Live-blogging the Schering-Plough Q1 Earnings Release

~~~~~~~~~~~~~~~~~~~~
[UPDATED APRIL 23 @ 8:55 AM EDT]
~~~~~~~~~~~~~~~~~~~~

▲ Schering CEO Fred Hassan just reiterated the line that “unwarranted confusion” is what is challenging the Vytorin/Zetia Joint Venture’s results. This flies in the face of his deciding to take an incremental $1 billion charge to resolve the issues — going out to 2012. How is it possible that he needs four years of charges and restructuring to address an “unwarranted confusion“?

This simply doesn’t meet the “straight-face” test.

▲ The claim was just made, on the call, that “a dozen” studies indicate lowering LDL is better for patients. That is true — but there is no evidence that the WAY Vytorin/Zetia lowers LDL improves any cardiac outcome. Those studies involve liver mechanisms, not gut-mechanisms. We won’t know until 2012 (IMPROVE-IT) whether the gut-mechanism improves outcomes.

▲ Without currency “tailwinds“, Schering Q1 sales would only be up 5 percent, even after excluding all the Organon items — a morass of back-and-forth, put-and-take, accounting.

▲ Over 80 percent of Vytorin/Zetia sales occur inside the US for the cholesterol franchise, so the growth of non-US is far less important than CFO Bob Bertonlini just implied.

▲ CFO Bob Bertolini flat-out admitted that the Q1 trends just discussed — will not persist through the rest of 2008. “Likely to be lower. . . .”

Again, how can it be that “unwarranted confusion” cannot be cleared up? This is simply hard-to-swallow.

▲ The claim is being made that Vytorin/Zetia “efficacy” is identical to lower LDL-levels. There is simply no proof that this is “efficacy” as to outcomes.

To claim the gut-mechanism is identical to LDL “efficacy” is at best ambiguous — and is, perhaps, misleading.

▲ EVP Carrie Smith-Cox said that most patients who switch are going to the generic Zocor. . . . [that is at about one-tenth the cost of Schering's drugs.]

▲ EVP Carrie Smith-Cox claimed that Pro Cordaptive (Merck’s niacin product) is a “niche” only product — not likely to impact the franchise. We’ll see about that — it will likely be FDA-approved next-week.

▲ EVP Carrie Smith-Cox said the resumption of “direct to consumer” (DTC) advertising for the franchise will resume when the company, and FDA, agree on it. Remember that FDA wants promotional materials changed over by April 24, 2008 — tomorrow. It must all mean that Schering is still in negotiations with FDA about those advertising-literature, and Television-spot changes.

▲ The Morgan Stanley analyst just flat-out got stiff-armed, by CEO Fred Hassan, at the very end of the call — she asked Schering to help “quantify the Vytorin/Zetia equity income declines,” now expected for 2008 — and specifically mentioned Merck’s owning up to a $700 million loss of income, here.

Well, Fred essentially hung up on her.

He said “we really have no model for this scenario“. That is simply false — from Schering’s own ‘34 Act filing (read: “carries liability for material misstatements/fraud“) with the SEC, of yesterday, Schering said otherwise.

Yep, just yesterday, Schering filed a Form 8-K with the SEC indicating that its joint venture entity (shared 50/50 with Merck) had made a “range of estimates” for the equity income fall-off, in 2008. Applicable SEC literature requires disclosure of that range.

“No model“, indeed. Fred — what are you thinking? Did you even look at that Form 8-K, yesterday, before your lawyers filed it?

[End of Call @ 9:05 a.m., EDT.]

[Call transcript from seekingalpha is now up.]

~~~~~~~~~~~~~~~~~~~~
[END, UPDATE.]
~~~~~~~~~~~~~~~~~~~~

Tomorrow morning, before NYSE open, I’ll be live-blogging the Schering-Plough first quarter earnings conference call — we should learn more about Vytorin and Zetia ’script-trends — and the status of any write-downs to be taken inside the Schering/Merck Joint Venture, as well at Schering-Plough, proper. We will hope for an update on the status of the pending Congressional, and governmental, investigations and all the 115 pieces of litigation.

This link should anchor directly to a log-in for a Windows Media feed of the call on Wednesday.

It will likely go “live” — at Schering — around 7:50 a.m., EDT.

~~~~~~~~~~~~~~~~~~~~
[UPDATED APRIL 23 @ 5:55 AM EDT]
~~~~~~~~~~~~~~~~~~~~

First, for the past few months, I’ve been guessing that Schering-Plough’s share-equivalents for 2008, fully-diluted, would rise to about 1.62 billion shares. My estimate was too low — Schering shows fully diluted Q1 share equivalents at 1.637 billion shares, making all my 2008 EPS guesses (of declines, here) slightly too conservative — too small. Wow.

Schering will henceforth have quite a few more shares that it needs to “cover” with earnings. This is due to the decline in common stock prices, rendering the 6% Convertible Preferred. . . . dilutive, in share counts, henceforth.

Now, an a GAAP-basis, Schering missed — $0.15 v. $0.37 expected, at the EPS line, according to FirstCall.

At the revenue line, FirstCall reported an expected range of revenue of between $4.16 and $4.80 billion — Schering’s actual Q1 was $4.7 billion, slightly above the median estimate. Net income is the story, though.

Net income available to common, at Schering, for the first quarter was $243 million (GAAP), and $543 million (Non-GAAP). HOLD ON A SECOND!! — that means that Joint Venture Equity Income was about 95 percent of all Schering-Plough’s Non-GAAP net income in the first quater.

NINETY-FIVE PERCENT!?! YIKES! [I'll go verify that those are apples to apples numbers, now -- Wow!]

Almost as importantly, Equity Income from the Vytorin/Zetia Joint Venture, on a sequential quarterly-basis, is down 9.5 percent.

That is bad. The First Quarter was over (by all but one day), by the time the ACC met, so Q2 simply must be significantly worse – and yet, the Q1 Equity Income share for Schering was only $517 million. The Fourth Quarter 2007 Equity Income was $566 million. And there are now declines, overall, admitted to by Schering now, not just in the US market.

