the facility. 38
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Hospiratakes these matters seriously and has responded fully, and in a timely manner, to the FDA'sWarning Letters (which are publicly available on the FDA'swebsite). Hospirahas submitted comprehensive remediation plans to address the items raised in the 2010 Warning Letter and 2012 Warning Letter and related subsequent Form 483 observations. In June 2013, Hospirasubmitted responses to the 2013 Device Warning Letter and the 2013 Pharmaceutical Warning Letter, both of which reference Hospira'spre-existing comprehensive remediation plans. The remediation plans involve commitments by Hospirato enhance its quality system, products, facilities, employee training, quality processes and procedures, and technology. The comprehensive remediation plan for devices includes the Device Strategy announced in May 2013. Elements of the device remediation plan are being implemented in a phased approach, with initial implementation at device component production facilities, service centers and design centers and a second phase of implementation at sites that primarily manufacture pharmaceutical products but also manufacture devices and combination products. For certain remediation plans, Hospirahas engaged third-party experts to assist with the remediation activities, established remediation project management teams, deployed new site leadership, and is hiring additional permanent employees in the manufacturing operations and quality organizations. Hospirawill continue to work through the commitments made in its remediation plans or responses and interact and work closely with the FDAwith the intent to align that all items noted in the Warning Letters and related subsequent Form 483s are appropriately addressed. While Hospirahas submitted remediation plans, the plans are subject to update and revision based on issues encountered by Hospiraor its third-party consultants during the remediation process, or on further interaction with the FDAor other regulatory bodies. Until these issues are corrected, Hospiramay not be able to gain regulatory approval for certain new products, and may be subject to additional regulatory action by the FDAor other regulatory authorities. Any such actions could significantly disrupt Hospira'songoing business and operations and have a material adverse impact on its financial position and operating results. There can be no assurance that the FDA, or other regulatory agencies, will be satisfied with Hospira'sresponse or corrective actions. All of Hospira'smanufacturing facilities and related operations are subject to routine FDAinspections and some of those facilities have received Form 483 observations or FDA-issued untitled letters or comparable inspection results from other governmental regulatory agencies, which are not included above. Hospirais working to achieve alignment between all of its facilities and quality policies, procedures and processes and the commitments made to the FDA, and as a result, Hospirahas incurred and will continue to incur additional costs for strengthening quality, compliance and production processes at other facilities. For example, third-party oversight and consulting costs for remediation activities have been and will continue to be incurred at a number of other manufacturing sites. Device Remediation Matters
Comprehensive Medication Management Product Review
In late 2010,
Hospiracommitted to the FDAthat it would engage in a comprehensive product review for each of Hospira'smedication management products to confirm compliance with current regulatory requirements and document safety and performance of the products. Hospiracompleted the product review investigations in 2013. As an outcome of the reviews, Hospiraidentified the need to take certain remediation actions, such as product recalls which require deployment of a modification to the installed customer base, design history file updates, incorporation of certain corrective actions into new production or other corrective or preventive actions for Hospira'smedication management products which will continue to be advanced. Examples of such remediation actions include deployment of a remediated battery and door roller assembly on the Plum A+™ pumps and deployment of a remediated door on the LifeCare PCA™ infusion pumps to the installed customer base. In May 2013, Hospiraannounced its Device Strategy, which builds on Hospira'scomprehensive device review of its global installed base of infusion pumps. In this regard, see matters discussed under the caption "Device Strategy" and "Product Development and Product Launches - Device Product Development" in this Item 7. Overall Financial Impact
The charges incurred for certain quality and product related matters collectively were reported in the Cost of products sold line item in the consolidated statements of (loss) income for the years ended,
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$ 64.4 $ 81.3 $ 11.8Other charges (primarily extended production downtime related costs and failure to supply penalties) 28.6 56.1 25.0 Inventory charges - 23.5 28.5 Device Product Related Third party consulting and other charges (product review and remediation activities) 25.4 17.4 2.8 Corrective action and life-cycle management charges 11.6 73.8
Other charges (asset impairments) - 8.2 - Total Charges
$ 130.0 $ 260.3 $ 111.2 Hospiraexpects the remediation activities to extend over the next two years and incur further charges at a lesser amount per year. In 2014, Hospiraexpects to incur aggregate charges of approximately $60 millionto $80 millionrelated to these quality and product related matters, which are primarily for third-party oversight and consulting and device remediation actions. The amount, timing and recognition of additional charges associated with these certain matters over this time period will be affected by the nature of spending and the occurrence of commitments and triggering events as defined under GAAP, among other factors. Corrective action and life-cycle management charges include credits in the twelve months ended December 31, 2013, due to the change in the expected corrective actions which no longer includes deployment of modifications for certain products as such products are part of the retirement and replacement programs under the Device Strategy. In addition to the charges incurred for these certain quality and product related matters, Hospirahas, and expects that it will continue to incur higher operating costs, which have been and will continue to be impacted by these matters. Further, costs for long-term solutions, product improvements and life-cycle management programs will depend on various production, quality, and development efforts and corresponding regulatory outcomes in connection therewith. In addition, capital expenditures to remediate and/or enhance Hospira'sexisting facilities and operations may be required. In this regard, see matters discussed in the "Continuous Improvement Activities - Facilities Optimization and Capacity Expansion" section within this Item 7. Hospiratakes all of these matters seriously and attempts to respond fully, and in a timely manner, to the FDAand other regulatory agencies. Hospiracannot, however, give any assurances as to the expected date of resolution of the matters identified above. For more information about risks related to these matters, see the section captioned " Hospira'sissues with its quality systems and processes could have an adverse effect upon Hospira'sbusiness, subject Hospirato further regulatory action and costly litigation, and cause a loss of confidence in Hospiraand its products" in "Item 1A. Risk Factors" of this report.
May 1, 2013, Hospiraannounced its Device Strategy, an initiative that will be implemented over the next approximately two years that is intended to establish a streamlined and modernized product portfolio to address customer needs and position Hospirafor future innovation and growth, while supporting continued advancement of device remediation, including device quality improvement efforts. Actions include investments in (i) modernizing and streamlining Hospira'sinstalled base of devices through retirement and replacement programs, (ii) strengthening device quality systems/processes and (iii) developing next generation technology with additional safety features to support further modernization of its installed base. The Device Strategy builds on Hospira'scomprehensive device review of its global installed base of infusion pumps. Hospirahas communicated this strategy to the FDAand other global regulatory agencies, and has been working with these agencies. Under the retirement and replacement actions, Hospirawill focus on retiring less robust and/or older pump technology from the market and initiating customer replacement programs. Hospiraanticipates, among alternatives to be provided to customers, that it will offer customer sales allowances and/or accommodations which may be used as a credit for transition to alternative technology. The majority of the activity includes: • retirement of Symbiq™ infusion pumps and older legacy Plum™ pumps,
replacing these devices with Plum A+™ pumps and future devices under
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• retirement of GemStar™ ambulatory pumps, replacing these devices with
Sapphire™ pumps in markets where the device is available, such as the U.S.
(where the Sapphire™ pump was given regulatory clearance by the
and distributes the Sapphire™ pump through a distribution agreement with Q
Core Medical, Ltd.; and • retirement of older legacy PCA pumps, replacing these devices with LifeCare PCA™ or Sapphire™ pumps. Hospirawill continue to support the affected pumps during the retirement and replacement period. In the U.S, Hospirawill begin to transition customers in the upcoming quarters over to Hospira'sstreamlined portfolio of remediated devices. See the section captioned "Certain Quality and Product Related Matters - Warning Letter ( August 2012) and Related Matters" within this Item for a description of international regulatory matters that could impact Hospira'sability to move forward with transitioning customers outside of the U.S. In connection with the Device Strategy, Hospiraexpects to incur aggregate charges related to these actions in the range of approximately $300 millionto $350 millionon a pretax basis. The total estimated aggregate charges include pre-tax cash costs of approximately $240 millionto $290 million. Major types of cash costs include the following: (i) customer sales allowances; (ii) customer accommodations, contract termination, and pump collection and destruction costs; and (iii) pump retirement and replacement program administration, quality systems/process improvement, consulting costs and other costs. Further, of the total pre-tax charges, approximately $60 millionrelates to non-cash charges for various asset charges, primarily pump inventory charges, other pump-related asset impairments and accelerated depreciation on production equipment and Hospira-owned pumps in service.
