Financial Review (1)

Abbott's revenues are derived primarily from the sale of a broad line of health care products under short-term receivable arrangements. Patent protection and licenses, technological and performance features, and inclusion of Abbott's products under a contract or by a pharmacy benefit manager most impact which products are sold; price controls, competition and rebates most impact the net selling prices of products; and foreign currency translation impacts the measurement of net sales and costs. Abbott's primary products are prescription pharmaceuticals, nutritional products, diagnostic testing products and vascular products. Abbott also owns 50 percent of TAP Pharmaceutical Products Inc. that Abbott accounts for on the equity method.

The worldwide launch of additional indications of HUMIRA, the acquisitions of Guidant's vascular intervention and endovascular solutions businesses and Kos Pharmaceuticals Inc., the amendments ending the Boehringer Ingelheim agreement and the Synagis co-promotion agreement, the loss of patent protection for some pharmaceutical products, and realized gains and unrealized losses on the Boston Scientific common stock have impacted Abbott's sales, costs and financial position over the last three years.

Pharmaceutical research and development is focused on therapeutic areas that include immunology, oncology, neuroscience, pain management, and infectious diseases. In 2003, Abbott began the worldwide launch of HUMIRA for rheumatoid arthritis, followed by launches for three additional indications, which increased HUMIRA's worldwide sales to $3.0 billion in 2007 compared to $2.0 billion in 2006, and $1.4 billion in 2005. Including the launch of a fifth indication in 2008, Abbott forecasts worldwide HUMIRA sales of approximately $4 billion in 2008. Substantial research and development and selling support has been and continues to be dedicated to maximizing the worldwide potential of HUMIRA. In December 2006, Abbott acquired Kos Pharmaceuticals Inc. which complements Abbott's existing franchise in the dyslipidemia market and strengthened the pharmaceutical pipeline for cholesterol management. In 2005, Abbott and Boehringer Ingelheim (BI) amended their agreement whereby Abbott distributed and promoted BI products. Effective January 1, 2006, Abbott no longer distributed or recorded sales for distribution activities for the BI products. Abbott's gross margins for BI products from the prior agreement in effect through December 31, 2005 were substantially lower than its average gross margins. Sales of BI products were $150 million and $2.3 billion in 2006 and 2005, respectively. In addition, increased generic competition resulted in U.S. sales of Omnicef declining from $637 million in 2006 to $235 million in 2007, and worldwide sales of clarithromycin declining from $1.1 billion in 2005 to $724 million in 2007.

On December 31, 2006, the U.S. co-promotion agreement for Synagis terminated. Revenues for co-promotion of Synagis were $373 million in 2006. Abbott's nutritional products businesses have been reorganized into a worldwide business to better leverage the opportunities available for strong nutritional brands. Significant efforts have been focused on capturing those opportunities, particularly in developing markets where growth has been strong.

In April 2006, Abbott acquired Guidant's vascular intervention and endovascular solutions businesses and began to integrate it with Abbott's vascular business. The acquisition significantly improved Abbott's competitive position in this business that is characterized by rapid innovation. In 2006, Abbott received European Union approval to market the Xience V drug eluting stent, and Abbott is awaiting approval in the U.S.

Abbott's diagnostic segment comprises three separate divisions-immunochemistry/hematology, point of care, and molecular. Subsequent to the termination of the agreement to sell the immunochemistry/hematology and point of care businesses to GE, Abbott has re-focused on managing and growing these businesses.

Abbott acquired 64.6 million shares of Boston Scientific in connection with Abbott's acquisition of the vascular intervention and endovascular solutions businesses of Guidant. In 2007, the net loss charged to expense for the investment was $153 million. At December 31, 2007, Abbott held 26.4 million shares of Boston Scientific common stock. Subsequent to year end, all of these shares were sold resulting in a small gain. Abbott's short- and long-term debt totaled $12.2 billion at December 31, 2007, largely incurred to finance recent acquisitions. Operating cash flows in excess of capital expenditures and cash dividends have partially funded acquisitions over the last three years. At December 31, 2007, Abbott's long-term debt rating was AA by Standard and Poor's Corporation and A1 by Moody's Investors Service.

In 2008, Abbott will focus on several key initiatives. In the pharmaceutical business, Abbott will continue the launch of newly approved indications for HUMIRA and continue to leverage the product and pipeline opportunities of its lipid franchise, including the Kos Pharmaceuticals Inc. business. Pharmaceutical research and development efforts will continue to focus on the therapeutic areas noted above with a significant portion of the development expenditures allocated to new HUMIRA indications, as well as Simcor and ABT-335, cholesterol drugs, ABT-335/Crestor fixed dose combination, ABT-874, a biologic for psoriasis and Crohn's disease, and controlled release Vicodin CR, as well as several Phase I and Phase II clinical programs in neuroscience and oncology. In the vascular business, Abbott will continue the launch of the Xience V drug-eluting stent internationally, and will launch in the U.S. upon approval by the FDA. For diabetes care, Abbott anticipates launching the FreeStyle Freedom Lite monitor in the U.S. as well as the FreeStyle Navigator. In the other business segments, Abbott will focus on developing or acquiring differentiated technologies in higher growth segments of those markets.

