Business context and reporting period
This Form 10-Q is for Schering-Plough Corporation, not Merck & Co., Inc., for the quarter and nine months ended September 30, 2009. Schering-Plough operated prescription pharmaceuticals, animal health and consumer health care businesses. Its proposed combination with Merck had been approved by both companies’ shareholders but was not yet complete at the filing date.
Financial results and position
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net sales | $4.499 billion | $4.576 billion | $13.539 billion | $14.154 billion |
| Income before taxes | $612 million | $658 million | $2.319 billion | $1.522 billion |
| Net income | $515 million | $614 million | $1.991 billion | $1.389 billion |
| Net income available to common shareholders | $477 million | $576 million | $1.878 billion | $1.276 billion |
| Diluted EPS | $0.29 | $0.35 | $1.13 | $0.78 |
| Gross margin | 61.8% | 62.0% | 65.0% | 59.1% |
For the nine months, operating cash flow was $2.624 billion, investing cash outflow $1.309 billion and financing cash outflow $457 million. Cash and cash equivalents were $4.312 billion at September 30, versus $3.373 billion at year-end 2008; short-term investments were $487 million. Total debt was approximately $8.2 billion and reported net debt was approximately $3.4 billion. A $2.0 billion revolving credit facility was undrawn.
Quarterly SG&A was $1.511 billion, down 9%; R&D was $913 million, up 2%. Nine-month SG&A was $4.629 billion, down 11%, and R&D was $2.580 billion, down 4%. Equity income from the Merck/Schering-Plough cholesterol joint venture was $387 million for Q3 and $1.157 billion for nine months.
Material changes versus prior comparable periods
- Sales declined 2% in Q3 and 4% for nine months. Management attributed the reported declines in part to unfavorable foreign exchange: 6% for Q3 and an estimated 8% for nine months. Q3 sales showed 4% operational growth before foreign exchange.
- Nine-month income before taxes rose versus 2008, while Q3 net income and diluted EPS fell. The 2008 comparison included substantial OBS acquisition purchase-accounting charges and a $160 million gain on divested animal-health products; nine-month 2008 depreciation and amortization also included $840 million of OBS inventory fair-value amortization.
- Cholesterol franchise sales (VYTORIN and ZETIA) declined 5% globally in Q3 and 12% for nine months. U.S. sales declined 10% and 18%, respectively; the reported U.S. prescription share for the combined franchise fell from 10.1% in December 2008 to 8.3% in September 2009.
- Animal Health sales fell 12% in Q3 and 14% for nine months, reflecting foreign exchange, economic conditions, a difficult comparison with the prior-year vaccine launch and product back orders associated primarily with manufacturing integration and quality standards. Prescription Pharmaceuticals were roughly flat in Q3 and down 3% for nine months.
- Nine-month gross margin improved to 65.0% from 59.1%, partly because prior-year cost of sales included substantially larger OBS purchase-accounting charges. Q3 gross margin edged down to 61.8% from 62.0%.
Outlook, commentary, risks and unusual items
- Management said the Productivity Transformation Program remained on track, targeting $1.5 billion of annualized savings by 2012, with approximately $1.25 billion expected by the end of 2010. The filing provides no earnings or revenue guidance.
- Management expected cash, operating cash generation and available credit to cover intermediate-term needs. It expected about $170 million of deferred-compensation plan funding in the remainder of 2009 and approximately $40 million of regular retirement-plan contributions.
- The Merck transaction terms provide Schering-Plough shareholders 0.5767 Merck shares plus $10.50 cash per Schering-Plough share. European Commission clearance was received October 22, 2009; the companies expected completion in Q4 2009, subject to remaining conditions and regulatory approvals. The filing states that its forward-looking operating outlook generally excludes merger effects.
- Centocor initiated arbitration over whether the proposed merger permits it to terminate Schering-Plough’s rights to distribute REMICADE and SIMPONI in certain territories; proceedings were expected to continue into 2010. This creates uncertainty around key licensed products.
- Risks include continuing investigations and litigation related to VYTORIN/ZETIA and the ENHANCE and SEAS trials, product-liability claims including NUVARING, pricing and reimbursement pressure, generic competition and patent challenges, regulatory and manufacturing compliance, foreign-exchange exposure, and merger execution. The FDA’s review of ENHANCE found the difference in carotid artery thickness changes was not statistically significant, while LDL reductions were significantly greater with VYTORIN.
- In August 2009, Schering-Plough, Merck and the cholesterol joint venture agreed to $41.5 million in settlements of most VYTORIN/ZETIA economic-damages class actions; the proposed class settlement remained subject to court approval. A separate multistate investigation settlement required $5.4 million for investigative costs, paid by the joint venture. A federal court ruled against Schering-Plough in an IRS refund case on August 28, 2009; the company was considering options, including appeal, and said reserves were adequate.
- The 2008 comparative income-tax expense was revised downward by $25 million for Q3 and $74 million for nine months due to an OBS purchase-accounting correction, increasing comparative net income and EPS. Schering-Plough reported a $1.3 billion U.S. net operating loss carryforward but maintained a valuation allowance because realization was not considered more likely than not.
Most important facts for investors to verify
- Confirm the issuer: this is Schering-Plough’s 10-Q, not a Merck 10-Q; assess the merger’s final closing status and terms separately.
- Track cholesterol franchise demand, U.S. share and joint-venture equity income, alongside REMICADE/SIMPONI rights and the Centocor arbitration.
- Reconcile earnings comparisons for OBS purchase-accounting effects, divestiture gains, tax benefits and other unusual charges.
- Review the status and potential exposure of material investigations, litigation, tax matters and product-safety or regulatory issues; many outcomes and loss amounts were uncertain.
- Monitor foreign-exchange effects, Animal Health supply and manufacturing performance, and progress against the stated cost-savings targets.