In 2013, charges incurred for the Device Strategy, primarily in the
Line Item in the Consolidated (dollars in millions) 2013 Statement of (Loss) Income Customer sales allowances
$ 104.3Net sales Consulting, customer accommodations, contract termination, collection and destruction, and other costs 65.2 Cost of products sold Inventory charges 45.5 Cost of products sold Other asset impairments and accelerated depreciation 11.9 Restructuring and impairment Total charges $ 226.9In 2014, Hospiraexpects to incur aggregate charges of approximately $30 millionto $40 millionrelated to the Device Strategy. The amount, timing and recognition of additional charges associated with the Device Strategy over the anticipated time period will be affected by the nature of spending and the occurrence of commitments and triggering events, among other factors. The Device Strategy charges above are exclusive of other device product-related and comprehensive product review charges. In this regard, see matters discussed above under "Certain Quality and Product Related Matters." For more information about risks related to these matters, see the sections captioned " Hospiramay not be able to realize all of the expected benefits of its global device strategy, could incur additional costs to execute the strategy, or could encounter unforeseen difficulties in implementing the strategy, all of which could adversely affect Hospira'sbusiness or operating results" in "Item 1A. Risk Factors" of this report.
Patent-Related Product Matters
Hospirais involved in patent-related disputes with certain companies with branded products over its efforts to market generic pharmaceutical products and with companies regarding certain of Hospira'sPrecedex™ patents. Hospirafaces potential generic competition for Precedex™ including certain legal proceedings challenging Hospira'spatents relating to Precedex™. The outcome of patent litigation, the timing of patent expirations, the breadth of patent coverage, the success of life-cycle management programs and other factors will impact the timing and extent of generic competition. For further details regarding Hospira'spatents and other patent-related litigation, see the section captioned "Product Development and Product Launches" within this Item 7, and see Note 25 to the consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data" of this report. It is possible that Hospiracould face generic competition at any time which would have a material adverse impact on Hospira'ssales of Precedex™ and related results of operations. 41
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December 2013, Hospiraentered into a settlement agreement in its patent litigation over Precedex™ with Sandoz, Inc.and Sandoz Canada, Inc.(collectively "Sandoz"), related to Sandoz's "Paragraph IV" notice indicating that it has filed an abbreviated new drug application with the FDAfor a generic version of Precedex™. The agreement provides for a market entry date for Sandoz to sell a generic version of Precedex™ no later than December 26, 2014. The agreement also includes a number of accelerator provisions which, if triggered, could lead to an earlier Sandoz market entry date, and is subject to standard contingencies. Hospiraand Sandoz have filed a Motion to Vacate the invalidity ruling for U.S. Patent No. 6,716,867 and Caraco has filed a Motion to Intervene. On January 15, 2014, the FDAopened a public docket to solicit comment from potential generic competitors of Precedex™ regarding the ability of potential competitors to "carve-out" indications for Precedex™ and potentially achieve final product approval at any time. Depending on how it rules, action by the FDAcould lead to a generic launch of Precedex™ anytime thereafter.
For more information about risks related to these matters, see the sections captioned "If Hospira is unable to protect its intellectual property rights, its business and prospects could be harmed" and "If Hospira infringes the intellectual property rights of third parties,
Hospiramay face legal action, adverse damage awards, increased costs and delays in marketing new products" in "Item 1A. Risk Factors" of this report.
Results of operations
A comparison of product line net sales by segment is as follows:
Percentage change at Percent Change Actual at Constant Currency Rates Currency Rates(1) Years Ended
December 31(dollars in millions) 2013 2012 2011 2013 2012 2013 2012 Americas- Specialty Injectable Pharmaceuticals $ 2,163.0 $ 1,991.0 $ 2,000.98.6 % (0.5 )% 9.1 % 0.1 % Medication Management 629.9 846.8 809.4 (25.6 )% 4.6 % (25.0 )% 5.0 % Other Pharma 382.9 401.6 396.2 (4.7 )% 1.4 % (4.3 )% 1.4 % Total Americas 3,175.8 3,239.4 3,206.5 (2.0 )% 1.0 % (1.4 )% 1.5 % EMEA- Specialty Injectable Pharmaceuticals 332.9 318.4 292.6 4.6 % 8.8 % 1.7 % 16.6 % Medication Management 97.8 119.9 128.7 (18.4 )% (6.8 )% (20.9 )% 0.2 % Other Pharma 77.9 87.5 96.1 (11.0 )% (8.9 )% (10.6 )% (5.7 )% Total EMEA 508.6 525.8 517.4 (3.3 )% 1.6 % (5.5 )% 8.4 % APAC- Specialty Injectable Pharmaceuticals 263.5 260.6 269.0 1.1 % (3.1 )% 7.3 % (2.0 )% Medication Management 42.1 49.8 49.2 (15.5 )% 1.2 % (12.0 )% 1.2 % Other Pharma 12.8 16.5 15.0 (22.4 )% 10.0 % (21.8 )% 10.0 % Total APAC 318.4 326.9 333.2 (2.6 )% (1.9 )% 2.9 % (1.0 )% Net Sales(2) $ 4,002.8 $ 4,092.1 $ 4,057.1(2.2 )% 0.9 % (1.6 )% 2.2 % Specialty Injectable Pharmaceuticals("SIP") include generic injectables, proprietary specialty injectables and, in certain markets, biosimilars. Medication Management includes infusion pumps, related software, services, dedicated administration sets, gravity administration sets, and other device products. Other Pharma includes large volume I.V. solutions, nutritionals and contract manufacturing. 42
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(1) The comparisons at constant currency rates reflect comparative local currency balances at prior periods' foreign exchange rates.
Hospiracalculated these percentages by taking current period reported Net sales less the respective prior period reported Net sales, divided by the prior
period reported Net sales, all at the respective prior period's foreign
exchange rates. This measure provides information on the change in Net
sales assuming that foreign currency exchange rates have not changed
between the prior and the current period. Management believes the use of
this measure aids in the understanding of changes in Net sales without the
impact of foreign currency and provides greater transparency into
to monitor business unit performance and in evaluating management
performance. These measures are intended to supplement the applicable GAAP
measures and should not be considered in isolation from or a replacement
for, financial measures prepared in accordance with GAAP.
(2) Net sales for the year ended
product line, including
million in the EMEA segment and
to the Device Strategy. Excluding this charge, Net sales increased 0.4%, or increased 0.9% further excluding the impact of changes in foreign exchange rates. See the section captioned "Device Strategy" above for further information.
Net sales in all segments were adversely impacted by
2013 compared to 2012: Net sales decreased (2.2)%, or decreased (1.6)% compared to 2012 excluding the impact of changes in foreign exchange rates. Excluding the impact of the Device Strategy charges, Net sales increased 0.4%, or increased 0.9% further excluding the impact of changes in foreign exchange rates. The following discussion, except as noted, reflects changes from the prior period excluding the impact of changes in foreign exchange rates.
AmericasNet sales in the Americassegment decreased (2.0)%, or decreased (1.4)% excluding the impact of changes in foreign exchange rates. Net sales of SIP increased due to certain product price increases in the U.S., the mid-2012 re-launch of oxaliplatin in the U.S., continued volume growth of the proprietary sedation drug Precedex™ and supply recovery in the U.S. This growth was partially offset by price erosion and decreased volume on docetaxel following its 2011 launch. Medication Management Net sales decreased, primarily due to the FDAimport alert prohibiting the importation into the U.S. of the Symbiq™, Plum™, GemStar™, and LifeCare PCA™ infusion pumps and Device Strategy charges. For more information on the retirement of the GemStar™ and Symbiq™ pumps and the Device Strategy, see section "Device Strategy" above. Medication Management Net sales also decreased due to lower sales volume on dedicated sets and consumables. Other Pharma Net sales decreased due to lower contract manufacturing volumes.