Critical Accounting Policies

Sales Rebates — Approximately 48 percent of Abbott's consolidated gross revenues are subject to various forms of rebates and allowances that Abbott records as reductions of revenues at the time of sale. Most of these rebates and allowances are in the Pharmaceutical Products segment and the Nutritional Products segment. Abbott provides rebates to pharmacy benefit management companies, to state agencies that administer the federal Medicaid and Medicare programs and the Special Supplemental Food Program for Women, Infants, and Children (WIC), wholesalers, group purchasing organizations, and other government agencies and private entities. Rebate amounts are usually based upon the volume of purchases using contractual or statutory prices for a product. Factors used in the rebate calculations include the identification of which products have been sold subject to a rebate, which customer or government agency price terms apply, and the estimated lag time between sale and payment of a rebate. Using historical trends, adjusted for current changes, Abbott estimates the amount of the rebate that will be paid, and records the liability as a reduction of gross sales when Abbott records its sale of the product. Settlement of the rebate generally occurs from two to 24 months after sale. Abbott regularly analyzes the historical rebate trends and makes adjustments to reserves for changes in trends and terms of rebate programs. Rebates and chargebacks charged against gross sales in 2007, 2006 and 2005 amounted to approximately $3.2 billion, $2.6 billion and $2.5 billion, respectively, or 21.5 percent, 23.2 percent, and 22.9 percent, respectively, based on gross sales of approximately $15.0 billion, $11.0 billion and $10.9 billion, respectively, subject to rebate. A one-percentage point increase in the percentage of rebates to related gross sales would decrease net sales and operating earnings by approximately $150 million in 2007. Abbott considers a one-percentage point increase to be a reasonably likely increase in the percentage of rebates to related gross sales. Other allowances charged against gross sales were approximately $325 million, $247 million and $284 million for cash discounts in 2007, 2006 and 2005, respectively, and $269 million, $209 million and $162 million for returns in 2007, 2006 and 2005, respectively. Cash discounts are known within 15 to 30 days of sale, and therefore can be reliably estimated. Returns can be reliably estimated because Abbott's historical returns are low, and because sales returns terms and other sales terms have remained relatively unchanged for several periods.

Management analyzes the adequacy of ending rebate accrual balances each quarter. In the domestic nutritional business, management uses both internal and external data available to estimate the level of inventory in the distribution channel. Management has access to several large customers' inventory management systems, and for other customers, utilizes data from a third party that continuously measures time on the retail shelf. These sources allow management to make reliable estimates of inventory in the distribution channel. Except for a transition period before or after a change in the supplier for the WIC business in a state, inventory in the distribution channel does not vary substantially. Management also estimates the states' processing lag time based on claims data. In addition, internal processing time is a factor in estimating the accrual. In the WIC business, the state where the sale is made, which is the determining factor for the applicable price, is reliably determinable. Estimates are required for the amount of WIC sales within each state where Abbott has the WIC business. External data sources utilized for that estimate are participant data from the U.S. Department of Agriculture (USDA), which administers the WIC program, participant data from some of the states, and internally administered market surveys. The USDA has been making its data available for many years. Internal data includes historical redemption rates and pricing data. At December 31, 2007, Abbott had the exclusive WIC business in 27 states.

In the domestic pharmaceutical business, the most significant charges against gross sales are for Medicaid and Medicare Rebates, Pharmacy Benefit Manager Rebates and Wholesaler Chargebacks. In order to evaluate the adequacy of the ending accrual balances, management uses both internal and external estimates of the level of inventory in the distribution channel and the rebate claims processing lag time. External data sources used to estimate the inventory in the distribution channel include inventory levels periodically reported by wholesalers and third party market data purchased by Abbott. Management estimates the processing lag time based on periodic sampling of claims data. To estimate the price rebate percentage, systems and calculations are used to track sales by product by customer and to estimate the contractual or statutory price. Abbott's systems and calculations have developed over time as rebates have become more significant, and Abbott believes they are reliable.

The following table is an analysis of the four largest rebate accruals, which comprise approximately 74 percent of the consolidated rebate provisions charged against revenues in 2007. Remaining rebate provisions charged against gross sales are not significant in the determination of operating earnings. (dollars in thousands)

		Domestic Pharmaceutical Products
	Domestic Nutritionals WIC Rebates	Medicaid and Medicare Rebates	Pharmacy Benefit Manager Rebates	Wholesaler Charge- backs
Balance at January 1, 2005	$98,047	$373,058	$153,798	$44,053
Provisions	641,189	663,043	253,499	450,901
Payments	(644,460)	(581,098)	(273,166)	(446,867)
Balance at December 31, 2005	94,776	455,003	134,131	48,087
Provisions	636,849	527,860	281,221	532,847
Payments	(595,477)	(533,632)	(246,456)	(513,905)
Business combination	—	36,191	50,675	20,189
Balance at December 31, 2006	136,148	485,422	219,571	87,218
Provisions	753,535	438,198	411,798	786,183
Payments	(690,438)	(503,580)	(394,692)	(781,547)
Balance at December 31, 2007	$199,245	$420,040	$236,677	$91,854

Historically, adjustments to prior years' rebate accruals have not been material to net income. In 2007, adjustments were made to prior years' rebate accruals. The Medicaid and Medicare rebate accrual was reduced by approximately $69 million and the WIC rebate accrual was increased by approximately $19 million. Abbott employs various techniques to verify the accuracy of claims submitted to it, and where possible, works with the organizations submitting claims to gain insight into changes that might affect the rebate amounts. For Medicaid, Medicare and other government agency programs, the calculation of a rebate involves interpretations of relevant regulations, which are subject to challenge or change in interpretation.