UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

 

 

Commission file number 1-6571

 

SCHERING-PLOUGH CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code:

(908) 298-4000

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

Common Shares Outstanding as of September 30, 2009: 1,639,151,392

 

 

PART I. FINANCIAL INFORMATION

 

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

STATEMENTS OF CONDENSED CONSOLIDATED OPERATIONS

 

(Unaudited)

(Amounts in millions, except per share figures)

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS

 

(Unaudited)

(Amounts in millions)

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

(Unaudited)

(Amounts in millions, except per share figures)

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

These unaudited Condensed Consolidated Financial Statements of Schering-Plough Corporation and subsidiaries (Schering-Plough), have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for reporting on Form 10-Q. Certain information and disclosures normally included in financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles have been condensed or omitted pursuant to such SEC rules and regulations. These statements should be read in conjunction with the accounting policies and notes to the consolidated financial statements included in Schering-Plough’s 2008 10-K.

 

In the opinion of Schering-Plough’s management, these financial statements reflect all adjustments necessary, including normal recurring accruals, for a fair presentation of the statements of operations, cash flows and financial position for the interim periods presented.

 

Third quarter and nine months ended September 30, 2008, income tax expense has been revised from the prior year 10-Q which reflected an overstatement of income tax expense relating to the accounting for the purchase of Organon BioSciences N.V. (OBS). This change resulted in a reduction of income tax expense and a corresponding increase in net income and net income available to common shareholders of $25 million for the third quarter of 2008 and $74 million for the nine months ended September 30, 2008, along with an associated increase in per share amounts.

 

In November 2007, Schering-Plough acquired OBS, a company that discovers, develops and manufactures human prescription and animal health products.

 

Schering-Plough has evaluated all subsequent events through October 29, 2009, the date of filing of this 10-Q.

 

Impact of Recently Issued Accounting Standards

 

In June 2009, the Financial Accounting Standards Board (FASB) issued guidance which is included in the Codification in FASB Accounting Standards Codification (ASC) 105, “Generally Accepted Accounting Principles.” This guidance modifies the Generally Accepted Accounting Principles (GAAP) hierarchy by establishing only two levels of GAAP, authoritative and nonauthoritative accounting literature. Effective July 2009, the FASB ASC, also known collectively as the “Codification,” is considered the single source of authoritative U.S. accounting and reporting standards, except for additional authoritative rules and interpretive releases issued by the SEC. This guidance is effective for financial statements issued for reporting periods that end after September 15, 2009. Where possible, FASB references have been replaced with ASC references.

 

As of January 1, 2009, Schering-Plough implemented the transition guidance related to FASB Staff Position (FSP) Emerging Issues Task Force (EITF) 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”, which is included in the codification in ASC 260-10, “Earnings Per Share” (ASC 260-10). ASC 260-10 requires Schering-Plough to treat unvested deferred stock units as participating securities in accordance with the two-class method in the calculation of both basic and diluted earnings per share. ASC 260-10 must be applied retrospectively. The effect of the retrospective application of ASC 260-10 was not material to Schering-Plough’s earnings per share in 2008, 2007 or 2006.

 

As of June 30, 2009, Schering-Plough implemented FASB ASC 825-10-65-1, “Financial Instruments” (ASC 825-10-65-1). ASC 825-10-65-1 provides disclosure about fair value of financial instruments in interim as well as in annual financial statements. This guidance is effective for periods ending after June 15, 2009. In the second quarter of 2009, Schering-Plough implemented this guidance. See Note 13, “Financial Instruments.”

 

Effective January 1, 2008, the Company adopted FASB ASC 820-10, “Fair Value Measurements and Disclosures” (“ASC 820-10”) with respect to its financial assets and liabilities. In February 2008, the FASB issued updated guidance related to fair value measurements, which is included in the Codification in ASC 820-10, Fair Value Measurements and Disclosures (see Note 14, Fair Value Measurements). The updated guidance provided a one year deferral of the effective date of ASC 820-10 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The implementation of the non-financial items measured on a non-recurring basis did not have a material impact on Schering-Plough’s condensed consolidated financial statements.

 

In December 2007, the FASB issued guidance which is included in the Codification in ASC 808, “Collaborative Arrangements” (ASC 808), which is effective for calendar-year companies beginning January 1, 2009. ASC 808 clarified the manner in which costs, revenues and sharing payments made to, or received by, a partner in a collaborative arrangement should be presented in the income statement and set forth certain disclosures that should be required in the partners’ financial statements. The implementation of this standard did not have a material impact on Schering-Plough’s condensed consolidated financial statements. Schering-Plough has a number of collaborative arrangements. For collaborative arrangements, sales are generally included in Net sales and payments to collaboration partners are classified in the statement of condensed consolidated operations based on their nature in Cost of sales or Research and development, as appropriate.

 

In December 2007, the FASB issued guidance which is included in the Codification in ASC 805, “Business Combination” (ASC 805). For calendar-year companies, the standard is applicable to new business combinations occurring on or after January 1, 2009. ASC 805 requires an acquiring entity to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Most significantly, ASC 805 requires that acquisition costs generally be expensed as incurred, certain acquired contingent liabilities be recorded at fair value, and acquired in-process research and development be recorded at fair value as an indefinite-lived intangible asset at the acquisition date. The implementation of this standard did not have a material impact on Schering-Plough’s condensed consolidated financial statements.