Net sales in the EMEA segment decreased (3.3)%, or decreased (5.5)% excluding the impact of changes in foreign exchange rates. SIP Net sales increased due to continued strong sales volume of biosimilar products Nivestim™ and Retacrit™. Additionally,
Hospira'sthird biosimilar, Inflectra™ was launched in Europeduring 2013 into several early-launch countries. This growth was partially offset by lower anti-infective and oncology product sales due to increased competition and price erosion. Medication Management Net sales decreased, primarily due to reduced sales volume on other device products due to regulatory agency restrictions on Plum™ and GemStar™ infusion pumps and Device Strategy charges. For more information on the retirement of the GemStar™ pump and the Device Strategy, see section "Device Strategy" above. These decreases were slightly offset with higher sales volume on dedicated sets for Plum™ infusion pumps and the mid-2013 launch of the Sapphire™ infusion pump. Other Pharma Net sales decreased due to lower contract manufacturing volumes. 43
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Net sales in the APAC segment decreased (2.6)%, or increased 2.9% excluding the impact of changes in foreign exchange rates. SIP Net sales increased primarily due to increased sales volume of paclitaxel in
Chinaand continued volume growth of Precedex™ in Japan. Medication Management Net sales were lower primarily due to lower sales volumes on Plum™ and GemStar™ infusion pumps due to regulatory agency restrictions and Device Strategy charges. For more information on the retirement of the GemStar™ pump and the Device Strategy, see section "Device Strategy" above. Other Pharma Net sales decreased due to lower contract manufacturing volumes. 2012 compared to 2011: Net sales increased 0.9%, or increased 2.2% compared to 2011 excluding the impact of changes in foreign exchange rates. The following discussion, except as noted, reflects changes from the prior period excluding the impact of changes in foreign exchange rates. Net sales in all segments were adversely impacted by Hospira'sinability to ship certain products to the market and to gain regulatory approval for certain new products due to the ongoing quality remediation efforts. AmericasNet sales in the Americassegment increased 1.0%, or increased 1.5% excluding the impact of changes in foreign exchange rates. Net sales of SIP were essentially flat due to various offsetting factors. The 2012 re-launch of oxaliplatin in the U.S. and continued volume growth of the proprietary sedation drug, Precedex™, had a positive impact on Net sales. Furthermore, Hospiraimplemented certain base product price increases in the U.S. beginning in the second half of 2012 which favorably impacted Net sales. These results were offset due to expected price erosion following the 2011 docetaxel launch partially offset by increased docetaxel volume compared with the same period in 2011. In addition, Net sales were also negatively impacted due to similar pricing and volume progression for new product launches in prior periods and supply constraints for certain products related to quality remediation efforts. Medication Management Net sales were higher primarily due to increased sales volumes for Plum™ infusion pumps and Hospira'sMedNet™ safety software. Other Pharma Net sales increased slightly due to higher contract manufacturing volumes partially offset by lower volumes for solution and nutritional products. EMEA Net sales in the EMEA segment increased 1.6%, or increased 8.4% excluding the impact of changes in foreign exchange rates. SIP Net sales increased due to strong volumes of generic meropenem, launched in 2011, and biosimilar products Nivestim™ and Retacrit™. Increases in generic volumes were offset by price decreases resulting primarily from competition for certain oncology products. Medication Management Net sales were slightly higher primarily due to increased volumes of GemStar™ dedicated sets partially offset by decreased volumes of Plum dedicated sets and consumables. Other Pharma Net sales decreased due to lower contract manufacturing volumes.
Net sales in the APAC segment decreased (1.9)%, or decreased (1.0)% excluding the impact of changes in foreign exchange rates. SIP Net sales were adversely impacted primarily due to lower volumes on proprietary drugs and price decreases on certain oncology products, including the expected price erosion following the 2011 docetaxel launch. These decreases were moderately offset with higher volumes on certain oncology products, including paclitaxel in
Chinaand continued growth of Precedex™ in Japan. Medication Management Net sales were higher primarily due to increased sales volumes on Plum™ and GemStar™ dedicated sets and consumables. Other Pharma Net sales increased due to higher contract manufacturing volumes.
Gross profit (Net sales less Cost of products sold)
2011 2013 2012 Gross profit
$ 1,080.5 $ 1,113.4 $ 1,397.6(3.0 )% (20.3 )% As a percent of Net sales 27.0 % 27.2 % 34.4 % 44
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2013 compared to 2012:
Gross profit decreased
Gross profit decreased in 2013 primarily due to charges of
$215.0 millionrelated to the Device Strategy. Gross profit also decreased in 2013 due to lower docetaxel sales, higher manufacturing spending related to strengthening quality, compliance and production processes, and lower sales on medication management products. These impacts were partially offset by lower charges associated with certain quality and product related matters, higher pricing on SIP products in the U.S. initiated in the second half of 2012 and continuing in 2013, and strong Precedex™ sales in the U.S. 2012 compared to 2011:
Gross profit decreased
Gross profit decreased in 2012 primarily due to charges associated with continuous improvement and certain quality and product related matters, higher manufacturing spending related to strengthening quality, compliance and production processes, and other manufacturing inefficiencies. Further, gross profit decreased due to expected price erosion primarily related to the 2011 docetaxel launch and similar progression for new product launches in prior periods. In 2012, and to a lesser extent in 2011, Net sales volume was lower due to supply constraints for certain products related to quality remediation efforts. These decreases were partially offset by higher sales volume in certain products including strong Precedex™ sales in the U.S. and the U.S. re-launch of oxaliplatin during the third quarter of 2012 as well as base product price increases in the U.S. Restructuring and impairment Percent change Years Ended December 31 (dollars in millions) 2013 2012 2011 2013 2012 Restructuring and impairment
$ 19.6 $ 63.3 $ 44.5(69.0 )% 42.2 % As a percent of Net sales 0.5 % 1.5 % 1.1 %
In 2013, Restructuring and impairment was
In 2012, Restructuring and impairment was
$63.3 millionof which $49.3 millionwas due to impairments and other charges related to Hospira'sfacility optimization and other restructuring-related activities. In addition, a total of $14.0 millionof intangible asset impairment charges were recognized in 2012. These impairment charges related primarily to a customer relationship intangible asset due to anticipated delayed launch dates for certain products. In 2011, Restructuring and impairment was $44.5 millionand included the following: intangible asset impairments of $25.9 million, distributor contract termination costs of $7.8 millionincurred for restructuring of certain Latin Americaoperations, an equipment impairment charge of $7.1 million, and restructuring charges of $3.7 millionrelated to Project Fuel, which was completed in early 2011. Goodwill impairment Percent change
2013 2012 Goodwill impairment $ - $ -
$ 400.2nm nm As a percent of Net sales nm nm 9.9 %
nm - Percentage change is not meaningful.
During the third quarter of 2011,
Hospiraperformed its annual goodwill impairment test. Hospiradetermined that the EMEA reporting unit's goodwill carrying value was in excess of its estimated fair value. Hospiraconsidered the current EMEA economic environment and the decline in Hospira'scommon stock price beginning late in the third quarter of 2011, which required an increase in the discount rate used to present value the estimated cash flows in order to reconcile Hospira'smarket 45
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capitalization to the aggregate estimated fair value of all of
Hospira'sreporting units. In addition, factors that contributed to the estimated fair value of the EMEA reporting unit being below its carrying value include (i) a decrease in projected revenues and operating margins due to continued competition and related price pressure and overall European region market conditions, and (ii) higher spending expected for strategic product portfolio expansion, in the near-term to mid-term with benefit to revenues and operating margin trailing the increased spending. Accordingly, Hospirarecognized a goodwill impairment charge of $151.2 millionfor the EMEA reporting unit as the implied fair value of goodwill, a non-recurring Level 3 fair value measurement, was less than its carrying value. During the fourth quarter of 2011, based on a combination of factors, including continued declines in Hospira'scommon stock price and declines in projected revenue and operating margins in all reporting units, Hospiraconcluded that there were sufficient indicators to require an interim goodwill impairment test for the EMEA and former APAC reporting units. Hospiraperformed the interim goodwill impairment test as of December 31, 2011, which indicated that the EMEA and former APAC reporting units' estimated fair value was below their respective carrying value. Accordingly, Hospirarecognized goodwill impairment charges of $77.9 millionand $171.1 millionfor the EMEA and former APAC reporting units respectively, as the implied fair value of goodwill, a non-recurring Level 3 fair value measurement, was less than their respective carrying value. Research and development Percent change
$ 301.7 $ 303.6 $ 258.8(0.6 )% 17.3 % As a percent of Net sales 7.5 % 7.4 % 6.4 % 2013 compared to 2012: R&D decreased $(1.9) million, or (0.6)%, in 2013, compared to 2012. In 2013, there was increased spending on a clinical trial for EPO in the U.S, generic pharmaceuticals product development for global expansion and R&D support activities, which was offset by reimbursements for development funding of $50.0 million, recognized as an offset to R&D expense, in connection with the NovaQuest agreement. For more information on the NovaQuest agreement, see Note 5 to the consolidated financial statements in "Item 8. Financial Statements and Supplementary Data" of this report.