Remember, Merck has already admitted that its share of this equity income fall-off will be off at least $700 million for the full year.

By my rough estimates, if Schering’s equity income line is off more like $900 million for the year 2008, it will cost them $0.55 per share of 2008 EPS. That may be offset, in part, by about $400 million of savings, or $0.25, on a per chare basis, from the 2008 Productivity Transformation Program, to be acheived in 2008 (total $1.5 billion through 2012) — but that still leaves SGP with about a $0.30 per share “hole” in 2008 EPS.

Next point — Schering is making the “As Adjusted” figures for the quarter, due almost exclusively to the purchase accounting adjustment/write-off of $688 million in total — of which $551 million is a write -down of inventory(!) — from the Organon acquisiton of last fall, pre-tax. Schering then shows an increase of $600 million on an after-tax basis, for having written this off. The plain implication here is that much is being buried in the Organon numbers, both historical, and pro-forma.

More soon.

Forbes is on to my story, of this morning, now. . . .

I posted on it this morning; this afternoon, Forbes is on it:

It seems Merck may have some ulterior motives, here — Merck gets all of the profits from Cordaptive (due to be approved by FDA as early as next week), which will likely cannibalize some (more) of the Vytorin/Zetia market-share. . . .

In short, “Why share with Schering-Plough (on Vytorin/Zetia), when we have a new drug — Cordaptive — one that goes 100 percent to our own bottom line?”

That seems to be what Merck was wondering, softly, yesterday, and now aloud, to Forbes (off the record, of course).

Live-blogging the Schering-Plough Q1 Earnings Release

~~~~~~~~~~~~~~~~~~~~
[UPDATED APRIL 23 @ 8:55 AM EDT]
~~~~~~~~~~~~~~~~~~~~

▲ Schering CEO Fred Hassan just reiterated the line that “unwarranted confusion” is what is challenging the Vytorin/Zetia Joint Venture’s results. This flies in the face of his deciding to take an incremental $1 billion charge to resolve the issues — going out to 2012. How is it possible that he needs four years of charges and restructuring to address an “unwarranted confusion“?

This simply doesn’t meet the “straight-face” test.

▲ The claim was just made, on the call, that “a dozen” studies indicate lowering LDL is better for patients. That is true — but there is no evidence that the WAY Vytorin/Zetia lowers LDL improves any cardiac outcome. Those studies involve liver mechanisms, not gut-mechanisms. We won’t know until 2012 (IMPROVE-IT) whether the gut-mechanism improves outcomes.

▲ Without currency “tailwinds“, Schering Q1 sales would only be up 5 percent, even after excluding all the Organon items — a morass of back-and-forth, put-and-take, accounting.

▲ Over 80 percent of Vytorin/Zetia sales occur inside the US for the cholesterol franchise, so the growth of non-US is far less important than CFO Bob Bertonlini just implied.

▲ CFO Bob Bertolini flat-out admitted that the Q1 trends just discussed — will not persist through the rest of 2008. “Likely to be lower. . . .”

Again, how can it be that “unwarranted confusion” cannot be cleared up? This is simply hard-to-swallow.

▲ The claim is being made that Vytorin/Zetia “efficacy” is identical to lower LDL-levels. There is simply no proof that this is “efficacy” as to outcomes.

To claim the gut-mechanism is identical to LDL “efficacy” is at best ambiguous — and is, perhaps, misleading.

▲ EVP Carrie Smith-Cox said that most patients who switch are going to the generic Zocor. . . . [that is at about one-tenth the cost of Schering's drugs.]

▲ EVP Carrie Smith-Cox claimed that Pro Cordaptive (Merck’s niacin product) is a “niche” only product — not likely to impact the franchise. We’ll see about that — it will likely be FDA-approved next-week.

▲ EVP Carrie Smith-Cox said the resumption of “direct to consumer” (DTC) advertising for the franchise will resume when the company, and FDA, agree on it. Remember that FDA wants promotional materials changed over by April 24, 2008 — tomorrow. It must all mean that Schering is still in negotiations with FDA about those advertising-literature, and Television-spot changes.

▲ The Morgan Stanley analyst just flat-out got stiff-armed, by CEO Fred Hassan, at the very end of the call — she asked Schering to help “quantify the Vytorin/Zetia equity income declines,” now expected for 2008 — and specifically mentioned Merck’s owning up to a $700 million loss of income, here.

Well, Fred essentially hung up on her.

He said “we really have no model for this scenario“. That is simply false — from Schering’s own ‘34 Act filing (read: “carries liability for material misstatements/fraud“) with the SEC, of yesterday, Schering said otherwise.

Yep, just yesterday, Schering filed a Form 8-K with the SEC indicating that its joint venture entity (shared 50/50 with Merck) had made a “range of estimates” for the equity income fall-off, in 2008. Applicable SEC literature requires disclosure of that range.

“No model“, indeed. Fred — what are you thinking? Did you even look at that Form 8-K, yesterday, before your lawyers filed it?

[End of Call @ 9:05 a.m., EDT.]

[Call transcript from seekingalpha is now up.]

~~~~~~~~~~~~~~~~~~~~
[END, UPDATE.]
~~~~~~~~~~~~~~~~~~~~

Tomorrow morning, before NYSE open, I’ll be live-blogging the Schering-Plough first quarter earnings conference call — we should learn more about Vytorin and Zetia ’script-trends — and the status of any write-downs to be taken inside the Schering/Merck Joint Venture, as well at Schering-Plough, proper. We will hope for an update on the status of the pending Congressional, and governmental, investigations and all the 115 pieces of litigation.

This link should anchor directly to a log-in for a Windows Media feed of the call on Wednesday.

It will likely go “live” — at Schering — around 7:50 a.m., EDT.

~~~~~~~~~~~~~~~~~~~~
[UPDATED APRIL 23 @ 5:55 AM EDT]
~~~~~~~~~~~~~~~~~~~~

First, for the past few months, I’ve been guessing that Schering-Plough’s share-equivalents for 2008, fully-diluted, would rise to about 1.62 billion shares. My estimate was too low — Schering shows fully diluted Q1 share equivalents at 1.637 billion shares, making all my 2008 EPS guesses (of declines, here) slightly too conservative — too small. Wow.