 

In December 2007, the FASB issued guidance which is included in the Codification in ASC 810-10-65-1, “Consolidation” (ASC 810-10-65-1), which is effective for calendar-year companies beginning January 1, 2009. This standard revised the accounting treatment for noncontrolling minority interests of partially-owned subsidiaries. The standard establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The implementation of this standard did not have a material impact on Schering-Plough’s condensed consolidated financial statements.

 

In March 2008, the FASB issued issued guidance which is included in the Codification in ASC 815-10, “Derivatives and Hedging.” This guidance is effective for calendar-year companies beginning January 1, 2009. The guidance enhances required disclosures regarding derivatives and hedging activities. The implementation of this standard did not have a material impact on Schering-Plough’s condensed consolidated financial statements.

 

In April 2008, the FASB issued ASC 350, “Intangibles-Goodwill and Other” (ASC 350). ASC 350 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. ASC 350 is effective for calendar-year companies beginning January 1, 2009. The requirement for determining useful lives must be applied prospectively to intangible assets acquired after the effective date and the disclosure requirements must be applied prospectively to all intangible assets recognized as of, and subsequent to, the effective date. The implementation of this standard did not have a material impact on Schering-Plough’s condensed consolidated financial statements.

 

In April 2009, the FASB issued updated guidance related to business combinations, which is included in the Codification in ASC 805-20, “Business Combinations — Identifiable Assets, Liabilities and Any Noncontrolling Interest” (ASC 805-20). ASC 805-20 amends the provisions in ASC 805 for the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies in business combinations. ASC 805-20 is effective for contingent assets or contingent liabilities acquired in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The implementation of this standard did not have a material impact on Schering-Plough’s condensed consolidated financial statements.

 

In May 2009, the FASB issued guidance which is included in the Codification in ASC 855, “Subsequent Events” (ASC 855). This guidance establishes the accounting and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. This guidance is effective for interim or annual financial periods ending after June 15, 2009, and as such, became effective for the

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Company on June 30, 2009. The implementation of this standard did not have a material impact on Schering-Plough’s condensed consolidated financial statements.

 

In June 2009, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 166, “Accounting for Transfers of Financial Assets, an amendment of SFAS No. 140” (SFAS 166), which has not yet been codified in the ASC. SFAS 166 amends SFAS No. 140 to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. This Statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The recognition and measurement provisions of this Statement shall be applied to transfers that occur on or after the effective date. Schering-Plough is currently assessing the impact of the adoption of SFAS 166.

 

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (SFAS 167), which has not yet been codified in the ASC. SFAS 167 amends certain requirements of FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. This Statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. Schering-Plough is currently assessing the impact of the adoption of SFAS 167.

 

In August 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-05, “Fair Value Measurements and Disclosures” (Topic 820) (ASU 2009-05). ASU 2009-05 provided amendments to ASC 820-10, “Fair Value Measurements and Disclosures — Overall,” for the fair value measurement of liabilities. ASU 2009-05 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using certain techniques. ASU 2009-05 also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of a liability. ASU 2009-05 also clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. The new guidance is effective for interim and annual periods beginning after August 27, 2009, and applies to all fair-value measurements of liabilities required by GAAP. Schering-Plough is currently assessing the impact of the adoption of ASU 2009-05.

 

In October 2009, the FASB issued ASU 2009-13, “Multiple-Deliverable Revenue Arrangements,” (amendments to FASB ASC Topic 605, Revenue Recognition ) (ASU 2009-13). ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-13 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. Schering-Plough is currently assessing the impact of the adoption of ASU 2009-13.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

Schering-Plough’s Productivity Transformation Program (PTP) is designed to reduce and avoid costs and increase productivity.

 

The following table summarizes activities reflected in the condensed consolidated financial statements related to the Productivity Transformation Program, for the nine months ended September 30, 2009:

 

 

For the three months ended September 30, 2009, special, merger and acquisition-related costs totaled $29 million, of which $24 million related to employee termination costs and $5 million related to the planned merger with Merck & Co., Inc (Merck). Planned merger costs are not included in the table above. For the nine months ended September 30, 2009, special, merger and acquisition-related costs totaled $133 million, of which $98 million related to employee termination costs and $35 million related to the planned merger with Merck.

 

The following table summarizes activities reflected in the condensed consolidated financial statements related to the Productivity Transformation Program, for the nine months ended September 30, 2008:

 

 

For the three months ended September 30, 2008, special and acquisition-related charges totaled $101 million ($93 million of employee termination costs and $8 million related to OBS integration activities). For the nine months ended September 30, 2008, special and acquisition-related charges totaled $218 million ($177 million of employee termination costs and $41 million to OBS integration activities).

