Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2001, for Schering-Plough Corporation. The registrant is a pharmaceutical company incorporated in New Jersey. The financial statements are unaudited and reflect all adjustments necessary for a fair statement of operations for the interim periods presented.
Key Financial Metrics
| Metric (in millions) | Q3 2001 | Q3 2000 | 9 Months 2001 | 9 Months 2000 |
|---|---|---|---|---|
| Net Sales | $2,382 | $2,383 | $7,330 | $7,397 |
| Net Income | $601 | $591 | $1,800 | $1,852 |
| Diluted EPS | $0.41 | $0.40 | $1.22 | $1.25 |
| Operating Cash Flow (9mo) | $1,753 (2001) vs $1,999 (2000) | |||
| Cash and Equivalents | $2,654 (Sep 30, 2001) | |||
| Cost of Sales Margin | 20.4% | 19.6% | 20.3% | 19.1% |
| Effective Tax Rate | 23.0% | 24.0% | 23.0% | 24.0% |
Liquidity and Debt: The company maintains a $1 billion committed, multi-currency unsecured revolving credit facility, with no funds drawn down as of September 30, 2001. Short-term borrowings and the current portion of long-term debt totaled $716 million.
Material Changes vs. Prior Period
- Sales Performance: Consolidated net sales were essentially flat in Q3 2001 compared to Q3 2000. For the nine-month period, sales decreased 1% ($67 million). Excluding foreign currency effects, sales increased 2% in Q3 and 1% for the nine months, offset by volume declines of 4% in Q3 and 3% year-to-date.
- Profitability: Net income increased 2% in Q3 but declined 3% for the nine-month period. Diluted EPS rose 3% in Q3 but fell 2% year-to-date.
- Product Mix Shifts:
- Allergy & Respiratory: Sales increased 8% in Q3, driven by CLARITIN ($828M) and NASONEX growth, though tempered by U.S. market share declines and inventory changes.
- Cardiovasculars: Sales dropped 5% in Q3 and 12% year-to-date due to generic competition (K-DUR, IMDUR) and trade inventory reductions.
- Dermatologicals: Sales fell 25% in Q3, primarily due to generic competition for LOTRISONE.
- Animal Health: Sales declined 2% due to manufacturing issues and the impact of BSE/FMD in Europe.
- Expenses: Cost of sales as a percentage of sales increased due to manufacturing issues and unfavorable foreign exchange. R&D spending decreased 9% in Q3 and 4% year-to-date.
Guidance, Outlook, Risks, and Contingencies
Management Commentary and Outlook:
- Manufacturing Issues: The company faces significant challenges related to FDA inspections of facilities in New Jersey and Puerto Rico citing Good Manufacturing Practices (GMP) deficiencies. These issues have led to reduced sales of certain products and temporary production interruptions. Management is implementing a comprehensive GMP Work Plan and investing in equipment and personnel upgrades.
- CLARITIN Patent Litigation: CLARITIN accounted for 29% of consolidated worldwide sales in the first nine months of 2001. The company is suing 13 generic manufacturers seeking to market generic loratadine before patent expiration. If the company does not prevail, generic entry could occur as early as December 20, 2002, potentially causing a rapid, sharp, and material decline in sales. Management estimates trade inventory reductions could negatively impact pretax profits by $175 million to $250 million.
- Regulatory Scrutiny: The company is under investigation by the DOJ, HHS, and state attorneys general regarding marketing practices, Average Wholesale Price (AWP) calculations, and disease management programs. An FTC administrative proceeding regarding K-DUR patent settlements is ongoing.
Legal and Environmental Contingencies:
- IRS Audit: The IRS has asserted a liability of approximately $195 million plus penalties for tax years 1990-1992 regarding interest rate swaps. The company disputes this.
- Shareholder Litigation: Consolidated class action lawsuits allege securities violations related to the disclosure of manufacturing issues and FTC proceedings.
- Patent Disputes: Ongoing litigation regarding REBETOL, PEG-INTRON (settled with Roche), and PRIME PAC vaccine (injunction issued, appeal pending).
Investor Verification Checklist
- CLARITIN Exposure: Verify the status of the 13 patent infringement lawsuits and the potential timeline for generic loratadine entry, given CLARITIN represents nearly 30% of sales.
- Manufacturing Resolution: Monitor progress on the GMP Work Plan and FDA re-inspection results to assess the duration of sales impacts on key products.
- Regulatory Investigations: Track outcomes of DOJ, FTC, and state investigations regarding marketing practices and pricing, which could result in fines or exclusion from government programs.
- IRS Dispute: Review the company's defense strategy regarding the $195 million tax liability claim.
- Capital Allocation: Confirm the resumption of the share repurchase program, which was suspended in Q1 2001, and the projected $750 million+ capital expenditure for 2001.