Schering will henceforth have quite a few more shares that it needs to “cover” with earnings. This is due to the decline in common stock prices, rendering the 6% Convertible Preferred. . . . dilutive, in share counts, henceforth.

Now, an a GAAP-basis, Schering missed — $0.15 v. $0.37 expected, at the EPS line, according to FirstCall.

At the revenue line, FirstCall reported an expected range of revenue of between $4.16 and $4.80 billion — Schering’s actual Q1 was $4.7 billion, slightly above the median estimate. Net income is the story, though.

Net income available to common, at Schering, for the first quarter was $243 million (GAAP), and $543 million (Non-GAAP). HOLD ON A SECOND!! — that means that Joint Venture Equity Income was about 95 percent of all Schering-Plough’s Non-GAAP net income in the first quater.

NINETY-FIVE PERCENT!?! YIKES! [I'll go verify that those are apples to apples numbers, now -- Wow!]

Almost as importantly, Equity Income from the Vytorin/Zetia Joint Venture, on a sequential quarterly-basis, is down 9.5 percent.

That is bad. The First Quarter was over (by all but one day), by the time the ACC met, so Q2 simply must be significantly worse – and yet, the Q1 Equity Income share for Schering was only $517 million. The Fourth Quarter 2007 Equity Income was $566 million. And there are now declines, overall, admitted to by Schering now, not just in the US market.

Remember, Merck has already admitted that its share of this equity income fall-off will be off at least $700 million for the full year.

By my rough estimates, if Schering’s equity income line is off more like $900 million for the year 2008, it will cost them $0.55 per share of 2008 EPS. That may be offset, in part, by about $400 million of savings, or $0.25, on a per chare basis, from the 2008 Productivity Transformation Program, to be acheived in 2008 (total $1.5 billion through 2012) — but that still leaves SGP with about a $0.30 per share “hole” in 2008 EPS.

Next point — Schering is making the “As Adjusted” figures for the quarter, due almost exclusively to the purchase accounting adjustment/write-off of $688 million in total — of which $551 million is a write -down of inventory(!) — from the Organon acquisiton of last fall, pre-tax. Schering then shows an increase of $600 million on an after-tax basis, for having written this off. The plain implication here is that much is being buried in the Organon numbers, both historical, and pro-forma.

More soon.

Forbes is on to my story, of this morning, now. . . .

I posted on it this morning; this afternoon, Forbes is on it:

It seems Merck may have some ulterior motives, here — Merck gets all of the profits from Cordaptive (due to be approved by FDA as early as next week), which will likely cannibalize some (more) of the Vytorin/Zetia market-share. . . .

In short, “Why share with Schering-Plough (on Vytorin/Zetia), when we have a new drug — Cordaptive — one that goes 100 percent to our own bottom line?”

That seems to be what Merck was wondering, softly, yesterday, and now aloud, to Forbes (off the record, of course).

The SEC — On Disclosure of Known Trends and Uncertainties; Ranges of Material Loss Contingencies. . . .

[UPDATE:Well -- this site just had a very-interesting returning visitor "hit". See the visit image, below. These visits last up to two-hours (a few weeks ago), and over three-minutes, once again, this morning. . . . Cool!]

New Monthly IMS data out of Schering this morning — but first (and I’ll have more on this here, in a few minutes), this new text disclosure will likely not serve Schering very well, with the staff of Corporation Finance, at the SEC:

“. . . .Q: What is Schering-Plough’s comment on Merck’s guidance regarding the cholesterol franchise?

A: Schering-Plough does not provide numeric guidance and does not comment on the guidance of other companies.

The Merck/Schering-Plough cholesterol joint venture developed potential scenarios about the 2008 equity income. Merck chose an estimate that is within the ranges established in those scenarios. . . .“
[Emphasis supplied.]

“Hold on a sec., there, pard’. . . .” Didn’t Schering announce a $1.5 billion charge, a good chunk of which will likely be booked into its First Quarter 2008 results? Now, doesn’t that press release indicate that the charge is, in part due to “. . .to the confusion in the U.S. market around cholesterol management that impacts the products of the Merck/Schering-Plough joint venture, Zetia and Vytorin. . .“?

Well, as a matter of fact, yes sir — it does. So, Schering, according to well-settled SEC law, needs to provide the range of the fall-off in the Cholesterol Franchise Joint Venture. It is clearly the reason for at least $1 billion of that charge. More on that below. [By the way, when was the last time you saw a Fortune 200 company take a $1 billion bath, and credit the write-down to "confusion"? wouldn't it be cheaper, and easier, if it were simply confusion, to get out there, with factual, forceful, proactive advertising -- and promptly "clear up" the confusion, rather than cut-out 10 percent of your workforce, and spend $1B, grande? So -- is it really "confusion", guys -- or something else? Ah, but I digress.]

The notion that Schering is not going to provide that range — the fall-off that drove the $1 billion of incremental cuts/charges — unless it does so on tomorrow’s call — is plainly frowned upon by SEC rules and releases. There can be no dispute that almost no number is more material to the future earnings of Schering, than the range of loss in profits now expected from the Cholesterol Joint Venture.

I’ll have a cite to the SEC literature on this in a moment below, but once a range has been established (jointly by agents of Schering and agents of Merck & Co., not some third party/interloper, here!), as to a material loss contingency, the range must be disclosed (unless the loss contingency is deemed “remote” by the auditors, and that is not the case here — what audit firm is going to take the risk that something Merck said was real, is “remote” as to Schering, a much, much smaller company?!) — even if the actual amount, with precision, cannot be determined, by tomorrow’s call.

The range must be disclosed. This franchise is over 55 percent of Schering’s (previously-) expected 2008 profitability.

This is not some goofy “the-Sky-is-falling” pronouncement from a crazy blogger, here (Heh!) — this is Schering’s 50-50 Joint Venture partner, a huge public company whose lawyers decided this was material, estimable and probable — as to their joint $5 billion business relationship. To persist in denying this, seems not only unwise from a legal point of view, it seems unsound from a public investor relations point of view.