 

 

In May 2000, Schering-Plough and Merck entered into two separate sets of agreements to jointly develop and market certain products in the U.S. including (1) two cholesterol-lowering drugs and (2) an allergy/asthma drug. In December 2001, the cholesterol agreements were expanded to include all countries of the world except Japan. In general, the companies agreed that the collaborative activities under these agreements would operate in a virtual joint venture to the maximum degree possible by relying on the respective infrastructures of the two

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

companies. These agreements generally provide for equal sharing of development costs and for co-promotion of approved products by each company.

 

The cholesterol agreements provide for Schering-Plough and Merck to jointly develop and commercialize ezetimibe in the cholesterol management field:

 

i. as a once-daily monotherapy (managed as ZETIA in the U.S. and Asia and EZETROL in Europe);

 

ii. in co-administration with various approved statin drugs; and

 

iii. as a fixed-combination tablet of ezetimibe and simvastatin (Zocor), Merck’s cholesterol-modifying medicine. This combination medication (ezetimibe/simvastatin) is managed as VYTORIN in the U.S. and as INEGY in many international countries.

 

ZETIA/EZETROL (ezetimibe) and VYTORIN/INEGY (the combination of ezetimibe/simvastatin) are approved for use in the U.S. and have been launched in many international markets.

 

Schering-Plough utilizes the equity method of accounting in recording its share of activity from the Merck/Schering-Plough cholesterol joint venture. As such, Schering-Plough’s net sales do not include the sales of the joint venture. The cholesterol joint venture agreements provide for the sharing of operating income generated by the joint venture based upon percentages that vary by product, sales level and country. In the U.S. market, Schering-Plough receives a greater share of profits on the first $300 million of annual ZETIA sales. Above $300 million of annual ZETIA sales, Merck and Schering-Plough generally share profits equally. Schering-Plough’s allocation of the joint venture income is increased by milestones recognized. Further, either company’s share of the joint venture’s income from operations is subject to a reduction if that company fails to perform a specified minimum number of physician details in a particular country. The companies agree annually to the minimum number of physician details by country.

 

The companies bear the costs of their own general sales forces and commercial overhead in marketing joint venture products around the world. In the U.S., Canada and Puerto Rico, the cholesterol agreements provide for a reimbursement to each company for physician details that are set on an annual basis, and in Italy, a contractual amount is included in the profit sharing calculation that is not reimbursed. In the U.S., Canada and Puerto Rico this amount is equal to each company’s agreed physician details multiplied by a contractual fixed fee. Schering-Plough reports these amounts as part of equity income from the cholesterol joint venture. These amounts do not represent a reimbursement of specific, incremental and identifiable costs for Schering- Plough’s detailing of the cholesterol products in these markets. In addition, these amounts are not reflective of Schering-Plough’s sales effort related to the joint venture as Schering-Plough’s sales force and related costs associated with the joint venture are generally estimated to be higher.

 

Costs of the joint venture that the companies contractually share are a portion of manufacturing costs, specifically identified promotion costs (including direct-to-consumer advertising and direct and identifiable out-of-pocket promotion) and other agreed upon costs for specific services such as market support, market research, market expansion, a specialty sales force and physician education programs.

 

Certain specified research and development expenses are generally shared equally by Schering-Plough and Merck.

 

The unaudited financial information below presents summarized combined financial information for the Merck/Schering-Plough cholesterol joint venture for the three and nine months ended September 30, 2009 and 2008:

 

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Amounts related to physician details, among other expenses, that are invoiced by Schering-Plough and Merck in the U.S., Canada and Puerto Rico are deducted from income from operations of the cholesterol joint venture.

 

Schering-Plough’s share of the cholesterol joint venture’s income from operations for the three and nine months ended September 30, 2009 was $357 million and $1.1 billion, respectively. For the three and nine months ended September 30, 2008, Schering-Plough’s share of the cholesterol joint venture’s income from operations were $393 million and $1.3 billion, respectively. Included in Schering-Plough’s share of income from operations is income of $19 million and $83 million, for the three and nine months ended September 30, 2008, respectively, related to the termination of a respiratory joint venture with Merck. In the U.S. market, Schering-Plough receives a greater share of income from operations on the first $300 million of annual ZETIA sales. As a result, Schering-Plough’s share of the cholesterol joint venture’s income from operations is generally higher in the first quarter than in subsequent quarters.

 

The following information provides a summary of the components of Schering-Plough’s equity income from the cholesterol joint venture for the three and nine months ended September 30, 2009 and 2008:

 

 

At September 30, 2009 and December 31, 2008, Schering-Plough had net receivables (including undistributed income) from the Merck/Schering-Plough Joint Venture of $75 million and $130 million, respectively.

 

Equity income from the joint venture excludes any profit arising from transactions between Schering-Plough and the joint venture until such time as there is an underlying profit realized by the joint venture in a transaction with a party other than Schering-Plough or Merck.

 

Due to the virtual nature of the cholesterol joint venture, Schering-Plough incurs substantial costs, such as selling, general and administrative costs, that are not reflected in Equity income and are borne by the overall cost structure of Schering-Plough. These costs are reported on their respective line items in the statements of condensed consolidated operations and are not separately identifiable. The cholesterol agreements do not provide for any jointly owned facilities and, as such, products resulting from the joint venture are manufactured in facilities owned by either Schering-Plough or Merck.

