Business Context and Reporting Period
This summary covers the Form 10-K for Schering-Plough Corporation for the fiscal year ended December 31, 2006. Schering-Plough is a global science-based health care company organized into three reportable segments: Prescription Pharmaceuticals, Consumer Health Care, and Animal Health. The company is executing a strategic "Action Agenda" to stabilize and grow the business, currently in the "Build the Base" phase. A significant portion of the company's profitability is derived from a joint venture with Merck & Co., Inc. regarding cholesterol-lowering products (VYTORIN and ZETIA), which is accounted for using the equity method.
Key Financial Metrics
| Metric | 2006 | 2005 | 2004 |
|---|---|---|---|
| Net Sales | $10,594 million | $9,508 million | $8,272 million |
| Net Income | $1,143 million | $269 million | $(947) million |
| Net Income Available to Common Shareholders | $1,057 million | $183 million | $(981) million |
| Diluted EPS | $0.71 | $0.12 | $(0.67) |
| Operating Cash Flow | $2,161 million | $882 million | $(154) million |
| Research & Development Expenses | $2,188 million | $1,865 million | $1,607 million |
| Long-Term Debt | $2,414 million | $2,399 million | $2,392 million |
| Total Assets | $16,071 million | $15,469 million | $15,911 million |
| Shareholders' Equity | $7,908 million | $7,387 million | $7,556 million |
Segment Profit (2006): Prescription Pharmaceuticals ($1,394 million), Consumer Health Care ($228 million), Animal Health ($120 million). Corporate and other expenses were $259 million.
Equity Income: Equity income from the cholesterol joint venture with Merck was $1,459 million in 2006, compared to $873 million in 2005.
Material Changes vs. Prior Period
- Revenue Growth: Consolidated net sales increased 11% to $10.6 billion, driven by volume growth in key products including REMICADE, NASONEX, PEG-INTRON, and TEMODAR. Foreign exchange had a slight unfavorable impact of 1%.
- Profitability Surge: Net income available to common shareholders jumped from $183 million in 2005 to $1.1 billion in 2006. This was primarily due to increased equity income from the cholesterol joint venture and lower special charges.
- Special Charges: Special charges decreased significantly to $102 million in 2006 (related to manufacturing streamlining) compared to $294 million in 2005 (which included a $250 million litigation reserve increase).
- Manufacturing Streamlining: The company closed a manufacturing plant in Puerto Rico and reduced the workforce by over 1,000 positions, incurring $146 million in cost of sales charges but expecting $100 million in annualized savings.
- Legal Settlement: In August 2006, the company settled the Massachusetts Investigation for $435 million (criminal fine and civil resolution). Payments of $388 million were made subsequent to year-end.
Guidance, Outlook, and Risks
Outlook: Management does not provide numeric guidance. However, they anticipate continued growth in VYTORIN and ZETIA sales in 2007 despite generic competition in the cholesterol market. R&D expenses are expected to grow faster than adjusted net sales due to increased clinical trial activity. Gross margins are expected to improve due to manufacturing streamlining savings.
Key Risks and Contingencies:
- Patent Challenges: Generic manufacturers have filed Abbreviated New Drug Applications (ANDAs) challenging patents for ZETIA and CLARINEX. An adverse outcome could lead to generic competition and sales declines.
- Legal and Regulatory: Ongoing investigations regarding Average Wholesale Price (AWP) practices and pricing. The company remains subject to an FDA Consent Decree regarding Good Manufacturing Practices (cGMP) at facilities in New Jersey and Puerto Rico.
- Product Dependence: Significant reliance on the cholesterol franchise (VYTORIN/ZETIA) and key products like REMICADE and PEG-INTRON. Competition for PEG-INTRON has intensified.
- Tax Matters: The IRS is auditing tax returns for 1997-2002. The company expects a decrease to opening retained earnings of $225-$300 million upon adopting FIN 48 in 2007.
Investor Verification Checklist
- Joint Venture Accounting: Verify the equity income recognition from the Merck cholesterol joint venture, as it is a primary driver of profitability but sales are not consolidated.
- Patent Litigation Status: Monitor the status of Paragraph IV certifications for ZETIA and CLARINEX, as generic entry could materially impact future revenue.
- Legal Reserves: Review the adequacy of reserves for ongoing AWP litigation and investigations, noting the $435 million Massachusetts settlement was paid post-year-end.
- Manufacturing Costs: Assess the realization of the projected $100 million annualized cost savings from the manufacturing streamlining actions.
- Tax Position: Evaluate the impact of the pending IRS audit and the upcoming adoption of FIN 48 on future tax liabilities and retained earnings.