So — I’d expect Schering to disclose the range tomorrow — and it will certainly be as high as $900 million (as I predicted yesterday), but may be even higher. . . . $1 or even $1.2 billion.

Other than the above, the SEC Form 8-K filed by Schering just now essentially confirmed what MRK said yesterday, about IMS trends, so I’ll not repeat it here.

On to the SEC’s rules and releases then — and Reg. S-K, Item 303(a):

“. . . .(3) Results of operations.

(i) Describe any unusual or infrequent events or transactions or any significant economic changes that materially affected the amount of reported income from continuing operations and, in each case, indicate the extent to which income was so affected. In addition, describe any other significant components of revenues or expenses that, in the registrant’s judgment, should be described in order to understand the registrant’s results of operations.

. . . .(ii) Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed.

(iii) To the extent that the financial statements disclose material increases in net sales or revenues, provide a narrative discussion of the extent to which such increases are attributable to increases in prices or to increases in the volume or amount of goods or services being sold or to the introduction of new products or services. . . .”

Indeed.

The SEC’s financial statement rules, collected under Reg. S-X (which incorporate FASB releases), provide thus — via SFAS No. 5:

“. . . .Disclosure of the nature of an accrual made pursuant to the provisions of paragraph 8, and in some circumstances the amount accrued, may be necessary for the financial statements not to be misleading. . . . [Editorial Note: Remember here that Schering has indicated it will take a $1.5 billion charge, or accrual, in large part to address the fall-off in the Joint Venture's business.]

If no accrual is made for a loss contingency because one or both of the conditions in paragraph 8 are not met, or if an exposure to loss exists in excess of the amount accrued pursuant to the provisions of paragraph 8, disclosure of the contingency shall be made when there is at least a reasonable possibility that a loss or an additional loss may have been incurred. The disclosure shall indicate the nature of the contingency and shall give an estimate of the possible loss or range of loss or state that such an estimate cannot be made. Disclosure is not required of a loss contingency involving an unasserted claim or assessment when there has been no manifestation by a potential claimant of an awareness of a possible claim or assessment unless it is considered probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable. . . .

. . . .After the date of an enterprise’s financial statements but before those financial statements are issued, information may become available indicating that an asset was impaired or a liability was incurred after the date of the financial statements or that there is at least a reasonable possibility that an asset was impaired or a liability was incurred after that date. . . . [T]he information may relate to a loss contingency that did not exist at the date of the financial statements, e.g., threat of expropriation of assets after the date of the financial statements or the filing for bankruptcy by an enterprise whose debt was guaranteed after the date of the financial statements. In none of the cases cited in this paragraph was an asset impaired or a liability incurred at the date of the financial statements, and the condition for accrual in paragraph 8(a) is, therefore, not met. Disclosure of those kinds of losses or loss contingencies may be necessary, however, to keep the financial statements from being misleading.
If disclosure is deemed necessary, the financial statements shall indicate the nature of the loss or loss contingency and give an estimate of the amount or range of loss or possible loss or state that such an estimate cannot be made. . . .

Occasionally, in the case of a loss arising after the date of the financial statements where the amount of asset impairment or liability incurrence can be reasonably estimated, disclosure may best be made by supplementing the historical financial statements with pro forma financial data giving effect to the loss as if it had occurred at the date of the financial statements. . . .

. . . .The SEC expands the disclosures about the nature of operations whenever a concentration exists that places the well-being of the entity at risk. The SEC believes that readers need to know about operational concentrations which, if the relationship with the concentration is severed or significantly reduced, could cause significant harm to the entity.

Concentrations come in many forms — so many, in fact, that the SEC felt compelled to list the particular concentrations that concern it the most. Specifically, the following four concentrations require disclosure if they meet the disclosure criteria:

▲ Concentrations in the volume of business transacted with a particular customer, supplier, lender, grantor or contributor;

▲ Concentrations in revenue from particular products, services or fund-raising events. . . .

. . . .When an entity has a concentration that belongs on the above list, the concentration must be disclosed when all three of the following criteria are met:

▲ The concentration exists at the date of the balance sheet;

▲ The concentration makes the enterprise vulnerable to the risk of near-term severe impact; and

▲ It is at least reasonably possible the events that could cause the severe impact will occur in the near term.

The SEC defines a “severe impact” as a “. . .significant financially disruptive effect on the normal functioning of the entity.” The term implies a higher threshold than a “material impact.” A material impact implies information that would alter decisions about an entity and may, in turn, alter the valuation of an entity’s capital stock or outstanding debt. A severe impact implies a more serious effect, one that would seriously upset the central manufacturing or marketing operations of the entity. To judge whether a severe impact is possible, the focus is on the core operating processes of the company. The question is how seriously the operating environment would be affected if the relationship with the concentration were disrupted. . . .

[Editorial Comment, here: This page had some fascinating traffic, today, no?]
. . . .The disclosure of the concentration should contain sufficient information to inform the reader of the nature of the risk caused by the concentration. Normally, this would consist of a narrative statement. The SEC only encourages the use of quantitative measures for the degree of the concentration. In addition, the SEC realizes that information about concentrations may already be presented in efforts to comply with other pronouncements such as SFAS No. 14, Financial Reporting for Segments of a Business Enterprise. . . .

The SEC mandates particular requirements for certain types of concentrations. When an entity has a concentration of customers or contributors or has a concentration of operations located outside the entity’s home country, the SEC removes some judgement: The entity should always consider it reasonably possible that the relationship or operations will be disrupted in the near term. . . .“

At the risk of repeating here, then, it seems obvious beyond peradventure, that if Merck & Co., at twice Schering’s size, believed this estimated $700 million profit decline is probable (not just “possible“), material, and estimable, then Schering simply must disclose its own view of the range, tomorrow. Up or down — whether it agrees, disagrees, or has some other path, here. It seems difficult to find any other lawful reading of the SEC’s 30-plus years of guidance, here.