2012 compared to 2011:
R&D expenses increased
$44.8 millionor 17.3% in 2012, compared to 2011 primarily due to higher spending in 2012 on a clinical trial for EPO, generic pharmaceuticals product development for global expansion and regulatory filing fees, and development for device products.
Selling, general and administrative
$ 742.6 $ 687.7 $ 637.38.0 % 7.9 % As a percent of Net sales 18.6 % 16.8 % 15.7 % 2013 compared to 2012: SG&A expenses increased $54.9 millionor 8.0%, in 2013, compared to 2012. The increase was due to increased selling and promotional expense for expansion in emerging markets and various products including Precedex™, legal costs and employee-related compensation expenses.
2012 compared to 2011:
SG&A expenses increased
$50.4 millionor 7.9%, in 2012, compared to 2011. The increase was due to higher costs associated with certain sales and promotional expenses for various emerging markets, and certain products including Precedex™. Costs were also higher for compensation, pension and other post-retirement benefits, and information technology. 46
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Interest expense slightly decreased in 2013 compared to 2012 due to higher capitalized interest on capital projects partially offset by higher interest expense associated with an overlap of outstanding debt for senior notes issued and senior notes redeemed.
Interest expense decreased in 2012 compared to 2011 primarily due to higher capitalized interest on capital projects partially offset by higher interest on other borrowings for international operations in
Refer to the section captioned "Liquidity and Capital Resources" below for further information regarding
Other expense (income), net
Other expense (income), net was
Other expense (income), net increased in 2013 compared to 2012 due to
The net expense in 2012 compared to net income in 2011 was primarily the result of certain investment impairments of
Foreign exchange loss (gain), net for 2013, 2012, and 2011 were
$9.1 million, $9.2 million, and $(2.8) million, respectively. Interest income for 2013, 2012 and 2011 was $5.3 million, $5.9 million, and $10.4 million, respectively.
Income tax (benefit) expense
The effective tax rate was a benefit of 79.8% for the year ended
December 31, 2013, compared to a benefit of 121.7% and expense of 103.0% in 2012 and 2011, respectively. The effective tax rates for all three years were impacted by certain items such as Device Strategy charges, integration, quality and product related matters, continuous improvement related charges and interest expense generating benefits in higher tax rate jurisdictions. These effective tax rates in these periods differ from the statutory U.S. federal income tax rate principally due to the benefit of tax exemptions, of varying durations, in certain jurisdictions outside the U.S. as well as lower statutory tax rates in substantially all non-U.S. jurisdictions in which Hospiraoperates. In 2012 the Internal Revenue Service ("IRS") commenced the audit of Hospira's2010 and 2011 U.S. federal tax returns. In addition, Hospiraremains open to tax audits in other jurisdictions and various tax statutes of limitation are expected to close within the next 12 months. Hospiraestimates that up to $10 millionof unrecognized tax benefits may be recognized within the next twelve months. In January 2013, the American Taxpayer Relief Act of 2012 was enacted, retroactively reinstating the federal research and development tax credit and other corporate provisions for the 2012 and 2013 tax years. As a result, the income tax provision for fiscal 2013 includes a discrete tax benefit of $13.8 millionrelated to 2012. Without this item, the 2013 effective tax rate was a benefit of 68.6%. 2013 compared to 2012: The tax benefit during both periods resulted from the impact of higher quality and device-related charges incurred in higher tax rate jurisdictions. Effective tax rates are generally less than the statutory U.S. federal income tax rate due to the benefit of tax exemptions of varying durations in certain jurisdictions outside the U.S. During 2013, the portion of income historically benefiting from these exemptions was negatively impacted by Device Strategy charges creating an unfavorable comparison to the 2012 tax benefit. 47
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2012 compared to 2011:
December 2012, the IRSaudit of Hospira's2008 and 2009 U.S. federal tax returns was concluded and the years were effectively settled. The audit settlement resulted in $18.8 millionof a discrete tax expense recognized in the fourth quarter. Excluding this audit settlement, the effective tax rate for 2012 is a benefit of 166.7%. In 2011, the effective tax rate was significantly impacted by the mostly non-deductible EMEA and former APAC reporting units' goodwill impairments. Also in 2011, the IRSaudit of Hospira's2006 and 2007 U.S. federal tax returns was concluded and the years were effectively settled. The audit settlement resulted in a $19.7 milliondiscrete income tax benefit. Excluding these goodwill impairment charges and the IRSaudit settlement, the effective rate for 2011 was an expense of 14.1%.
Equity Income From Affiliates, Net
Equity income from affiliates, net was
$16.6 millionin 2013, $35.1 millionin 2012, and $45.6 millionin 2011. The decreases in 2013 and 2012 are primarily due to income from Hospira'sjoint venture associated with the U.S. launch of docetaxel in 2011 and subsequent price erosion associated with increased competition in 2013 and 2012.
Liquidity and Capital Resources
Net cash provided by operating activities continues to be
Hospira'sprimary source of funds to finance operating needs, the pending acquisition of Orchid's penem and penicillin API business, capital expenditures, certain quality and product related matters, research and development related expenditures, common stock repurchases and repayments of debt. Other capital resources include cash on hand, borrowing availability under the revolving credit facility, other uncommitted lines of credit in certain international countries and access to the capital markets. In addition, Hospiramay enter into further development alliances and collaborations to fund Hospira'sresearch and development activities. Hospirabelieves that its current capital resources will be sufficient to finance its operations, including debt service obligations, capital expenditures, the pending acquisition of Orchid's penem and penicillin API business, product development and investments in continuous improvement, quality-related activities, and Device Strategy initiatives for the foreseeable future. Of the total cash and cash equivalents at December 31, 2013, approximately $353 millionis held in foreign jurisdictions. Hospiraregularly reviews its needs in the U.S. for possible repatriation of foreign subsidiary earnings, and intends to permanently invest all foreign subsidiary earnings outside of the U.S. Hospiraplans to use these foreign subsidiary earnings and cash held outside the U.S. in its foreign operations to fund foreign investments or meet foreign working capital and capital expenditure needs. Hospirabelieves that its current U.S. cash flow from operations, U.S. cash balances, borrowing capacity under its credit facility and access to capital markets are sufficient to meet U.S. operating and strategic needs. Additionally, Hospirautilizes certain funding strategies in an effort to ensure its worldwide cash is available in the locations in which it is needed. For the foregoing reasons, Hospirahas no intention of repatriating cash held in foreign locations. Under current U.S. tax laws, if funds were repatriated for use in Hospira'sU.S. operations, Hospiracould be required to pay additional income taxes, net of available foreign tax credits, at the tax rates then in effect. Future changes in U.S. tax legislation could cause Hospirato reevaluate the possible repatriation of foreign subsidiary earnings. Hospirahas incurred and expects to incur further charges and higher capital expenditures related to certain quality and product-related matters, the Device Strategy, and continuous improvement activities that will require cash outflows in the future. These matters are further discussed above under sections captioned "Certain Quality and Product Related Matters," "Device Strategy," and "Continuous Improvement Activities." Hospiracurrently believes current capital resources will be sufficient to fund capital expenditures and costs associated with these activities. Specific to acquisitions, the pending transaction to acquire Orchid's penem and penicillin API business is for approximately $218 millionin cash. The purchase price is fixed in Indian rupees and subject to change depending on the movement of foreign currency rates through closing. The transaction is expected to be completed in the first half of 2014, but Hospiracan give no assurance that the transaction will be consummated during that time period, or at all. Hospirahas and may continue to make advances to Orchid to supply certain API products, some of which may be settled upon the pending close of the transaction or settled upon receipt of the API products. The outstanding Orchid supplier advances of $36.4 millionas of December 31, 2013are interest bearing, primarily unsecured and subject to credit risk. For more information about risks related to this matter, see the section captioned " Hospira'sproposed acquisition of an API business from Orchid may not result in the anticipated benefits, or may not be completed in a timely or cost-effective matter, or at all" in "Item 1A. Risk Factors" of this report. In 2013, 2012 and 2011, Hospiraadvanced $15.0 million, $10.0 millionand $50.0 million, respectively, to Celltrion for the expected purchase of certain biosimilar products. As of December 31, 2013, Hospirahas received $7.2 millionin inventory 48
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against these advances. Additional supplier advances in aggregate of
$25.0 millionfor these products may be required over the next two years, the timing of which is based on estimated regulatory approval dates and commercial launch dates. These supplier advances are refundable under certain conditions, interest free and unsecured. Hospiramay distribute and market additional products sourced from Celltrion which would require additional advances. Summary of Sources and (Uses) of Cash Years Ended December 31 (dollars in millions) 2013 2012 2011 Operating activities $ 317.4 $ 478.0 $ 434.4Investing activities (370.3 ) (304.0 ) (282.3 ) Financing activities 94.3 (0.6 ) (147.0 ) Operating Activities
Net cash provided by operating activities decreased in 2013 compared to 2012 primarily due to increases in inventory, payments related to strengthening quality, manufacturing and compliance functions and higher income tax payments, partially offset by distributions received from equity affiliates.
Net cash provided by operating activities increased in 2012 compared to 2011 primarily due to lower investments in working capital including lower income tax payments, supplier advances, employee benefit-related payments and the timing of joint venture profit-share payments. This increase in operating cash flows was partially offset by increased spending for certain quality and product related matters, investments in strengthening commercial, quality, manufacturing and compliance functions, and research and development initiatives. In addition, there were no distributions received from equity affiliates in 2012 compared to 2011. Cash flows provided by operating activities for 2011 were adversely impacted by higher inventory levels due to increased cycle times.
Net cash used in investing activities was higher in 2013 compared to 2012 primarily due to higher capital expenditures at several of
Net cash used in investing activities was higher in 2012 compared to 2011 primarily due to acquisition payments for the pending transaction to acquire Orchid's penem and penicillin API business.
Net cash provided by (used in) financing activities in 2013 was
$94.3 millioncompared to $(0.6) millionin 2012. The increase in 2013 is due to increased borrowings to support non-U.S. operations and Hospira'srefinancing of certain senior unsecured notes, as described below, with net proceeds of $41.8 million, which are offset by payments of $39.8 millionfor the early extinguishment of the notes. Net cash used in financing activities in 2012 was $(0.6)compared to $(147.0) millionin 2011. In 2011, Hospirarepurchased $200.0 millionof common stock compared to no repurchases in 2012. In addition, there were lower stock option exercise proceeds during 2012 compared to the same period in 2011 due to Hospira'slower common stock market values in 2012.
Summary of Financial Position As of
$ 798.1 $ 772.1Working capital 1,673.4 1,731.2
Short-term borrowings and long-term debt 1,840.7 1,735.7
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Working Capital (Total Current Assets less Total Current Liabilities)
The slight decrease in available working capital as of
December 31, 2013compared to December 31, 2012was primarily due to increases in current liabilities, including higher borrowings to support non-U.S. operations, higher trade accounts payable due to the timing of vendor payments and capital expenditures and higher accrued operating expenses. Debt and Capital Senior Notes. Hospira'ssenior notes as of December 31, consisted of the following: (dollars in millions) 2013 2012 5.90% Notes due June 2014 $ - $ 400.06.40% Notes due May 2015 - 250.0 6.05% Notes due March 2017 550.0 550.0 5.20% Notes due August 2020 350.0 - 5.80% Notes due August 2023 350.0 -
5.60% Notes due
$ 1,750.0 $ 1,700.0In August 2013, Hospiraissued, in a registered public offering, $350.0 millionprincipal amount of 5.20% notes due on August 12, 2020and $350.0 millionprincipal amount of 5.80% notes due on August 12, 2023("2020 and 2023 Notes"). In September 2013, the net proceeds of the 2020 and 2023 Notes, after deducting approximately $2.1 millionof bond discounts and underwriting fees of $6.1 millionplus cash on-hand, were used to extinguish $400.0 millionprincipal amount of 5.90% notes originally due June 2014("2014 Notes"), $250.0 millionprincipal amount of 6.40% notes originally due May 2015("2015 Notes"), accrued interest and a make-whole premium payment of $39.8 million. In aggregate, Hospiraincurred $33.4 millionin charges associated with the early extinguishment of the 2014 and 2015 Notes, which are reported in Other expense (income), net for the year ended December 31, 2013. The early debt extinguishment charges include a make-whole premium, write-off of previously capitalized debt issuance costs, discounts and deferred gains on interest rate hedges.
The senior notes contain customary covenants that limit
Interest Rate Swaps. In
August 2013, Hospiraterminated the forward starting interest rate swaps, notional amount of $550.0 million, which had effectively fixed the benchmark interest rates upon entering into the transactions in July 2013and up to the issuance of the 2020 and 2023 Notes. As a result of the swap terminations, Hospirapaid $3.6 million, including interest. The corresponding loss of $3.6 millionwill be deferred in Accumulated other comprehensive loss and amortized into Interest expense over the terms of the 2020 and 2023 Notes, respectively. In July 2011, Hospiraterminated, without penalty, interest rate swap contracts originally entered into in December 2010with a total notional amount of $400.0 million, which had effectively converted from fixed to variable rate debt $250.0 millionof the 2014 Notes and $150.0 millionof the 2015 Notes. As a result of the swap terminations Hospirareceived $9.0 millionin cash, including accrued interest. In June 2010, Hospiraterminated, without penalty, interest rate swap contracts originally entered into in 2009 with a total notional amount of $300.0 million, which had effectively converted from fixed to variable rate debt $200.0 millionof the 2014 Notes and $100.0 millionof the 2015 Notes. As a result of the swap terminations, Hospirareceived $15.4 millionin cash, including accrued interest. The corresponding 2011 and 2010 terminated swap contract gains described above related to the basis adjustment of the debt associated with the contracts were deferred and were amortized as a reduction of interest expense over the remaining term of the related 2014 and 2015 Notes until the early extinguishment when the deferred gains, of $7.7 million, were written off to Other expense (income), net. Prior to early extinguishment, the gains recognized against interest expense over the term of the underlining 2014 and 2015 Notes, were $3.2 million, $6.7 millionand $5.6 million, in 2013, 2012 and 2011, respectively.
The cash flows from these interest rate contracts are reported as operating activities in the consolidated statements of cash flows.
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Other Borrowings. In connection with acquisitions, facility expansions, international capital structure optimization and equipment lease requirements,
Hospiramay enter into other borrowings including mortgages, lease arrangements and promissory notes. Additionally, Hospiraenters into uncommitted lines of credits in certain international countries, available for general entity purposes in their respective countries that are subject to banks' approval. These borrowings bear a weighted average interest rate of 6.5% and 6.2% at December 31, 2013and 2012, respectively, with principal and interest due in various intervals, and are primarily unsecured. As of December 31, 2013and 2012, Hospirahad $4.4 millionand $8.0 millionof indebtedness secured by equipment and property, respectively. As of December 31, 2013and 2012, Hospirahad $95.3 millionand $26.4 million, respectively, of other borrowings outstanding, of which $93.7 millionand $22.1 million, respectively, were classified as short-term. Revolving Credit Facility. In 2011, Hospiraentered into a $1.0 billionunsecured revolving credit facility (the "Revolver") maturing in October 2016. The Revolver replaced the $700.0 millionrevolving credit agreement that was scheduled to expire in October 2012. The Revolver is available for general corporate purposes. Borrowings under the Revolver bear interest at LIBORor a base rate plus a margin. Hospiraalso pays a facility fee on the aggregate amount of the commitments under the Revolver. The annual percentage rates for the LIBORmargin, the base rate margin and the facility fee are 1.25%, 0.25% and 0.25%, respectively, and could be subject to increase or decrease if there is a change in Hospira'scredit ratings. The amount of available borrowings may be increased to a maximum of $1.3 billion, under certain circumstances. For the year ended and as of December 31, 2013, Hospirahad no amounts borrowed or otherwise outstanding under the Revolver, and Hospirahad approximately $638 millionof availability for borrowings under the Revolver. The availability of funds is limited by financial covenants related to Hospira'sdebt and financial position. For the years ended December 31, 2012and 2011, Hospirahad no amounts borrowed or otherwise outstanding under the Revolver. Debt Covenants. The Revolver and the indenture governing Hospira'ssenior notes contain, among other provisions, covenants with which Hospiramust comply while they are in force. The covenants in the Revolver limit Hospira'sability to, among other things, sell assets, incur secured indebtedness and liens, incur indebtedness at the subsidiary level, and merge or consolidate with other companies. The covenants in the indenture governing Hospira'ssenior unsecured notes limit Hospira'sability, among other things, to incur secured indebtedness, enter into certain sales and lease transactions and merge or consolidate with other companies. Hospira'sdebt instruments also include customary events of default (including, in the case of the Revolver, a change of control default), which would permit amounts borrowed to be accelerated and would permit the lenders under the revolving credit agreement to terminate their lending commitments. The Revolver has a financial covenant that requires Hospirato maintain a maximum leverage ratio (consolidated total debt to consolidated net earnings before financing expense, taxes and depreciation, amortization, adjusted for certain agreed upon non-cash items and certain product quality related charges) below a stated maximum. On April 30, 2013, Hospiraentered into an amendment to the Revolver that, among other things, permits Hospirato add back certain additional charges related to the items identified above under the sections captioned "Certain Quality and Product Related Matters" and "Device Strategy" when calculating the leverage ratio. In addition, the leverage ratio was increased from 3.50 to 1.00 to 3.75 to 1.00 for the periods ended March 31, 2013through December 31, 2014, reverting to 3.50 to 1.00 thereafter. In connection with the Revolver amendment, Hospiraincurred various fees and expenses of approximately $0.5 million. Such fees and expenses will be amortized to Interest expense over the remaining term of the Revolver.