 

Schering-Plough and Merck are developing a single-tablet combination of ezetimibe and atorvastatin as a treatment for elevated cholesterol levels.

 

In April 2008, the Merck/Schering-Plough joint venture received a not-approvable letter from the U.S. Food and Drug Administration (FDA) for the proposed fixed combination of loratadine/montelukast. During the second quarter of 2008 the respiratory joint venture was terminated in accordance with the agreements. This action has no impact on the cholesterol joint venture.

 

See Note 17, “Legal, Environmental and Regulatory Matters,” — “Litigation and Investigations relating to the Merck/Schering-Plough Cholesterol Joint Venture,” for additional information.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

A summary of the options, deferred stock units and performance-based deferred stock units granted during the three and nine months ended September 30, 2009 and 2008 is as follows:

 

 

Options generally become exercisable in equal annual installments over a three-year period. The deferred stock units generally vest at the end of a three-year period from the date they were granted. The performance-based deferred stock units vest at the end of a three-year performance period if specific pre-established levels of performance, market conditions and service are met.

 

The weighted-average assumptions used in the Black-Scholes option pricing model for the three and nine months ended September 30, 2009 and 2008, were as follows:

 

 

Total compensation expense related to stock options, deferred stock units and performance-based deferred stock units for the three and nine months ended September 30, 2009 was $53 million and $135 million, respectively. Total compensation expense related to stock options, deferred stock units and performance-based deferred stock units for the three and nine months ended September 30, 2008 was $52 million and $171 million, respectively.

 

At September 30, 2009, the total remaining unrecognized compensation cost related to the performance-based deferred stock units granted in 2009 amounted to $23 million, which will be amortized over the weighted-average remaining requisite service period of 2.25 years. The remaining unrecognized compensation cost for the performance-based deferred stock units may vary each reporting period based on changes in the expected achievement of performance measures.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

The components of other expense/(income), net are as follows:

 

 

In September 2008, Schering-Plough completed its previously announced divestitures of certain Animal Health products as required by regulatory agencies in the U.S. and Europe in connection with the acquisition of OBS. As a result of these divestitures, Schering-Plough recognized a gain of $160 million ($149 million after tax). In addition, during the nine months ended September 30, 2008, Schering-Plough recognized a gain of $17 million ($12 million after tax) on the sale of a manufacturing site. These gains were included in Gain on sales of assets. Net cash proceeds from the divested animal health products were $210 million.

 

During 2008, Schering-Plough participated in health care refinancing programs adopted by local government fiscal authorities in a major European market. During the three and nine months ended September 30, 2008, Schering-Plough transferred $47 million of its trade accounts receivables owned by a foreign subsidiary to third-party financial institutions without recourse. The transfer of trade accounts receivable qualified as sales of accounts receivable under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” For the three and nine months ended September 30, 2008, the transfer of these trade accounts receivable did not have a material impact on Schering-Plough’s Statements of Condensed Consolidated Operations. Cash flows from these transactions are included in the change in accounts receivable in operating activities.

 

 

Schering-Plough reported a U.S. Net Operating Loss (NOL) carryforward of approximately $1.3 billion on its 2008 tax return, which will be available to offset future U.S. taxable income, in varying amounts, through 2028.

 

This U.S. NOL carryforward could be materially reduced after examination of Schering-Plough’s income tax returns by the Internal Revenue Service (IRS). Schering-Plough continues to maintain a valuation allowance against its U.S. deferred tax assets, as management cannot conclude that it is more likely than not the benefit of the U.S. net deferred tax assets can be realized.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

Schering-Plough has defined benefit pension plans covering eligible employees in the U.S. and certain foreign countries. In addition, Schering-Plough provides post-retirement medical and life insurance benefits primarily to its eligible U.S. retirees and their dependents through its post-retirement benefit plans.

 

The components of net pension expense were as follows:

 

 

The components of other post-retirement benefits expense were as follows:

 

 

For the three and nine months ended September 30, 2009, Schering-Plough made regular contributions of $30 million and $216 million, respectively, to its retirement plans. For the three and nine months ended September 30, 2008, Schering-Plough contributed $57 million and $153 million, respectively, to its retirement plans. Schering-Plough expects to make regular contributions of approximately $40 million to its retirement plans during the remainder of 2009.

 

In addition, in 2009 Schering-Plough contributed an aggregate of $367 million of cash equivalents to non-qualified trusts designated to fund certain pension and other employee benefit payments related to the planned combination with Merck. These amounts are included in Other assets in the Condensed Consolidated Balance Sheets. Further, Schering-Plough expects to fund certain deferred compensation plan requirements in the approximate amount of $170 million during the remainder of 2009.

 

 

As of January 1, 2009, Schering-Plough began to treat unvested deferred stock units as participating securities in accordance with the two-class method in the calculation of both basic and diluted earnings per share. This was also applied retrospectively. The effect of the retrospective application of this method was not material to Schering-Plough’s earnings per share in 2008.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following tables summarize the components of basic and diluted earnings per common share computations.

 

 

 

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

 

 

Comprehensive income is comprised of the following:

 

 

 

Inventories consisted of the following:

 

 

For the nine months ended September 30, 2008, $840 million of amortization of the fair value step-up recorded as part of the OBS acquisition are included in Depreciation and amortization in the condensed consolidated statements of cash flows.