Now, consider this, from the SEC’s MD&A literature:

“. . . .In assessing whether disclosure of a trend, event, etc. is required, management must consider both whether it is reasonably likely to occur and whether a material effect is reasonably likely to occur. As the Commission noted when it adopted the requirement, the “reasonably likely to occur” test is to be used rather than the Basic v. Levinson probability and magnitude test for materiality of contingent events. See Securities Act Release No. 6835 (May 18, 1989) [54 FR 22427] at fns. 27-28 and accompanying text. . . .”

That pretty much seals it.

And, while not directly applicable to these facts, this is illuminating, from the Form 8-K Release, as Schering chose to make this disclosure by way of a Form 8-K, so updates are now required:

“. . . .If at the time of filing the company is unable to make a good faith estimate of the amount. . . . it need not disclose an estimate at that time, but must nevertheless file the Form 8-K report describing the company’s commitment to a course of action under which it will incur a material charge. Within four business days after the company formulates an estimate, the company must amend its earlier Form 8-K filing to include the estimate. . . .”

As ever, more to come.

The SEC — On Disclosure of Known Trends and Uncertainties; Ranges of Material Loss Contingencies. . . .

[UPDATE:Well -- this site just had a very-interesting returning visitor "hit". See the visit image, below. These visits last up to two-hours (a few weeks ago), and over three-minutes, once again, this morning. . . . Cool!]

New Monthly IMS data out of Schering this morning — but first (and I’ll have more on this here, in a few minutes), this new text disclosure will likely not serve Schering very well, with the staff of Corporation Finance, at the SEC:

“. . . .Q: What is Schering-Plough’s comment on Merck’s guidance regarding the cholesterol franchise?

A: Schering-Plough does not provide numeric guidance and does not comment on the guidance of other companies.

The Merck/Schering-Plough cholesterol joint venture developed potential scenarios about the 2008 equity income. Merck chose an estimate that is within the ranges established in those scenarios. . . .“
[Emphasis supplied.]

“Hold on a sec., there, pard’. . . .” Didn’t Schering announce a $1.5 billion charge, a good chunk of which will likely be booked into its First Quarter 2008 results? Now, doesn’t that press release indicate that the charge is, in part due to “. . .to the confusion in the U.S. market around cholesterol management that impacts the products of the Merck/Schering-Plough joint venture, Zetia and Vytorin. . .“?

Well, as a matter of fact, yes sir — it does. So, Schering, according to well-settled SEC law, needs to provide the range of the fall-off in the Cholesterol Franchise Joint Venture. It is clearly the reason for at least $1 billion of that charge. More on that below. [By the way, when was the last time you saw a Fortune 200 company take a $1 billion bath, and credit the write-down to "confusion"? wouldn't it be cheaper, and easier, if it were simply confusion, to get out there, with factual, forceful, proactive advertising -- and promptly "clear up" the confusion, rather than cut-out 10 percent of your workforce, and spend $1B, grande? So -- is it really "confusion", guys -- or something else? Ah, but I digress.]

The notion that Schering is not going to provide that range — the fall-off that drove the $1 billion of incremental cuts/charges — unless it does so on tomorrow’s call — is plainly frowned upon by SEC rules and releases. There can be no dispute that almost no number is more material to the future earnings of Schering, than the range of loss in profits now expected from the Cholesterol Joint Venture.

I’ll have a cite to the SEC literature on this in a moment below, but once a range has been established (jointly by agents of Schering and agents of Merck & Co., not some third party/interloper, here!), as to a material loss contingency, the range must be disclosed (unless the loss contingency is deemed “remote” by the auditors, and that is not the case here — what audit firm is going to take the risk that something Merck said was real, is “remote” as to Schering, a much, much smaller company?!) — even if the actual amount, with precision, cannot be determined, by tomorrow’s call.

The range must be disclosed. This franchise is over 55 percent of Schering’s (previously-) expected 2008 profitability.

This is not some goofy “the-Sky-is-falling” pronouncement from a crazy blogger, here (Heh!) — this is Schering’s 50-50 Joint Venture partner, a huge public company whose lawyers decided this was material, estimable and probable — as to their joint $5 billion business relationship. To persist in denying this, seems not only unwise from a legal point of view, it seems unsound from a public investor relations point of view.

So — I’d expect Schering to disclose the range tomorrow — and it will certainly be as high as $900 million (as I predicted yesterday), but may be even higher. . . . $1 or even $1.2 billion.

Other than the above, the SEC Form 8-K filed by Schering just now essentially confirmed what MRK said yesterday, about IMS trends, so I’ll not repeat it here.

On to the SEC’s rules and releases then — and Reg. S-K, Item 303(a):

“. . . .(3) Results of operations.

(i) Describe any unusual or infrequent events or transactions or any significant economic changes that materially affected the amount of reported income from continuing operations and, in each case, indicate the extent to which income was so affected. In addition, describe any other significant components of revenues or expenses that, in the registrant’s judgment, should be described in order to understand the registrant’s results of operations.

. . . .(ii) Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed.

(iii) To the extent that the financial statements disclose material increases in net sales or revenues, provide a narrative discussion of the extent to which such increases are attributable to increases in prices or to increases in the volume or amount of goods or services being sold or to the introduction of new products or services. . . .”

Indeed.

The SEC’s financial statement rules, collected under Reg. S-X (which incorporate FASB releases), provide thus — via SFAS No. 5:

“. . . .Disclosure of the nature of an accrual made pursuant to the provisions of paragraph 8, and in some circumstances the amount accrued, may be necessary for the financial statements not to be misleading. . . . [Editorial Note: Remember here that Schering has indicated it will take a $1.5 billion charge, or accrual, in large part to address the fall-off in the Joint Venture's business.]

If no accrual is made for a loss contingency because one or both of the conditions in paragraph 8 are not met, or if an exposure to loss exists in excess of the amount accrued pursuant to the provisions of paragraph 8, disclosure of the contingency shall be made when there is at least a reasonable possibility that a loss or an additional loss may have been incurred. The disclosure shall indicate the nature of the contingency and shall give an estimate of the possible loss or range of loss or state that such an estimate cannot be made. Disclosure is not required of a loss contingency involving an unasserted claim or assessment when there has been no manifestation by a potential claimant of an awareness of a possible claim or assessment unless it is considered probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable. . . .

. . . .After the date of an enterprise’s financial statements but before those financial statements are issued, information may become available indicating that an asset was impaired or a liability was incurred after the date of the financial statements or that there is at least a reasonable possibility that an asset was impaired or a liability was incurred after that date. . . . [T]he information may relate to a loss contingency that did not exist at the date of the financial statements, e.g., threat of expropriation of assets after the date of the financial statements or the filing for bankruptcy by an enterprise whose debt was guaranteed after the date of the financial statements. In none of the cases cited in this paragraph was an asset impaired or a liability incurred at the date of the financial statements, and the condition for accrual in paragraph 8(a) is, therefore, not met. Disclosure of those kinds of losses or loss contingencies may be necessary, however, to keep the financial statements from being misleading.
If disclosure is deemed necessary, the financial statements shall indicate the nature of the loss or loss contingency and give an estimate of the amount or range of loss or possible loss or state that such an estimate cannot be made. . . .

Occasionally, in the case of a loss arising after the date of the financial statements where the amount of asset impairment or liability incurrence can be reasonably estimated, disclosure may best be made by supplementing the historical financial statements with pro forma financial data giving effect to the loss as if it had occurred at the date of the financial statements. . . .

. . . .The SEC expands the disclosures about the nature of operations whenever a concentration exists that places the well-being of the entity at risk. The SEC believes that readers need to know about operational concentrations which, if the relationship with the concentration is severed or significantly reduced, could cause significant harm to the entity.

Concentrations come in many forms — so many, in fact, that the SEC felt compelled to list the particular concentrations that concern it the most. Specifically, the following four concentrations require disclosure if they meet the disclosure criteria:

▲ Concentrations in the volume of business transacted with a particular customer, supplier, lender, grantor or contributor;

▲ Concentrations in revenue from particular products, services or fund-raising events. . . .

. . . .When an entity has a concentration that belongs on the above list, the concentration must be disclosed when all three of the following criteria are met:

▲ The concentration exists at the date of the balance sheet;

▲ The concentration makes the enterprise vulnerable to the risk of near-term severe impact; and

▲ It is at least reasonably possible the events that could cause the severe impact will occur in the near term.

The SEC defines a “severe impact” as a “. . .significant financially disruptive effect on the normal functioning of the entity.” The term implies a higher threshold than a “material impact.” A material impact implies information that would alter decisions about an entity and may, in turn, alter the valuation of an entity’s capital stock or outstanding debt. A severe impact implies a more serious effect, one that would seriously upset the central manufacturing or marketing operations of the entity. To judge whether a severe impact is possible, the focus is on the core operating processes of the company. The question is how seriously the operating environment would be affected if the relationship with the concentration were disrupted. . . .

[Editorial Comment, here: This page had some fascinating traffic, today, no?]
. . . .The disclosure of the concentration should contain sufficient information to inform the reader of the nature of the risk caused by the concentration. Normally, this would consist of a narrative statement. The SEC only encourages the use of quantitative measures for the degree of the concentration. In addition, the SEC realizes that information about concentrations may already be presented in efforts to comply with other pronouncements such as SFAS No. 14, Financial Reporting for Segments of a Business Enterprise. . . .

The SEC mandates particular requirements for certain types of concentrations. When an entity has a concentration of customers or contributors or has a concentration of operations located outside the entity’s home country, the SEC removes some judgement: The entity should always consider it reasonably possible that the relationship or operations will be disrupted in the near term. . . .“

At the risk of repeating here, then, it seems obvious beyond peradventure, that if Merck & Co., at twice Schering’s size, believed this estimated $700 million profit decline is probable (not just “possible“), material, and estimable, then Schering simply must disclose its own view of the range, tomorrow. Up or down — whether it agrees, disagrees, or has some other path, here. It seems difficult to find any other lawful reading of the SEC’s 30-plus years of guidance, here.

Now, consider this, from the SEC’s MD&A literature:

“. . . .In assessing whether disclosure of a trend, event, etc. is required, management must consider both whether it is reasonably likely to occur and whether a material effect is reasonably likely to occur. As the Commission noted when it adopted the requirement, the “reasonably likely to occur” test is to be used rather than the Basic v. Levinson probability and magnitude test for materiality of contingent events. See Securities Act Release No. 6835 (May 18, 1989) [54 FR 22427] at fns. 27-28 and accompanying text. . . .”

That pretty much seals it.

And, while not directly applicable to these facts, this is illuminating, from the Form 8-K Release, as Schering chose to make this disclosure by way of a Form 8-K, so updates are now required:

“. . . .If at the time of filing the company is unable to make a good faith estimate of the amount. . . . it need not disclose an estimate at that time, but must nevertheless file the Form 8-K report describing the company’s commitment to a course of action under which it will incur a material charge. Within four business days after the company formulates an estimate, the company must amend its earlier Form 8-K filing to include the estimate. . . .”

As ever, more to come.

The SEC — On Disclosure of Known Trends and Uncertainties; Ranges of Material Loss Contingencies. . . .

[UPDATE:Well -- this site just had a very-interesting returning visitor "hit". See the visit image, below. These visits last up to two-hours (a few weeks ago), and over three-minutes, once again, this morning. . . . Cool!]

New Monthly IMS data out of Schering this morning — but first (and I’ll have more on this here, in a few minutes), this new text disclosure will likely not serve Schering very well, with the staff of Corporation Finance, at the SEC:

“. . . .Q: What is Schering-Plough’s comment on Merck’s guidance regarding the cholesterol franchise?

A: Schering-Plough does not provide numeric guidance and does not comment on the guidance of other companies.

The Merck/Schering-Plough cholesterol joint venture developed potential scenarios about the 2008 equity income. Merck chose an estimate that is within the ranges established in those scenarios. . . .“
[Emphasis supplied.]