For the year ended and as of
Share Repurchases. In
April 2011, Hospira'sBoard of Directors authorized the repurchase of up to $1.0 billionof Hospira'scommon stock. In April and May 2011, Hospiraentered into accelerated share repurchase contracts with a third party financial institution to repurchase $200.0 millionin aggregate of Hospira'scommon stock under which Hospirareceived 3.7 million shares. Hospiramay periodically repurchase additional shares under this authorization the timing of which will depend on various factors such as cash generation from operations, cash expenditures required for other purposes, current stock price and other factors. No common stock repurchases were made during the years ended December 31, 2013and 2012.
The following table summarizes
Table of Contents Payment Due by Period 2019 and (dollars in millions) Total 2014 2015-2016 2017-2018 Thereafter Debt and interest payments
$ 2,360.7 $ 190.2 $ 204.4 $ 699.6 $ 1,266.5Lease obligations 134.7 31.1 46.7 29.7 27.2 Purchase commitments(1) 659.9 649.8 10.0 0.1 - Other long-term liabilities reflected on the consolidated balance sheet(2) 201.1 0 175.8 22.9 2.4 Total $ 3,356.4 $ 871.1 $ 436.9 $ 752.3 $ 1,296.1
(1) Purchase obligations for purchases made in the normal course of business to
meet operational and capital requirements.
potential future "milestone" payments to third parties as part of
in-licensing and development agreements. Payments under these agreements are
contingent upon achievement of certain developmental, regulatory and/or
commercial milestones and are not included in the table above. For further
details regarding collaborative and other arrangements, see Note 5 to the
consolidated financial statements included in "Item 8. Financial Statements
and Supplementary Data" of this report.
(2) Includes liability of
penalties and interest; excludes
related primarily to pension and other post-retirement benefit obligations.
Hospira'sother commercial commitments as of December 31, 2013, representing commitments not recorded on the balance sheet but potentially triggered by future events, primarily consist of non-debt letters of credit to provide credit support for certain transactions as requested by third parties. In the normal course of business, Hospiraprovides indemnification for guarantees it arranges in the form of bonds guaranteeing the payment of value-added taxes, performance bonds, custom bonds and bid bonds. As of December 31, 2013, Hospirahad $31.5 millionof these commitments, with a majority expiring from 2014 to 2015. No amounts have been drawn on these letters of credit or bonds. Hospirahas no material exposures to off-balance sheet arrangements, no special purpose entities and no activities that include non-exchange-traded contracts accounted for at fair value. 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. Hospirabelieves 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 included in "Item 8. Financial Statements and Supplementary Data" of this report.
Hospirarecognizes revenues from product sales when persuasive evidence of an arrangement exists, delivery has occurred (or services have been rendered), the price is fixed or determinable and collectability is reasonably assured. For other than certain drug delivery pumps and contract manufacturing, product revenue is recognized when products are delivered to customers and title passes. Contract manufacturing typically involves filling customers' API into delivery systems. Under these arrangements, customers' API is often consigned to Hospiraand revenue is recorded for the materials and labor provided by Hospira, plus a profit, primarily upon shipment to the customer. Upon recognizing revenue from a sale, Hospirarecords 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 other items (such as cash discounts and returns). Provisions for chargebacks and rebates represent the most significant and complex of these estimates. Arrangements with Multiple Deliverables-In certain circumstances, Hospiraenters into arrangements in which it commits to provide multiple elements (deliverables) to its customers. Hospira accounts for sales of drug delivery pumps ("pumps") and server-based suite of software applications ("software"), inclusive of certain software related services, under multi-element arrangements, depending on the functionality of the software associated with the pump, as one or two units of accounting. 52
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Hospiraallocates revenue to arrangements with multiple deliverables based on their relative selling prices. In such circumstances, Hospiraapplies a hierarchy to determine the selling price to be used for allocating revenue to deliverables as follows: (i) vendor-specific objective evidence ("VSOE") of fair value, (ii) third-party evidence of selling price ("TPE"), and (iii) best estimate of the selling price ("ESP"). VSOE generally exists only when Hospirasells the deliverable separately and is the price actually charged by Hospirafor that deliverable. Where VSOE and TPE are not available, Hospira'sprocess for determining ESP includes multiple factors that may vary depending upon the unique facts and circumstances related to each deliverable. Key factors considered in developing the ESP for pumps, software and software related services include prices charged by Hospirafor similar offerings, historical pricing practices, the market and nature of the deliverable and the relative ESP of certain deliverables compared to the total selling price of the arrangement. For certain arrangements where the software is not essential to the functionality of the pump, Hospirahas identified three primary deliverables. The first deliverable is the pump which is recognized as delivered, the second deliverable is the related sale of disposable products ("sets"), which are recognized as the products are delivered and the third deliverable is the software and software related services. Revenue recognition for the third deliverable is further described below in the Software section. The allocation of revenue for the first and second deliverable is based on VSOE and for the third deliverable is based on Hospira'sESP. For other arrangements where the software is essential to the functionality of the pump, Hospirahas also identified three primary deliverables. The first deliverable is the pump and software essential to the functionality of the pump which is delivered and recognized at the time of installation. The second deliverable is the related sale of sets which are recognized as the products are delivered and the third deliverable is software related services. Revenue recognition for the third deliverable is further described below in the Software section. The allocation of revenue for the first and third deliverable is based on Hospira'sESP. The allocation of revenue for the second deliverable is based on VSOE. Software- Hospirarecognizes revenue for the server-based suite of software applications not essential to the functionality of a pump and related maintenance and implementation services in accordance with software specific accounting guidance. Software revenue for multiple-element revenue arrangements is allocated based on the relative fair value of each element, and fair value is generally determined by VSOE. If Hospiracannot objectively determine the fair value of any undelivered element included in such multiple-element arrangements, Hospiradefers revenue until all elements are delivered and services have been performed. Perpetual software license revenue and implementation service revenue are generally recognized as obligations are completed. Software subscription license and software maintenance revenue is recognized ratably over the applicable contract period. Chargebacks-Hospira sells a significant portion of its specialty injectable pharmaceutical products through wholesalers, which maintain inventories of Hospiraproducts and later sell those products to end customers. In connection with its sales and marketing efforts, Hospiranegotiates 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 Hospiraproduct 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 Hospiraback for the difference between the price the wholesaler paid Hospiraand the contract price paid by the end customer (a "chargeback"). Hospirarecords 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'sproduct sales and most recent historical average chargeback credits by product, actual and estimated wholesaler inventory levels, current contract pricing, anticipated future contract pricing changes and claims processing lag time. Hospiraestimates the levels of inventory at the wholesalers through analysis of wholesaler purchases and inventory data obtained directly from certain wholesalers. Hospiraregularly monitors the provision for chargebacks and makes adjustments when it believes the actual chargebacks may differ from earlier estimates. The methodology used to estimate and provide for chargebacks was consistent across all periods presented. Hospira'stotal chargeback accrual for all products was $133.5 millionand $182.2 millionat December 31, 2013and 2012, respectively, and included in Trade receivables on the consolidated balance sheets. Settlement of chargebacks generally occurs between 25 and 37 days after the sale to wholesalers. A one percent decrease in end customer contract prices for sales pending chargeback at December 31, 2013, would decrease Net sales and increase Loss Before Income Taxes by approximately $1.8 million. A one percent increase in units sold subject to chargebacks held by wholesalers at December 31, 2013, would 53
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decrease Net sales and increase Loss Before Income Taxes by approximately
$1.1 million, compared to what Net sales would have been if the units sold were not subject to chargebacks. Rebates- Hospiraoffers 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 Hospiraproducts 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. Hospiraestimates the amount of the rebate due at the time of sale, and records the liability as a reduction of gross sales at the same time the product sale is recorded. Settlement of the rebate generally occurs from 1 to 15 months after sale. In determining provisions for rebates to direct customers, Hospiraconsiders the volume of eligible purchases by these customers and the rebate terms. In determining rebates on sales through wholesalers, Hospiraconsiders 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 "Chargebacks." Upon receipt of a chargeback, due to the availability of product and customer specific information, Hospiracan 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. Hospiraregularly analyzes the historical rebate trends and makes adjustments to recorded accruals for changes in trends and terms of rebate programs. At December 31, 2013and 2012, accrued rebates of $150.4 millionand $143.4 million, respectively, are included in Other accrued liabilities on the consolidated balance sheets. 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 years ended 2013 and 2012: (dollars in millions) Chargebacks Rebates Balance at January 1, 2012 $ 148.2 $ 129.5Provisions 1,431.0 228.7 Payments and releases (1,397.0 ) (214.8 )
975.8 201.1 Payments and releases (1,024.5 ) (194.1 )
Returns-Provisions for returns are provided for at the time the related Net sales are recognized, and are reflected as a reduction of sales. The estimate of the provision for returns is primarily based on historical experience of actual returns. Additionally,
Hospiraconsiders other factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued and entrance in the market of additional competition. This estimate is reviewed periodically and, if necessary, revised, with any revisions recognized immediately as adjustments to Net sales. Accrued returns were $30.4 millionand $28.8 millionas of December 31, 2013and 2012, respectively, and included in Other accrued liabilities and Post-retirement obligations and other long-term liabilities on the consolidated balance sheets.