 

Included in Other assets (non-current) at September 30, 2009 and December 31, 2008 was $237 million and $205 million, respectively, of inventory not expected to be sold within one year.

 

 

Goodwill was $2,879 million at September 30, 2009 as compared to $2,778 million at December 31, 2008. The increase was due to foreign currency translation.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The components of other intangible assets, net are as follows:

 

 

These intangible assets are amortized on the straight-line method over their respective useful lives. The residual value of intangible assets is estimated to be zero. Amortization expense for the three months ended September 30, 2009 and 2008 was $139 million and $148 million, respectively and $401 million and $439 million for the nine months ended September 30, 2009 and 2008, respectively. Annual amortization expenses related to these intangible assets for the years 2009 to 2013 is expected to be approximately $535 million.

 

 

Schering-Plough’s outstanding borrowings at September 30, 2009 and December 31, 2008 were as follows:

 

 

The decrease in the Floating rate Euro-denominated term loan due 2012 was due to an early principal repayment of Euro 50 million in the first quarter of 2009. No prepayment penalty was incurred relating to this principal repayment. The other changes in outstanding Euro-denominated borrowings at September 30, 2009 were due to foreign currency translation on Euro-denominated debt balances.

 

 

The table below presents the carrying values and estimated fair values for certain of Schering-Plough’s financial instruments at September 30, 2009 and December 31, 2008. Estimated fair values were determined based on market prices, where available, or dealer quotes. The carrying values of all other financial instruments, including cash and cash equivalents, approximated their estimated fair values at September 30, 2009 and December 31, 2008.

 

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

 

 

Schering-Plough’s condensed consolidated balance sheet at September 30, 2009 includes the following assets that are measured at fair value on a recurring basis:

 

 

At September 30, 2009 there were no liabilities that were subject to fair value measurement.

 

The majority of Schering-Plough’s assets measured at fair value on a recurring basis are measured using unadjusted quoted prices in active markets for identical items (Level 1) as inputs, multiplied by the number of units held at the balance sheet date. As of September 30, 2009, assets with fair values measured using significant other observable inputs (Level 2) include measurements using quoted prices for identical items in markets that are not active and measurements using inputs that are derived principally from or corroborated by observable market data.

 

 

Schering-Plough has three reportable segments: Prescription Pharmaceuticals, Animal Health and Consumer Health Care. The segment sales and profit data that follow are consistent with Schering-Plough’s current management reporting structure. The Prescription Pharmaceuticals segment discovers, develops, manufactures and markets human pharmaceutical products. The Animal Health segment discovers, develops, manufactures and markets animal health products. The Consumer Health Care segment develops, manufactures and markets over-the-counter, foot care and sun care products, primarily in the U.S.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Net sales by segment:

 

 

Profit by segment:

 

 

 

 

 

Schering-Plough’s consolidated net sales do not include sales of VYTORIN and ZETIA, which are managed in the cholesterol joint venture with Merck, as Schering-Plough accounts for this joint venture under the equity method of accounting (see Note 3, “Equity Income,” for additional information). The Prescription Pharmaceuticals segment includes equity income from the Merck/Schering-Plough joint venture.

 

“Corporate and other” includes interest income and expense, foreign exchange gains and losses, headquarters expenses, special, merger and acquisition-related charges and other miscellaneous items. The accounting policies used for segment reporting are the same as those described in Note 1, “Summary of Significant Accounting Policies,” in Schering-Plough’s 2008 10-K.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Sales of products comprising 10 percent or more of Schering-Plough’s U.S. or international sales for the three and nine months ended September 30, 2009, were as follows:

 

 

For the three and nine months ended September 30, 2009, net sales outside the U.S. totaled $3.2 billion and $9.3 billion, respectively. Net sales outside the U.S. approximated 70 percent and 69 percent of consolidated net sales for the three and nine months ended September 30, 2009, respectively.

 

Schering-Plough does not disaggregate assets on a segment basis for internal management reporting and, therefore, such information is not presented.

 

 

In December 2007, Schering-Plough and Centocor revised their distribution agreement regarding the development, commercialization and distribution of both REMICADE and SIMPONI (golimumab), extending Schering-Plough’s rights to exclusively market REMICADE to match the duration of Schering-Plough’s exclusive marketing rights for SIMPONI. On October 6, 2009 the European Commission approved SIMPONI as a treatment for rheumatoid arthritis and other immune system disorders in two presentations — a novel auto-injector and pre-filled syringe. As a result, Schering-Plough’s marketing rights for both products extend for 15 years from the first commercial sale of SIMPONI in the EU following the receipt of pricing and reimbursement approval within the EU. After operating expenses and subject to certain adjustments, Schering-Plough currently is entitled to receive an approximately 60 percent share of profits on Schering-Plough’s distribution in the Schering-Plough marketing territory. Beginning in 2010, share of profits will change over time to a 50 percent share of profits by 2014 for both products and the share of profits will remain fixed thereafter for the remainder of the term. Schering-Plough may independently develop and market SIMPONI for a Crohn’s disease indication in its territories, with an option for Centocor to participate. In addition, Schering-Plough and Centocor agreed to share certain development costs relating to SIMPONI’s auto-injector delivery system .