“Hold on a sec., there, pard’. . . .” Didn’t Schering announce a $1.5 billion charge, a good chunk of which will likely be booked into its First Quarter 2008 results? Now, doesn’t that press release indicate that the charge is, in part due to “. . .to the confusion in the U.S. market around cholesterol management that impacts the products of the Merck/Schering-Plough joint venture, Zetia and Vytorin. . .“?

Well, as a matter of fact, yes sir — it does. So, Schering, according to well-settled SEC law, needs to provide the range of the fall-off in the Cholesterol Franchise Joint Venture. It is clearly the reason for at least $1 billion of that charge. More on that below. [By the way, when was the last time you saw a Fortune 200 company take a $1 billion bath, and credit the write-down to "confusion"? wouldn't it be cheaper, and easier, if it were simply confusion, to get out there, with factual, forceful, proactive advertising -- and promptly "clear up" the confusion, rather than cut-out 10 percent of your workforce, and spend $1B, grande? So -- is it really "confusion", guys -- or something else? Ah, but I digress.]

The notion that Schering is not going to provide that range — the fall-off that drove the $1 billion of incremental cuts/charges — unless it does so on tomorrow’s call — is plainly frowned upon by SEC rules and releases. There can be no dispute that almost no number is more material to the future earnings of Schering, than the range of loss in profits now expected from the Cholesterol Joint Venture.

I’ll have a cite to the SEC literature on this in a moment below, but once a range has been established (jointly by agents of Schering and agents of Merck & Co., not some third party/interloper, here!), as to a material loss contingency, the range must be disclosed (unless the loss contingency is deemed “remote” by the auditors, and that is not the case here — what audit firm is going to take the risk that something Merck said was real, is “remote” as to Schering, a much, much smaller company?!) — even if the actual amount, with precision, cannot be determined, by tomorrow’s call.

The range must be disclosed. This franchise is over 55 percent of Schering’s (previously-) expected 2008 profitability.

This is not some goofy “the-Sky-is-falling” pronouncement from a crazy blogger, here (Heh!) — this is Schering’s 50-50 Joint Venture partner, a huge public company whose lawyers decided this was material, estimable and probable — as to their joint $5 billion business relationship. To persist in denying this, seems not only unwise from a legal point of view, it seems unsound from a public investor relations point of view.

So — I’d expect Schering to disclose the range tomorrow — and it will certainly be as high as $900 million (as I predicted yesterday), but may be even higher. . . . $1 or even $1.2 billion.

Other than the above, the SEC Form 8-K filed by Schering just now essentially confirmed what MRK said yesterday, about IMS trends, so I’ll not repeat it here.

On to the SEC’s rules and releases then — and Reg. S-K, Item 303(a):

“. . . .(3) Results of operations.

(i) Describe any unusual or infrequent events or transactions or any significant economic changes that materially affected the amount of reported income from continuing operations and, in each case, indicate the extent to which income was so affected. In addition, describe any other significant components of revenues or expenses that, in the registrant’s judgment, should be described in order to understand the registrant’s results of operations.

. . . .(ii) Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed.

(iii) To the extent that the financial statements disclose material increases in net sales or revenues, provide a narrative discussion of the extent to which such increases are attributable to increases in prices or to increases in the volume or amount of goods or services being sold or to the introduction of new products or services. . . .”

Indeed.

The SEC’s financial statement rules, collected under Reg. S-X (which incorporate FASB releases), provide thus — via SFAS No. 5:

“. . . .Disclosure of the nature of an accrual made pursuant to the provisions of paragraph 8, and in some circumstances the amount accrued, may be necessary for the financial statements not to be misleading. . . . [Editorial Note: Remember here that Schering has indicated it will take a $1.5 billion charge, or accrual, in large part to address the fall-off in the Joint Venture's business.]

If no accrual is made for a loss contingency because one or both of the conditions in paragraph 8 are not met, or if an exposure to loss exists in excess of the amount accrued pursuant to the provisions of paragraph 8, disclosure of the contingency shall be made when there is at least a reasonable possibility that a loss or an additional loss may have been incurred. The disclosure shall indicate the nature of the contingency and shall give an estimate of the possible loss or range of loss or state that such an estimate cannot be made. Disclosure is not required of a loss contingency involving an unasserted claim or assessment when there has been no manifestation by a potential claimant of an awareness of a possible claim or assessment unless it is considered probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable. . . .

. . . .After the date of an enterprise’s financial statements but before those financial statements are issued, information may become available indicating that an asset was impaired or a liability was incurred after the date of the financial statements or that there is at least a reasonable possibility that an asset was impaired or a liability was incurred after that date. . . . [T]he information may relate to a loss contingency that did not exist at the date of the financial statements, e.g., threat of expropriation of assets after the date of the financial statements or the filing for bankruptcy by an enterprise whose debt was guaranteed after the date of the financial statements. In none of the cases cited in this paragraph was an asset impaired or a liability incurred at the date of the financial statements, and the condition for accrual in paragraph 8(a) is, therefore, not met. Disclosure of those kinds of losses or loss contingencies may be necessary, however, to keep the financial statements from being misleading.
If disclosure is deemed necessary, the financial statements shall indicate the nature of the loss or loss contingency and give an estimate of the amount or range of loss or possible loss or state that such an estimate cannot be made. . . .

Occasionally, in the case of a loss arising after the date of the financial statements where the amount of asset impairment or liability incurrence can be reasonably estimated, disclosure may best be made by supplementing the historical financial statements with pro forma financial data giving effect to the loss as if it had occurred at the date of the financial statements. . . .

. . . .The SEC expands the disclosures about the nature of operations whenever a concentration exists that places the well-being of the entity at risk. The SEC believes that readers need to know about operational concentrations which, if the relationship with the concentration is severed or significantly reduced, could cause significant harm to the entity.

Concentrations come in many forms — so many, in fact, that the SEC felt compelled to list the particular concentrations that concern it the most. Specifically, the following four concentrations require disclosure if they meet the disclosure criteria:

▲ Concentrations in the volume of business transacted with a particular customer, supplier, lender, grantor or contributor;

▲ Concentrations in revenue from particular products, services or fund-raising events. . . .

. . . .When an entity has a concentration that belongs on the above list, the concentration must be disclosed when all three of the following criteria are met:

▲ The concentration exists at the date of the balance sheet;

▲ The concentration makes the enterprise vulnerable to the risk of near-term severe impact; and

▲ It is at least reasonably possible the events that could cause the severe impact will occur in the near term.

The SEC defines a “severe impact” as a “. . .significant financially disruptive effect on the normal functioning of the entity.” The term implies a higher threshold than a “material impact.” A material impact implies information that would alter decisions about an entity and may, in turn, alter the valuation of an entity’s capital stock or outstanding debt. A severe impact implies a more serious effect, one that would seriously upset the central manufacturing or marketing operations of the entity. To judge whether a severe impact is possible, the focus is on the core operating processes of the company. The question is how seriously the operating environment would be affected if the relationship with the concentration were disrupted. . . .

[Editorial Comment, here: This page had some fascinating traffic, today, no?]
. . . .The disclosure of the concentration should contain sufficient information to inform the reader of the nature of the risk caused by the concentration. Normally, this would consist of a narrative statement. The SEC only encourages the use of quantitative measures for the degree of the concentration. In addition, the SEC realizes that information about concentrations may already be presented in efforts to comply with other pronouncements such as SFAS No. 14, Financial Reporting for Segments of a Business Enterprise. . . .

The SEC mandates particular requirements for certain types of concentrations. When an entity has a concentration of customers or contributors or has a concentration of operations located outside the entity’s home country, the SEC removes some judgement: The entity should always consider it reasonably possible that the relationship or operations will be disrupted in the near term. . . .“

At the risk of repeating here, then, it seems obvious beyond peradventure, that if Merck & Co., at twice Schering’s size, believed this estimated $700 million profit decline is probable (not just “possible“), material, and estimable, then Schering simply must disclose its own view of the range, tomorrow. Up or down — whether it agrees, disagrees, or has some other path, here. It seems difficult to find any other lawful reading of the SEC’s 30-plus years of guidance, here.

Now, consider this, from the SEC’s MD&A literature:

“. . . .In assessing whether disclosure of a trend, event, etc. is required, management must consider both whether it is reasonably likely to occur and whether a material effect is reasonably likely to occur. As the Commission noted when it adopted the requirement, the “reasonably likely to occur” test is to be used rather than the Basic v. Levinson probability and magnitude test for materiality of contingent events. See Securities Act Release No. 6835 (May 18, 1989) [54 FR 22427] at fns. 27-28 and accompanying text. . . .”

That pretty much seals it.

And, while not directly applicable to these facts, this is illuminating, from the Form 8-K Release, as Schering chose to make this disclosure by way of a Form 8-K, so updates are now required:

“. . . .If at the time of filing the company is unable to make a good faith estimate of the amount. . . . it need not disclose an estimate at that time, but must nevertheless file the Form 8-K report describing the company’s commitment to a course of action under which it will incur a material charge. Within four business days after the company formulates an estimate, the company must amend its earlier Form 8-K filing to include the estimate. . . .”

As ever, more to come.

Another Interesting Cafepharma Question, here. . . .

A reader at Cafepharma asked another question — my answer is apparently caught in the moderation que, at the moment, over there, so here it is:

Anonymous wrote:

when will the criminal case start on insider trading -

a) Never
b) 3077
c) Already settled

your answer ??

My answer:

“I doubt it is settled already — that would require a public SEC filing, a report — and we haven’t seen any.

As to the individual officers/directors, I think proving a criminal (as opposed to civil) insider trading case — at least, on the facts as we now know/understand them — would be a tall order. I think to prove that crime, one would need to show far more than just “access” to the ENHANCE data, by those who traded prior to disclosure — while in a purely civil case, this “access”, plus the top-of-market prices, might be enough to convince a court to impose a civil penalty — or at least, to extract a civil charge settlement in deferred prosecution/negotiations with the SEC, directly, in the weeks leading up to a trial, at some 2009 date.

It is quite difficult to say, as it is all very early in the process of finding out what evidence exists, beyond what is already known by the public.

I think it would be similarly difficult (based on the public documents, thus far) to prove that the “enterprise” conspired to conduct the August 2007 $3.8 billion offerings with specific intent to defraud. That does not mean it did not happen. It just means it would be very difficult to prove. Your mileage may vary. . . .“

We may learn much more in the coming months that will render this polly-anna-ish and out-of-date, but right now, I really can’t see the SEC filing [sincere thanks go to Anon. No. 2, in the comments hereto, for the suggested edit!] referring a criminal case, to the DoJ, on these facts. Not on what we know thus far.

Another Interesting Cafepharma Question, here. . . .

A reader at Cafepharma asked another question — my answer is apparently caught in the moderation que, at the moment, over there, so here it is:

Anonymous wrote:

when will the criminal case start on insider trading -

a) Never
b) 3077
c) Already settled

your answer ??

My answer:

“I doubt it is settled already — that would require a public SEC filing, a report — and we haven’t seen any.

As to the individual officers/directors, I think proving a criminal (as opposed to civil) insider trading case — at least, on the facts as we now know/understand them — would be a tall order. I think to prove that crime, one would need to show far more than just “access” to the ENHANCE data, by those who traded prior to disclosure — while in a purely civil case, this “access”, plus the top-of-market prices, might be enough to convince a court to impose a civil penalty — or at least, to extract a civil charge settlement in deferred prosecution/negotiations with the SEC, directly, in the weeks leading up to a trial, at some 2009 date.

It is quite difficult to say, as it is all very early in the process of finding out what evidence exists, beyond what is already known by the public.

I think it would be similarly difficult (based on the public documents, thus far) to prove that the “enterprise” conspired to conduct the August 2007 $3.8 billion offerings with specific intent to defraud. That does not mean it did not happen. It just means it would be very difficult to prove. Your mileage may vary. . . .“

We may learn much more in the coming months that will render this polly-anna-ish and out-of-date, but right now, I really can’t see the SEC filing [sincere thanks go to Anon. No. 2, in the comments hereto, for the suggested edit!] referring a criminal case, to the DoJ, on these facts. Not on what we know thus far.