Inventories are stated at the lower of cost (first-in, first-out basis) or market. Inventory cost includes material and conversion costs.
Hospiramonitors inventories for exposures related to obsolescence, excess and date expiration, non-conformance, product recalls and loss and damage, and recognizes a charge to Cost of products sold for the amount required to reduce the carrying value of inventory to estimated net realizable value. If conditions are less favorable than estimated, additional charges may be required. Inventory reserves were $143.3 millionand $126.8 millionat December 31, 2013and 2012, respectively. 54
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Hospiracapitalizes costs associated with certain products prior to regulatory approval and launch. Hospiracapitalizes product costs, material and conversion costs, in preparation for product launches prior to regulatory approval when the products are considered to have a high probability of regulatory approval. Generic injectable pharmaceutical product capitalization typically occurs no earlier than a formal submission for drug approval with the applicable regulatory authority. For biosimilars, the regulatory pathway may differ for each product and location where the product is launched. Capitalization considerations include the regulatory approval process, required clinical trial phases and results and status thereof, among other factors, but Hospirawould not capitalize biosimilar products earlier than after Phase I study results are final. Hospiramonitors the status of unapproved products on a regular basis and, in making the determination to capitalize the costs, considers the regulatory approval process, specific regulatory risks or other contingencies, such as legal risks or hurdles, or if there are any specific issues identified during the process relating to the safety, efficacy, manufacturing, marketing or labeling of the product. To meet the initial product launch requirements, Hospiracapitalizes product costs based on anticipated future sales and product expiry dates, which support the net realizable value. Expiry dates of the product are affected by the stage of completion. Hospiramanages the levels of products at each stage to optimize the shelf life of the product in relation to anticipated market demand in order to attempt to avoid product expiry issues. If there is a delay in commercialization or regulatory approval is no longer considered highly probable, the capitalized product costs are evaluated and Hospirarecognizes a charge to Cost of products sold for the amount required to reduce the carrying value to estimated net realizable value. Unapproved product inventories were $7.1 millionand $9.1 millionas of December 31, 2013and 2012, respectively, and are included in Prepaid expenses in the consolidated balance sheets. Unapproved product reserves were $2.3 millionand $6.7 millionas of December 31, 2013and 2012, respectively.
Stock-based compensation transactions are recognized as compensation cost over the vesting period based on the fair value of the instrument on the date of grant.
Hospirauses the Black-Scholes option valuation model and the Monte Carlo simulation model to determine the fair value of stock options and performance share awards, respectively. The fair value models include various assumptions, including the expected volatility, expected life of the awards and forfeiture rates. These assumptions reflect Hospira'sbest estimates, but they involve inherent uncertainties based on market conditions generally outside of Hospira'scontrol. As a result, if other assumptions had been used, stock-based compensation expense, as calculated, could have been materially impacted. Furthermore, if Hospirauses different assumptions for future stock-based compensation transactions, stock-based compensation expense could be materially impacted in future periods. See Note 24 to the consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data" of this report for additional information regarding stock-based compensation.
Pension and Other Post-Retirement Benefits
Hospiraprovides pension and other post-retirement medical and dental benefits to certain of its active and retired employees based both in and outside of the U.S. Hospiradevelops assumptions, the most significant of which are the discount rate, the expected rate of return on plan assets and the 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. These assumptions involve inherent uncertainties based on market conditions generally outside of Hospira'scontrol. Assumption changes could affect the reported funded status of Hospira'splans and, as a result, could result in higher funding requirements and net periodic benefit costs. The U.S. discount rate estimates were developed with the assistance of actuarially developed yield curves. For non-U.S. plans, benchmark yield data for high-quality fixed income investments for which the timing and amounts of payments match the timing and amounts of projected benefit payments is used to derive discount rate assumptions. The expected return on assets for the pension plans represent the average rate of return to be earned on plan assets over the period the benefits are expected to be paid. The expected return on assets are developed from the expected future return of each asset class, weighted by the expected allocation of pension assets to that asset class. Hospiraconsiders historical performance for the types of assets in which the plans invest, independent market forecasts and economic and capital market conditions.
Sensitivity analysis for U.S. plans which represent the primary portion of obligations is as follows:
Table of Contents Year Ended December 31, As of December 31, 2013 2013 Net Benefit Cost Benefit Obligation (Income)/Expense (Decrease)/Increase One One One One Percentage- Percentage- Percentage- Percentage- Point Point Point Point (dollars in millions) Increase Decrease Increase Decrease Pension Plan-U.S. Discount rate
$ (4.3 ) $ 5.0 $ (59.5 ) $ 72.6Expected long-term return on assets (4.6 ) 4.6 - - Medical and Dental Plan-U.S. Discount rate (0.1 ) 0.1 (4.6 ) 5.6 Expected healthcare cost trend rate (initial and ultimate) 0.5 (0.5 ) 5.3 (4.5 )
Impairment of Long-Lived and Other Assets
Property and Equipment and Intangible Assets, Net-The carrying value of long-lived assets, including amortizable intangible assets and property and equipment, are reviewed whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Impairment of assets with definite-lives is generally determined by comparing projected undiscounted cash flows to be generated by the asset, or appropriate grouping of assets, to its carrying value. Indefinite-lived intangible assets are tested for impairment at least annually, or more frequently if an event occurs or circumstances change that would reduce the fair value below its carrying value. If an impairment is identified, a loss is recorded equal to the excess of the asset's net book value over its fair value, and the cost basis is adjusted. Determining the extent of an impairment, if any, typically requires various estimates and assumptions including using management's judgment, cash flows directly attributable to the asset, the useful life of the asset and residual value, if any. When necessary,
Hospirauses internal cash flow estimates, quoted market prices and appraisals as appropriate to determine fair value. Actual results could vary from these estimates. In addition, the remaining useful life of the impaired asset is revised, if necessary. Goodwill-Goodwill represents the excess of the purchase price and related costs over the value assigned to the net tangible and identifiable intangible assets of businesses acquired. Goodwill is not amortized but is evaluated for impairment at least annually, using either a qualitative assessment, if elected, or a quantitative test. Goodwill can be tested more frequently if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. The qualitative assessment allows Hospirato first assess qualitative factors to determine whether it is more likely than not that the reporting unit's fair value is less than its carrying amount. Hospiracompleted its 2013 annual impairment test in the fourth quarter of 2013 in accordance with this policy, electing to bypass the qualitative only assessment. Historically, Hospira'sreporting units included the U.S., Canada, Latin America, EMEA and APAC. During 2013, Hospirasplit the APAC reporting unit into two separate reporting units, Australia and New Zealand("ANZ") and Asiaand Japan("Asia"), creating six total reporting units. During 2013, Hospiratested the ANZ and Asiareporting units as of October 31, 2012, with no identified impairment charges. The change in reporting units will be applicable prospectively. The quantitative goodwill impairment test ("Step-one") is based upon the estimated fair value of Hospira'sreporting units compared to the net carrying value of assets and liabilities. Hospirauses internal discounted cash flow ("DCF") estimates and market value comparisons to determine estimated fair value. If the Step-one test indicates that impairment potentially exists, a second quantitative step ("Step-two") is performed to measure the amount of goodwill impairment, if any. Goodwill impairment exists in Step-two when the implied fair value of goodwill is less than the carrying value of goodwill. The implied fair value of goodwill is determined based on the difference between the fair value of the reporting unit determined in Step-one and the fair value allocated to the identifiable assets, including unrecognized intangible assets, and liabilities of the reporting unit. Prior to 2012, Hospira'spolicy was to perform the annual impairment test for goodwill at September 30of each year. Hospiracompleted its 2012 annual impairment test in the third quarter of 2012 in accordance with this policy electing to bypass the qualitative only assessment, with no identified impairment charges. During the fourth quarter of 2012, Hospirachanged the date of its annual goodwill impairment test to October 31to better align with the timing of its annual and long-term planning process, which is a significant element in the testing process. The fourth quarter test in 2012 resulted in no impairment charges. Hospirabelieves this change in accounting principle is preferable. The change did not delay, accelerate, nor avoid an impairment charge. This change in the goodwill impairment testing date was applied prospectively beginning on October 31, 2012and had no effect on the consolidated financial statements. This change was not applied retrospectively as it is impracticable to do so because retrospective application would have required the application of significant estimates and assumptions without the use of hindsight. 56
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During the third quarter of 2011,
Hospiraperformed its annual goodwill impairment test and determined that the EMEA reporting unit's goodwill carrying value was in excess of its estimated fair value. Accordingly, Hospirarecognized a goodwill impairment charge of $151.2 millionfor the EMEA reporting unit. During the fourth quarter of 2011, based on a combination of factors, including continued declines in Hospira'scommon stock price and declines in projected revenue and operating margins in all reporting units, Hospiraconcluded that there were sufficient indicators to require an interim goodwill impairment test for the EMEA and former APAC reporting units. Hospiraperformed the interim goodwill impairment test as of December 31, 2011, which indicated that the EMEA and former APAC reporting units' estimated fair values were below their respective carrying value. Hospirarecognized goodwill impairment charges of $77.9 millionand $171.1 millionfor the EMEA and former APAC reporting units, respectively. The goodwill impairment testing process involves the use of significant assumptions, estimates and judgments, and is subject to inherent uncertainties and subjectivity in performing the qualitative assessment, if elected, and in determination of the fair value of the reporting units in Step-one, and, if necessary in Step-two, the allocation of the fair value to identifiable assets and liabilities. Estimating a reporting unit's projected cash flows involves the use of significant assumptions, estimates and judgments with respect to numerous factors, including long-term rate of revenue growth, operating margin, including research and development, selling, general and administrative expense rates, capital expenditures, allocation of shared or corporate items, among other factors. These estimates are based on internal current operating plans and long-term forecasts for each reporting unit. These projected cash flow estimates are then discounted, which necessitates the selection of an appropriate discount rate. The discount rates selected reflect market-based estimates of the risks associated with the projected cash flows of the reporting unit. The market value comparisons of fair value require the selection of appropriate peer group companies. In addition, Hospiraanalyzes differences between the sum of the fair value of the reporting units and Hospira'stotal market capitalization for reasonableness, taking into account certain factors including control premiums. In Step-two, the fair value allocation requires several analyses to determine fair value of assets and liabilities including, among others, trade names, customer relationships, inventory, intangible assets (both recognized and unrecognized) and property, plant and equipment. The use of different assumptions, estimates or judgments in the goodwill impairment testing process may significantly increase or decrease the estimated fair value of a reporting unit or the implied fair value of goodwill, or both. Generally, changes in DCF estimates would have a similar effect on the estimated fair value of the reporting unit. That is, a one percent decrease in estimated DCF's would decrease the estimated fair value of the reporting unit by approximately one percent. Hospirabelieves that its estimates of DCF's and allocations of fair value to assets and liabilities and the above underlying assumptions used are reasonable, but future changes in the underlying assumptions could differ due to the inherent judgment in making such estimates. Goodwill impairment charges may be recognized in future periods to the extent changes in factors or circumstances occur, including deterioration in the macro-economic environment or in the equity markets, including the market value of our common shares, deterioration in our performance or our future projections, or changes in Hospira'splans for one or more reporting units. Investments- Hospiraregularly reviews its investments to determine whether an impairment or other-than-temporary decline in market value exists. Hospiraconsiders factors affecting the investee, factors affecting the industry the investee operates in and general equity market trends. Hospiraconsiders the length of time an investment's market value has been below carrying value and the prospects for recovery to carrying value. When Hospiradetermines that an impairment or other-than-temporary decline has occurred, the carrying basis of the investment is written down to fair value and the amount of the write-down is included in Other expense (income), net.
Product Recalls, Customer Sales Allowances, Customer Accommodations and Other Related Accruals
Hospiraaccrues for costs of product recalls, customer sales allowances, customer accommodations and other related costs based on management's best estimates when it is probable a charge or liability has been incurred, management commits to a plan, and/or regulatory requirement dictates the need for corrective or preventive action and the amount of loss can be reasonably estimated. Product recall and customer accommodations related charges, recognized in Cost of products sold, include materials, development costs to address identified issues, deployment costs such as labor, freight, product disposal and other customer accommodations. Cost estimates consider factors such as historical experience, product quantity, product type (device hardware or software, pharmaceutical product), location of product subject to recall, age of the device and duration of activities, among other factors. Customer sales allowances costs, recognized as a reduction of Net sales, include amounts to be offered to customers, which may be used as a credit for transition to alternative technology. Cost estimates consider factors such as the device product sold, age of the device, among other factors. Accruals for various product recalls, customer sales 57
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allowances, customer accommodations and other related costs were
Hospiraaccrues for loss contingencies when a loss is considered probable and the amount can be reasonably estimated. If a reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, the minimum loss contingency amount in the range is accrued. 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. Income Taxes
Liabilities for unrecognized tax benefits are established when, despite
Hospira'sbelief 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 liabilities are based on management's judgment, utilizing internal and external tax advisors and represent management's best estimate as to the likely outcome of tax audits. The provision for income taxes includes the impact of changes to unrecognized tax benefits. Each quarter, Hospirareviews the anticipated mix of income derived from the various taxing jurisdictions and its associated liabilities. Hospiraconsiders prescribed recognition thresholds and measurement attributes for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. 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. Deferred taxes are also recognized for net operating loss and tax credit carryovers. A valuation allowance is provided if, based upon the weight of available evidence, it is more likely than not that a portion of the deferred tax assets will not be realized. The factors used to assess the likelihood of realization of these assets include our calculation of cumulative pre-tax book income or loss, turn-around of temporary timing differences, available tax planning strategies that could be implemented to realize the deferred tax assets, and where appropriate, forecasted pre-tax book income and taxable income by specific tax jurisdiction. Provision for income taxes and foreign withholding taxes are not provided for undistributed earnings of certain foreign subsidiaries when Hospiraintends to reinvest these earnings indefinitely to fund foreign investments or meet foreign working capital and plant and equipment acquisition needs.
Recently Issued and Adoption of New Accounting Standards
The disclosures provided in Note 1 to the consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data" of this report are incorporated herein by reference.
Private Securities Litigation Reform Act of 1995-A Caution Concerning Forward-Looking Statements
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including projections of certain measures of
Hospira'sresults of operations; projections of certain charges, expenses, and cash flow; and other statements regarding Hospira'sgoals, plans and strategy. Hospiracautions that these forward-looking statements are subject to risks and uncertainties, including adequate and sustained progress on the company's quality initiatives, continuous improvement activities, and device strategy, that may cause actual results to differ materially from those indicated in the forward-looking statements. Economic, competitive, governmental, regulatory, legal, technological, supply, quality and other factors that may affect Hospira'soperations and may cause actual results to be materially different from expectations include the risks, uncertainties and factors discussed under the headings "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this report. Hospiraundertakes no obligation to release publicly any revisions to forward-looking statements as the result of subsequent events or developments. 58
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