 

 

Schering-Plough is involved in various claims, investigations and legal proceedings.

 

Schering-Plough records a liability for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. Schering-Plough adjusts its liabilities for contingencies to reflect the current best estimate of probable loss or minimum liability, as the case may be. Where no best estimate is determinable, Schering-Plough records the minimum amount within the most probable range of its liability. Expected insurance recoveries have not been considered in determining the amounts of recorded liabilities for environmental related matters.

 

If Schering-Plough believes that a loss contingency is reasonably possible, rather than probable, or the amount of loss cannot be estimated, no liability is recorded. However, where a liability is reasonably possible, disclosure of the loss contingency is made.

 

Schering-Plough reviews the status of all claims, investigations and legal proceedings on an ongoing basis, including related insurance coverages. From time to time, Schering-Plough may settle or otherwise resolve these matters on terms and conditions management believes are in the best interests of Schering-Plough. Resolution of any or all claims, investigations and legal proceedings, individually or in the aggregate, could have a material adverse effect on Schering-Plough’s condensed consolidated results of operations, cash flows or financial condition.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Except for the matters discussed in the remainder of this Note, the recorded liabilities for contingencies at September 30, 2009, and the related expenses incurred during the three and nine months ended September 30, 2009, were not material. In the opinion of management, based on the advice of legal counsel, the ultimate outcome of these matters, except matters discussed in the remainder of this Note, is not expected to have a material impact on Schering-Plough’s consolidated results of operations, cash flows or financial condition.

 

AWP Litigation and Investigations

 

Schering-Plough continues to respond to existing and new litigation by certain states and private payors and investigations by the Department of Health and Human Services, the Department of Justice and several states into industry and Schering-Plough practices regarding average wholesale price (AWP). Schering-Plough is cooperating with these investigations.

 

These litigations and investigations relate to whether the AWP used by pharmaceutical companies for certain drugs improperly exceeds the average prices paid by providers and, as a consequence, results in unlawful inflation of certain reimbursements for drugs by state programs and private payors that are based on AWP. The complaints allege violations of federal and state law, including fraud, Medicaid fraud and consumer protection violations, among other claims. In the majority of cases, the plaintiffs are seeking class certifications. In some cases, classes have been certified. The outcome of these litigations and investigations could include substantial damages, the imposition of substantial fines, penalties and injunctive or administrative remedies.

 

Securities and Class Action Litigation

 

Federal Securities Litigation

 

Following Schering-Plough’s announcement that the FDA had been conducting inspections of Schering-Plough’s manufacturing facilities in New Jersey and Puerto Rico and had issued reports citing deficiencies concerning compliance with current Good Manufacturing Practices, several lawsuits were filed against Schering-Plough and certain named officers. These lawsuits allege that the defendants violated the federal securities law by allegedly failing to disclose material information and making material misstatements. Specifically, they allege that Schering-Plough failed to disclose an alleged serious risk that a new drug application for CLARINEX would be delayed as a result of these manufacturing issues, and they allege that Schering-Plough failed to disclose the alleged depth and severity of its manufacturing issues. These complaints were consolidated into one action in the U.S. District Court for the District of New Jersey, and a consolidated amended complaint was filed on October 11, 2001, purporting to represent a class of shareholders who purchased shares of Schering-Plough stock from May 9, 2000 through February 15, 2001. The complaint seeks compensatory damages on behalf of the class. The Court certified the shareholder class on October 10, 2003. Notice of pendency of the class action was sent to members of that class in July 2007. On February 18, 2009 the Court signed an order preliminarily approving a settlement agreement. The proposed settlement agreement was presented to the Court on June 1, 2009. The Court took the settlement agreement under advisement.

 

ERISA Litigation

 

On March 31, 2003, Schering-Plough was served with a putative class action complaint filed in the U.S. District Court in New Jersey alleging that Schering-Plough, Schering-Plough’s Employee Savings Plan (Plan) administrator, several current and former directors, and certain former corporate officers breached their fiduciary obligations to certain participants in the Plan. The complaint seeks damages in the amount of losses allegedly suffered by the Plan. The complaint was dismissed on June 29, 2004. The plaintiffs appealed. On August 19, 2005 the U.S. Court of Appeals for the Third Circuit reversed the dismissal by the District Court and the matter has been remanded back to the District Court for further proceedings. On September 30, 2008, the District Court entered an order granting in part, and denying in part, the named putative class representative’s motion for class certification. Schering-Plough thereafter petitioned the United States District Court of Appeals for the Third Circuit for leave to appeal the class certification decision. Schering-Plough’s petition was granted on December 10, 2008 and the appeal is currently pending before the Third Circuit.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

K-DUR Antitrust Litigation

 

Schering-Plough had settled patent litigation with Upsher-Smith, Inc. (Upsher-Smith) and ESI Lederle, Inc. (Lederle) relating to generic versions of K-DUR, Schering-Plough’s long-acting potassium chloride product supplement used by cardiac patients, for which Lederle and Upsher Smith had filed Abbreviated New Drug Applications. Following the commencement of an FTC administrative proceeding alleging anti-competitive effects from those settlements (which has been resolved in Schering-Plough’s favor), alleged class action suits were filed in federal and state courts on behalf of direct and indirect purchasers of K-DUR against Schering-Plough, Upsher-Smith and Lederle. These suits claim violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. These suits seek unspecified damages. In February 2009, a special master recommended that the U.S. District Court for the District of New Jersey dismiss the class action lawsuits on summary judgment. The U.S. District Court judge has not yet ruled on the recommendation.

