MRK

Business Context and Reporting Period

This Form 10-Q covers Schering-Plough Corporation for the quarterly period ended September 30, 2008. The company is a global healthcare firm operating in Human Prescription Pharmaceuticals, Animal Health, and Consumer Health Care. The reporting period is significantly influenced by the integration of the Organon BioSciences N.V. (OBS) acquisition, which closed in November 2007, and ongoing challenges related to the Merck/Schering-Plough cholesterol joint venture (VYTORIN and ZETIA) following the release of the ENHANCE clinical trial results.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 63% ($1.8 billion) for the quarter and 58% ($5.2 billion) for the nine months compared to the prior year periods. This growth is primarily attributable to the inclusion of OBS products.
• Profitability Decline: Despite revenue growth, Net Income available to common shareholders decreased 23% for the quarter and 32% for the nine months. This was driven by:
  • Purchase Accounting: Significant non-cash charges ($1.3 billion for the nine months) related to the amortization of inventory and intangible assets from the OBS acquisition.
  • Interest Expense: Increased due to debt issuance in late 2007 to fund the OBS acquisition.
  • Equity Income: Decreased due to declining sales of the cholesterol franchise (VYTORIN/ZETIA) in the U.S.
• One-Time Items: The 2008 period included a $160 million gain on the divestiture of certain Animal Health products. The 2007 period included a $321 million mark-to-market gain on foreign currency options, which is not present in 2008.
• Debt Reduction: Total debt decreased from $9.5 billion at year-end 2007 to $8.4 billion at September 30, 2008, due to early repayments of Euro-denominated term loans and commercial paper.

Guidance, Outlook, and Risks

• Guidance: Schering-Plough does not provide numeric guidance.
• Outlook: Management anticipates that U.S. sales of the cholesterol joint venture products (VYTORIN and ZETIA) will decline year-over-year in the fourth quarter of 2008. Consequently, equity income is expected to be lower in Q4 2008 than in the first three quarters. R&D spending is expected to increase in Q4 2008.
• Productivity Transformation Program (PTP): A program targeting $1.5 billion in annualized savings by 2012 is underway, with approximately 3,000 positions eliminated through September 30, 2008.
• Key Risks:
  • Cholesterol Franchise: Continued sales declines and market share loss for VYTORIN and ZETIA due to the ENHANCE trial results and subsequent media scrutiny.
  • Legal Proceedings: Ongoing investigations by Congress, the DOJ, and state attorneys general regarding the ENHANCE trial timing and disclosures. Multiple securities class actions and product liability suits are pending.
  • Regulatory Environment: Increased scrutiny on pharmacovigilance and manufacturing practices globally.

Investor Verification Checklist

• Cholesterol Franchise Trajectory: Verify the extent of U.S. sales decline for VYTORIN and ZETIA and the impact on future equity income.
• Legal Exposure: Assess the potential financial impact of the ENHANCE-related investigations and pending securities litigation.
• Purchase Accounting Impact: Confirm the duration and magnitude of non-cash amortization charges related to the OBS acquisition affecting gross margins.
• Debt Servicing: Review the company's ability to service its $8.4 billion debt load given the current credit market volatility and reduced equity income.
• PTP Execution: Monitor the realization of the targeted $1.5 billion in savings from the Productivity Transformation Program.