 

Third-party Payor Actions

 

Several purported class action litigations have been filed following the announcement of the settlement of the Massachusetts Investigation. Plaintiffs in these actions seek damages on behalf of third-party payors resulting from the allegations of off-label promotion and improper payments to physicians that were at issue in the Massachusetts Investigation.

 

Litigation and Investigations relating to the Merck/Schering-Plough Cholesterol Joint Venture

 

Background.  In January 2008, the Merck/Schering-Plough Cholesterol Joint Venture announced the results of the ENHANCE clinical trial (Effect of Combination Ezetimibe and High-Dose Simvastatin vs. Simvastatin Alone on the Atherosclerotic Process in Patients with Heterozygous Familial Hypercholesterolemia). In July 2008 the Merck/Schering-Plough Cholesterol Joint Venture announced the results of the SEAS clinical trial (Simvastatin and Ezetimibe in Aortic Stenosis). Litigation and investigations with respect to matters relating to these clinical trials have been disclosed in prior filings.

 

Schering-Plough is cooperating fully with the various investigations and responding to the requests for information, and Schering-Plough intends to vigorously defend the lawsuits that have been filed relating to the ENHANCE study.

 

Investigations and Inquiries.  Through the date of filing this 10-Q, Schering-Plough, the Cholesterol Joint Venture and/or its joint venture partner, Merck, received a number of governmental inquiries and have been the subject of a number of investigations and inquiries relating to the ENHANCE clinical trial. These include several letters from Congress, including the Subcommittee on Oversight and Investigations of the House Committee on Energy and Commerce, and the ranking minority member of the Senate Finance Committee, collectively seeking a combination of witness interviews, documents and information on a variety of issues related to the Merck/Schering-Plough Cholesterol Joint Venture’s ENHANCE clinical trial. These also include several subpoenas from state officials, including State Attorneys General, and requests for information from U.S. Attorneys and the Department of Justice seeking similar information and documents. In addition, Schering-Plough received letters from the Subcommittee on Oversight and Investigations of the House Committee on Energy and Commerce seeking certain information and documents related to the SEAS clinical trial, and other matters. Schering-Plough, Merck and the Joint Venture are cooperating with these investigations and responding to the inquiries.

 

In January 2008, after the initial release of ENHANCE data, the FDA stated that it would review the results of the ENHANCE trial. On January 8, 2009 the FDA announced the results of its review. The FDA stated that following two years of treatment,

 

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The FDA also stated that the results from ENHANCE do not change its position that an elevated LDL cholesterol is a risk factor for cardiovascular disease and that lowering LDL cholesterol reduces the risk for cardiovascular disease. The FDA also stated that pending the results of the IMPROVE-IT clinical trial, patients should not stop taking VYTORIN or other cholesterol lowering medications and should talk to their doctors if they have any questions.

 

Litigation.  Schering-Plough continues to respond to existing and new litigation, including civil class action lawsuits alleging common law and state consumer fraud claims in connection with Schering-Plough’s sale and promotion of the Merck/Schering-Plough joint venture products VYTORIN and ZETIA; several putative shareholder securities class action lawsuits (where several officers are also named defendants) alleging false and misleading statements and omissions by Schering-Plough and its representatives related to the timing of disclosures concerning the ENHANCE results, allegedly in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934; a putative shareholder securities class action lawsuit (where several officers and directors are also named), alleging material misstatements and omissions related to the ENHANCE results in the offering documents in connection with Schering-Plough’s 2007 securities offerings, allegedly in violation of the Securities Act of 1933, including Section 11; several putative class action suits alleging that Schering-Plough and certain officers and directors breached their fiduciary duties under ERISA and seeking damages in the amount of losses allegedly suffered by the Plans; a Shareholder Derivative Action alleging that the Board of Directors breached its fiduciary obligations relating to the timing of the release of the ENHANCE results; and a letter on behalf of a single shareholder requesting that the Board of Directors investigate the allegations in the litigation described above and, if warranted, bring any appropriate legal action on behalf of Schering-Plough.

 

On July 15, 2009, Schering-Plough and Merck announced a settlement with a multistate group of 36 Attorneys General that was investigating whether the companies violated state consumer protection laws in connection with the ENHANCE clinical trial or the promotion and marketing of VYTORIN. As part of the civil resolution of these investigations, the companies agreed to reimburse the 35 states and the District of Columbia for their collective investigative costs, which totaled $5.4 million. The payments under this settlement were made by the Merck/Schering-Plough Pharmaceuticals cholesterol joint venture. The settlement agreement does not require any further payment.

 

With respect to VYTORIN and ZETIA, the agreement also includes voluntary assurances of compliance by the companies, including assurances that the companies will continue to comply with various laws and regulations, such as the U.S. Food and Drug Administration (FDA) Amendments Act, the Food, Drug and Cosmetic Act, and various laws requiring truthful and non-misleading marketing of products. The agreement is not an admission by the companies of any misconduct or liability.

 

On August 5, 2009, Schering-Plough, Merck and the cholesterol joint venture entered into settlement agreements resolving for a total fixed amount of $41.5 million, civil class action litigation relating to the purchase or use of VYTORIN and ZETIA. The cholesterol joint venture recorded these charges in the second quarter 2009.

 

The settlements resolve all but one of the class action lawsuits (including claims for attorneys’ fees, costs and nongovernmental liens) that seek economic damages related to the purchase of VYTORIN and ZETIA. The settlements were reached with plaintiffs seeking to represent proposed classes of consumers, insurers and other entities and with a separate group of independently represented health plans that purchased, used or paid money towards the purchase of VYTORIN or ZETIA from the time of the products’ introduction to the market. The agreement with the proposed classes is subject to court approval and certain conditions related to participation. The agreement with the independently represented health plans is not a class settlement and does not require court approval.

 

Legal Proceedings Related to the Merck Combination

 

Class Action Suits.  Since the announcement of the proposed combination, several putative class action lawsuits seeking to enjoin the merger, among other things, have been filed on behalf of shareholders of Schering-Plough in federal and state court.

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

On April 30, 2009, the federal actions were consolidated. On July 23, 2009, Schering-Plough entered into an agreement regarding a settlement of the consolidated federal class action for certain disclosures relating to the proposed merger. See Schering-Plough’s Form 8-K filed July 24, 2009. The agreement to make the additional disclosures does not constitute an acknowledgment that the additional disclosures are required under any applicable state or federal law, statute, rule or regulation. The parties also agreed that plaintiffs’ counsel may apply to the Court for an award of attorneys’ fees and costs.

 

Two additional putative class action complaints have been filed on behalf of public shareholders of Merck. On June 4, 2009, plaintiffs filed a consolidated class action complaint seeking, among other things, class action status, an order preliminarily and permanently enjoining the proposed combination, rescission of the combination if it is consummated, and attorneys’ fees and expenses. On July 23, 2009, Schering-Plough and Merck entered into an agreement regarding a settlement of these consolidated actions for certain disclosures relating to the proposed merger which had previously been made. The agreement to make the additional disclosures does not constitute an acknowledgment that the additional disclosures are required under any applicable state or federal law, statute, rule or regulation. The parties also agreed that plaintiffs’ counsel may apply to the court for an award of attorneys’ fees and costs.

 

Centocor Distribution Agreement.  On May 27, 2009, Centocor, a wholly owned subsidiary of Johnson & Johnson, delivered to Schering-Plough a notice initiating an arbitration proceeding to resolve whether, as a result of the proposed merger between Schering-Plough and Merck, Centocor is permitted to terminate Schering-Plough’s rights to distribute and commercialize REMICADE and golimumab (SIMPONI) in certain territories. The arbitration process involves a number of steps, including the selection of an independent arbitrator, information exchanges and hearings, before a final decision will be reached. The arbitration process is expected to continue in 2010.

 

Tax Matters

 

In October 2001, IRS auditors asserted that two interest rate swaps that Schering-Plough entered into with an unrelated party should be recharacterized as loans from affiliated companies, resulting in additional tax liability for the 1991 and 1992 tax years. In September 2004, Schering-Plough made payments to the IRS in the amount of $194 million for income tax and $279 million for interest. Schering-Plough filed refund claims for the tax and interest with the IRS in December 2004. Following the IRS’s denial of Schering-Plough’s claims for a refund, Schering-Plough filed suit in May 2005 in the U.S. District Court for the District of New Jersey for refund of the full amount of the tax and interest. On August 28, 2009, the District Court ruled in the Government’s favor. Schering-Plough is considering its options, including appealing the decision. Schering-Plough’s tax reserves were adequate to cover the above-mentioned payments.

 

Pending Administrative Obligations

 

In connection with the settlement of an investigation with the U.S. Department of Justice and the U.S. Attorney’s Office for the Eastern District of Pennsylvania, Schering-Plough entered into a five-year corporate integrity agreement (CIA). The CIA was amended in August 2006 in connection with the settlement of the Massachusetts Investigation, commencing a new five-year term. Failure to comply with the obligations under the CIA could result in financial penalties. To date, Schering-Plough believes it has complied with its obligations.

 

Other Matters

 

Products Liability

 

Beginning in May 2007, a number of complaints were filed in various jurisdictions asserting claims against Organon USA, Inc., Organon Pharmaceuticals USA, Inc., Organon International (Organon), and Schering-Plough Corporation arising from Organon’s marketing and sale of NUVARING, a combined hormonal contraceptive vaginal ring. The plaintiffs contend that Organon and Schering-Plough failed to adequately warn of the alleged increased risk of venous thromboembolism (VTE) posed by NUVARING, and/or downplayed the risk of VTE. The plaintiffs seek damages for injuries allegedly sustained from their product use, including some alleged

 

SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES