-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EwughzDL4t2AgkXvcEWBghw/DUuqoKWfoctlXZFRuwa1DBrc3o4H+4XwBqiwNsMu HTw+z1fWzDwI4d3QGuzaSA== 0000950123-04-012647.txt : 20041028 0000950123-04-012647.hdr.sgml : 20041028 20041028165712 ACCESSION NUMBER: 0000950123-04-012647 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20041028 DATE AS OF CHANGE: 20041028 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCHERING PLOUGH CORP CENTRAL INDEX KEY: 0000310158 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 221918501 STATE OF INCORPORATION: NJ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-06571 FILM NUMBER: 041103235 BUSINESS ADDRESS: STREET 1: ONE GIRALDA FARMS CITY: MADISON STATE: NJ ZIP: 07940-1000 BUSINESS PHONE: 9738227000 10-Q 1 y67941e10vq.txt FORM 10-Q FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2004 COMMISSION FILE NUMBER 1-6571 SCHERING-PLOUGH CORPORATION (Exact name of registrant as specified in its charter) New Jersey 22-1918501 (State or other jurisdiction of incorporation) (I.R.S. Employer 2000 Galloping Hill Road Identification No.) Kenilworth, NJ (908) 298-4000 (Address of principal executive offices) (Registrant's telephone 07033 number, (Zip Code) including area code) 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, and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [X] NO [ ] Common Shares Outstanding as of September 30, 2004: 1,472,762,054 PART I. FINANCIAL INFORMATION Item 1. Financial Statements SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES STATEMENTS OF CONDENSED CONSOLIDATED OPERATIONS (UNAUDITED) (Amounts in millions, except per share figures)
Three Months Nine Months Ended Ended September 30, September 30, ---------------------- ---------------------- 2004 2003 2004 2003 ------- ------- ------- ------- Net sales $ 1,978 $ 1,998 $ 6,088 $ 6,386 ------- ------- ------- ------- Cost of sales 711 652 2,241 2,094 Selling, general and administrative 892 873 2,785 2,653 Research and development 378 382 1,201 1,074 Other expense (income), net 34 41 112 49 Special charges 26 350 138 370 Equity (income) from cholesterol joint venture (95) (24) (249) (21) ------- ------- ------- ------- Income/(loss) before income taxes 32 (276) (140) 167 Income taxes (expense)/benefit (6) 11 28 (77) ------- ------- ------- ------- Net income/(loss) $ 26 $ (265) $ (112) $ 90 ------- ------- ------- ------- Preferred stock dividends 12 - 12 - ------- ------- ------- ------- Net income/(loss) available to common shareholders $ 14 $ (265) $ (124) $ 90 ======= ======= ======= ======= Diluted earnings/(loss) per common share $ .01 $ (.18) $ (.08) $ .06 ======= ======= ======= ======= Basic earnings/(loss) per common share $ .01 $ (.18) $ (.08) $ .06 ======= ======= ======= ======= Dividends per common share $ .055 $ .17 $ .165 $ .51 ======= ======= ======= =======
See notes to condensed consolidated financial statements. 2 SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (Dollars in millions, except per share figures)
September 30, December 31, 2004 2003 ------------- ------------ Assets Cash and cash equivalents $ 4,685 $ 4,218 Short-term investments 881 587 Accounts receivable, net 1,342 1,329 Inventories 1,516 1,651 Deferred income taxes 460 472 Prepaid expenses and other current assets 550 890 --------------- -------- Total current assets 9,434 9,147 Property, plant and equipment 6,843 6,817 Less accumulated depreciation 2,391 2,290 --------------- -------- Property, net 4,452 4,527 Goodwill 214 218 Other intangible assets, net 241 401 Other assets 762 809 --------------- -------- Total assets $ 15,103 $ 15,102 =============== ======== Liabilities and Shareholders' Equity Accounts payable $ 926 $ 1,030 Short-term borrowings and current portion of long-term debt 866 1,023 Other accrued liabilities 1,942 2,556 --------------- -------- Total current liabilities 3,734 4,609 Long-term debt 2,392 2,410 Other long-term liabilities 729 746 --------------- -------- Total long-term liabilities 3,121 3,156 Shareholders' Equity: Mandatory convertible preferred shares - $1 par value; issued - 28,750,000; $50 per share face value 1,438 - Common shares - $.50 par value; issued:2,029,686,377 1,015 1,015 Paid-in capital 1,251 1,272 Retained earnings 10,452 10,918 Accumulated other comprehensive loss (469) (426) --------------- -------- Total 13,687 12,779 Less treasury shares: 2004 - 556,924,323 shares; 2003 - 558,666,318 shares, at cost 5,439 5,442 --------------- -------- Total shareholders' equity 8,248 7,337 --------------- -------- Total liabilities and shareholders' equity $ 15,103 $ 15,102 =============== ========
See notes to condensed consolidated financial statements. 3 SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, (UNAUDITED) (Amounts in millions)
2004 2003 ------- ------- Operating Activities: Net (loss)/income $ (112) $ 90 Adjustments to reconcile net (loss)/income to net cash provided by operating activities: Tax refund from loss carryback 404 - Tax matters (473) - Special charges (124) 370 Depreciation and amortization 325 297 Changes in assets and liabilities: Accounts receivable (36) 594 Inventories 103 (207) Prepaid expenses and other assets 17 27 Accounts payable and other liabilities (95) (796) ------- ------- Net cash provided by operating activities 9 375 ------- ------- Investing Activities: Capital expenditures (299) (462) Proceeds from transfer of license 118 35 Purchases of investments (294) (212) Other, net (3) 5 ------- ------- Net cash used for investing activities (478) (634) ------- ------- Financing Activities: Cash dividends paid to common shareholders (243) (750) Net change in short-term borrowings (173) 1,136 Proceeds from preferred stock issuance, net 1,394 - Other, net (42) 10 ------- ------- Net cash provided by financing activities 936 396 ------- ------- Effect of exchange rates on cash and cash equivalents - 1 ------- ------- Net increase in cash and cash equivalents 467 138 Cash and cash equivalents, beginning of period 4,218 3,521 ------- ------- Cash and cash equivalents, end of period $ 4,685 $ 3,659 ======= =======
See notes to condensed consolidated financial statements. 4 SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Basis of Presentation These unaudited condensed consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. Certain prior year amounts have been reclassified to conform to the current year presentation. These statements should be read in conjunction with the accounting policies and notes to consolidated financial statements included in the Company's 2003 Annual Report on Form 10-K. In the opinion of management, the financial statements reflect all adjustments necessary for a fair statement of the operations and financial position for the interim periods presented. Revenue Recognition The Company's pharmaceutical products are sold to direct purchasers (e.g., wholesalers, retailers and certain health maintenance organizations). Price discounts and rebates on such sales are paid to federal and state agencies as well as to indirect purchasers and other market participants (e.g., managed care organizations that indemnify beneficiaries of health plans for their pharmaceutical costs and pharmacy benefit managers). The Company recognizes revenue when title and risk of loss passes to the purchaser and when reliable estimates of the following can be determined: i. commercial discount and rebate arrangements; ii. rebate obligations under certain Federal and state governmental programs and; iii. sales returns in the normal course of business. When recognizing revenue the Company estimates and records the applicable commercial and governmental discounts and rebates as well as sales returns that have been or are expected to be granted or made for products sold during the period. These amounts are deducted from sales for that period. Estimates recorded in prior periods are re-evaluated as part of this process. If reliable estimates of these items can not be made, the Company defers the recognition of revenue. Special Charges Special charges for the three months ended September 30, 2004 totaled $26 million, primarily relating to employee termination costs. Special charges for the nine months ended September 30, 2004 totaled $138 million, comprised of $111 million in employee termination costs and $27 million in asset impairment charges. For the nine month period ended September 30, 2003, special charges totaled $370 million, comprised of $20 million of asset impairment charges and $350 million in increased litigation reserves. 5 Employee Termination Costs In August 2003, the Company announced a global workforce reduction initiative. The first phase of this initiative was a Voluntary Early Retirement Program in the United States. Under this program, eligible employees in the United States had until December 15, 2003, to elect early retirement and receive an enhanced retirement benefit. Approximately 900 employees elected to retire under the program, of which approximately 750 employees retired at or near year-end 2003 and approximately 150 employees have staggered retirement dates in the future. The total cost of this program is estimated to be $191 million, comprised of increased pension costs of $108 million, increased post-retirement health care costs of $57 million, vacation payments of $4 million and costs related to accelerated vesting of stock grants of $22 million. For employees with staggered retirement dates in the future, these amounts are being recognized as a special charge over the employees' remaining service periods. This delayed expense recognition follows the guidance in Statement of Financial Accounting Standards (SFAS) No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." Amounts recognized, relating to this program, during the three and nine months ended September 30, 2004 were $2 million and $19 million, respectively, with cumulative costs recognized of $183 million through September 30, 2004. Amounts expected to be recognized during the remainder of 2004 and 2005 are $1 million and $7 million, respectively. In addition to the Voluntary Early Retirement Program in the United States, the Company recognized $23 million and $92 million, respectively, of other employee severance costs for the three and nine months ended September 30, 2004. Asset Impairment Charges Asset impairment charges have been recognized in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." For the nine months ended September 30, 2004, the Company recognized asset impairment charges of $27 million, based on discounted cash flows. The asset impairments primarily related to the anticipated exit from a small European research-and-development facility. For the nine month period ended September 30, 2003, the Company recognized asset impairment charges of $20 million related to manufacturing facility assets. Litigation Charges During the three and nine months ended September 30, 2003, the Company recognized $350 million of litigation charges primarily as a result of the investigations into the Company's sales and marketing practices (see "Legal, Environmental and Regulatory Matters" footnote for additional information). 6 Summary of Selected Special Charges The following summarizes the activity in the accounts related to employee termination costs and asset impairment charges ($ in millions):
Employee Asset Termination Impairment Costs Charges ----------- ---------- Special charges accrual balance at December 31, 2003 $ 29 $ - Special charges incurred during nine months ended September 30, 2004 111 27 Write-offs - (27) Credit to retirement benefit plan liability (19) - Cash disbursements (78) - ----- ------ Special charges accrual balance at September 30, 2004 $ 43 $ - ===== ======
The balance at September 30, 2004 for employee termination costs represents the value of stock grants ($22 million) not yet distributed and severance payments remaining to be paid ($21 million) as of September 30, 2004. Strategic Agreement In September 2004, the Company announced that it entered into a strategic agreement with Bayer Pharmaceuticals Corporation ("Bayer") intended to enhance the companies' pharmaceutical resources. Commencing in October 2004, in the United States and Puerto Rico, the Company will market, sell and distribute Bayer's primary care products including Avelox (moxifloxacin HCl) and Cipro (ciprofloxacin HCl) under an exclusive license agreement. The Company will pay Bayer substantial royalties on these products based on sales. Also commencing in October 2004, the Company will assume Bayer's responsibilities for U.S. commercialization activities related to the erectile dysfunction medicine Levitra (vardenafil HCl) under Bayer's co-promotion agreement with GlaxoSmithKline PLC. The Company will report its share of Levitra's results as alliance revenue. Additionally, under the terms of the agreement, Bayer will support the promotion of certain of the Company's oncology products in the United States and key European markets for a defined period of time. In Japan, upon regulatory approval, Bayer will co-market the Company's cholesterol absorption inhibitor ZETIA (ezetimibe). This arrangement does not include the rights to any future cholesterol combination product. This agreement with Bayer potentially restricts the Company from marketing products in the United States that would compete with any of the products under the strategic alliance. As a result, the Company expects that it may need to sublicense rights to garenoxacin, the quinolone antibacterial agent that the Company licensed from Toyama Chemical Co. Ltd. ("Toyama"). The Company is exploring its options with regard to garenoxacin and 7 will continue to fulfill its commitments to Toyama under its arrangement, including taking the product through regulatory approval. The Toyama arrangement is discussed in further detail in the "Product License" footnote below. Product License On June 21, 2004, the Company entered into a collaboration and license agreement with Toyama. Under the terms of the agreement, the Company has acquired the exclusive worldwide rights, excluding Japan, Korea and China, to develop, use and sell garenoxacin, Toyama's quinolone antibacterial agent currently in development. In connection with the execution of the agreement, the Company incurred a charge in the second quarter of 2004 for an up-front fee of $80 million to Toyama. This amount has been expensed and reported in "Research and development" for the nine months ended September 30, 2004 in the Statements of Condensed Consolidated Operations. Inventories Inventories consisted of ($ in millions):
September 30, December 31, 2004 2003 ------------- ------------ Finished products $ 551 $ 664 Goods in process 659 648 Raw materials and supplies 306 339 ------ ------ Total inventories $1,516 $1,651 ====== ======
Other Intangible Assets The components of the balance sheet caption "Other intangible assets, net" are as follows ($ in millions):
September 30, 2004 December 31, 2003 ---------------------------------- ---------------------------------- Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Net Amount Amortization Net -------- ------------ --- -------- ------------ --- Patents and licenses $418 $277 $141 $614 $318 $296 Trademarks and other 143 43 100 143 38 105 ---- ---- ---- ---- ---- ---- Total other intangible assets $561 $320 $241 $757 $356 $401 ==== ==== ==== ==== ==== ====
These intangible assets are amortized on the straight-line method over their respective useful lives. In the nine months ended September 30, 2004, the Company did not make any payments that were capitalized for patent and licensing rights. For the three months ended September 30, 2004 the net carrying amount of patents and 8 licenses was reduced by approximately $118 million as a result of Bristol-Myers Squibb's reacquisition of co- promotion rights of TEQUIN in the U.S. In the nine months ended September 30, 2003, the Company paid $11 million for patent and licensing rights. These amounts are being amortized over approximately 9 years. The residual value of intangible assets is estimated to be zero. Amortization expense related to other intangible assets for the nine months ended September 30, 2004 and 2003 was $30 million and $41 million, respectively. Other intangible assets are reviewed to determine their recoverability by comparing their carrying values to their expected undiscounted future cash flows when events or circumstances warrant such a review. Full year amortization expense in each of the next five years is estimated to be approximately $40 million per year based on the intangible assets recorded as of September 30, 2004. Accounting for Stock-Based Compensation The following table reconciles net income/(loss) and earnings/(loss) per common share (EPS), as reported, for the three and nine months ended September 30, 2004 and 2003 to pro forma net income/(loss) and EPS, as if the Company had expensed the grant date fair value of both stock options and deferred stock units as permitted by SFAS No. 123, "Accounting for Stock-Based Compensation." These pro forma amounts may not be representative of the initial impact of adopting SFAS No. 123 since, as amended, it permits alternative methods of adoption. ($ in millions, except per share figures):
Three months Nine months ended ended -------------------------- ------------------------- Sept 30, Sept 30, Sept 30, Sept 30, 2004 2003 2004 2003 ------- -------- -------- ------- Net income/(loss), as reported $ 26 $ (265) $ (112) $ 90 Add back: Expense included in reported net income/(loss) for deferred stock units, net of tax 8 14 28 38 Deduct: Pro forma expense as if both stock options and deferred stock units were charged against net income/(loss), net of tax (24) (33) (77) (95) ------ ------- ------- ------ Pro forma net income/(loss) using the fair value method $ 10 $ (284) $ (161) $ 33 ====== ======= ======= ====== Diluted earnings/(loss) per common share: Diluted earnings/(loss) per common share, as reported $ .01 $ (.18) $ (.08) $ .06 Pro forma diluted earnings/(loss) per common share using the fair value method .00 (.19) (.12) .02 Basic earnings/(loss) per common share: Basic earnings/(loss) per common share, as reported $ .01 $ (.18) $ (.08) $ .06 Pro forma basic earnings/(loss) per common share using the fair value method .00 (.19) (.12) .02
Basic and diluted earnings/(loss) per common share are calculated based on net income/(loss) available to common shareholders. 9 Other expense (income), net The components of other expense (income), net are as follows ($ in millions):
Three Months Nine Months Ended Ended September 30, September 30, 2004 2003 2004 2003 ---- ---- ----- ---- Interest cost incurred $ 44 $ 26 $ 144 $ 56 Less: amount capitalized on construction (5) (2) (14) (7) ---- ---- ----- ---- Interest expense 39 24 130 49 Interest income (20) (9) (50) (37) Foreign exchange (gains) losses - (1) 5 1 Other, net 15 27 27 36 ---- ---- ----- ---- Total $ 34 $ 41 $ 112 $ 49 ==== ==== ===== ====
Cash paid for interest, net of amounts capitalized, was $85 million for the nine months ended September 30, 2004. Cash paid for interest, net of amounts capitalized, was $27 million for the nine months ended September 30, 2003. Consent Decree On May 17, 2002, the Company announced that it had reached an agreement with the FDA for a consent decree to resolve issues involving the Company's compliance with current Good Manufacturing Practices (cGMP) at certain manufacturing facilities in New Jersey and Puerto Rico. The U.S. District Court for the District of New Jersey approved and entered the consent decree on May 20, 2002. Under terms of the consent decree, the Company agreed to pay a total of $500 million to the U.S. government in two equal installments of $250 million; the first installment was paid in May 2002, and the second installment was paid in May 2003. As previously reported, the Company accrued a $500 million provision for this consent decree in the fourth quarter of 2001. The consent decree requires the Company to complete a number of actions. In the event certain actions agreed upon in the consent decree are not satisfactorily completed on time, the FDA may assess payments for each deadline missed. The consent decree required the Company to develop and submit for FDA's concurrence comprehensive cGMP Work Plans for the Company's manufacturing facilities in New Jersey and Puerto Rico that are covered by the decree. The Company received FDA concurrence with its proposed cGMP Work Plans on May 14, 2003. The cGMP Work Plans contain a number of Significant Steps whose timely and satisfactory completion are subject to payments of $15,000 per business day for each deadline missed. These payments may not exceed $25 million for 2002, and $50 million for each of the years 2003, 2004 and 2005. These payments are subject to an overall cap of $175 million. In connection with its discussions with FDA regarding the Company's cGMP Work Plans, and pursuant to the terms of the decree, the Company and FDA entered into a letter agreement dated April 14, 2003. In the letter agreement, the Company and FDA agreed to extend by six months the time period during which the Company may incur payments as described above with respect to certain of the Significant Steps whose due dates are 10 December 31, 2005. The letter agreement does not increase the yearly or overall caps on payments described above. In addition, the decree requires the Company to complete programs of revalidation of the finished drug products and bulk active pharmaceutical ingredients manufactured at the covered manufacturing facilities. The Company is required under the consent decree to complete its revalidation programs for bulk active pharmaceutical ingredients by September 30, 2005, and for finished drugs by December 31, 2005. In general, the timely and satisfactory completion of the revalidations are subject to payments of $15,000 per business day for each deadline missed, subject to the caps described above. However, if a product scheduled for revalidation has not been certified as having been validated by the last date on the validation schedule, the FDA may assess a payment of 24.6 percent of the net domestic sales of the uncertified product until the validation is certified. Any such payment would not be subject to the caps described above. Further, in general, if a product scheduled for revalidation under the consent decree is not certified within six months of its scheduled date, the Company must cease production of that product until certification is obtained. The completion of the Significant Steps in the Work Plans and the completion of the revalidation programs are subject to third-party expert certification, which must be accepted by the FDA. The consent decree provides that if the Company believes that it may not be able to meet a deadline, the Company has the right, upon the showing of good cause, to request extensions of deadlines in connection with the cGMP Work Plans and revalidation programs. However, there is no guarantee that FDA will grant any such requests. Although the Company believes it has made significant progress in meeting its obligations under the consent decree, it is possible that (1) the Company may fail to complete a Significant Step or a revalidation by the prescribed deadline; (2) the third party expert may not certify the completion of the Significant Step or revalidation; or (3) the FDA may disagree with an expert's certification of a Significant Step or revalidation. In such a case, it is possible that the FDA may assess payments as described above. The Company would expense any payments assessed under the decree if and when incurred. The consent decree contains a sunset provision that permits the Company to petition the Court to dissolve the decree if, during any five year period following the entry of the decree (May 20, 2002), FDA has not notified the Company that there has been a significant violation of FDA law, regulations, or the decree. If these conditions are satisfied, the decree states that FDA will not oppose the Company's petition. The earliest the Company would be in a position to submit such a petition would be May, 2007 (five years after the entry of the decree). However, the Company cannot predict at this time when or how long FDA may take to complete a review of the Company's completion of its cGMP Work Plans and validation program requirements under the decree. Also, as noted in the "Legal, Environmental and Regulatory Matters" footnote below, in April 2003, the Company received notice of a False Claims Act complaint brought by an individual purporting to act on behalf of the U.S. government against it and approximately 25 other pharmaceutical companies in the U.S. District Court for the Northern District of Texas. The complaint alleges that the pharmaceutical companies, including the Company, have defrauded the United States by having made sales to various federal governmental agencies of drugs that were allegedly manufactured in a manner that did not comply with current Good Manufacturing Practices. The Company and the other defendants filed a motion to dismiss the second amended complaint in this action on April 12, 2004. 11 Equity Income from Cholesterol Joint Venture The Company and Merck have agreements to jointly develop and market ZETIA (ezetimibe) as a once-daily monotherapy, as co-administration of ZETIA with statins, and VYTORIN, a once-daily fixed-combination tablet of ezetimibe and simvastatin (Zocor), Merck's cholesterol-modifying medicine. The agreements also involve the development and marketing of a once-daily, fixed-combination tablet containing CLARITIN and Singulair. Singulair is Merck's once-daily leukotriene receptor antagonist for the treatment of asthma and seasonal allergic rhinitis. In January 2002, Schering-Plough/Merck Pharmaceuticals reported on results of Phase III clinical trials of a fixed-combination tablet containing CLARITIN and Singulair, which did not demonstrate sufficient added benefits in the treatment of seasonal allergic rhinitis. The agreements generally provide for equal sharing of development costs and for co-promotion of approved products by each company in the United States and in most other countries of the world, except Japan. In Japan, no agreement with Merck exists (see "Strategic Agreement" footnote above for information regarding the Company's agreement with Bayer to co-market ZETIA in Japan). In general, co-promotion provides that each company will provide equal physician marketing efforts and that each company will bear the cost of its own sales force in marketing the products. In general, the agreements provide that the venture will operate in a "virtual" mode to the maximum degree possible by relying on the respective infrastructures of the two companies. However, the companies have agreed to share certain costs, but these costs are limited to a portion of the costs of manufacturing, the cost of a specialty sales force and certain specially identified promotion costs. It should be noted that the Company incurs substantial costs, such as selling, general and administrative costs, that are not reflected in "Equity (income) from cholesterol joint venture" and are borne by the overall cost structure of the Company. The agreements do not provide for any jointly owned facilities and, as such, products resulting from the collaboration will be manufactured in facilities owned by either Merck or the Company. During 2003, the Company earned a milestone of $20 million that relates to certain European approvals of ZETIA, and in the first quarter of 2004 the Company earned an additional $7 million milestone relating to the approval of ezetimibe/simvastatin in Mexico. Under certain other conditions, as specified in the agreements, Merck could pay additional milestones to the Company totaling $125 million. The Company utilizes the equity method of accounting for the cholesterol joint venture. Under that method, the Company records its share of the operating profits less its share of the research and development costs in "Equity (income) from cholesterol joint venture" in the Statements of Condensed Consolidated Operations. Operating profit in the context of the joint venture represents net sales, less cost of sales, direct promotion expenses and other costs that the Company and Merck may agree to share. Operating profit excludes the cost of the Company's sales forces throughout the world, as well as the many indirect costs incurred by the Company to support the manufacturing, marketing and management of ZETIA and VYTORIN. As such, the amount reported as "Equity (income) from cholesterol joint venture" represents the contribution the Company receives from the joint venture to fund the costs incurred by the Company that are not shared with Merck. "Equity (income) from cholesterol joint venture" totaled $95 million for the three months ended September 30, 2004. "Equity (income) from cholesterol joint venture" totaled $249 million for the nine months ended September 30, 2004, which includes the $7 million milestone earned for the Mexico approval. U.S. ZETIA sales exceeded a pre-defined annual sales level, as stipulated in the joint venture contract, during the second 12 quarter of 2004. As a result, profit from the U.S. sales of ZETIA will be split 50/50 for the remainder of the year, down from a previously higher profit split. As discussed above, the Company accounts for the Merck/Schering-Plough Cholesterol Partnership under the equity method of accounting. As such the Company's net sales do not include the sales of this joint venture. The joint venture launched VYTORIN in the U.S. market during the third quarter of 2004. In order to ensure immediate product availability at the pharmacy level, purchasers were offered limited, one-time distribution allowances, as well as, extended payment terms on their first orders. Substantially all of the approximately $42 million of VYTORIN net sales made by the joint venture in the third quarter were made under these initial terms. Subsequent sales of product were made under customary terms, which do not have such allowances or extended payment terms. The level of trade inventories for VYTORIN in the U.S. distribution channel is expected to be at normal levels by year-end 2004. Revenue from the sales of VYTORIN is recognized by the joint venture when title and risk of loss has passed to the customer. To date, management of the joint venture has been able to make reliable estimates of product returns, rebates and other discounts for VYTORIN by using the historical experiences of comparable product launches in the U.S. marketplace. Borrowings On November 26, 2003, the Company issued $1.25 billion aggregate principal amount of 5.3 percent senior unsecured notes due 2013 and $1.15 billion aggregate principal amount of 6.5 percent senior unsecured notes due 2033. Interest is payable semi-annually. The net proceeds from this offering were $2.37 billion. Upon issuance, the notes were rated A3 by Moody's Investors Service, Inc. (Moody's), and A+ (on CreditWatch with negative implications) by Standard & Poor's Rating Services (S&P). The interest rates payable on the notes are subject to adjustment as follows: If the rating assigned to a particular series of notes by either Moody's or S&P changes to a rating set forth below, the interest rate payable on that series of notes will be the initial interest rate (5.3 percent for the notes due 2013 and 6.5 percent for the notes due 2033) plus the additional interest rate set forth below for each rating assigned by Moody's and S&P.
Additional Additional Moody's Rating Interest Rate S&P Rating Interest Rate - -------------- ------------- ------------- -------------- Baa 1 0.25% BBB+ 0.25% Baa2 0.50% BBB 0.50% Baa3 0.75% BBB- 0.75% Ba 1 or below 1.00% BB+ or below 1.00%
In no event will the interest rate for any of the notes increase by more than 2 percent above the initial coupon rates of 5.3 percent and 6.5 percent, respectively. If either Moody's or S&P subsequently upgrades its ratings, the interest rates will be correspondingly reduced, but not below 5.3 percent or 6.5 percent, respectively. Furthermore, the interest rate payable on a particular series of notes will return to 5.3 percent and 6.5 percent, respectively, and the rate adjustment provisions will permanently cease to apply if, following a downgrade by both Moody's and S&P below A3 or A-, respectively, both Moody's and S&P raise their rating to A3 and A-, respectively, or better. On July 14, 2004, Moody's lowered its rating of the notes to "Baa1" and, accordingly, the interest payable on each note will increase by 25 basis points, respectively, effective December 1, 2004. Therefore, on December 1, 2004, the interest rate payable on the notes due 2013 will increase from 5.3% to 5.55%, and the interest rate 13 payable on the notes due 2033 will increase from 6.5% to 6.75%. This adjustment to the interest rate payable on the notes will increase the Company's interest expense by $6 million annually. The notes are redeemable in whole or in part, at the Company's option at any time, at a redemption price equal to the greater of (1) 100 percent of the principal amount of such notes or (2) the sum of the present values of the remaining scheduled payments of principal and interest discounted using the rate of treasury notes with comparable remaining terms plus 25 basis points for the 2013 notes or 35 basis points for the 2033 notes. Credit Facilities The Company has two revolving credit facilities totaling $1.5 billion. Both facilities are from a syndicate of major financial institutions. The most recently negotiated facility (May 2004) is a $1.25 billion, five-year credit facility. This facility matures in May 2009 and requires the Company to maintain a total debt to total capital ratio of no more than 60 percent. The second credit facility provides a $250 million line of credit through its maturity date in May 2006 and requires the Company to maintain a total debt to total capital ratio of no more than 60 percent anytime the Company is rated at or below Baa3 by Moody's and BBB- by S&P. These facilities are available for general corporate purposes and are considered as support for the Company's commercial paper borrowings. These facilities do not require compensating balances; however, a nominal commitment fee is paid. At September 30, 2004, no funds were drawn under either of these facilities. Shelf Registration On May 11, 2004, the Company's shelf registration, as amended, was declared effective by the SEC. The shelf registered for issuance up to $2 billion in various debt and equity securities. Subsequently, the Company issued $1.438 billion face amount of mandatory convertible preferred stock on August 10, 2004 under the shelf. As of September 30, 2004, $563 million principal amount of securities remain registered and unissued. See below for additional information on the preferred stock issuance. Mandatory Convertible Preferred Stock On August 10, 2004, the Company issued 28,750,000 shares of 6% mandatory convertible preferred stock with a face value of $1.438 billion. Net proceeds to the Company were $1.39 billion after deducting commissions, discounts and other underwriting expenses. The proceeds are being used for general corporate purposes, including the reduction of commercial paper borrowings. The mandatory conversion date of the shares is September 14, 2007. On this date, each share will automatically convert into between 2.2451 and 2.7840 common shares of the Company depending on the average closing price of the Company's common shares over a period immediately preceding the mandatory conversion date, as defined in the prospectus. The preferred shareholders may elect to convert at anytime prior to September 14, 2007 at the minimum conversion ratio of 2.2451 common shares per share of the preferred stock. Additionally, if at anytime prior to the mandatory conversion date, the closing price of the Company's common shares exceeds $33.41 (for at least 20 trading days within a period of 30 consecutive trading days) the Company may elect to cause the conversion of all, but not less than all, of the preferred shares then outstanding at the same minimum conversion ratio of 2.2451 common shares for each preferred share. The preferred stock accrues dividends at an annual rate of 6% on shares outstanding. The dividends are cumulative from the date of issuance and, to the extent the Company is legally permitted to pay dividends and the Board of Directors declares a dividend payable, the Company will pay dividends on each dividend payment 14 date. The dividend payment dates are March 15, June 15, September 15 and December 15, with the first dividend to be paid on December 15, 2004, if so declared by the Board of Directors. A dividend was declared by the Board of Directors on September 28, 2004, payable on December 15, 2004. Credit Ratings Changes in Credit Ratings On February 18, 2004, S&P downgraded the Company's senior unsecured debt ratings to "A-" from "A." At the same time, S&P also lowered the Company's short-term corporate credit and commercial paper rating to "A-2" from "A-1." The Company's S&P rating outlook remains negative. On March 3, 2004, S&P assigned the shelf registration, which was declared effective on May 11, 2004, a preliminary rating of "A-" for senior unsecured debt and a preliminary subordinated debt rating of "BBB+". As of September 30, 2004, $563 million remains registered and unissued under the shelf registration. On April 29, 2004, Moody's placed the Company's senior unsecured credit rating of "A3" on its Watchlist for possible downgrade based upon concerns related to market share declines, litigation risks and a high degree of reliance on the success of VYTORIN. On July 14, 2004, Moody's lowered the Company's senior unsecured credit rating from "A3" to "Baa1", lowered the Company's senior unsecured shelf registration rating from "(P)A3" to "(P)Baa1", lowered the Company's subordinated shelf registration rating from "(P)Baa1" to "(P)Baa2", lowered the Company's cumulative and non-cumulative preferred stock shelf registration rating from "(P)Baa2" to "(P)Baa3", confirmed the Company's "P-2" commercial paper rating and removed the Company from the Watchlist. Moody's rating outlook for the Company is negative. On November 20, 2003, Fitch Ratings (Fitch) downgraded the Company's senior unsecured and bank loan ratings to "A-" from "A+," and its commercial paper rating to "F-2" from "F-1." The Company's rating outlook remained negative. In announcing the downgrade, Fitch noted that the sales decline in the Company's leading product franchise, the INTRON franchise, was greater than anticipated, and that it was concerned that total Company growth is reliant on the performance of two key growth drivers, ZETIA and REMICADE, in the near term. On August 4, 2004, Fitch affirmed the Company's "A-" senior unsecured and bank loan rating and the "F-2" commercial paper rating, and reiterated the negative outlook. Comprehensive Income (Loss) Total comprehensive income (loss) for the three months ended September 30, 2004 and 2003 was $45 million and $(267) million, respectively. Total comprehensive income (loss) for the nine months ended September 30, 2004 and 2003 was $(155) million and $206 million, respectively. 15 Earnings Per Common Share The following table reconciles the components of the basic and diluted EPS computations (amounts in millions):
Three Months Nine Months Ended Ended September 30, September 30, EPS Numerator: 2004 2003 2004 2003 ----- ------- ------ ------ Net income/(loss) $ 26 $ (265) $ (112) $ 90 Less: Preferred stock dividends 12 - 12 - ----- ------- ------ ------ Net income/(loss) available to common shareholders $ 14 $ (265) $ (124) $ 90 ----- ------- ------ ------ EPS Denominator: Average shares outstanding 1,472 1,469 1,472 1,469 for basic EPS Dilutive effect of options and deferred stock units 3 - - 1 ----- ------- ------ ------ Average shares outstanding for diluted EPS 1,475 1,469 1,472 1,470 ----- ------- ------ ------
For the nine months ended September 30, 2004, the equivalent of 88 million common shares issuable under the Company's stock incentive plans were excluded from the computation of diluted EPS because their effect would have been antidilutive. Also, 42 million of common shares obtainable upon conversion of the Company's mandatory convertible preferred stock were excluded from the computation of diluted EPS because their effect would have been antidilutive. See "Mandatory Convertible Preferred Stock" footnote above for additional information. Retirement Plans and Other Post-Retirement Benefits The Company has defined benefit pension plans covering eligible employees in the United States and certain foreign countries, and the Company provides post-retirement health care benefits to its eligible U.S. retirees and their dependents. The components of net pension expense were as follows ($ in millions):
Three months ended Nine months ended September 30, September 30, ------------------ --------------- 2004 2003 2004 2003 ----- ----- ----- ----- Service cost $ 25 $ 24 $ 74 $ 69 Interest cost 33 29 99 85 Expected return on plan assets (37) (40) (113) (117) Amortization, net 9 - 25 - Termination benefits (1) 1 - 12 - Settlement (1) 1 - 5 - ----- ----- ----- ----- Net pension expense $ 32 $ 13 $ 102 $ 37 ===== ===== ===== =====
16 The components of other post-retirement benefits expense were as follows ($ in millions):
Three months ended Nine months ended September 30, September 30, -------------------- -------------------- 2004 2003 2004 2003 -------- -------- ------- -------- Service cost $ 1 $ 2 $ 8 $ 7 Interest cost 2 4 15 12 Expected return on plan assets (1) (4) (9) (12) Amortization, net - - 2 - Termination benefits (1) - - 2 - -------- -------- -------- -------- Net other post-retirement benefits expense $ 2 $ 2 $ 18 $ 7 ======== ======== ======== ========
(1) Termination benefits and Settlement costs primarily relate to the matters discussed in the "Special Charges" footnote. In accordance with FASB Staff Position No. 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" (the "Medicare Act"), the Company began accounting for the effect of the federal subsidy under the Medicare Act in the third quarter of 2004. As a result, the Company's accumulated benefit obligation for other post-retirement benefits was reduced by $51 million, and the Company's net other post-retirement benefits expense was reduced by $5 million for the nine months ended September 30, 2004. The reduction in the other post-retirement benefits expense consists of reductions in service cost, interest cost and net amortization of $1 million, $2 million and $2 million, respectively. Segment Data ($ in millions) The Company has three reportable segments: Prescription Pharmaceuticals, Consumer Health Care and Animal Health. The segment sales and profit data that follow are consistent with the Company's current management reporting structure, established in the second quarter of 2003. The Prescription Pharmaceuticals segment discovers, develops, manufactures and markets human ethical pharmaceutical products. The Consumer Health Care segment develops, manufactures and markets OTC, foot care and sun care products, primarily in the United States. The Animal Health segment discovers, develops, manufactures and markets animal health products. Net sales by segment:
Three months ended Nine months ended September 30, September 30, --------------------------- --------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Prescription Pharmaceuticals $ 1,556 $ 1,585 $ 4,681 $ 5,101 Consumer Health Care 239 243 868 802 Animal Health 183 170 539 483 ------------ ------------ ------------ ------------ Consolidated net sales $ 1,978 $ 1,998 $ 6,088 $ 6,386 ============ ============ ============ ============
17 Profit by segment:
Three months ended Nine months ended September 30, September 30, -------------------- -------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Prescription Pharmaceuticals $ 83 $ 80 $ 43 $ 496 Consumer Health Care 35 48 180 156 Animal Health 20 19 41 56 Corporate and other (1) (106) (423) (404) (541) -------- -------- -------- -------- Consolidated profit/(loss) before tax $ 32 $ (276) $ (140) $ 167 ======== ======== ======== ========
(1) For the three and nine months ended September 30, 2004, Corporate and other included special charges of $26 million and $138 million, respectively, related to the Voluntary Early Retirement Program, other employee severance costs and asset impairment charges (see "Special Charges" footnote for additional information). Special charges for the three months ended September 30, 2004 relate to the reportable segments as follows: Prescription Pharmaceuticals - $23 million, Consumer Health Care - $1 million and Corporate and other - $2 million. Special charges for the nine months ended September 30, 2004 relate to the reportable segments as follows: Prescription Pharmaceuticals - $119 million, Consumer Health Care - $3 million, Animal Health - $2 million and Corporate and other - $14 million. For the three and nine months ended September 30, 2003, Corporate and other included special charges of $350 million and $370 million, respectively, related to increased litigation reserves of $350 million and asset impairment charges of $20 million (see "Special Charges" footnote for additional information). Corporate and other also includes interest income and expense, foreign exchange gains and losses, headquarters expenses and other miscellaneous items. The accounting policies used for segment reporting are the same as those described in the "Summary of Significant Accounting Policies" in the Company's 2003 Annual Report. Sales of products comprising 10% or more of the Company's U.S. or international sales in the nine months ended September 30, 2004 were as follows ($ in millions):
U.S. International ---- ------------- CLARINEX $ 313 $ 218 NASONEX 271 178 OTC CLARITIN 344 - REMICADE - 535
The Company does not disaggregate assets on a segment basis for internal management reporting and, therefore, such information is not presented. 18 Legal, Environmental and Regulatory Matters Background The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability cases and Superfund sites discussed below. The Company adjusts its accrued liabilities to reflect the current best estimate of its probable loss exposure. Where no best estimate is determinable, the Company accrues the minimum amount within the most probable range of its liability. The recorded liabilities for the above matters at September 30, 2004, and the related expenses incurred during the nine months ended September 30, 2004 were not material. Expected insurance recoveries have not been considered in determining the costs for environmental-related liabilities. The Company believes that, except for the matters discussed in the remainder of this section, it is remote at this time that any material liability in excess of the amounts accrued will be incurred. With respect to the matters discussed in the remainder of this section, except where noted, it is not practicable to estimate a range of reasonably possible loss; where it is, a reserve has been included in the financial statements. Resolution of any or all of the matters discussed in the remainder of this section, individually or in the aggregate, could have a material adverse effect on the Company's results of operations or financial condition. The Company reviews the status of the matters discussed in the remainder of this section on an ongoing basis and from time to time may settle or otherwise resolve them on such terms and conditions as management believes are in the best interests of the Company. The Company is aware that settlements of matters of the types set forth in the remainder of this section, and in particular under "Investigations," frequently involve fines and/or penalties that are material to the financial condition and the results of operations of the entity entering into the settlement. There are no assurances that the Company will prevail in any of these matters, that settlements can be reached on acceptable terms (including the scope of release provided) or in amounts that do not exceed the amounts reserved. Even if an acceptable settlement were to be reached, there can be no assurance that further investigations or litigations will not be commenced raising similar type issues, potentially exposing the Company to additional material liabilities. Further, the Company cannot predict the timing of the resolution of these matters or their outcomes. Patent Matters PRIME PAC PRRS Patent. In January 2000, a jury found that the Company's PRIME PAC PRRS (Porcine Respiratory and Reproductive Syndrome) vaccine infringed a patent owned by Boehringer Ingelheim Vetmedica, Inc ("Boehringer Ingelheim"). An injunction was issued in August 2000 barring further sales of the Company's vaccine. On June 3, 2004, a jury in the United States District Court for the district of New Jersey awarded Boehringer Ingelheim $6.9 million plus interest in this matter. DR. SCHOLL'S FREEZE AWAY Patent. On July 26, 2004, OraSure Technologies filed an action in the U.S. District Court for the Eastern District of Pennsylvania alleging patent infringement by Schering-Plough Healthcare Products by its sale of DR. SCHOLL'S FREEZE AWAY wart removal product. The FREEZE AWAY product was launched in March 2004. For the nine months ended September 30, 2004, net sales of this product totaled approximately $16 million. United Kingdom Patent Infringement Action. On August 6, 2004, the Company brought a patent infringement action in the United Kingdom against Cipla Ltd. and Neolabs Ltd. following the defendants advising of their intent to pursue marketing of desloratadine in the United Kingdom. In 2003, the Company's sales of desloratadine in the United Kingdom were approximately $24.2 million. 19 Investigations Pennsylvania Investigation. On July 30, 2004, Schering-Plough Corporation, the U.S. Department of Justice and the U.S. Attorney's Office for the Eastern District of Pennsylvania announced settlement of the previously disclosed investigation by that Office. Under the settlement, Schering Sales Corporation, an indirect wholly owned subsidiary of Schering-Plough Corporation, has pleaded guilty to a single federal criminal charge concerning a payment to a managed care customer. As a result, Schering Sales Corporation will be excluded from participating in federal healthcare programs. The settlement will not affect the ability of Schering-Plough Corporation to participate in those programs. The aggregate settlement amount is $345.5 million in fines and damages, comprised of a $52.5 million fine to be paid by Schering Sales Corporation, and $293 million in civil damages to be paid by Schering-Plough Corporation. Schering-Plough Corporation will be credited with $53.6 million that was previously paid in additional Medicaid rebates against the civil damages amount, leaving a net settlement amount of $291.9 million. Of that amount, $177.5 million of the total settlement was paid in the third quarter of 2004. The remaining portion will be paid by March 4, 2005. Interest accrues on the unpaid balance at the rate of 4 percent. The payments have been and will be funded by cash from operations, borrowings and proceeds from the issuance of securities. There will be no impact on 2004 full year results related to the Pennsylvania settlement. Under the settlement, Schering-Plough Corporation also entered into a five year corporate integrity agreement with the Office of the Inspector General of the Department of Health and Human Services, under which Schering-Plough Corporation agreed to implement specific measures to promote compliance with regulations on issues such as marketing. Failure to comply can result in financial penalties. Details of the initiation and progress of the investigation can be found in the Company's prior 10-K and 10-Q reports beginning with the 10-K for 1999. The Company cannot predict the impact of this settlement, if any, on other outstanding investigations. AWP Investigations. The Company is responding to investigations by the Department of Health and Human Services, the Department of Justice and certain states into certain industry and Company practices regarding average wholesale price (AWP). These investigations include a Department of Justice review of the merits of a federal action filed by a private entity on behalf of the United States in the U.S. District Court for the Southern District of Florida, as well as an investigation by the U.S. Attorney's Office for the District of Massachusetts, regarding, inter alia, whether the AWP set by pharmaceutical companies for certain drugs improperly exceeds the average prices paid by dispensers and, as a consequence, results in unlawful inflation of certain government drug reimbursements that are based on AWP. In March 2001, the Company received a subpoena from the Massachusetts Attorney General's office seeking documents concerning the use of AWP and other pricing and/or marketing practices. The Company has also responded to subpoenas from the Attorney General of California concerning these matters. The Company is cooperating with these investigations. The outcome of these investigations could include the imposition of substantial fines, penalties and injunctive or administrative remedies. 20 Massachusetts Investigation. The U.S. Attorney's Office for the District of Massachusetts is investigating whether the Company's sales of a product manufactured under a private label arrangement with a managed care organization should have been included in the Company's Medicaid best price calculations. In early November 2002, the Company was served with two additional grand jury subpoenas by the U.S. Attorney for the District of Massachusetts. Among other information, the subpoenas seek a broad range of information concerning the Company's sales, marketing and clinical trial practices and programs with respect to INTRON A, REBETRON and TEMODAR; the Company's sales and marketing contacts with managed care organizations and doctors; and the Company's offering or provision of grants, honorariums or other items or services of value to managed care organizations, physician groups, doctors and educational institutions. The Company understands that this investigation is focused on whether certain sales, marketing and clinical trial practices and conduct related thereto, which in certain instances relate to the use of one or more of the above-mentioned products for indications for which FDA approval had not been obtained - so-called "off-label" uses - were in violation of federal laws and regulations with respect to off-label promotional activities. The investigation also appears to focus on whether drug samples, clinical trial grants and other items or services of value were given to providers to incentivize them to prescribe one or more of the above-mentioned products, including for "off-label" uses, in violation of the federal health care anti-kickback laws. In April 2004, the Company received an additional grand jury subpoena that requests documents concerning PROVENTIL, VANCERIL, VANCENASE, NITRO-DUR, IMDUR, K-DUR and CLARITIN. The subpoena requests (1) documents relating to dealings with certain managed care entities; (2) documents relating to all contracts where the price of one drug is dependent on the purchase of another; (3) documents relating to outside audits in the Medicaid best price area; and (4) documents concerning Warrick Pharmaceuticals ("Warrick"), the Company's generic subsidiary. The Company has received other subpoenas and informal document requests in this investigation. The Company has implemented certain changes to its sales, marketing and clinical trial practices and is continuing to review those practices to ensure compliance with relevant laws and regulations. The Company is cooperating with these investigations. Future sales of INTRON A, REBETRON and TEMODAR may be adversely affected, but the Company cannot at this time predict the ultimate impact, if any, on such sales. The outcome of these investigations could include the commencement of civil and/or criminal proceedings involving the imposition of substantial fines, penalties and injunctive or administrative remedies, including exclusion from government reimbursement programs. During the 2003 third quarter, the Company increased its litigation reserves related to the investigations by the U.S. Attorney's Office for the District of Massachusetts described in this paragraph and the investigation described above by the U.S. Attorney's Office for the Eastern District of Pennsylvania, by $350 million. The increased litigation reserves reflect an adjustment to the Company's estimate of its minimum liability relating to those investigations, in compliance with Generally Accepted Accounting Principles ("GAAP"). Under GAAP, companies are required to estimate and recognize a minimum liability when a loss is probable but no better estimate of the loss can be made. In the fourth quarter of 2002, the Company increased its litigation reserves by $150 million for the same matters. The litigation reserves at September 30, 2004 continue to reflect a minimum liability for the Massachusetts investigation. As noted above, the Pennsylvania investigation has been settled, and therefore, the remaining reserves reflect the agreed upon settlement amounts yet to be paid. The Company notes that its total reserves reflect an estimate and that any final settlement or adjudication of any of these matters could possibly be less than or could materially exceed the aggregate liability accrued by the Company and could have a materially adverse effect on the operations or financial condition of the Company. The Company cannot predict the timing of resolution of these matters or their outcomes. As reported in the 8-K filed May 30, 2003, Schering-Plough has disclosed that, in connection with the above-described investigations by the U.S. Attorney's Office for the District of Massachusetts into its sales, marketing and clinical trial practices, among other matters, on May 28, 2003, Schering Corporation, a wholly owned and significant operating subsidiary of Schering-Plough, received a letter (the "Boston Target Letter") from that 21 Office advising that Schering Corporation (including its subsidiaries and divisions) is a target of a federal criminal investigation with respect to four areas: 1. Providing remuneration, such as drug samples, clinical trial grants and other items or services of value, to managed care organizations, physicians and others to induce the purchase of Schering pharmaceutical products for which payment was made through federal health care programs; 2. Sale of misbranded or unapproved drugs, which the Company understands to mean drugs promoted for indications for which approval by the U.S. FDA had not been obtained (so-called "off-label uses"); 3. Submitting false pharmaceutical pricing information to the government for purposes of calculating rebates required to be paid to the Medicaid program, by failing to include prices of products under a repackaging arrangement with a managed care customer as well as the prices of free and nominally priced goods provided to that customer to induce the purchase of Schering products; and 4. Document destruction and obstruction of justice relating to the government's investigation. A "target" is defined in Department of Justice guidelines as a person as to whom the prosecutor or the grand jury has substantial evidence linking him or her to the commission of a crime and who, in the judgment of the prosecutor, is a putative defendant (U.S. Attorney's Manual, Section 9-11.151). Consumer Products Matter. The U.S. Department of Justice, Antitrust Division, is investigating whether the Company's Consumer Products Division entered into an agreement with another company to lower the commission rate of a consumer products broker. In February 2003, the Antitrust Division served a grand jury subpoena on the Company seeking documents for the first time. The Company is cooperating with the investigation. NITRO-DUR Investigation. In August 2003, the Company received a civil investigative subpoena issued by the Office of Inspector General of the U.S. Department of Health and Human Services, seeking documents concerning the Company's classification of NITRO-DUR for Medicaid rebate purposes, and the Company's use of nominal pricing and bundling of product sales. The Company is cooperating with the investigation. It appears that the subpoena is one of a number addressed to pharmaceutical companies concerning an inquiry into issues relating to the payment of government rebates. Securities and Class Action Litigation On February 15, 2001, the Company stated in a press release that the FDA had been conducting inspections of the Company's manufacturing facilities in New Jersey and Puerto Rico and had issued reports citing deficiencies concerning compliance with current Good Manufacturing Practices, primarily relating to production processes, controls and procedures. The next day, February 16, 2001, a lawsuit was filed in the U.S. District Court for the District of New Jersey against the Company and certain named officers alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Additional lawsuits of the same tenor followed. These complaints were consolidated into one action in the U.S. District Court for the District of New Jersey, and a lead plaintiff, the Florida State Board of Administration, was appointed by the Court on July 2, 2001. On October 11, 2001, a consolidated amended complaint was filed, alleging the same violations described in the second sentence of this paragraph and purporting to represent a class of shareholders who purchased shares of Company stock from May 9, 2000, through February 15, 2001. The Company's motion to dismiss the consolidated amended complaint was denied on May 24, 2002. On October 10, 2003, the Court certified the shareholder class. Discovery is ongoing. 22 In addition to the lawsuits described in the immediately preceding paragraph, two lawsuits were filed in the U.S. District Court for the District of New Jersey, and two lawsuits were filed in New Jersey state court against the Company (as a nominal defendant) and certain officers, directors and a former director seeking damages on behalf of the Company, including disgorgement of trading profits made by defendants allegedly obtained on the basis of material non-public information. The complaints in each of those four lawsuits relate to the issues described in the Company's February 15, 2001 press release, and allege a failure to disclose material information and breach of fiduciary duty by the directors. One of the federal court lawsuits also includes allegations related to the investigations by the U.S. Attorney's Offices for the Eastern District of Pennsylvania and the District of Massachusetts, the FTC's administrative proceeding against the Company, and the lawsuit by the state of Texas against Warrick, the Company's generic subsidiary. The U.S. Attorney's investigation and the FTC proceeding are described herein. The Texas litigation is described in previously filed Reports on Form 10-K and 10-Q. Each of these lawsuits is a shareholder derivative action that purports to assert claims on behalf of the Company, but as to which no demand was made on the Board of Directors and no decision has been made on whether the Company can or should pursue such claims. In August 2001, the plaintiffs in each of the New Jersey state court shareholder derivative actions moved to dismiss voluntarily the complaints in those actions, which motions were granted. The two shareholder derivative actions pending in the U.S. District Court for the District of New Jersey have been consolidated into one action, which is in its very early stages. On January 2, 2002, the Company received a demand letter dated December 26, 2001, from a law firm not involved in the derivative actions described above, on behalf of a shareholder who also is not involved in the derivative actions, demanding that the Board of Directors bring claims on behalf of the Company based on allegations substantially similar to those alleged in the derivative actions. On January 22, 2002, the Board of Directors adopted a Board resolution establishing an Evaluation Committee, consisting of three directors, to investigate, review and analyze the facts and circumstances surrounding the allegations made in the demand letter and the consolidated amended derivative action complaint described above, but reserving to the full Board authority and discretion to exercise its business judgment in respect of the proper disposition of the demand. The Committee engaged independent outside counsel to advise it and issued a report on the findings of its investigation to the independent directors of the Board in late October 2002. That report determined that the shareholder demand should be refused, and finding no liability on the part of any officers or directors. In November 2002, the full Board adopted the recommendation of the Evaluation Committee. The Company is a defendant in a number of purported nationwide or state class action lawsuits in which plaintiffs seek a refund of the purchase price of laxatives or phenylpropanolamine-containing cough/cold remedies ("PPA products") they purchased. Other pharmaceutical manufacturers are co-defendants in some of these lawsuits. In general, plaintiffs claim that they would not have purchased or would have paid less for these products had they known of certain defects or medical risks attendant with their use. In the litigation of the claims relating to the Company's PPA products, courts in the national class action suit and several state class action suits have denied certification and dismissed the suits. A similar application to deny class certification in New Jersey, the only remaining statewide class action suit involving the Company, was granted on September 30, 2004. Approximately 96 individual lawsuits relating to the laxative products, PPA products and recalled albuterol/VANCERIL/VANCENASE inhalers are also pending against the Company seeking recovery for personal injuries or death. In a number of these lawsuits punitive damages are claimed. On March 31, 2003, the Company was served with a putative class action complaint filed in the U.S. District Court in New Jersey alleging that the Company, Richard Jay Kogan (who resigned as Chairman of the Board November 13, 2002, and retired as Chief Executive Officer, President and Director of the Company April 20, 2003) and the Company's Employee Savings Plan (Plan) administrator breached their fiduciary obligations to certain participants in the Plan. In May 2003, the Company was served with a second putative class action complaint filed in the same court with allegations nearly identical to the complaint filed March 31, 2003. On 23 October 6, 2003, a consolidated amended complaint was filed, which names as additional defendants seven current and former directors and other corporate officers. The Court dismissed this complaint on June 29, 2004. On July 16, 2004, the plaintiffs filed a Notice of Appeal. On August 18, 2003, a lawsuit filed in the New Jersey Superior Court, Chancery Division, Union County, was served on the Company (as a nominal defendant) and the Company's outside directors, alleging breach of fiduciary duty by the directors relating to the Company's receipt of the Boston Target Letter described under the "Investigations" section in this footnote. This action was temporarily stayed pending adjudication of a separate but related action framed as a shareholder request for access to the Company's books and records and seeking documents and other information relating to the Massachusetts investigation. In March 2004, the Superior Court granted the Company's motion for summary judgment and dismissed the books and records action. On September 20, 2004, this case was dismissed by the Court upon consent of the parties. Antitrust and FTC Matters On April 2, 2001, the FTC started an administrative proceeding against the Company, Upsher-Smith, Inc. (Upsher-Smith) and Lederle. The complaint alleged anti-competitive effects from the settlement of patent lawsuits between the Company and Lederle, and the Company and Upsher-Smith. The lawsuits that were settled related to generic versions of K-DUR, the Company's long-acting potassium chloride product, which was the subject of Abbreviated New Drug Applications (ANDAs) filed by Lederle and Upsher-Smith. In June 2002, the administrative law judge overseeing the case issued a decision that the patent litigation settlements complied with the law in all respects and dismissed all claims against the Company. An appeal of this decision to the full Commission was filed by the FTC staff. On December 18, 2003, the full Commission issued an opinion that reversed a 2002 decision of an Administrative Law Judge who had found no violation of the antitrust laws, ruling instead that the Company's settlements did in fact violate those laws. The FTC's decision does not involve a monetary penalty. The Company has appealed the decision to a federal court of appeals. K-DUR is a potassium chloride supplement used by cardiac patients. Following the commencement of the FTC administrative proceeding, alleged class action suits were filed on behalf of direct and indirect purchasers of K-DUR against the Company, Upsher-Smith and Lederle in federal and state courts. These suits all allege essentially the same facts and claim violations of federal and state antitrust laws, as well as other state statutory and/or common law causes of action. On April 6, 2004, the court overseeing these actions in federal court remanded 19 of the approximately 40 lawsuits back to various state courts. On September 30, 2004, the federal court overseeing many of these cases denied the Company's motion to dismiss. Discovery is ongoing. Pricing Matters In December 2001, the Prescription Access Litigation project (PAL), a Boston-based group formed in 2001 to litigate against drug companies, filed a class action suit in Federal Court in Massachusetts against the Company. In September 2002, a consolidated complaint was filed in this court as a result of the coordination by the Multi-District Litigation Panel of all federal court AWP cases from throughout the country. The consolidated complaint alleges that the Company and Warrick Pharmaceuticals, the Company's generic subsidiary, conspired with providers to defraud consumers by reporting fraudulently high AWPs for prescription medications reimbursed by Medicare or third-party payers. The complaint seeks a declaratory judgment and unspecified damages, including treble damages. Included in the litigation described in the prior paragraph are lawsuits that allege that the Company and Warrick reported inflated AWPs for prescription pharmaceuticals and thereby caused state and federal entities and third-party payers to make excess reimbursements to providers. Some of these actions also allege that the Company 24 and Warrick failed to report accurate prices under the Medicaid Rebate Program and thereby underpaid rebates to some states. These actions, which began in October 2001, have been brought by state Attorneys General, private plaintiffs, nonprofit organizations and employee benefit funds. They allege violations of federal and state law, including fraud, antitrust, Racketeer Influenced Corrupt Organizations Act (RICO) and other claims. During the first quarter of 2004, the Company and Warrick were among five groups of companies put on an accelerated discovery track in the proceeding. In addition, Warrick and the Company are defendants in a number of such lawsuits in state courts. The actions are generally brought by states and/or political subdivisions and seek unspecified damages, including treble and punitive damages. SEC Inquiries and Related Litigation On September 9, 2003, the SEC and the Company announced settlement of the SEC enforcement proceeding against the Company and Richard Jay Kogan, former Chairman and Chief Executive Officer, regarding meetings held with investors the week of September 30, 2002, and other communications. Without admitting or denying the allegations, the Company agreed not to commit future violations of Regulation FD and related securities laws and paid a civil penalty of $1 million. Mr. Kogan paid a civil penalty of $50 thousand. On September 25, 2003, a lawsuit was filed in New Jersey Superior Court, Union County, against Richard Jay Kogan and the Company's outside Directors alleging breach of fiduciary duty, fraud and deceit and negligent misrepresentation, all relating to the alleged disclosures made during the meetings mentioned above. The Company removed this case to federal court. The case was remanded to state court. The Company has filed a motion to dismiss. Environmental The Company has responsibilities for environmental cleanup under various state, local and federal laws, including the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. At several Superfund sites (or equivalent sites under state law), the Company is alleged to be a potentially responsible party (PRP). Except where a site is separately disclosed, the Company believes that it is remote at this time that there is any material liability in relation to such sites. The Company estimates its obligations for cleanup costs for Superfund sites based on information obtained from the federal Environmental Protection Agency (EPA), an equivalent state agency and/or studies prepared by independent engineers, and on the probable costs to be paid by other PRPs. The Company records a liability for environmental assessments and/or cleanup when it is probable a loss has been incurred and the amount can be reasonably estimated. Residents in the vicinity of a publicly owned waste-water treatment plant in Barceloneta, Puerto Rico, have filed two lawsuits against the plant owner and operator, and numerous companies that discharge into the plant, including a subsidiary of the Company, for damages and injunctive relief relating to odors allegedly coming from the plant and connecting sewers. One of these lawsuits is a class action claiming damages of $600 million. No trial date has been set for these cases, but the matter has been submitted to mediation. The New Jersey Department of Environmental Protection sent the Company a letter, received September 24, 2003, stating that the Company "may be legally responsible for damages to natural resources" in the state. The Department has not adopted regulations covering how such liability is to be calculated, making it difficult to accurately predict the ultimate extent of the Company's exposure. On September 24, 2004, the Company, along with approximately 80 other parties, were named as third-party defendants in a complaint, alleging that it (and other parties) generated waste that was sent to the Burlington Environmental Management Services, Inc. Landfill ("BEMS Site"), located in Southampton Township, Burlington County, New Jersey. The complaint also indicates that the Company and the other 80 parties are 25 liable for costs expended to clean up the BEMS Site under New Jersey's Spill Compensation and Control Act (New Jersey's "Superfund" statute). The Company is currently investigating the allegations. Other Matters The Company is subject to pharmacovigilance reporting requirements in many countries and other jurisdictions, including the United States, the European Union (EU) and the EU member states. The requirements differ from jurisdiction to jurisdiction, but all include requirements for reporting adverse events that occur while a patient is using a particular drug in order to alert the manufacturer of the drug and the governmental agency to potential problems. During pharmacovigilance inspections by officials of the British and French medicines agencies conducted at the request of the European Agency for the Evaluation of Medicinal Products (EMEA), serious deficiencies in reporting processes were identified. The Company is taking urgent actions to rectify these deficiencies as quickly as possible. The Company does not know what action, if any, the EMEA or national authorities will take in response to these findings. Possible actions include further inspections, demands for improvements in reporting systems, criminal sanctions against the Company and/or responsible individuals and changes in the conditions of marketing authorizations for the Company's products. In April 2003, the Company received notice of a False Claims Act complaint brought by an individual purporting to act on behalf of the U.S. government against it and approximately 25 other pharmaceutical companies in the U.S. District Court for the Northern District of Texas. The complaint alleges that the pharmaceutical companies, including the Company, have defrauded the United States by having made sales to various federal governmental agencies of drugs that were allegedly manufactured in a manner that did not comply with current Good Manufacturing Practices. The Company and the other defendants filed a motion to dismiss the second amended complaint in this action on April 12, 2004. Tax Matters In October of 2001, IRS auditors asserted, in reports, that the Company is liable for additional tax for the 1990 through 1992 tax years. The reports allege that two interest rate swaps that the Company entered into with an unrelated party should be recharacterized as loans from affiliated companies. In April of 2004, the Company received a formal Notice of Deficiency (Statutory Notice) from the IRS asserting additional federal income tax due. The Company received bills related to this matter from the IRS on September 7, 2004. Payment in the amount of $194 million for income tax and $279 million for interest was made on September 13, 2004. The Company believes it has complied with all applicable rules and regulations and intends to file a suit for refund for the full amount of the tax and interest. The Company's tax reserves were adequate to cover the above-mentioned payments. 26 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and Board of Directors of Schering-Plough Corporation: We have reviewed the accompanying condensed consolidated balance sheet of Schering-Plough Corporation and subsidiaries (the "Corporation") as of September 30, 2004, and the related statements of condensed consolidated operations for the three-month and nine-month periods ended September 30, 2004 and 2003, and the statements of condensed consolidated cash flows for the nine-month periods ended September 30, 2004 and 2003. These interim financial statements are the responsibility of the Corporation's management. We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Schering-Plough Corporation and subsidiaries as of December 31, 2003, and the related statements of consolidated operations, shareholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated February 19, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/Deloitte & Touche LLP Parsippany, New Jersey October 27, 2004 27 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Executive Summary About the Company: Schering-Plough is a research-based pharmaceutical company committed to discovering, developing, manufacturing and marketing new therapies and treatments to enhance human health. As a research-based pharmaceutical company, Schering-Plough invests substantial amounts of funds in scientific research with the goal of creating important medical and commercial value. There is a high rate of failure inherent in scientific research and, as a result, there is a high risk that the funds invested will not generate financial returns. Further compounding this risk profile is the fact that research has a long investment cycle. To bring a pharmaceutical compound from discovery phase to commercial phase may take a decade or more. Because of the high risk nature of research investments, financial resources typically must come from internal sources (operations and cash reserves) or from equity-type capital. The current state of the Company: During the past three years, the Company experienced a confluence of negative events that have strained and continue to strain the Company's financial resources. These negative events converged almost simultaneously and in large part caused a rapid, sharp and material decline in sales, a material increase in costs and material amounts of actual and potential payments for fines, settlements and penalties. These events have had a severe, negative impact on the Company. If this situation were to continue unmitigated, it may impair the Company's ability to invest in marketing and research efforts at historical levels. Throughout this period of time, the Company has held to its core strategy and continued to invest in sales and marketing and scientific research at historical levels. However, this level of investment is not sustainable without a significant increase in cash flow from operations. Unfortunately, increased sales of existing products and cost reductions alone cannot be expected to increase cash flow from operations sufficiently to offset the negative events. In order to maintain its current business model, the Company must introduce new products in the near term. There are two sources of new products: products acquired through acquisition and licensing arrangements, and products in the Company's late-stage research pipeline. With respect to acquisitions and licensing, there are limited opportunities for critical late-stage products, and these limited opportunities typically require substantial amounts of funding. The Company competes for these products against companies often with far greater financial resources than that of the Company. Due to the present financial situation, it will be challenging for the Company to acquire or license critical late-stage products that will have a positive material impact on operating cash flows. 28 With respect to products in the Company's late-stage research pipeline, there is only one product that was recently approved by the FDA, which could materially increase cash flow from operations. That product is VYTORIN, the combination of ZETIA, the Company's cholesterol absorption inhibitor, and Zocor, Merck & Co., Inc.'s (Merck) statin medication. The U.S. approval and commercial launch of VYTORIN enables the Company to expand its position in the approximately $25 billion cholesterol-reduction market, the single largest pharmaceutical market in the world. However, VYTORIN competes against other, well-established cholesterol-management products marketed by companies with financial resources much greater than that of the Company. The financial commitment to compete in this marketplace is shared with Merck; however, profits from VYTORIN are also shared with Merck. If VYTORIN does not provide a material amount of cash flow from operations, the Company would likely evaluate the need to examine strategic alternatives. With regard to an examination of strategic alternatives, the contracts with Merck for ZETIA and VYTORIN and the contract with Centocor, Inc. for REMICADE (exhibits 10 (r) and 10 (u), respectively, to the Company's 2003 Form 10-K) contain provisions dealing with a change of control, as defined in those contracts. These provisions could result in the aforementioned products being acquired by Merck or reverting back to Centocor, Inc., as the case may be. The negative events that converged to strain financial resources during the past three years are summarized as follows: - Since 2001, the Company has been working with the FDA to resolve issues involving the Company's compliance with current Good Manufacturing Practices (cGMP) at certain of its manufacturing sites in New Jersey and Puerto Rico. In 2002, the Company reached a formal agreement with the FDA for a consent decree. Under the terms of the consent decree, the Company has made payments totaling $500 million and agreed to revalidate the manufacturing processes at these sites. These manufacturing sites have remained opened throughout this period; however, the consent decree has placed significant additional controls on production and release of products from these sites, including review and third-party certification of production variances, and, for some products, review and third-party certification of batch production records. The third-party certifications and other cGMP improvement projects have resulted in higher costs as well as reduced output at these facilities. In addition, the Company has found it necessary to discontinue certain older products. The Company's research and development operations have also been negatively impacted by the decree because these operations share common facilities with the manufacturing operations. The Company's commitments under the GMP Work Plan and Validation Program required by the consent decree are scheduled for completion by December 31, 2005. However, the consent decree will not be lifted at that point. The decree will remain in place until the Company successfully petitions the court to have it lifted. Under the terms of the decree, the Company is allowed to petition the court to lift the decree if, after any five year period following the decree's entry in May 2002, the Company has not been notified by FDA of a significant violation of FDA law, regulation, or the decree. Thus, the earliest date by which the Company could petition the court to lift the decree is May 2007 (five years after the decree's entry). The Company has no assurance that the decree will be lifted at that time. The impact of the consent decree is discussed in more detail in the sections that follow. - Certain of the Company's sales and marketing practices are under investigation by the U.S. Attorney's Office in Massachusetts. This investigation poses significant financial and commercial risks to the Company. The Company announced settlement with the U.S. Attorney's Office for the Eastern District of Pennsylvania regarding that Office's investigation into the Company's sales and marketing practices. The settlement requires payments by the Company totaling $345.5 million, of which $53.6 29 million was previously paid in 2003 as additional Medicaid rebates against the damages amount, leaving net payments of $291.9 million. During the third quarter of 2004, $177.5 million was paid related to this settlement. These matters are discussed in further detail in the "Legal, Environmental and Regulatory Matters" footnote included in the financial statements to this report. - In December 2002, the Company switched all formulations of CLARITIN in the United States from prescription to over-the-counter (OTC) status. This switch followed the loss of marketing exclusivity for the product. The average unit selling price for an OTC product is much lower than the price in the prescription market. Further, with the loss of marketing exclusivity, the Company faces additional competition from comparable brands and generics in the OTC marketplace. Prior to 2003, CLARITIN in the United States had been the Company's leading product in terms of sales, and even more so in terms of profit. As a result, the Company has experienced a rapid, sharp and material decline in earnings and cash flow beginning in 2003. - Market shares and sales levels for PEG-INTRON (pegylated interferon) and REBETOL (ribavirin) have fallen significantly, in a market that continues to contract. In late 2002, a competitor entered the hepatitis C marketplace with its own versions of pegylated interferon and ribavirin, and pursued aggressive pricing and marketing practices. Prior to the introduction of these competing products, the Company held a leading position in the hepatitis C market. As a result of the introduction of this competitor, earnings and cash flow from PEG-INTRON have been and may continue to be materially and negatively impacted. In addition, generic forms of REBETOL have been approved in the important U.S. market, also resulting in a material and negative impact on earnings and cash flow. - Sales of other important products have been negatively impacted by overall market conditions. For example, CLARINEX competes in a declining prescription antihistamine market and NASONEX competes in a market with little to no growth. - The Company's manufacturing sites operate well below optimum levels due to the sales declines and the reduction in output related to the consent decree. At the same time, overall costs of operating the manufacturing sites have increased due to the consent decree activities. The impact of this is a material increase in costs. At this time, the major investments in manufacturing capacity are not impaired; however, the Company continues to review the carrying value of these assets for indications of impairment. Future events and decisions may lead to asset impairment losses and accelerated depreciation due to shortened asset lives. In response to the above, a new management team was appointed during 2003. A program was initiated to reduce costs and to reinvest the savings into the business to stabilize market shares of key products and to help ensure the successful launch of VYTORIN. Due to the need to reinvest, the overall cost structure of the Company has not declined. During the third quarter of 2004, market share trends of certain products have begun to show early signs of sequential stabilization. However, overall markets for many of these products continue to contract. No assurance can be given that such stabilization will continue. The Company's ability to generate profits is dependent upon growing sales of existing products, successfully commercializing VYTORIN and controlling expenses. Through the first nine months of 2004, the Company has incurred a net loss of $112 million, which included pre-tax special charges of $138 million and pre-tax research and development charges of $80 million for product licensing fees related to the agreement with Toyama Chemical Co. Ltd. ("Toyama"). Management cannot give assurance that operations will generate profits in the near term, especially if VYTORIN is not a commercial success. 30 Net Sales Consolidated net sales for the third quarter totaled $2.0 billion, a decrease of $20 million or 1 percent compared with the same period in 2003. Consolidated net sales for the third quarter reflected a volume decline of 4 percent and a favorable foreign exchange rate impact of 3 percent. For the nine months, consolidated net sales decreased $298 million or 5 percent versus 2003. Consolidated net sales for the first nine months reflected a volume decline of 9 percent and a favorable foreign exchange rate impact of 4 percent. Net sales in the United States decreased 4 percent versus the third quarter of 2003 and 17 percent for the nine-month period. International sales advanced 1 percent for the third quarter and 5 percent year-to-date compared with the same periods in 2003. International sales included a favorable foreign exchange rate impact of 5 percent for the quarter and 8 percent for the first nine months. The Company accounts for the Merck/Schering-Plough cholesterol joint venture under the equity method of accounting. As such, the Company's net sales do not include the sales of this joint venture. Net sales for the third quarter and nine months ended September 30, were as follows: (Dollars in millions)
Third Quarter Nine Months ------------- ----------- 2004 2003 % 2004 2003 % ---- ---- - ---- ---- - GLOBAL PHARMACEUTICALS $1,556 $ 1,585 (2) $4,681 $ 5,101 (8) Remicade 188 142 33 535 382 40 Clarinex / Aerius 175 169 3 530 561 (6) Nasonex 153 114 34 449 368 22 PEG-Intron 132 172 (23) 425 641 (34) Temodar 121 90 35 309 237 31 Integrilin 94 79 18 245 260 (6) Intron A 81 103 (21) 239 302 (21) Claritin Rx * 67 68 (1) 240 247 (3) Rebetol 52 125 (58) 239 540 (56) Subutex 45 37 22 136 103 32 Elocon 42 41 2 127 121 5 Caelyx 39 30 32 109 78 39 CONSUMER HEALTH CARE 239 243 (1) 868 802 8 OTC 150 149 1 456 441 3 OTC Claritin 110 111 (1) 344 336 2 Foot Care 86 80 9 252 224 12 Sun Care 3 14 (79) 160 137 17 ANIMAL HEALTH 183 170 8 539 483 12 ------ ------- ---- ------ ------- ---- CONSOLIDATED NET SALES $1,978 $ 1,998 (1) $6,088 $ 6,386 (5) ------ ------- ---- ------ ------- ----
* Includes international sales of CLARITIN Rx only. Canadian sales of CLARITIN are now reported in the OTC line within Consumer Health Care. The prior period has been reclassified accordingly. Certain prior period amounts have been reclassified to conform to the current year presentation. Global net sales of CLARINEX (marketed as AERIUS in many countries outside the U.S.) for the treatment of seasonal outdoor allergies and year-round indoor allergies were $175 million in the third quarter of 2004, an increase of 3 percent versus the third quarter of 2003. Sales outside the U.S. climbed 39 percent to $57 million in the third quarter due to market share gains and continued conversion from prescription CLARITIN. U.S. 31 sales decreased 8 percent to $118 million in the third quarter due to the continued contraction in the U.S. prescription antihistamine market following the launch of OTC CLARITIN and other branded and non-branded nonsedating antihistamines coupled with market share declines. Global net sales of CLARINEX decreased 6 percent to $530 million for the nine-month period. International net sales of REMICADE, for the treatment of rheumatoid arthritis, Crohn's disease and ankylosing spondylitis, were up $46 million or 33 percent to $188 million in the third quarter and were up $153 million or 40 percent to $535 million for the first nine months. The increase was primarily due to greater medical use and expanded indications in European markets. Global net sales of NASONEX Nasal Spray, a once-daily corticosteroid nasal spray for allergies, rose 34 percent to $153 million in the third quarter primarily due to favorable trade inventory comparisons in the U.S. Global net sales increased 22 percent to $449 million for the first nine months primarily due to favorable trade inventory comparisons in the U.S. coupled with international sales growth, tempered by a decline in U.S. market share. International sales of NASONEX grew 23 percent to $48 million for the quarter and 23 percent to $178 million for the nine-month period due to market share gains and market growth. Global net sales of PEG-INTRON Powder for Injection, a pegylated interferon product for treating hepatitis C, decreased 23 percent to $132 million in the third quarter and decreased 34 percent to $425 million year-to-date due to ongoing market competition in a contracting market. Market share of PEG-INTRON has been declining, reflecting the entrance of a competitor's new products in the hepatitis C market in 2003. Global net sales of TEMODAR Capsules, for treating certain types of brain tumors, increased 35 percent to $121 million for the third quarter and increased 31 percent to $309 million year-to-date due to increased market penetration. Global net sales of INTRON A Injection, for chronic hepatitis B and C and other antiviral and anticancer indications, decreased 21 percent to $81 million for the third quarter and 21 percent to $239 million year-to-date due primarily to lower demand. In the third quarter and first nine months of 2004, global net sales of REBETOL Capsules for use in combination with INTRON or PEG-INTRON for treating hepatitis C, decreased 58 percent to $52 million and 56 percent to $239 million, respectively, due to ongoing competition including the launch of generic versions of REBETOL in the United States in April 2004 and increased price competition outside the U.S. International net sales of prescription CLARITIN decreased 1 percent to $67 million in the third quarter and decreased 3 percent to $240 million for the nine month period of 2004 due to the continued conversion to CLARINEX. Global net sales of INTEGRILIN Injection, a glycoprotein platelet aggregation inhibitor for the treatment of patients with acute coronary syndromes which is sold primarily in the U.S., increased 18 percent to $94 million for the third quarter due to increased patient utilization coupled with favorable U.S. trade inventory comparisons. Global net sales decreased 6 percent to $245 million for the first nine months of 2004 due to unfavorable changes in U.S. trade inventory levels. Millennium Pharmaceuticals, Inc. ("Millennium") and the Company have a co- promotion agreement for INTEGRILIN. Millennium notified the Company that it intends to exercise its right under the agreement to assume responsibilities for consumer service, managed care contracting, government reporting and physical distribution of INTEGRILIN. As a result, as early as the fourth quarter of 2005, the Company expects to cease recording sales of INTEGRILIN and would begin to record its share of the co-promotion profits as alliance revenue. This change in reporting would have no impact on earnings. 32 International sales of SUBUTEX, for the treatment of opiate addiction, increased 22 percent to $45 million in the third quarter and 32 percent to $136 million for the nine-month period due to increased market penetration. International net sales of CAELYX, for the treatment of ovarian cancer, metastatic breast cancer and Kaposi's sarcoma, increased 32 percent to $39 million for the third quarter and 39 percent to $109 million for the first nine months of 2004. The increase reflects the launch of expanded indications including the treatment of metastatic breast cancer in patients who are at increased cardiac risk. Contributing to the decline in global sales in the third quarter and first nine months of 2004 was the absence of LOSEC revenues in Europe, as the Company's agreement with AstraZeneca ended in the 2003 third quarter. LOSEC revenues were $52 million in the third quarter of 2003 and $130 million for the first nine months of 2003. Net sales of consumer health care products, which include OTC, foot care and sun care products, decreased $4 million or 1 percent in the third quarter. Sales of OTC CLARITIN for the third quarter of 2004 were $110 million, down 1 percent from $111 million in 2003. The decrease in sales was due to competition from branded and private label loratadine. For the year-to-date period of 2004, net sales of consumer health care products increased $66 million or 8 percent. Sales of foot care products increased 9 percent to $86 million in the third quarter and 12 percent to $252 million year-to-date due primarily to the successful launch of FREEZE AWAY, a wart-remover product. Net sales of sun care products increased $23 million or 17 percent year-to-date due to the timing of orders and shipments coupled with favorable weather conditions. Global net sales of animal health products increased 8 percent in the third quarter of 2004 to $183 million and 12 percent to $539 million for the nine-month period. Sales were favorably impacted by foreign exchange of 4 percent and 7 percent for the quarter and nine-month period, respectively. Costs and Expenses Cost of sales as a percentage of net sales increased to 35.9 and 36.8 percent for the third quarter and first nine months of 2004, respectively, versus 32.6 and 32.8 percent in the third quarter and nine-month period of 2003. The increase was primarily due to lower production volumes coupled with increased spending related to the FDA consent decree and efforts to upgrade the Company's global infrastructure. The absence of European LOSEC revenues in both the third quarter and nine months of 2004 contributed to the unfavorable comparison as well. Selling, general and administrative expenses increased $19 million or 2 percent to $892 million for the third quarter and increased $132 million or 5 percent to $2.8 billion for the first nine months of 2004. The increase was primarily due to higher sales force costs associated with the previously reported field force expansion coupled with the unfavorable impact of foreign exchange, tempered by lower promotional spending. The third quarter and year-to-date ratios to net sales of 45.1 and 45.7 percent, respectively, are higher than the 43.7 and 41.5 percent ratios in the respective prior year periods, primarily due to these increased costs coupled with the lower overall sales reported in the 2004 periods. 33 Research and development spending decreased 1 percent to $378 million in the third quarter and increased 12 percent to $1.2 billion year-to-date, representing 19.1 and 19.7 percent of net sales, respectively. The decrease in research and development spending for the third quarter is primarily due to the timing of spending on research programs. Research and development spending for the nine-month period of 2004 includes an $80 million charge in conjunction with the license from Toyama Chemical Company Ltd. for garenoxacin, a quinolone antibiotic currently in development. Other expense (income), net for the third quarter of 2004 decreased versus the third quarter of 2003 due primarily to provisions for asset write-offs in the prior year, offset by higher net interest expense. Other expense (income), net for the first nine months of 2004 reflects higher net interest expense. Interest expense increased primarily because the Company changed the composition of its debt portfolio. Prior to this change, the Company was financed entirely with short-term debt (primarily commercial paper). In the fourth quarter of 2003, the Company issued $2.4 billion of fixed-rate, long-term debt. Although the interest rate on the long-term debt is higher than the rate on short-term debt, this change in composition of the debt portfolio decreased the inherent risk associated with reliance on short-term financing. Interest expense also increased because overall borrowings have increased over the prior year. Partially offsetting the higher interest expense is an increase in interest income due to higher investment balances as well as the interest income from the investment of the proceeds from the August 2004 issuance of the mandatory convertible preferred shares. Special Charges Special charges for the three months ended September 30, 2004 totaled $26 million, primarily relating to employee termination costs. Special charges for the nine months ended September 30, 2004 were comprised of $111 million of employee termination costs and $27 million of asset impairment charges. For the nine month period ended September 30, 2003 special charges totaled $370 million, comprised of $350 million to increase litigation reserves and $20 million of asset impairment charges. Employee Termination Costs In August 2003, the Company announced a global workforce reduction initiative. The first phase of this initiative was a Voluntary Early Retirement Program (VERP) in the United States. The total cost of this program is estimated to be $191 million, comprised of increased pension costs of $108 million, increased post-retirement health care costs of $57 million, vacation payments of $4 million and costs related to accelerated vesting of stock grants of $22 million. Amounts recognized relating to this program during the third quarter and first nine months of 2004 were $2 million and $19 million, respectively, with cumulative costs of $183 million recognized through September 30, 2004. Amounts expected to be recognized during the remainder of 2004 and 2005 are $1 million and $7 million, respectively. In addition to the VERP, the Company recognized $23 million and $92 million of other employee severance costs in the third quarter and nine-month period of 2004, respectively, primarily outside the United States. Asset Impairment Charges The Company recognized $27 million of asset impairment charges in the first nine months of 2004, primarily related to the anticipated exit from a small European research-and-development facility. The Company recognized $20 million of asset impairment charges in the first nine months of 2003 related to manufacturing facility assets. 34 Litigation Charges During the three and nine months ended September 30, 2003, the Company recognized $350 million of litigation charges, primarily as a result of the investigations into the Company's sales and marketing practices (see "Legal, Environmental and Regulatory Matters" footnote for additional information). Equity Income from Cholesterol Joint Venture Global cholesterol franchise sales, which include ZETIA and VYTORIN, totaled $344 million in the 2004 third quarter and $780 million year-to-date compared with sales of $137 million and $306 million in the third quarter and first nine months of 2003, respectively. VYTORIN has now been approved in 11 countries and has completed the European Mutual Recognition Process (MRP) as of October 1, 2004. ZETIA has been approved in 71 countries. In the United States, more than 12 million prescriptions have been written for the product since its U.S. launch in November 2002, according to IMS Health. The Company utilizes the equity method of accounting for its cholesterol joint venture with Merck. Under that method, the Company records its share of the operating profits less its share of the research and development costs in "Equity (income) from cholesterol joint venture." Operating profit in the context of the joint venture represents net sales, less cost of sales, direct promotion expenses and other costs that the Company and Merck may agree to share. Operating profit excludes the cost of the Company's sales forces throughout the world, as well as the many indirect costs incurred by the Company to support the manufacturing, marketing and management of ZETIA and VYTORIN. As such, the amount reported as "Equity (income) from cholesterol joint venture" represents the contribution the Company receives from the joint venture to fund the costs incurred by the Company that are not shared with Merck. "Equity (income) from cholesterol joint venture," as defined, totaled $95 million in the third quarter of 2004 versus $24 million in the third quarter of 2003. For 2004 year-to-date, equity income from cholesterol joint venture totaled $249 million including a $7 million milestone earned as a result of the approval in Mexico of the ezetimibe/simvastatin product, versus $21 million for the first nine months of 2003. Net income/(loss) Net income/(loss) was income of $26 million for the 2004 third quarter versus a loss of ($265) million in 2003. Net income in the third quarter of 2004 includes pre-tax special charges of $26 million, as described above. Net loss in the third quarter of 2003 includes a non-tax deductible special charge of $350 million, as described above. Net income/(loss) was a loss of ($112) million for the first nine months of 2004 versus income of $90 million in 2003. Net loss for year-to-date 2004 includes a pre-tax research and development charge of $80 million for the license of garenoxacin from Toyama Chemical Company Ltd. as well as pre-tax special charges of $138 million, as described above. Net income for the first nine months of 2003 includes special charges of $370 million, as described above. Effective Tax Rate The effective tax rate was 20.0 percent in the third quarter and first nine months of 2004. The effective tax rate was 15.0 percent for the first nine months of 2003 excluding the $350 million non-tax deductible special charge in 2003 to increase litigation reserves. 35 Liquidity and Financial Resources - nine months ended September 30, 2004 Background The following background information presents the current state of the Company's liquidity and financial resources. At September 30, 2004, the majority of cash and cash equivalents and short-term investments shown in the accompanying balance sheet were held by wholly-owned, foreign-based subsidiaries. At the same time, substantially all of the debt shown in the accompanying balance sheet was owed by the parent company. In the past, this geographic disparity between the location of funds and the location of debt was not a pivotal issue for the Company. However, with the material decline in earnings following the loss of marketing exclusivity of CLARITIN in the United States, this geographic disparity has taken on more importance. On a consolidated basis, dividends and capital expenditures exceed cash generated from operations. This excess becomes particularly pronounced when disaggregated on a geographic basis. Foreign operations generate cash in excess of cash needs. However, U.S. operations have cash needs well in excess of cash generated in the U.S. The U.S. operations fund dividend payments, the vast majority of research and development costs and approximately half of the worldwide capital expenditures. In the past, these cash needs were funded primarily through operations. However, following the loss of marketing exclusivity of CLARITIN, U.S. profits declined materially and U.S. cash needs now exceed U.S. cash generation. Cash and cash equivalents, plus short-term investments, exceeded total debt at September 30, 2004 by $2.3 billion. However, as discussed above, the majority of cash is held by foreign-based subsidiaries, and the U.S. operations have cash needs and carry substantially all the debt. Generally, using the funds held by the foreign-based subsidiaries for the cash needs of the U.S.-based subsidiaries results in U.S. income tax payments. The amount of any U.S. income tax payments would depend upon a number of factors, including the amount of the funds used, whether the U.S. operations were generating taxable profits or losses and changes in U.S. tax laws (see discussion of the "American Jobs Creation Act of 2004" below). In 2003, the U.S. operations generated tax losses, primarily due to the decline of CLARITIN sales and the continued investment in research and development. For 2003, the entire amount of the U.S. tax losses was used to recoup taxes paid in previous years (carryback benefit). In 2004, management expects the U.S. operations to again generate tax losses. However, only a portion of these losses is expected to be used to recoup taxes paid in previous years because, under current law, the Company's U.S. carryback benefit will be exhausted. The amount of the expected 2004 loss in excess of that used to recoup taxes paid in previous years becomes available to reduce taxable income in the future (carryforward benefit). When the U.S. operations generate losses that cannot be used to recoup taxes paid in previous years, the Company has a choice. It can either use the carryforward benefits in future years, or utilize some or all of those losses to absorb taxable distributions to the U.S. of cash or other assets held by the foreign-based subsidiaries. Absorbing the U.S. operating losses in this manner allows a portion of the assets held by the foreign-based subsidiaries to become available for use in the U.S. operations without having to make additional U.S. income tax payments. See discussion of the "American Jobs Creation Act of 2004" below. 36 On October 22, 2004, the President signed the "American Jobs Creation Act of 2004" (the "Act"). A provision of this Act allows companies to repatriate funds held by foreign-based subsidiaries at a reduced tax rate under certain circumstances. The Company is currently evaluating the provisions of the Act and is investigating the repatriation of foreign-based subsidiaries' funds under its provisions. In 2005, and possibly beyond, the Company expects to finance a portion of its U.S. cash needs by accessing the funds held by foreign based subsidiaries. The Company expects to access these funds either by repatriating some of these amounts and utilizing some or all of its current U.S. operating losses or by repatriating funds under the provisions of the Act. If funds were to be repatriated under the Act, a tax payment would be due, albeit at a reduced rate. Any such tax payment will be accrued in future periods. Also, repatriation of funds under the Act will not reduce the Company's operating losses. These losses can be carried forward to offset future taxable income. Based on the provisions of the Act, a maximum of $9.2 billion of undistributed foreign earnings may be eligible for repatriation under the Act. As indicated above, the Company is considering the details of the Act. If a decision is made that some or all of the unremitted foreign earnings are no longer considered permanently reinvested, additional tax will be payable which could be recognized as early as the fourth quarter of 2004. Discussion of Cash Flow Cash provided by operating activities totaled $9 million for the first nine months of 2004. This amount includes the receipt of $404 million for a U.S. tax refund relating to the 2003 "carryback benefit" described above, the payment of $473 million to the U.S. government for a tax deficiency related to certain transactions entered into in 1991 and 1992 and the payment of $177.5 million under the settlement agreement with the U.S. Attorney's Office for the Eastern District of Pennsylvania. The final payment under the settlement agreement is $114.4 million, plus interest which accrues on the unpaid balance at 4 percent per year, due by March 4, 2005. (See the "Legal, Environmental and Regulatory Matters" footnote included in the financial statements to this report.) For the first nine months of 2004 operating activities provided minimal cash. As a result, capital expenditures and dividends were funded through the existing cash balances, borrowings and the mandatory convertible preferred stock issuance. As discussed above, this overall net use of cash occurred entirely in the U.S. operations. Foreign operations generated net cash of approximately $795 million through the first nine months, but the net use of cash in the U.S. totaled approximately $1.3 billion during this same period of time. Through the first nine months of 2004, the cash shortfall in the U.S. was funded with cash that was available in the U.S. at the beginning of the year, as well as with the proceeds received from the issuance of $1.438 billion of mandatory convertible preferred shares, discussed below, and U.S. commercial paper borrowings. In August 2004, the Company issued 6% mandatory convertible preferred stock (see "Mandatory Convertible Preferred Stock" footnote included in the financial statements to this report) and received net proceeds of $1.39 billion after deducting commissions, discounts and other underwriting expenses. The proceeds were used to reduce short-term commercial paper borrowings, for the payment of settlement amounts and litigation costs (as described above), funding of operating expenses, shareholder dividends and capital expenditures. The preferred 37 stock was issued under the Company's $2.0 billion shelf registration. As of September 30, 2004, $563 million remains registered and unissued under the shelf registration. For the remainder of 2004 and for 2005, the net use of cash in the U.S. operations is expected to continue. The Company expects to use commercial paper borrowings to fund the U.S. operations through the end of 2004. Beginning in early 2005, however, the Company expects to have to access the funds held by its foreign-based subsidiaries to fund its U.S. operations. The tax implications of accessing these funds is discussed above. The Company's credit rating could decline further. The impact of such decline could be reduced availability of commercial paper borrowing and would increase the interest rate on the Company's long-term debt. If this were to occur, the Company may have to seek short-term financing from other sources at higher interest rates than that of commercial paper, or to repatriate additional funds currently held by foreign affiliates that would incur additional U.S. income tax. Borrowings and Credit Facilities On November 26, 2003, the Company issued $1.25 billion aggregate principal amount of 5.3 percent senior unsecured notes due 2013 and $1.15 billion aggregate principal amount of 6.5 percent senior unsecured notes due 2033. Proceeds from this offering of $2.4 billion were used for general corporate purposes, including to repay commercial paper outstanding in the United States. Upon issuance, the notes were rated A3 by Moody's Investors' Service (Moody's) and A+ (on CreditWatch with negative implications) by Standard & Poor's (S&P). The interest rates payable on the notes are subject to adjustment. If the rating assigned to the notes by either Moody's or S&P is downgraded below "A3" or "A-," respectively, the interest rate payable on that series of notes will increase. See the "Borrowings" footnote included in the financial statements to this report for additional information. On July 14, 2004, Moody's lowered its rating on the notes to "Baa1". Accordingly, the interest payable on each note will increase 25 basis points, respectively, effective December 1, 2004. Therefore, on December 1, 2004, the interest rate payable on the notes due 2013 will increase from 5.3% to 5.55%, and the interest rate payable on the notes due 2033 will increase from 6.5% to 6.75%. This adjustment to the interest rate payable on the notes will increase the Company's interest expense by $6 million annually. The Company has two revolving credit facilities totaling $1.5 billion. Both facilities are from a syndicate of major financial institutions. The most recently negotiated facility (May 2004) is a $1.25 billion, five-year credit facility. This facility matures in May 2009 and requires the Company to maintain a total debt to total capital ratio of no more than 60 percent. The second credit facility provides a $250 million line of credit through its maturity date in May 2006 and requires the Company to maintain a total debt to total capital ratio of no more than 60 percent anytime the Company is rated at or below Baa3 by Moody's and BBB- by S&P. These facilities are available for general corporate purposes and are considered as support for the Company's commercial paper borrowings. These facilities do not require compensating balances; however, a nominal commitment fee is paid. At September 30, 2004, no funds were drawn under either of these facilities. At September 30, 2004, short-term borrowings totaled $866 million. Approximately 91 percent of this was outstanding commercial paper. The commercial paper ratings discussed below have not significantly affected the Company's ability to issue or rollover its outstanding commercial paper borrowings at this time. However, the Company believes the ability of commercial paper issuers, such as the Company, with one or more short-term credit ratings of "P-2" from Moody's, "A-2" from S&P and/or "F2" from Fitch Ratings (Fitch) to issue or rollover outstanding commercial paper can, at times, be less than that of companies with higher short-term 38 credit ratings. In addition, the total amount of commercial paper capacity available to such issuers is typically less than that of higher rated companies. The Company maintains sizable lines of credit with commercial banks, as well as cash and short-term investments held by foreign-based subsidiaries, to serve as alternative sources of liquidity and to support its commercial paper program. Credit Ratings On February 18, 2004, S&P downgraded the Company's senior unsecured debt ratings to "A-" from "A." At the same time, S&P also lowered the Company's short-term corporate credit and commercial paper rating to "A-2" from "A-1." The Company's S&P rating outlook remains negative. On May 11, 2004, the shelf registration, as amended, that allowed the Company to issue up to $2 billion in various debt and equity securities was declared effective by the SEC. On March 3, 2004, S&P assigned the shelf registration a preliminary rating of "A-" for senior unsecured debt and a preliminary subordinated debt rating of "BBB+". As of September 30, 2004, $563 million remains registered and unissued under the shelf registration. On April 29, 2004, Moody's placed the Company's senior unsecured credit rating of "A3" on its Watchlist for possible downgrade based upon concerns related to market share declines, litigation risks and a high degree of reliance on the success of VYTORIN. On July 14, 2004, Moody's lowered the Company's senior unsecured credit rating from "A3" to "Baa1", lowered the Company's senior unsecured shelf registration rating from "(P)A3" to "(P)Baa1", lowered the Company's subordinated shelf registration rating from "(P)Baa1" to "(P)Baa2", lowered the Company's cumulative and non-cumulative preferred stock shelf registration rating from "(P)Baa2" to "(P)Baa3", confirmed the Company's "P-2" commercial paper rating and removed the Company from the Watchlist. Moody's rating outlook for the Company is negative. See the "Borrowings and Credit Facilities" section above for a discussion of the impact of Moody's rating downgrade on the interest rates payable on the Company's long-term debt. On November 20, 2003, Fitch downgraded the Company's senior unsecured and bank loan ratings to "A-" from "A+," and its commercial paper rating to "F-2" from "F-1." The Company's rating outlook remained negative. In announcing the downgrade, Fitch noted that the sales decline in the Company's leading product franchise, the INTRON franchise, was greater than anticipated, and that it was concerned that total Company growth is reliant on the performance of two key growth drivers, ZETIA and REMICADE, in the near term. On August 4, 2004, Fitch affirmed the Company's "A-" senior unsecured rating and bank loan rating and the "F-2" commercial paper rating, and reitereated the negative outlook. Financial Arrangements Containing Credit Rating Downgrade Triggers The Company has an interest rate swap arrangement that contains a credit rating downgrade trigger. This arrangement requires the Company to maintain a long-term debt rating of at least "A2" by Moody's or "A" by S&P. Both S&P's and Moody's current credit ratings are below this specified minimum. As a result, the counterparty to the interest rate swap can elect early termination following a specified period, as described below. This arrangement utilizes two long-term interest rate swap contracts (each contract consisting of twenty individual confirmations). One contract is between a foreign-based subsidiary and a bank, and the other contract is between a U.S. subsidiary and the same bank. The two contracts have equal and offsetting terms and are covered by a master netting arrangement. The contract involving the foreign-based subsidiary permits the 39 subsidiary to prepay a portion of its future obligation to the bank, and the contract involving the U.S. subsidiary permits the bank to prepay a portion of its future obligation to the U.S. subsidiary. Interest is paid on the prepaid balances by both parties at market rates. Prepayments totaling $1.9 billion have been made under both contracts as of September 30, 2004 and December 31, 2003. The prepaid amounts have been netted in the preparation of the condensed consolidated balance sheet in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 39, "Offsetting of Amounts Related to Certain Contracts." The arrangement provides that in the event the Company fails to maintain the required minimum credit ratings, the counterparty may terminate the transaction by designating an early termination date not earlier than 36-months following the date of such notice to terminate. Both S&P's and Moody's current credit ratings are below the specified minimum. As of this date the counterparty has not given the company notice to terminate. Early termination requires repayment of all prepaid amounts, and repayment must occur in the original tax jurisdiction in which the prepaid amounts were made. Accordingly, early termination would require the Company's U.S. subsidiary to repay $1.9 billion to the bank and for the bank to repay $1.9 billion to the Company's foreign-based subsidiary. The financial impact of early termination depends on the manner and extent to which the Company decides to finance its U.S. repayment obligation. The Company could finance its entire obligation by obtaining short- or long-term financing in the United States. (In this case, cash and debt would increase by equal amounts in the consolidated balance sheet.) However, the Company's ability to finance its obligation under the swaps will depend on the Company's credit ratings and business operations, as well as market conditions, at the time such financing is contemplated. Alternatively, the Company could repatriate to the United States some or all of the funds received by the foreign-based subsidiary. Repatriating funds could have U.S. income tax consequences depending primarily on profitability of the U.S. operations. Any such tax would be accrued against future earnings, and may result in the Company reporting a higher effective tax rate. Currently, the U.S. operations are generating tax losses. However, future tax losses may be insufficient to absorb any or all of the potential tax should the Company repatriate some or all of the funds received by the foreign-based subsidiary. Under the "American Jobs Creation Act of 2004" previously discussed in this "Liquidity and Financial Resources" section, the Company may be able to finance its U.S. repayment obligation by repatriating the funds received by the foreign-based subsidiary at a significantly reduced tax cost. As stated above, both S&P's and Moody's current credit ratings are below the specified minimum, however, termination of the transaction is not required to occur earlier than 36 months following the date on which the Company receives a termination notice from the counterparty. As of this date, the Company has not received a termination notice from the counterparty. Accordingly, early termination is not imminent. Due to this fact, as well as the alternative courses of action available to the Company in the event of early termination, the potential of early termination does not impact current liquidity and financial resources. 40 The Company had a second, unrelated interest rate swap arrangement that was terminated earlier in 2004 due to the Company's recent credit rating downgrade. The impact of the termination was not material. Additional Factors Influencing Operations In the United States, many of the Company's pharmaceutical products are subject to increasingly competitive pricing as managed care groups, institutions, government agencies and other groups seek price discounts. In most international markets, the Company operates in an environment of government-mandated cost-containment programs. In the U.S. market, the Company and other pharmaceutical manufacturers are required to provide statutorily defined rebates to various government agencies in order to participate in Medicaid, the veterans health care program and other government-funded programs. Several governments have placed restrictions on physician prescription levels and patient reimbursements, emphasized greater use of generic drugs and enacted across-the-board price cuts as methods to control costs. Since the Company is unable to predict the final form and timing of any future domestic or international governmental or other health care initiatives, including the passage of laws permitting the importation of pharmaceuticals into the United States, their effect on operations and cash flows cannot be reasonably estimated. Similarly, the effect on operations and cash flows of decisions of government entities, managed care groups and other groups concerning formularies and pharmaceutical reimbursement policies cannot be reasonably estimated. The Company cannot predict what net effect the Medicare prescription drug benefit will have on markets and sales. The program does not go into effect until 2006 and many of the Company's leading drugs are already covered under Medicare Part B (e.g., TEMODAR, INTEGRILIN and INTRON A). Others have a relatively small portion of their sales to the Medicare population (e.g., CLARINEX, the hepatitis C franchise). The Company could experience expanded utilization of ZETIA and VYTORIN and new drugs in the Company's R&D pipeline. Of greater consequence for the Company may be the legislation's impact on pricing, rebates and discounts. A significant portion of net sales are made to major pharmaceutical and health care products distributors and major retail chains in the United States. Consequently, net sales and quarterly growth comparisons may be affected by fluctuations in the buying patterns of major distributors, retail chains and other trade buyers. These fluctuations may result from seasonality, pricing, wholesaler buying decisions or other factors. 41 The market for pharmaceutical products is competitive. The Company's operations may be affected by technological advances of competitors, industry consolidation, patents granted to competitors, new products of competitors, new information from clinical trials of marketed products or post-marketing surveillance and generic competition as the Company's products mature. In addition, patent positions are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products. The effect on operations of competitive factors and patent disputes cannot be predicted. The Company launched OTC CLARITIN in the United States in December 2002. Also in December 2002, a competing OTC loratadine product was launched in the United States and private-label competition was introduced. In November 2003, the FDA approved CLARITIN for the over-the-counter relief of hives. The Company continues to market CLARINEX (desloratadine) 5 mg Tablets for the treatment of allergic rhinitis, which combines the indication of seasonal allergic rhinitis with the indication of perennial allergic rhinitis, as well as the treatment of chronic idiopathic urticaria, or hives of unknown cause. The ability of the Company to capture and maintain market share for CLARINEX and OTC CLARITIN in the U.S. market will depend on a number of factors, including: additional entrants in the market for allergy treatments; clinical differentiation of CLARINEX from other allergy treatments and the perception of the extent of such differentiation in the marketplace; the pricing differentials among OTC CLARITIN, CLARINEX, other allergy treatments and generic OTC loratadine; the erosion rate of OTC CLARITIN and CLARINEX sales upon the entry of additional generic OTC loratadine products; and whether or not one or both of the other branded second-generation antihistamines are switched from prescription to OTC status. CLARINEX is experiencing intense competition in the prescription U.S. allergy market. The prescription allergy market has been shrinking since the OTC switch of CLARITIN in December 2002. The Company is implementing new marketing efforts to address market share performance for CLARINEX. The switch of CLARITIN to OTC status and the introduction of competing OTC loratadine has resulted in a rapid, sharp and material decline in CLARITIN sales in the United States and the Company's results of operations. U.S. sales of prescription CLARITIN products were $25 million or 0.3 percent of the Company's consolidated global sales in 2003 and $1.4 billion or 14 percent in 2002. Sales of CLARINEX in the United States and abroad have also been materially adversely affected by the presence of generic OTC loratadine and OTC CLARITIN. In light of the factors described above, management believes that the Company's December 2002 introduction of OTC CLARITIN, as well as the introduction of a competing OTC loratadine product in December 2002 and additional entrants of generic OTC loratadine products in the market, have had a rapid, sharp and material adverse effect on the Company's results of operations and will likely continue for an indeterminate period of time. Following settlement in 2003 of patent litigation by the Company involving three drug manufacturers, and dismissal of patent litigation relating to ribavirin patents that did not involve the Company, generic forms of ribavirin entered the U.S. market in April 2004. In October 2004, a third generic ribavirin was approved by the FDA. The generic forms of ribavirin compete with the Company's REBETOL (ribavirin) Capsules in the United States. The REBETOL patents are material to the Company's business. U.S. sales of REBETOL in 2003 were $306 million. For the nine months ended September 30, 2004, U.S. sales of REBETOL were $54 million. PEG-INTRON and REBETOL combination therapy for hepatitis C contributed substantially to sales in 2003 and 2002. During the fourth quarter of 2002, a competing pegylated interferon-based combination product, including a brand of ribavirin, received regulatory approval in most major markets, including the United States. 42 The overall market share of the hepatitis C franchise has declined sharply, reflecting this new market competition. Management believes that the ability of PEG-INTRON and REBETOL combination therapy to maintain market share will continue to be adversely affected by new competition in the hepatitis C marketplace. As a result of the introduction of a competitor for pegylated interferon and the introduction of generic ribavirin, the value of the Company's second most important product franchise has been severely diminished and earnings and cash flow have been materially and negatively impacted. In October 2002, Merck/Schering-Plough Pharmaceuticals announced that the FDA approved ZETIA (ezetimibe) 10 mg for use either by itself or together with statins for the treatment of elevated cholesterol levels. In March 2003, the Company announced that ezetimibe (EZETROL, as marketed in Europe) had successfully completed the European Union (EU) mutual recognition procedure (MRP). With the completion of the MRP process, the 15 EU member states as well as Iceland and Norway can grant national marketing authorization with unified labeling for EZETROL. EZETROL has been launched in many international markets. The Merck/Schering-Plough partnership also developed a once-daily tablet combining ezetimibe with simvastatin (Zocor), Merck's cholesterol-modifying medicine. Ezetimibe/simvastatin (INEGY, marketed as VYTORIN in the United States) completed the MRP in Europe on October 1, 2004. Ezetimibe/simvastatin has been approved for marketing in several countries, including Germany in April of 2004 and in Mexico in March of 2004. On July 23, 2004, Merck/Schering-Plough Pharmaceuticals announced that the FDA had approved VYTORIN. In September 2004, the Company announced that it entered into an agreement with Bayer Pharmaceuticals Corporation ("Bayer") intended to enhance the companies' pharmaceutical resources. The agreement was entered into by the Company primarily for strategic purposes. Commencing in October 2004, in the United States and Puerto Rico, the Company will market, sell and distribute Bayer's primary care products including Avelox (moxifloxacin HCl) and Cipro (ciprofloxacin HCl) under an exclusive license agreement. The Company will pay Bayer royalties in excess of 50% on these products based on sales, which will have an unfavorable impact on the Company's gross margin percentage. In addition, the Company expects to add 800-900 existing Bayer sales representatives to support these products. Also commencing in October 2004, the Company will assume Bayer's responsibilities for U.S. commercialization activities related to the erectile dysfunction medicine Levitra (vardenafil HCl) under Bayer's co-promotion agreement with GlaxoSmithKline PLC. The Company will report its share of Levitra's results as alliance revenue. Additionally, under the terms of the agreement, Bayer will support the promotion of certain of the Company's oncology products in the United States and key European markets for a defined period of time. In Japan, upon regulatory approval Bayer will co-market the Company's cholesterol absorption inhibitor ZETIA (ezetimibe). This arrangement does not include the rights to any future cholesterol combination product. ZETIA was filed with regulatory authorities in Japan during the fourth quarter of 2003. This agreement with Bayer potentially restricts the Company from marketing products in the United States that would compete with any of the products under the strategic alliance. As a result, the Company expects that it may need to sublicense rights to garenoxacin, the quinolone antibacterial agent that the Company licensed from 43 Toyama Chemical Co. Ltd. ("Toyama"). The Company is exploring its options with regard to garenoxacin and will continue to fulfill its commitments to Toyama under its arrangement, including taking the product through regulatory approval. Under the Bayer agreement, there will be a business integration and transition period during the remainder of 2004. The transaction is expected to be mildly dilutive in 2004 in terms of its impact on earnings per share. Uncertainties inherent in government regulatory approval processes, including, among other things, delays in approval of new products, formulations or indications, may also affect the Company's operations. The effect of regulatory approval processes on operations cannot be predicted. The Company is subject to the jurisdiction of various national, state and local regulatory agencies and is, therefore, subject to potential administrative actions. Of particular importance is the FDA in the United States. It has jurisdiction over all the Company's businesses and administers requirements covering the testing, safety, effectiveness, approval, manufacturing, labeling and marketing of the Company's products. From time to time, agencies, including the FDA, may require the Company to address various manufacturing, advertising, labeling or other regulatory issues, such as those noted below relating to the Company's current manufacturing issues. Failure to comply with governmental regulations can result in delays in the release of products, seizure or recall of products, suspension or revocation of the authority necessary for the production and sale of products, discontinuance of products, fines and other civil or criminal sanctions. Any such result could have a material adverse effect on the Company's financial position and its results of operations. Additional information regarding government regulation that may affect future results is provided in Part I, Item I, "Business," in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2003. Additional information about cautionary factors that may affect future results is provided under the caption "Cautionary Factors That May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995)" in this Management's Discussion and Analysis of Operations and Financial Condition. As noted in the "Consent Decree" footnote included in the financial statements to this report, on May 17, 2002, the Company announced that it had reached an agreement with the FDA for a consent decree to resolve issues involving the Company's compliance with current Good Manufacturing Practices at certain manufacturing facilities in New Jersey and Puerto Rico. The U.S. District Court for the District of New Jersey approved and entered the consent decree on May 20, 2002. Under terms of the consent decree, the Company agreed to pay a total of $500 million to the U.S. government in two equal installments of $250 million; the first installment was paid in May 2002 and the second installment was paid in May 2003. As previously reported, the Company accrued a $500 million provision for this consent decree in the fourth quarter of 2001. The consent decree requires the Company to complete a number of actions. In the event certain actions agreed upon in the consent decree are not satisfactorily completed on time, the FDA may assess payments for each deadline missed. The consent decree required the Company to develop and submit for FDA's concurrence comprehensive cGMP Work Plans for the Company's manufacturing facilities in New Jersey and Puerto Rico that are covered by the decree. The Company received FDA concurrence with its proposed cGMP Work Plans on May 14, 2003. The cGMP Work Plans contain a number of Significant Steps whose timely and satisfactory completion are subject to payments of $15,000 per business day for each deadline missed. These payments may not exceed $25 million for 2002, and $50 million for each of the years 2003, 2004 and 2005. These payments are subject to an overall cap of $175 million. 44 In connection with its discussions with FDA regarding the Company's cGMP Work Plans, and pursuant to the terms of the decree, the Company and the FDA entered into a letter agreement dated April 14, 2003. In the letter agreement the Company and the FDA agreed to extend by six months the time period during which the Company may incur payments as described above with respect to certain of the Significant Steps whose due dates are December 31, 2005. The letter agreement does not increase the yearly or overall caps on payments described above. In addition, the decree requires the Company to complete programs of revalidation of the finished drug products and bulk active pharmaceutical ingredients manufactured at the covered manufacturing facilities. The Company is required under the consent decree to complete its revalidation programs for bulk active pharmaceutical ingredients by September 30, 2005, and for finished drugs by December 31, 2005. In general, the timely and satisfactory completion of the revalidations are subject to payments of $15,000 per business day for each deadline missed, subject to the caps described above. However, if a product scheduled for revalidation has not been certified as having been validated by the last date on the validation schedule, the FDA may assess a payment of 24.6 percent of the net domestic sales of the uncertified product until the validation is certified. Any such payment would not be subject to the caps described above. Further, in general, if a product scheduled for revalidation under the consent decree is not certified within six months of its scheduled date, the Company must cease production of that product until certification is obtained. The completion of the Significant Steps in the Work Plans and the completion of the revalidation programs are subject to third-party expert certification, which must be accepted by the FDA. The consent decree provides that if the Company believes that it may not be able to meet a deadline, the Company has the right, upon the showing of good cause, to request extensions of deadlines in connection with the cGMP Work Plans and revalidation programs. However, there is no guarantee that FDA will grant any such requests. Although the Company believes it has made significant progress in meeting its obligations under the consent decree, it is possible that (1) the Company may fail to complete a Significant Step or a revalidation by the prescribed deadline; (2) the third party expert may not certify the completion of the Significant Step or revalidation; or (3) the FDA may disagree with an expert's certification of a Significant Step or revalidation. In such a case, it is possible that the FDA may assess payments as described above. The Company would expense any payments assessed under the decree if and when incurred. In addition, the failure to meet the terms of the consent decree could result in delays in approval of new products, seizure or recall of products, suspension or revocation of the authority necessary for the production and sale of products, fines and other civil or criminal sanctions. In April 2003, the Company received notice of a False Claims Act complaint brought by an individual purporting to act on behalf of the U.S. government against it and approximately 25 other pharmaceutical companies in the U.S. District Court for the Northern District of Texas. The complaint alleges that the pharmaceutical companies, including the Company, have defrauded the United States by having made sales to various federal governmental agencies of drugs that were allegedly manufactured in a manner that did not comply with current Good Manufacturing Practices. The Company and the other defendants filed a motion to dismiss the second amended complaint in this action on April 12, 2004. The Company is subject to pharmacovigilance reporting requirements in many countries and other jurisdictions, including the United States, the European Union (EU) and the EU member states. The requirements differ from 45 jurisdiction to jurisdiction, but all include requirements for reporting adverse events that occur while a patient is using a particular drug in order to alert the manufacturer of the drug and the governmental agency to potential problems. During pharmacovigilance inspections by officials of the British and French medicines agencies conducted at the request of the European Agency for the Evaluation of Medicinal Products (EMEA), serious deficiencies in reporting processes were identified. The Company is taking urgent actions to rectify these deficiencies as quickly as possible. The Company does not know what action, if any, the EMEA or national authorities will take in response to these findings. Possible actions include further inspections, demands for improvements in reporting systems, criminal sanctions against the Company and/or responsible individuals and changes in the conditions of marketing authorizations for the Company's products. As described more specifically in the "Legal, Environmental and Regulatory Matters" footnote included in the financial statements to this report, to which the reader of this report is directed, the pricing, sales and marketing programs and arrangements, and related business practices of the Company and other participants in the health care industry are under increasing scrutiny from federal and state regulatory, investigative, prosecutorial and administrative entities. These entities include the Department of Justice and its U.S. Attorney's Offices, the Office of Inspector General of the Department of Health and Human Services, the FDA, the Federal Trade Commission (FTC) and various state Attorneys General offices. Many of the health care laws under which certain of these governmental entities operate, including the federal and state "anti-kickback" statutes and statutory and common law "false claims" laws, have been construed broadly by the courts and permit the government entities to exercise significant discretion. In the event that any of those governmental entities believes that wrongdoing has occurred, one or more of them could institute civil or criminal proceedings, which, if instituted and resolved unfavorably, could subject the Company to substantial fines, penalties and injunctive or administrative remedies, including exclusion from government reimbursement programs, and the Company also cannot predict whether any investigations will affect its marketing practices or sales. Any such result could have a material adverse effect on the Company, its financial condition or its results of operations. Critical Accounting Policies Revenue Recognition The Company's pharmaceutical products are sold to direct purchasers (e.g., wholesalers, retailers and certain health maintenance organizations). Price discounts and rebates on such sales are paid to federal and state agencies as well as to indirect purchasers and other market participants (e.g., managed care organizations that indemnify beneficiaries of health plans for their pharmaceutical costs and pharmacy benefit managers). The Company recognizes revenue when title and risk of loss passes to the purchaser and when reliable estimates of the following can be determined: i. commercial discount and rebate arrangements; ii. rebate obligations under certain Federal and state governmental programs and; iii. sales returns in the normal course of business. When recognizing revenue the Company estimates and records the applicable commercial and governmental discounts and rebates as well as sales returns that have been or are expected to be granted or made for products sold during the period. These amounts are deducted from sales for that period. Estimates recorded in prior 46 periods are re-evaluated as part of this process. If reliable estimates of these items can not be made, the Company defers the recognition of revenue. Revenue recognition for new products is based on specific facts and circumstances including estimated acceptance rates from established products with similar marketing characteristics. Absent the ability to make reliable estimates of rebates, discounts and returns, the Company would defer revenue recognition. Product discounts granted are based on the terms of arrangements with direct, indirect and other market participants as well as market conditions, including prices charged by competitors. Rebates are estimated based on sales terms, historical experience, trend analysis and projected market conditions in the various markets served. The Company evaluates market conditions for products or groups of products primarily through the analysis of wholesaler and other third party sell-through and market research data as well as internally generated information. Data and information provided by purchasers and obtained from third parties are subject to inherent limitations as to their accuracy and validity. Sales returns are generally estimated and recorded based on historical sales and returns information, analysis of recent wholesale purchase information, consideration of stocking levels at wholesalers and forecasted demand amounts. Products that exhibit unusual sales or return patterns due to dating, competition or other marketing matters are specifically investigated and analyzed as part of the formulation of accruals. During 2004, the Company entered into agreements with the major U.S. pharmaceutical wholesalers. These agreements deal with a number of commercial issues, such as product returns, timing of payment, processing of chargebacks and the quantity of inventory held by these wholesalers. With respect to the quantity of inventory held by these wholesalers, these agreements provide a financial disincentive for these wholesalers to acquire quantities of product in excess of what is necessary to meet current patient demand. Through the use of this monitoring and the above noted agreements, the Company expects to avoid situations where the Company's shipments of product are not reflective of current demand. Rebates, Discounts and Returns Rebate accruals for Federal and state governmental programs were $131 million at September 30, 2004 and $127 million at December 31, 2003. Commercial discounts and other rebate accruals were $144 million at September 30, 2004 and $211 million at December 31, 2003, respectively. These and other rebate accruals are established in the period the related revenue was recognized resulting in a reduction to sales and the establishment of a liability, which is included in other accrued liabilities. In the case of the governmental rebate programs, the Company's payments involve interpretations of relevant statutes and regulations. These interpretations are subject to challenges and changes in interpretive guidance by governmental authorities. The result of such a challenge or change could affect whether the estimated governmental rebate amounts are ultimately sufficient to satisfy the Company's obligations. Additional information on governmental inquiries focused in part on the calculation of rebates is contained in the "Legal, Environmental and Regulatory Matters" footnote included in the financial statements to this report. In addition, it is possible that, as a result of governmental challenges or changes in interpretive guidance, actual rebates could materially exceed amounts accrued. 47 The following summarizes the activity in the accounts related to accrued rebates, sales returns and discounts:
Three Months Nine Months Ended Ended September 30, 2004 September 30, 2004 Accrued Rebates / Returns / Discounts, Beginning of Period $ 452 $ 487 ----- ----- Provision for Rebates 100 309 Payments (123) (372) ----- ----- (23) (63) ----- ----- Provision for Returns 14 39 Returns (1) (24) ----- ----- 13 15 ----- ----- Provision for Discounts 21 143 Discounts granted (38) (157) ----- ----- (17) (14) ----- ----- Accrued Rebates / Returns / Discounts, End of Period $ 425 $ 425 ===== =====
Management makes estimates and uses assumptions in recording the above accruals. Actual amounts may differ from these estimates. Adjustments to estimated amounts during the above periods were not significant. Refer to "Management's Discussion and Analysis of Operations and Financial Condition" in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003 for disclosures regarding the Company's other critical accounting policies. 48 Disclosure Notice Cautionary Factors That May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this report and other written reports and oral statements made from time to time by the Company may contain "forward-looking statements" within the meaning of the Securities Litigation Reform Act of 1995. Forward-looking statements relate to expectations or forecasts of future events. They use words such as "anticipate," "believe," "could," "estimate," "expect," "forecast," "project," "intend," "plan," "potential," "will," and other words and terms of similar meaning in connection with a discussion of potential future events, circumstances or future operating or financial performance. You can also identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. In particular, forward-looking statements include statements relating to future actions, ability to access the capital markets, prospective products, the status of product approvals, future performance or results of current and anticipated products, sales efforts, development programs, estimates of rebates, discounts and returns, expenses and programs to reduce expenses, the cost of and savings from reductions in work force, the outcome of contingencies such as litigation and investigations, growth strategy and financial results. Any or all forward-looking statements here or in other publications may turn out to be wrong. Actual results may vary materially, and there are no guarantees about Schering-Plough's financial and operational performance or the performance of Schering-Plough stock. Schering-Plough does not assume the obligation to update any forward-looking statement. Many factors could cause actual results to differ from Schering-Plough's forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. Although it is not possible to predict or identify all such factors, they may include the following: - - A significant portion of net sales are made to major pharmaceutical and health care products distributors and major retail chains in the United States. Consequently, net sales and quarterly growth comparisons may be affected by fluctuations in the buying patterns of major distributors, retail chains and other trade buyers. These fluctuations may result from seasonality, pricing, wholesaler buying decisions or other factors. - - Competitive factors, including technological advances attained by competitors, patents granted to competitors, new products of competitors coming to the market, new indications for competitive products, and generic, prescription and/or OTC products that compete with products of Schering-Plough or the Merck/Schering-Plough Pharmaceuticals joint venture (such as competition from OTC statins, like the one approved for use in the U.K. for which impact in the cholesterol reduction market is not yet known). - - Increased pricing pressure both in the United States and abroad from managed care organizations, institutions and government agencies and programs. In the United States, among other developments, consolidation among customers may increase pricing pressures and may result in various customers having greater influence over prescription decisions through formulary decisions and other policies. - - The potential impact of the Medicare Prescription Drug, Improvement and Modernization Act of 2003; possible other U.S. legislation or regulatory action affecting, among other things, pharmaceutical pricing and reimbursement, including Medicaid and Medicare, involuntary approval of prescription medicines for over-the-counter use; and other health care reform initiatives and drug importation legislation. 49 Legislation or regulations in markets outside the U.S. affecting product pricing, reimbursement or access. Laws and regulations relating to trade, antitrust, monetary and fiscal policies, taxes, price controls and possible nationalization. - - Patent positions can be highly uncertain and patent disputes are not unusual. An adverse result in a patent dispute can preclude commercialization of products or negatively impact sales of existing products or result in injunctive relief and payment of financial remedies. - - Uncertainties of the FDA approval process and the regulatory approval and review processes in other countries, including, without limitation, delays in approval of new products. - - Failure to meet Good Manufacturing Practices established by the FDA and other governmental authorities can result in delays in the approval of products, release of products, seizure or recall of products, suspension or revocation of the authority necessary for the production and sale of products, fines and other civil or criminal sanctions. The resolution of manufacturing issues with the FDA discussed in Schering-Plough's 10-Ks, 10-Qs and 8-Ks are subject to substantial risks and uncertainties. These risks and uncertainties, including the timing, scope and duration of a resolution of the manufacturing issues, will depend on the ability of Schering-Plough to assure the FDA of the quality and reliability of its manufacturing systems and controls, and the extent of remedial and prospective obligations undertaken by Schering-Plough. - - Difficulties in product development. Pharmaceutical product development is highly uncertain. Products that appear promising in development may fail to reach market for numerous reasons. They may be found to be ineffective or to have harmful side effects in clinical or pre-clinical testing, they may fail to receive the necessary regulatory approvals, they may turn out not to be economically feasible because of manufacturing costs or other factors or they may be precluded from commercialization by the proprietary rights of others. - - Efficacy or safety concerns or new information from clinical trials of marketed products or post-marketing surveillance, whether or not scientifically justified, leading to recalls, withdrawals or declining sales. - - Major products such as CLARITIN, CLARINEX, INTRON A, PEG-INTRON, REBETOL Capsules, REMICADE and NASONEX accounted for a material portion of Schering-Plough's 2003 revenues. If any major product were to become subject to a problem such as loss of patent protection, OTC availability of the Company's product or a competitive product (as has been disclosed for CLARITIN and its current and potential OTC competition), previously unknown side effects; if a new, more effective treatment should be introduced; generic availability of competitive products; or if the product is discontinued for any reason, the impact on revenues could be significant. Also, such information about important new products, such as ZETIA and VYTORIN, or important products in our pipeline, may impact future revenues. Further, the launch of VYTORIN may negatively impact sales of ZETIA. - - Unfavorable outcomes of government (local and federal, domestic and international) investigations, litigation about product pricing, product liability claims, other litigation and environmental concerns could preclude commercialization of products, negatively affect the profitability of existing products, materially and adversely impact Schering-Plough's financial condition and results of operations, or contain conditions that impact business operations, such as exclusion from government reimbursement programs. - - Economic factors over which Schering-Plough has no control, including changes in inflation, interest rates and foreign currency exchange rates. - - Instability, disruption or destruction in a significant geographic region - due to the location of manufacturing facilities, distribution facilities or customers - regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. - - Changes in tax laws including changes related to taxation of foreign earnings. 50 - - Changes in accounting standards promulgated by the American Institute of Certified Public Accountants, the Financial Accounting Standards Board, the SEC, or the Public Company Accounting Oversight Board that would require a significant change to Schering-Plough's accounting practices. Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company is exposed to market risk primarily from changes in foreign currency exchange rates and, to a lesser extent, from interest rates and equity prices. Refer to "Management's Discussion and Analysis of Operations and Financial Condition" in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003 for additional information. Item 4. Controls and Procedures Management, including the chief executive officer and the chief financial officer, has evaluated the Company's disclosure controls and procedures as of the end of the quarterly period covered by this Form 10-Q and has concluded that the Company's disclosure controls and procedures are effective. They also concluded that there were no changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 51 PART II. OTHER INFORMATION Item 1. Legal Proceedings Legal proceedings involving the Company are described in the 2003 10-K and the 2004 first and second quarter 10-Qs, together referred to as the "Reports" in this Legal Proceedings Item. Unless specifically indicated below, matters described in the Reports are still pending. The following description should be read together with the Reports. It covers material developments to previously reported proceedings and new legal proceedings involving the Company that arose since the August 3, 2004 filing date of the 2004 second quarter 10-Q. Patent Matters. United Kingdom Patent Infringement Action. On August 6, 2004, the Company brought a patent infringement action in the United Kingdom against Cipla Ltd. and Neolabs Ltd. following the defendants advising of their intent to pursue marketing of desloratadine in the United Kingdom. In 2003, the Company's sales of desloratadine in the United Kingdom were approximately $24.2 million. Investigations. Pennsylvania Investigation. On July 30, 2004, Schering-Plough Corporation, the U.S. Department of Justice and the U.S. Attorney's Office for the Eastern District of Pennsylvania announced settlement of the previously disclosed investigation by that Office. Under the settlement, Schering Sales Corporation, an indirect wholly owned subsidiary of Schering-Plough Corporation, has pleaded guilty to a single federal criminal charge concerning a payment to a managed care customer. As a result, Schering Sales Corporation will be excluded from participating in federal healthcare programs. The settlement will not affect the ability of Schering-Plough Corporation to participate in those programs. The aggregate settlement amount is $345.5 million in fines and damages, comprised of a $52.5 million fine to be paid by Schering Sales Corporation, and $293 million in civil damages to be paid by Schering-Plough Corporation. Schering-Plough Corporation will be credited with $53.6 million that was previously paid in additional Medicaid rebates against the civil damages amount, leaving a net settlement amount of $291.9 million. Of that amount, $177.5 million of the total settlement was paid in the third quarter of 2004. The remaining portion will be paid by March 4, 2005. Interest accrues on the unpaid balance at the rate of 4 percent. The payments have been and will be funded by cash from operations, borrowings and proceeds from the issuance of securities. There will be no impact on 2004 full year results related to the Pennsylvania settlement. Under the settlement, Schering-Plough Corporation also entered into a five year corporate integrity agreement with the Office of the Inspector General of the Department of Health and Human Services, under which Schering-Plough Corporation agreed to implement specific measures to promote compliance with regulations on issues such as marketing. Failure to comply can result in financial penalties. Details of the initiation and progress of the investigation can be found in the Company's prior 10-K and 10-Q reports beginning with the 10-K for 1999. The Company cannot predict the impact of this settlement, if any, on other outstanding investigations. Securities and Class Action Litigation. The Company is a defendant in a number of purported nationwide or state class action lawsuits in which plaintiffs seek a refund of the purchase price of laxatives or phenylpropanolamine-containing cough/cold remedies ("PPA products") they purchased. Other pharmaceutical 52 manufacturers are co-defendants in some of these lawsuits. In general, plaintiffs claim that they would not have purchased or would have paid less for these products had they known of certain defects or medical risks attendant with their use. In the litigation of the claims relating to the Company's PPA products, courts in the national class action suit and several state class action suits have denied certification and dismissed the suits. A similar application to deny class certification in New Jersey, the only remaining statewide class action suit involving the Company, was granted on September 30, 2004. Approximately 96 individual lawsuits relating to the laxative products, PPA products and recalled albuterol/VANCERIL/VANCENASE inhalers are also pending against the Company seeking recovery for personal injuries or death. In a number of these lawsuits punitive damages are claimed. SEC Inquiries and Related Litigation. On September 9, 2003, the SEC and the Company announced settlement of the SEC enforcement proceeding against the Company and Richard Jay Kogan, former Chairman and Chief Executive Officer, regarding meetings held with investors the week of September 30, 2002, and other communications. Without admitting or denying the allegations, the Company agreed not to commit future violations of Regulation FD and related securities laws and paid a civil penalty of $1 million. Mr. Kogan paid a civil penalty of $50 thousand. On September 25, 2003, a lawsuit was filed in New Jersey Superior Court, Union County, against Richard Jay Kogan and the Company's outside Directors alleging breach of fiduciary duty, fraud and deceit and negligent misrepresentation, all relating to the alleged disclosures made during the meetings mentioned above. The Company removed this case to federal court. The case was remanded to state court. The Company has filed a motion to dismiss. Environmental Matters. On September 24, 2004, the Company, along with approximately 80 other parties, were named as third-party defendants in a complaint, alleging that it (and other parties) generated waste that was sent to the Burlington Environmental Management Services, Inc. Landfill ("BEMS Site"), located in Southampton Township, Burlington County, New Jersey. The complaint also indicates that the Company and the other 80 parties are liable for costs expended to clean up the BEMS Site under New Jersey's Spill Compensation and Control Act (New Jersey's "Superfund" statute). The Company is currently investigating the allegations. Tax Matters. In October of 2001, IRS auditors asserted, in reports, that the Company is liable for additional tax for the 1990 through 1992 tax years. The reports allege that two interest rate swaps that the Company entered into with an unrelated party should be recharacterized as loans from affiliated companies. In April of 2004, the Company received a formal Notice of Deficiency (Statutory Notice) from the IRS asserting additional federal income tax due. The Company received bills from the IRS related to this matter on September 7, 2004. Payment in the amount of $194 million for income tax and $279 million of interest was made on September 13, 2004. The Company believes it has complied with all applicable rules and regulations and intends to file a suit for refund for the full amount of the tax and interest. The Company's tax reserves were adequate to cover the above-mentioned payments. 53 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ISSUER PURCHASES OF EQUITY SECURITIES
Total Number of Maximum Number of Shares Purchased as Shares that May Yet Be Part of Publicly Purchased Under the Total Number of Average Price Paid Announced Plans or Plans or PERIOD Shares Purchased per Share Programs Programs ------ ---------------- ------------------ ------------------- ---------------------- January 1, 2004 through March 31, 2004 54,862 (1) $17.97 N/A N/A April 1, 2004 through June 30, 2004 0 0 N/A N/A July 1, 2004 through September 30, 2004 23,928 (1) $18.88 N/A N/A TOTAL 2004 78,790 $18.24
(1) All of the shares included in the table above were repurchased pursuant to the Company's stock incentive program and represent shares delivered to the Company by option holders for payment of the exercise price and tax withholding obligations in connection with stock options. Item 5. Other Information Regulatory Affairs Development: The Company sells numerous upper respiratory products which contain pseudoephedrine (PSE), an FDA approved ingredient for the relief of nasal congestion. The Company's annual sales of upper respiratory products which contain PSE totaled approximately $160 million in 2003 and approximately $152 million through September 2004. These products include all CLARITIN-D products as well as some DRIXORAL, CORICIDIN and CHLOR-TRIMETON products. The Company understands that PSE has been used in the illicit manufacture of methamphetamine, a dangerous and addictive drug. To date, we believe that twelve states and Canada have enacted regulations concerning the sale of PSE, including limiting the amount of these products that can be purchased at one time, or requiring that these products be located behind the counter, with the stated goal of deterring the illicit/illegal manufacture of methamphetamine. To date, the regulations have had no material impact on the Company's operations or financial results. Were such regulations to be adopted throughout the United States and in other countries that are key markets for the products, the impact of such regulations on the Company's sales of these specific products cannot be predicted. At this time, the Company has no information indicating that, based on these regulations, a material adverse impact on the Company's operations or financial condition is likely based on these regulations in the next several years. 54 Item 6. Exhibits Exhibits - The following Exhibits are filed with this document:
Exhibit Number Description - ------------- ------------ 3(i) Restated Certificate of Incorporation 12 Computation of Ratio of Earnings to Fixed Charges 15 Awareness letter 31.1 Sarbanes-Oxley Act of 2002, Section 302 Certification for Chairman of the Board, Chief Executive Officer and President 31.2 Sarbanes-Oxley Act of 2002, Section 302 Certification for Executive Vice President and Chief Financial Officer 32.1 Sarbanes-Oxley Act of 2002, Section 906 Certification for Chairman of the Board, Chief Executive Officer and President 32.2 Sarbanes-Oxley Act of 2002, Section 906 Certification for Executive Vice President and Chief Financial Officer
55 SIGNATURE(S) Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Schering-Plough Corporation (Registrant) Date: October 28, 2004 /s/Douglas J. Gingerella ------------------------- Douglas J. Gingerella Vice President and Controller (Duly Authorized Officer and Chief Accounting Officer) 56 EX-3.I 2 y67941exv3wi.txt RESTATED CERTIFICATE OF INCORPORATION EXHIBIT 3(i) RESTATED CERTIFICATE OF INCORPORATION OF SCHERING-PLOUGH CORPORATION PURSUANT TO N.J.S. 14A:9-5(4) DATED: SEPTEMBER 28, 2004 The undersigned corporation certifies that it has adopted the following restated certificate of incorporation: FIRST: The name of the Corporation is Schering-Plough Corporation. SECOND: The Corporation is organized to engage in any activity within the purposes for which a corporation may be organized under the New Jersey Business Corporation Act. THIRD: The aggregate number of shares which the Corporation shall have authority to issue shall be two billion four hundred fifty million (2,450,000,000) shares to consist of: (a) Two billion four hundred million (2,400,000,000) Common Shares of the par value of Fifty Cents ($0.50) per share, and (b) Fifty million (50,000,000) Preferred Shares of the par value of One Dollar ($1.00) per share issuable in series to consist of: (1) Twelve million (12,000,000) Preferred Shares designated "Series A Junior Participating Preferred Stock," (2) Twenty-eight million seven hundred fifty thousand (28,750,000) Preferred Shares designated "6.00% Mandatory Convertible Preferred Stock," and (3) Nine million two hundred fifty thousand (9,250,000) Preferred Shares whose designations have not yet been determined. FOURTH: The relative rights, preferences and limitations of each class and series are as follows: (a) Common Shares. (1) Voting Rights. Each holder of record of Common Shares shall be entitled to one vote in person or by proxy for each share standing in his name on the books of the Corporation. (2) Dividends. Dividends may be paid on the Common Shares when and as declared by the Board of Directors after payment has been made, or funds have been set aside for payment, of all dividends, sinking funds, retirement funds or other retirement benefits to which the holders of Preferred Shares are entitled. (3) Liquidation. In the event of any liquidation or dissolution, after the full preferential amounts to which the holders of Preferred Shares and any other class having preference over the Common Shares have been paid or set aside, the holders of the Common Shares shall be entitled to receive the remaining assets of the Corporation available for distribution. (b) Preferred Shares. (1) Issuance. The Board of Directors may issue the Preferred Shares in series and fix the voting powers, designations, preferences, rights, qualifications, limitations and restrictions of each such series to the extent not fixed or limited by the provisions set forth herein (and subject to limitations prescribed by law). (2) Voting. Whenever accrued dividends on the Preferred Shares in an amount equivalent to six quarterly dividends shall not have been paid or declared and a sum sufficient for the payment thereof set aside, the holders of the Preferred Shares, voting separately as a class, shall be entitled to elect two directors at the next annual or special meeting of the shareholders. Such right of the holders of the Preferred Shares to elect two directors may be exercised until dividends in default on the Preferred Stock shall have been paid in full or declared and a sum sufficient for the payment thereof set aside. When so paid or provided for, the right of the holders of the Preferred Shares to elect such number of directors shall cease, but subject always to the same provisions for the vesting of such voting rights in the case of any such future dividend default or defaults. During any time that the holders of the Preferred Shares, voting as a class, are entitled to elect two directors as hereinabove provided, the holders of any series of Preferred Shares entitled to participate with the holders of the Common Shares in the election of directors shall not be so entitled to participate with the holders of the Common Shares in the election of such directors. At any annual or special meeting of the shareholders or any adjournment thereof at which the holders of Preferred Shares shall be entitled to elect two directors, if the holders of at least a majority of the Preferred Shares then outstanding shall be present or represented by proxy, then, by vote of the holders of at least a majority of the Preferred Shares then present or so represented at such meeting, the authorized number of directors of the Corporation shall be increased by two, and at such meeting, the holders of the Preferred Shares, voting as a class, shall be entitled to elect the additional directors so provided for. Whenever the holders of Preferred Shares shall be divested of special voting power as herein provided, the terms of all persons elected as directors by the holders of the Preferred Shares as a class shall terminate at the next annual meeting, and the authorized number of directors of the Corporation shall be reduced accordingly. (c) Series A Junior Participating Preferred Stock. Pursuant to the authority conferred by this Article Fourth, the following series of Preferred Shares has been designated with such series consisting of the number of shares, with such designations, voting powers, preferences, rights, qualifications, limitations and restrictions as are stated in Annex A attached hereto and incorporated herein by reference: -2- Annex A Series A Junior Participating Preferred Stock. (d) 6.00% MANDATORY CONVERTIBLE PREFERRED STOCK: Pursuant to the authority conferred by this Article Fourth, the following series of Preferred Shares has been designated with such series consisting of the number of shares, with such designations, voting powers, preferences, rights, qualifications, limitations and restrictions as are stated in Annex B attached hereto and incorporated herein by reference: Annex B 6.00% Mandatory Convertible Preferred Stock FIFTH: The Board of Directors may divide the Preferred Shares into classes or series or both and may determine or change the designation, number of shares, relative rights, preferences and limitations of any class or series except as otherwise provided herein. SIXTH: The address of the Corporation's current registered office is: 2000 Galloping Hill Road Kenilworth, New Jersey 07033 and the name of the Corporation's current registered agent at such address is Susan Ellen Wolf. SEVENTH: Neither the name "Schering" nor the name "Plough" shall be deleted from the name of the Corporation except with the affirmative vote of at least two-thirds of the shares at the time outstanding and entitled to vote. EIGHTH: The number of directors constituting the current Board of Directors is ten. The names and addresses of the directors are as follows:
NAMES ADDRESSES ----- --------- Fred Hassan 2000 Galloping Hill Road Kenilworth, New Jersey 07033 Philip Leder, M.D. 2000 Galloping Hill Road Kenilworth, New Jersey 07033 Eugene R. McGrath 2000 Galloping Hill Road Kenilworth, New Jersey 07033 Richard de J. Osborne 2000 Galloping Hill Road Kenilworth, New Jersey 07033 Hans W. Becherer 2000 Galloping Hill Road Kenilworth, New Jersey 07033
-3- Kathryn C. Turner 2000 Galloping Hill Road Kenilworth, New Jersey 07033 Robert F.W. van Oordt 2000 Galloping Hill Road Kenilworth, New Jersey 07033 Carl E. Mundy, Jr. 2000 Galloping Hill Road Kenilworth, New Jersey 07033 Patricia F. Russo 2000 Galloping Hill Road Kenilworth, New Jersey 07033 Arthur F. Weinbach 2000 Galloping Hill Road Kenilworth, New Jersey 07033
NINTH: Board of Directors (a) Number, Election and Terms. The business and affairs of the Corporation shall be managed by a Board of Directors which, subject to any rights of the holders of any series of Preferred Shares of the Corporation ("Preferred Shares") then outstanding to elect additional directors under specified circumstances, shall consist of not less than nine (9) nor more than twenty-one (21) persons. The exact number of directors within the minimum and maximum limitations specified in the preceding sentence shall be fixed from time to time by either (i) the Board of Directors pursuant to a resolution adopted by a majority of the entire Board of Directors or (ii) the affirmative vote of the holders of at least 80% of the voting power of all of the shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class. No decrease in the number of directors constituting the Board of Directors shall shorten the term of any incumbent director. At the 1985 annual meeting of shareholders, the directors shall be divided into three classes, as nearly equal in number as possible (but with not less than three directors in each class), with the term of office of the first class to expire at the 1986 annual meeting of shareholders, the term of office of the second class to expire at the 1987 annual meeting of shareholders and the term of office of the third class to expire at the 1988 annual meeting of shareholders, and with the members of each class to hold office until their successors shall have been elected and qualified. At each annual meeting of shareholders following such initial classification and election, directors elected to succeed those directors whose terms expire shall be elected for a term of office to expire at the third succeeding annual meeting of shareholders after their election. (b) Shareholder Nomination of Director Candidates. Advance notice of shareholder nominations for the election of directors shall be given in the manner provided in the By-laws. (c) Newly Created Directorships and Vacancies. Subject to the rights of the holders of any series of Preferred Shares then outstanding, newly created directorships -4- resulting from any increase in the authorized number of directors and any vacancies in the Board of Directors resulting from death, resignation, retirement, disqualification, removal from office or other cause may be filled by a majority vote of the directors then in office even though less than a quorum, or by a sole remaining director. (d) Removal. Subject to the rights of the holders of any series of Preferred Shares then outstanding, any director, or the entire Board of Directors, may be removed from office at any time only for cause and only by the affirmative vote of the holders of at least 80% of the voting power of all of the shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class. (e) Amendment, Repeal, etc. Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the affirmative vote of the holders of at least 80% of the voting power of all of the shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to alter, amend, adopt any provision inconsistent with or repeal this Article Ninth entitled "Board of Directors", or to alter, amend, adopt any provision inconsistent with or repeal Sections 1 ("Number, Election and Terms"), 2 ("Removal") or 3 ("Newly Created Directorships and Vacancies") of Article V ("Directors"), Article VI ("Nominations of Director Candidates") or Article IX ("Amendment, Repeal, etc.") of the By-laws of the Corporation. TENTH: Shareholder Action Subject to the rights of the holders of any series of Preferred Shares then outstanding, any action required or permitted to be taken by the shareholders of the Corporation must be effected at a duly called annual or special meeting of shareholders of the Corporation and may not be effected by any consent in writing by such shareholders unless all of the shareholders entitled to vote thereon consent thereto in writing. Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the affirmative vote of the holders of at least 80% of the voting power of all of the shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to alter, amend, adopt any provision inconsistent with or repeal this Article entitled "Shareholder Action", or to alter, amend, adopt any provision inconsistent with or repeal Article IV ("Shareholder Action") of the By-laws of the Corporation. ELEVENTH: Business Combinations (a) Vote Required for Business Combinations. (1) Higher Vote for Business Combinations. In addition to any affirmative vote required by law or this Certificate of Incorporation, and except as otherwise expressly provided in Section (b) of this Article Eleventh, any Business Combination (as hereinafter defined) shall require the affirmative vote of the holders of at least 80% of the voting power of all of the then outstanding shares of capital stock of the Corporation -5- entitled to vote generally in the election of directors (the "Voting Stock"), voting together as a single class (it being understood that, for purposes of this Article Eleventh, each share of the Voting Stock shall have the number of votes granted to it pursuant to Article Fourth of this Certificate of Incorporation). Such affirmative vote shall be required notwithstanding the fact that no vote may be required, or that a lesser percentage may be specified, by law or in any agreement with any national securities exchange or otherwise. (2) Definition of "Business Combination". The term "Business Combination" as used in this Article Eleventh shall mean any transaction which is referred to in any one or more of the following clauses (A) through (E): (A) any merger or consolidation of the Corporation or any Subsidiary (as hereinafter defined) with (i) any Interested Shareholder (as hereinafter defined) or (ii) any other corporation (whether or not itself an Interested Shareholder) which is, or after such merger or consolidation would be, an Affiliate (as hereinafter defined) of an Interested Shareholder; or (B) any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or a series of transactions) to or with any Interested Shareholder or any Affiliate of any Interested Shareholder of any assets of the Corporation or any Subsidiary having an aggregate Fair Market Value (as hereinafter defined) of $50,000,000 or more; or (C) the issuance or transfer by the Corporation or any Subsidiary (in one transaction or a series of transactions) of any securities of the Corporation or any Subsidiary having an aggregate Fair Market Value of $50,000,000 or more to any Interested Shareholder or any Affiliate of any Interested Shareholder; or (D) the adoption of any plan or proposal for the liquidation or dissolution of the Corporation proposed by or on behalf of an Interested Shareholder or any Affiliate of any Interested Shareholder; or (E) any reclassification of securities (including any reverse stock split), or recapitalization of the Corporation, or any merger or consolidation of the Corporation with any of its Subsidiaries or any other transaction (whether or not with or into or otherwise involving an Interested Shareholder) which has the effect, directly or indirectly, of increasing the proportionate share of the outstanding shares of any class of equity or convertible securities of the Corporation or any Subsidiary which is directly or indirectly owned by any Interested Shareholder or any Affiliate of any Interested Shareholder. (b) When Higher Vote is Not Required. The provisions of Section (a) of this Article Eleventh shall not be applicable to any particular Business Combination, and such Business Combination shall require only such affirmative vote as is required by law and any other provision of this Certificate of Incorporation, if all of the conditions specified in either of the following paragraphs (1) or (2) are met: -6- (1) Approval by Continuing Directors. The Business Combination shall have been approved by a majority of the total number of the Continuing Directors (as hereinafter defined), it being understood that this condition shall not be capable of satisfaction unless there is at least one Continuing Director. (2) Price, Form of Consideration and Procedural Requirements. All of the following conditions shall have been met: (A) The aggregate amount of the cash and the Fair Market Value as of the date of the consummation of the Business Combination (the "Consummation Date") of consideration other than cash to be received per share by holders of Common Shares of the Corporation (the "Common Shares") in such Business Combination shall be at least equal to the sum of: (i) the greater of (x) (if applicable) the highest per share price (including any brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Interested Shareholder for any shares of Common Shares acquired or beneficially owned by it that were acquired within the two-year period immediately prior to the first public announcement of the proposal of the Business Combination (the "Announcement Date") or in the transaction in which it became an Interested Shareholder, whichever is higher, or (y) the Fair Market Value per share of Common Shares on the day after the Announcement Date or on the date on which the Interested Shareholder became an Interested Shareholder (such latter date is referred to in this Article Eleventh as the "Determination Date"), whichever is higher; and (ii) interest on the per share price calculated at the rate for 90-day United States Treasury obligations in effect on the Determination Date, compounded annually from that date until the Consummation Date, less the per share amount of cash dividends payable to holders of record on record dates occurring in the interim, up to the amount of such interest. (B) The aggregate amount of the cash and the Fair Market Value as of the Consummation Date of consideration other than cash to be received per share by holders of shares of any class of outstanding Voting Stock, other than Common Shares (and other than Institutional Voting Stock, as hereinafter defined), in such Business Combination shall be at least equal to the sum of the following, unless such Business Combination is one in which the Corporation is to become the surviving entity and such class of outstanding Voting Stock is to remain outstanding without any change in its rights, preferences and limitations, in which case such aggregate amount shall be at least equal to the sum of (x) the higher of the amounts set forth in subparagraphs (i)(x) and (i)(z) below and (y) the amount set forth in subparagraph (ii) below [it being intended that the requirements of this paragraph (2)(B) shall be required to be met with respect to every such class of outstanding Voting Stock (other than Institutional Voting Stock), whether or not the Interested Shareholder has previously acquired any shares of a particular class of Voting Stock]: -7- (i) the greatest of (x) (if applicable) the highest per share price (including any brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Interested Shareholder for any shares of such class of Voting Stock acquired or beneficially owned by it that were acquired within the two-year period immediately prior to the Announcement Date or in the transaction in which it became an Interested Shareholder, whichever is higher, (y) (if applicable) the highest preferential amount per share to which the holders of shares of such class of Voting Stock are entitled in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, or (z) the Fair Market Value per share of such class of Voting Stock on the day after the Announcement Date or on the Determination Date, whichever is higher; and (ii) interest on the per share price calculated at the rate of 90-day United States Treasury obligations in effect on the Determination Date, compounded annually from that date until the Consummation Date, less the per share amount of cash dividends payable on such class to holders of record on record dates occurring in the interim, up to the amount of such interest. (C) The consideration to be received by holders of a particular class of outstanding Voting Stock (including Common Shares) shall be in cash or in the same form as the Interested Shareholder has previously paid for shares of such class of Voting Stock. If the Interested Shareholder has paid for shares of any class of Voting Stock with varying forms of consideration, the form of consideration for such class of Voting Stock shall be either cash or the form used to acquire the largest number of shares of such class of Voting Stock previously acquired by it. (D) The holders of all outstanding shares of Voting Stock not beneficially owned by the Interested Shareholder immediately prior to the consummation of any Business Combination shall be entitled to receive in such Business Combination cash or other consideration for their shares meeting all of the terms and conditions of this paragraph (2) (provided, however, that the failure of any shareholders who are exercising their statutory rights to dissent from such Business Combination and receive payment of the fair value of their shares to exchange their shares in such Business Combination shall not be deemed to have prevented the condition set forth in this subparagraph (2)(D) from being satisfied). (E) After such Interested Shareholder has become an Interested Shareholder and prior to the consummation of such Business Combination: (i) except as approved by a majority of the total number of Continuing Directors, there shall have been no failure to declare and pay at the regular date therefor any full quarterly dividends (whether or not cumulative) on the outstanding Preferred Shares of the Corporation; (ii) there shall have been (x) no reduction in the annual rate of dividends paid on the Common Shares (except as necessary to reflect any subdivision of the Common Shares), except as approved by a majority of the total number of Continuing Directors, and (y) an increase in such annual rate of dividends as necessary to reflect any reclassification (including any reverse stock split), recapitalization, reorganization or any similar transaction which has the effect of reducing the number of outstanding Common Shares, -8- unless the failure so to increase such annual rate is approved by a majority of the total number of Continuing Directors; and (iii) such Interested Shareholder shall not have become the beneficial owner of any additional shares of Voting Stock except as part of the transaction which results in such Interested Shareholder becoming an Interested Shareholder. (F) After such Interested Shareholder has become an Interested Shareholder, such interested Shareholder shall not have received the benefit, directly or indirectly (except proportionately as a shareholder), of any loans, advances, guarantees, pledges or other financial assistance or any tax credits or other tax advantages provided by the Corporation, whether in anticipation of or in connection with such Business Combination or otherwise. (G) A proxy or information statement describing the proposed Business Combination and complying with the requirements of the Securities Exchange Act of 1934 and the rules and regulations thereunder (or any subsequent provisions replacing such Act, rules or regulations) shall be mailed to public shareholders of the Corporation at least 30 days prior to the consummation of such Business Combination (whether or not such proxy or information statement is required to be mailed pursuant to such Act or subsequent provisions). Such proxy or information statement shall contain, if a majority of the total number of Continuing Directors so requests, an opinion of a reputable investment banking firm (which firm shall be selected by a majority of the total number of Continuing Directors, furnished with all information it reasonably requests, and paid a reasonable fee for its services by the Corporation upon the Corporation's receipt of such opinion) as to the fairness (or lack of fairness) of the terms of the proposed Business Combination from the point of view of the holders of shares of Voting Stock (other than the Interested Shareholder). (c) Certain Definitions. For the purposes of this Article Eleventh: (1) A "person" shall mean any individual, firm, corporation or other entity. (2) "Interested Shareholder" shall mean any person (other than the Corporation or any Subsidiary) who or which: (A) is the beneficial owner, directly or indirectly, of more than 10% of the voting power of the then outstanding Voting Stock; or (B) is an Affiliate of the Corporation and at any time within the two-year period immediately prior to the date in question was the beneficial owner, directly or indirectly, of 10% or more of the voting power of the then outstanding Voting Stock; or (C) is an assignee of or has otherwise succeeded to any shares of Voting Stock which were at any time within the two-year period immediately prior to the date in question beneficially owned by any Interested Shareholder, if such assignment or succession shall have occurred in the course of a transaction or series of transactions not involving a public offering within the meaning of the Securities Act of 1933. -9- (3) A person shall be a "beneficial owner" of any shares of Voting Stock: (A) which such person or any of its Affiliates or Associates (as hereinafter defined) beneficially owns, directly or indirectly; or (B) which such person or any of its Affiliates or Associates has (i) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of conversion rights, exchange rights, warrants or options, or otherwise, or (ii) the right to vote pursuant to any agreement, arrangement or understanding; or (C) which are beneficially owned, directly or indirectly, by any other person with which such person or any of its Affiliates or Associates has any agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of any shares of Voting Stock. (4) In determining whether a person is an Interested Shareholder pursuant to paragraph (2) of this Section (c), the number of shares of Voting Stock deemed to be outstanding shall include shares deemed owned through application of paragraph (3) of this Section (c) but shall not include any other shares of Voting Stock which may be issuable pursuant to any agreement, arrangement or understanding, or upon exercise of conversion rights, warrants or options, or otherwise. (5) "Affiliate" or "Associate" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as in effect on April 23, 1985. (6) "Subsidiary" shall mean any corporation of which a majority of any class of equity security is owned, directly or indirectly, by the Corporation; provided, however, that for the purposes of the definition of Interested Shareholder set forth in paragraph (2) of this Section (c), the term "Subsidiary" shall mean only a corporation of which a majority of each class of equity security is owned, directly or indirectly, by the Corporation. (7) "Continuing Director" shall mean any member of the Board of Directors of the Corporation who is unaffiliated with the Interested Shareholder and who was a member of the Board of Directors prior to the time that the Interested Shareholder became an Interested Shareholder, and any successor of a Continuing Director who is unaffiliated with the Interested Shareholder and who is recommended to succeed a Continuing Director by a majority of the total number of Continuing Directors then on the Board of Directors. (8) "Fair Market Value" shall mean: (A) in the case of stock, the highest closing sale price during the 30-day period immediately preceding the date in question of a share of such stock on the Composite Tape for New York Stock Exchange-Listed Stocks, or, if such stock is not quoted on the Composite Tape, on the New York Stock Exchange, or, if such stock is not listed on such Exchange, on the principal United States securities exchange registered under the Securities Exchange Act of 1934 on which such -10- stock is listed, or, if such stock is not listed on any such exchange, the highest closing bid quotation with respect to a share of such stock during the 30-day period preceding the date in question on the National Association of Securities Dealers, Inc. Automated Quotations System or any system then in use, or if no such quotations are available, the fair market value on the date in question of a share of such stock as determined by a majority of the total number of Continuing Directors in good faith, in each case with respect to any class of such stock, appropriately adjusted for any dividend or distribution in shares of such stock or any stock split or reclassification of outstanding shares of such stock into a greater number of shares of such stock or any combination or reclassification of outstanding shares of such stock into a smaller number of shares of such stock; and (B) in the case of property other than cash or stock, the fair market value of such property on the date in question as determined by a majority of the total number of Continuing Directors in good faith. (9) In the event of any Business Combination in which the Corporation survives, the phrase "consideration other than cash to be received" as used in paragraphs (2)(A) and (2)(B) of Section (b) of this Article Eleventh shall include the Common Shares and/or the shares of any other class of outstanding Voting Stock retained by the holders of such shares. (10) References to "highest per share price" shall in each case with respect to any class of stock reflect an appropriate adjustment for any dividend or distribution in shares of such stock or any stock split or reclassification of outstanding shares of such stock into a greater number of shares of such stock or any combination or reclassification of outstanding shares of such stock into a smaller number of shares of such stock. (11) "Institutional Voting Stock" shall mean any class of Voting Stock which was issued to and continues to be held solely by one or more insurance companies, pension funds, commercial banks, savings banks or similar financial institutions or institutional investors. (d) Powers of the Board and the Continuing Directors. A majority of the entire Board of Directors of the Corporation shall have the power and duty to determine for the purposes of this Article Eleventh, on the basis of information known to them after reasonable inquiry, whether a person is an Interested Shareholder. Once the Board of Directors has made a determination, pursuant to the preceding sentence, that a person is an Interested Shareholder, a majority of the total number of Directors of the Corporation who would qualify as Continuing Directors shall have the power and duty to interpret all of the terms and provisions of this Article Eleventh, and to determine on the basis of information known to them after reasonable inquiry all facts necessary to ascertain compliance with this Article Eleventh, including, without limitation, (1) the number of shares of Voting Stock beneficially owned by any person, (2) whether a person is an Affiliate or Associate of another, (3) whether the assets which are the subject of any Business Combination have, or the consideration to be received for the issuance or transfer of securities by the Corporation or any Subsidiary in any Business Combination has, an aggregate Fair Market Value of $50,000,000 or more, and (4) whether all -11- of the applicable conditions set forth in paragraph (2) of Section (b) of this Article Eleventh have been met with respect to any Business Combination. Any determination pursuant to this Section (d) made in good faith shall be binding and conclusive on all parties. (e) No Effect on Fiduciary Obligations of Interested Shareholders. Nothing contained in this Article Eleventh shall be construed to relieve any Interested Shareholder from any fiduciary obligation imposed by law. (f) Amendment, Repeal, etc. Notwithstanding any other provisions of this Certificate of Incorporation or the By-laws of the Corporation (and notwithstanding the fact that a lesser percentage may be specified by law, this Certificate of Incorporation or the By-laws of the Corporation), and in addition to any affirmative vote of the holders of Preferred Shares or any other class of capital stock of the Corporation or any series of any of the foregoing then outstanding which is required by law or by or pursuant to this Certificate of Incorporation, the affirmative vote of the holders of 80% or more of the voting power of all the shares of the then outstanding Voting Stock, voting together as a single class, shall be required to amend or repeal, or adopt any provision inconsistent with, this Article Eleventh of this Certificate of Incorporation. TWELFTH: Anti-Greenmail (a) Except as expressly permitted in section (b) of this Article Twelfth, any purchase by the Corporation, or any Subsidiary (as hereinafter defined), of shares of Voting Stock (as hereinafter defined) from a 5% Shareholder (as hereinafter defined) at a per share price in excess of the Market Price (as hereinafter defined) at the time of such purchase of the shares so purchased shall require the affirmative vote of the holders of that amount of the voting power of the Voting Stock equal to the sum of (i) the voting power of the shares of Voting Stock of which the 5% Shareholder is the beneficial owner (as hereinafter defined) and (ii) a majority of the voting power of the remaining outstanding shares of Voting Stock, voting together as a single class. (b) The provisions of Section (a) of this Article Twelfth shall not be applicable to any purchase of shares of Voting Stock pursuant to (1) an offer made available on the same terms to the holders of all of the outstanding shares of the same class of Voting Stock as those so purchased or (2) a purchase program effected on the open market and not as a result of a privately-negotiated transaction. (c) For the purposes of this Article Twelfth: (1) A "person" shall mean any individual, firm, corporation or other entity. (2) "Voting Stock" shall mean the outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors. -12- (3) "5% Shareholder" shall mean any person (other than the Corporation or any Subsidiary) who or which: (A) is the beneficial owner, directly or indirectly, of more than five percent of the voting power of the outstanding shares of Voting Stock; or (B) is an Affiliate (as hereinafter defined) of the Corporation and at any time within the two-year period immediately prior to the date in question was the beneficial owner, directly or indirectly, of more than five percent of the voting power of the then outstanding shares of Voting Stock; or (C) is an assignee of or has otherwise succeeded to any shares of Voting Stock which were at any time within the two-year period immediately prior to the date in question beneficially owned by any 5% Shareholder, if such assignment or succession shall have occurred in the course of a transaction or series of transactions not involving a public offering within the meaning of the Securities Act of 1933. (4) A person shall be a "beneficial owner" of any shares of Voting Stock: (A) which such person or any of its Affiliates or Associates (as hereinafter defined) beneficially owns, directly or indirectly; or (B) which such person or any of its Affiliates or Associates has (i) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of conversion rights, exchange rights, warrants or options, or otherwise, or (ii) the right to vote pursuant to any agreement, arrangement or understanding; or (C) which are beneficially owned, directly or indirectly, by any other person with which such person or any of its Affiliates or Associates has any agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of any shares of Voting Stock. (5) For the purpose of determining whether a person is a 5% Shareholder pursuant to paragraph (3) of this Section (c), the number of shares of Voting Stock deemed to be outstanding shall include shares deemed owned through application of paragraph (4) of this Section (c), but shall not include any other shares of Voting Stock which may be issuable pursuant to any agreement, arrangement or understanding, or upon exercise of conversion rights, warrants or options, or otherwise. (6) "Affiliate" and "Associate" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as in effect on April 28, 1987. (7) "Subsidiary" shall mean any corporation of which a majority of any class of equity security is owned, directly or indirectly, by the Corporation; provided, however, that for the purpose of the definition of a 5% Shareholder set forth in paragraph (3) of this Section (c) the term "Subsidiary" shall mean only a corporation of which a majority of -13- the voting power of the capital stock entitled to vote generally in the election of directors is owned, directly or indirectly, by the Corporation. (8) "Market Price" shall mean the last closing sale price immediately preceding the time in question of a share of the stock in question on the Composite Tape for New York Stock Exchange-Listed Stocks, or, if such stock is not quoted on the Composite Tape, on the New York Stock Exchange, or, if such stock is not listed on such Exchange, on the principal United States securities exchange registered under the Securities Exchange Act of 1934 on which such stock is listed, or, if such stock is not listed on any such exchange, the last closing bid quotation with respect to a share of such stock immediately preceding the time in question on the National Association of Securities Dealers, Inc. Automated Quotations System or any comparable system then in use (or any other system of reporting or ascertaining quotations then available), or, if such stock is not so quoted, the fair market value at the time in question of a share of such stock as determined by a majority of the entire Board of Directors in good faith. (d) The Board of Directors of the Corporation shall have the power and duty to determine for the purposes of this Article Twelfth, on the basis of information known to them after reasonable inquiry, (1) whether the provisions of this Article Twelfth are applicable to a particular transaction, (2) whether a person is a 5% Shareholder, (3) the number of shares of Voting Stock beneficially owned by any person and (4) whether a person is an Affiliate or an Associate of another person. The good faith determination of the Board of Directors shall be conclusive and binding for all purposes of this Article Twelfth. (e) Notwithstanding anything contained in this Certificate of Incorporation or the By-Laws of the Corporation to the contrary (and notwithstanding the fact that a lesser percentage may be specified by law, this Certificate of Incorporation or the By-Laws of the Corporation), and in addition to any affirmative vote of the holders of Preferred Shares or any other class of capital stock of the Corporation or any series of any of the foregoing then outstanding which is required by law or by or pursuant to this Certificate of Incorporation, the affirmative vote of the holders of at least 80% of the voting power of the outstanding Voting Stock, voting together as a single class, shall be required to alter, amend, adopt any provision inconsistent with or repeal this Article Twelfth. THIRTEENTH: Limitation of Liability, Indemnification and Insurance (a) Elimination of Certain Liability. (1) A director of the Corporation shall not be personally liable to the Corporation or its shareholders for damages for breach of any duty owed to the Corporation or its shareholders, except for liability for any breach of duty based upon an act or omission (A) in breach of such person's duty of loyalty to the Corporation or its shareholders, (B) not in good faith or involving a knowing violation of law or (C) resulting in receipt by such person of an improper personal benefit. -14- (2) An officer of the Corporation shall not be personally liable, for the duration of any time permitted by law as it now exists or may hereafter be amended, to the Corporation or its shareholders for damages for breach of any duty owed to the Corporation or its shareholders, except for liability for any breach of duty based upon an act or omission (A) in breach of such person's duty of loyalty to the Corporation or its shareholders, (B) not in good faith or involving a knowing violation of law or (C) resulting in receipt by such person of an improper personal benefit. (b) Indemnification and Insurance. (1) Right to Indemnification. Each person who was or is made a party or is threatened to be made a party to or is involved in any pending, threatened or completed civil, criminal, administrative or arbitrative action, suit or proceeding, or any appeal therein or any inquiry or investigation which could lead to such action, suit or proceeding (a "proceeding"), by reason of his or her being or having been a director, officer, employee, or agent of the Corporation or of any constituent corporation absorbed by the Corporation in a consolidation or merger, or by reason of his or her being or having been a director, officer, trustee, employee or agent of any other corporation (domestic or foreign) or of any partnership, joint venture, sole proprietorship, trust, employee benefit plan or other enterprise (whether or not for profit), serving as such at the request of the Corporation or of any such constituent corporation, or the legal representative of any such director, officer, trustee, employee or agent, shall be indemnified and held harmless by the Corporation to the fullest extent permitted by the New Jersey Business Corporation Act, as the same exists or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Corporation to provide broader indemnification rights than said Act permitted prior to such amendment), from and against any and all reasonable costs, disbursements and attorneys' fees, and any and all amounts paid or incurred in satisfaction of settlements, judgments, fines and penalties, incurred or suffered in connection with any such proceeding, and such indemnification shall continue as to a person who has ceased to be a director, officer, trustee, employee or agent and shall inure to the benefit of his or her heirs, executors, administrators and assigns; provided, however, that, except as provided in paragraph (2) of this Section (b), the Corporation shall indemnify any such person seeking indemnification in connection with a proceeding (or part thereof) initiated by such person only if such proceeding (or part thereof) was specifically authorized by the Board of Directors of the Corporation. The right to indemnification conferred in this Section shall be a contract right and shall include the right to be paid by the Corporation the expenses incurred in connection with any proceeding in advance of the final disposition of such proceeding as authorized by the Board of Directors; provided, however, that, if the New Jersey Business Corporation Act so requires, the payment of such expenses in advance of the final disposition of a proceeding shall be made only upon receipt by the Corporation of an undertaking, by or on behalf of such director, officer, employee, or agent to repay all amounts so advanced unless it shall ultimately be determined that such person is entitled to be indemnified under this Section or otherwise. (2) Right of Claimant to Bring Suit. If a claim under paragraph (1) of this Section (b) is not paid in full by the Corporation within thirty days after a written request -15- has been received by the Corporation, the claimant may at any time thereafter apply to a court for an award of indemnification by the Corporation for the unpaid amount of the claim and, if successful on the merits or otherwise in connection with any proceeding, or in the defense of any claim, issue or matter therein, the claimant shall be entitled also to be paid by the Corporation any and all expenses incurred or suffered in connection with such proceeding. It shall be a defense to any such action (other than an action brought to enforce a claim for the advancement of expenses incurred in connection with any proceeding where the required undertaking, if any, has been tendered to the Corporation) that the claimant has not met the standard of conduct which makes it permissible under the New Jersey Business Corporation Act for the Corporation to indemnify the claimant for the amount claimed, but the burden of proving such defense shall be on the Corporation. Neither the failure of the Corporation (including its Board of Directors, independent legal counsel or its shareholders) to have made a determination prior to the commencement of such proceeding that indemnification of the claimant is proper in the circumstances because he or she has met the applicable standard of conduct set forth in the New Jersey Business Corporation Act, nor an actual determination by the Corporation (including its Board of Directors, independent legal counsel or its shareholders) that the claimant has not met such applicable standard of conduct, nor the termination of any proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent, shall be a defense to the action or create a presumption that the claimant has not met the applicable standard of conduct. (3) Non-Exclusivity of Rights. The right to indemnification and advancement of expenses provided by or granted pursuant to this Section (b) shall not exclude or be exclusive of any other rights to which any person may be entitled under a certificate of incorporation, by-law, agreement, vote of shareholders or otherwise, provided that no indemnification shall be made to or on behalf of such person if a judgment or other final adjudication adverse to such person establishes that such person has not met the applicable standard of conduct required to be met under the New Jersey Business Corporation Act. (4) Insurance. The Corporation may purchase and maintain insurance on behalf of any director, officer, employee or agent of the Corporation or another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise against any expenses incurred in any proceeding and any liabilities asserted against him or her by reason of such person's being or having been such a director, officer, employee or agent, whether or not the Corporation would have the power to indemnify such person against such expenses and liabilities under the provisions of this Section (b) or otherwise. -16- IN WITNESS WHEREOF, the undersigned corporation has caused this certificate to be executed on its behalf by its duly authorized officer as of the date first above written. SCHERING-PLOUGH CORPORATION By: /s/ Susan Ellen Wolf Secretary, Associate General Counsel and Staff Vice President -17- ANNEX A SERIES A JUNIOR PARTICIPATING PREFERRED STOCK (1) Designation and Amount. The shares of such series shall be designated as "Series A Junior Participating Preferred Stock" (the "Series A Preferred Stock") and the number of shares constituting the Series A Preferred Stock shall be 12,000,000. Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, that no decrease shall reduce the number of shares of Series A Preferred Stock to a number less than the number of shares then outstanding plus the number of shares reserved for issuance upon the exercise of outstanding options, rights or warrants or upon the conversion of any outstanding securities issued by the Corporation convertible into Series A Preferred Stock. (2) Dividends and Distributions. (A) Subject to the rights of the holders of any shares of any series of Preferred Stock (or any similar stock) ranking prior and superior to the Series A Preferred Stock with respect to dividends, the holders of shares of Series A Preferred Stock, in preference to the holders of Common Stock, par value $.50 per share (the "Common Stock"), of the Corporation, and of any other junior stock, shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on the first day of March, June, September and December in each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series A Preferred Stock, in an amount per share (rounded to the nearest cent) equal to the greater of (a) $1 or (b) subject to the provision for adjustment hereinafter set forth, 100 times the aggregate per share amount of all cash dividends, and 100 times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions, other than a dividend payable in shares of Common Stock or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock since the immediately preceding Quarterly Dividend Payment Date or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series A Preferred Stock. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the amount to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event under clause (b) of the preceding sentence shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) The Corporation shall declare a dividend or distribution on the Series A Preferred Stock as provided in paragraph (A) of this Section immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock); provided that, in the event no dividend or distribution shall have been declared A-1 on the Common Stock during the period between any Quarterly Dividend Payment Date and the next subsequent Quarterly Dividend Payment Date, a dividend of $1 per share on the Series A Preferred Stock shall nevertheless be payable on such subsequent Quarterly Dividend Payment Date. (C) Dividends shall begin to accrue and be cumulative on outstanding shares of Series A Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares, unless the date of issue of such shares is prior to the record date for the first Quarterly Dividend Payment Date, in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of Series A Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares of Series A Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series A Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be not more than 60 days prior to the date fixed for the payment thereof. (3) Voting Rights. The holders of shares of Series A Preferred Stock shall have the following voting rights: (A) Subject to the provision for adjustment hereinafter set forth, each share of Series A Preferred Stock shall entitle the holder thereof to 100 votes on all matters submitted to a vote of the stockholders of the Corporation. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the number of votes per share to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event shall be adjusted by multiplying such number by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) Except as otherwise provided herein, in any other Certificate of Amendment creating a series of Preferred Stock or any similar stock, or by law, the holders of shares of Series A Preferred Stock and the holders of shares of Common Stock and any other capital stock of the Corporation having general voting rights shall vote together as one class on all matters submitted to a vote of stockholders of the Corporation. (C) Except as set forth herein, or as otherwise provided by law or the Certificate of Incorporation, holders of Series A Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of Common Stock as set forth herein) for taking any corporate action. A-2 (4) Certain Restrictions. (A) Whenever quarterly dividends or other dividends or distributions payable on the Series A Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series A Preferred Stock outstanding shall have been paid in full, the Corporation shall not: (i) declare or pay dividends, or make any other distributions, on any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock; (ii) declare or pay dividends, or make any other distributions, on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except dividends paid ratably on the Series A Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; (iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such junior stock in exchange for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series A Preferred Stock; or (iv) redeem or purchase or otherwise acquire for consideration any shares of Series A Preferred Stock, or any shares of stock ranking on a parity with the Series A Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes. (B) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (A) of this Section 4, purchase or otherwise acquire such shares at such time and in such manner. (5) Reacquired Shares. Any shares of Series A Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of Preferred Stock and may be reissued as part of a new series of Preferred Stock subject to the conditions and restrictions on issuance set forth herein, in the Certificate of Incorporation, or in any other Certificate of Amendment creating a series of Preferred Stock or any similar stock or as otherwise required by law. A-3 (6) Liquidation, Dissolution or Winding Up. Upon any liquidation, dissolution or winding up of the Corporation, no distribution shall be made (1) to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock unless, prior thereto, the holders of shares of Series A Preferred Stock shall have received $100 per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment, provided that the holders of shares of Series A Preferred Stock shall be entitled to receive an aggregate amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times the aggregate amount to be distributed per share to holders of shares of Common Stock, or (2) to the holders of shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except distributions made ratably on the Series A Preferred Stock and all such parity stock in proportion to the total amounts to which the holders of all such shares are entitled upon such liquidation, dissolution or winding up. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the aggregate amount to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event under the proviso in clause (1) of the preceding sentence shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (7) Consolidation, Merger, etc. In case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash and/or any other property, then in any such case each share of Series A Preferred Stock shall at the same time be similarly exchanged or changed into an amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the amount set forth in the preceding sentence with respect to the exchange or change of shares of Series A Preferred Stock shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (8) No Redemption. The shares of Series A Preferred Stock shall not be redeemable. (9) Rank. The Series A Preferred Stock shall rank, with respect to the payment of dividends and the distribution of assets, junior to all series of any other class of the Corporation's Preferred Stock. A-4 (10) Amendment. The Certificate of Incorporation of the Corporation shall not be amended in any manner which would materially alter or change the powers, preferences or special rights of the Series A Preferred Stock so as to affect them adversely without the affirmative vote of the holders of at least two-thirds of the outstanding shares of Series A Preferred Stock, voting together as a single class. A-5 ANNEX B 6.00% MANDATORY CONVERTIBLE PREFERRED STOCK (1) Designation and Amount. This series of Preferred Shares shall be designated as "6.00% Mandatory Convertible Preferred Stock" (the "CONVERTIBLE PREFERRED STOCK") and the number of shares constituting such series shall be 28,750,000, with a par value of $1.00 per share. (2) Ranking. The Convertible Preferred Stock shall rank, as to payment of dividends and distribution of assets upon dissolution, liquidation or winding up of the Corporation, (a) senior to (i) the Common Stock, (ii) the Series A Preferred Stock and (iii) any class or series of capital stock issued by the Corporation which by its terms ranks junior to the Convertible Preferred Stock (collectively, the "JUNIOR SECURITIES"), (b) junior to any class or series of capital stock issued by the Corporation which by its terms ranks senior to the Convertible Preferred Stock (the "SENIOR SECURITIES"), and (c) pari passu with any other class or series of capital stock issued by the Corporation (the "PARITY SECURITIES"), in each case, whether now outstanding or to be issued in the future. (3) Dividends. (a) Dividends on the Convertible Preferred Stock will be payable quarterly when, as and if declared by the Board, or a duly authorized committee thereof, when the Corporation is legally permitted to do so, on each Dividend Payment Date, at the annual rate of $3.00 per share, subject to adjustment as provided for in Section 18(c). The initial dividend on the Convertible Preferred Stock for the first Dividend Period, commencing on the date of first issuance of the Convertible Preferred Stock (assuming a date of first issuance of August 10, 2004), to but excluding December 15, 2004, will be $1.0417 per share, and when, as and if declared, will be payable on December 15, 2004, provided that the Corporation is legally permitted to pay such dividends at such time. Each subsequent quarterly dividend on the Convertible Preferred Stock, when, as and if declared, will be $0.75 per share, subject to adjustment as provided for in Section 18(c). Dividends payable, when, as and if declared, on a Dividend Payment Date will be payable to Record Holders for the applicable Dividend Payment Date, except as otherwise provided in Section 6(a). (b) The amount of dividends payable on each share of Convertible Preferred Stock for each full quarterly period will be computed by dividing the annual dividend rate by four. The amount of dividends payable for any other period that is shorter or longer than a full quarterly dividend period will be computed on the basis of a 360-day year consisting of twelve 30-day months. Dividends on the Convertible Preferred Stock shall accrue and cumulate if the Corporation fails to declare one or more dividends on the Convertible Preferred Stock in any amount, whether or not the Corporation is then legally permitted to pay such dividends. (c) No interest or sum of money in lieu of interest shall be payable in respect of any dividend not paid on a Dividend Payment Date or any other late payment. The Corporation will also not pay Holders of the Convertible Preferred Stock any dividend in excess of the full dividends on the Convertible Preferred Stock that are payable as described above. (d) Dividends in arrears on the Convertible Preferred Stock not declared for payment or not paid on any Dividend Payment Date may later be declared by the Board, or a duly authorized committee thereof, and paid on any date fixed by the Board, or a duly authorized committee thereof, whether or not a Dividend Payment Date, to the Holders of record as they appear on the stock register of the Corporation on a record date selected by the Board, or a duly authorized committee thereof, which shall (i) not precede the date the Board, or an authorized committee thereof, declares the dividend payable and (ii) not be more than 60 days prior to the date the dividend is paid. (4) Payment Restrictions. (a) Unless all accrued, cumulated and unpaid dividends on the Convertible Preferred Stock for all prior Dividend Periods have been paid, the Corporation may not: (i) declare or pay any dividend or make any distribution of assets on any Junior Securities, other than dividends or distributions in the form of Junior Securities and cash solely in lieu of fractional shares in connection with any such dividend or distribution; (ii) redeem, purchase or otherwise acquire any Junior Securities or pay or make any monies available for a sinking fund for such Junior Securities, other than (A) upon conversion or exchange for other Junior Securities, (B) redemptions or purchases of any Series A Preferred Stock purchase rights or (C) the purchase of fractional interests in shares of any Junior Securities pursuant to the conversion or exchange provisions of such Junior Securities; or (iii) redeem, purchase or otherwise acquire any Parity Securities, except upon conversion into or exchange for other Parity Securities or Junior Securities and cash solely in lieu of fractional shares in connection with any such conversion or exchange, provided, however, that in the case of a redemption, purchase or other acquisition of Parity Securities upon conversion into or exchange for other Parity Securities (A) the aggregate amount of the liquidation preference of such other Parity Securities does not exceed the aggregate amount of the liquidation preference, plus accrued, cumulated and unpaid dividends, of the Parity Securities that are converted into or exchanged for such other Parity Securities, (B) the aggregate number of shares of Common Stock issuable upon conversion, redemption or exchange of such other Parity Securities does not exceed the aggregate number of shares of Common Stock issuable upon conversion, redemption or exchange of the Parity Securities that are converted into or exchanged for such other Parity Securities and (C) such other Parity Securities contain terms and conditions (including, without limitation, with respect to the payment of dividends, dividend rates, liquidation preferences, voting and representation rights, payment restrictions, anti-dilution rights, change of control rights, covenants, remedies and conversion and redemption rights) that are not materially less favorable, taken as a whole, to the Corporation or the Holders of the Convertible Preferred Stock than those contained in the Parity Securities that are converted or exchanged for such other Parity Securities. B-2 (5) Voting Rights. (a) Except as otherwise required by law, the Certificate of Incorporation or set forth in this Section 5, Holders of the Convertible Preferred Stock are not entitled to any voting rights and their consent shall not be required for the taking of any corporate action. (b) So long as any shares of Convertible Preferred Stock are outstanding, the Corporation will not, without the approval of the Holders of at least two-thirds of the shares of Convertible Preferred Stock then outstanding, given in person or by proxy either at an annual meeting or at a special meeting called for that purpose, at which the Holders of the Convertible Preferred Stock shall vote separately as a single class, amend, alter or repeal (by merger, consolidation, combination, reclassification or otherwise) any of the provisions of the Corporation's Certificate of Incorporation so as to affect adversely the rights, preferences or voting powers of the Holders of the Convertible Preferred Stock; provided that any amendment of the provisions of the Certificate of Incorporation so as to issue, authorize or increase the authorized amount of, or issue or authorize any obligation or security convertible into or evidencing a right to purchase, any Parity Securities or Junior Securities shall be deemed not to affect adversely the rights, preferences or voting powers of the Holders of the Convertible Preferred Stock. Notwithstanding anything in this Section 5 to the contrary, any amendment, alteration or repeal of any of the provisions of the Corporation's Certificate of Incorporation occurring in connection with any merger or consolidation of the Corporation of the type described in Section 14(e)(i) or any statutory exchange of securities of the Corporation with another Person (other than in connection with a merger or acquisition) of the type described in Section 14(e)(iv) shall be deemed not to adversely affect the rights, preferences or voting power of the Holders of the Convertible Preferred Stock, provided that, subject to Section 10, in the event the Corporation does not survive the transaction, the shares of the Convertible Preferred Stock will become shares of the successor Person, having in respect of such successor Person the same rights, preferences or voting powers of the Holders of the Convertible Preferred Stock immediately prior to the consummation of such merger, consolidation, or statutory exchange and shall be convertible into the kind and amount of net cash, securities and other property as determined in accordance with Section 14(e) hereof, provided further that following any such merger, consolidation or statutory exchange, such successor Person shall succeed to and be substituted for, and may exercise all of the rights and powers of the Corporation under the Convertible Preferred Stock. (c) If at any time dividends on the then-outstanding shares of Convertible Preferred Stock or any other class or series of Preferred Shares in an amount equivalent to six quarterly dividends, whether or not consecutive, shall not have been (i) paid or (ii)(A) declared and (B) a sum sufficient for the payment thereof set aside, the holders of Preferred Shares (including the Convertible Preferred Stock), voting separately as a single class, shall be entitled to increase the authorized number of directors on the Board by two and elect such two directors (the "PREFERRED STOCK DIRECTORS") at the next annual or special meeting of the shareholders called in the manner described below. At any such annual or special meeting of the shareholders, or any adjournment thereof, if the holders of at least a majority of the Preferred Shares then outstanding shall be present or represented by proxy, then, (1) by vote of the holders of at least a majority of the Preferred Shares, voting as a class, then present or so represented, the authorized number of directors of the Corporation shall be increased by two, and (2) at such meeting the holders of the Preferred Shares, voting as a class, shall be entitled to elect the B-3 Preferred Stock Directors by vote of the holders of at least a majority of the Preferred Shares then present or so represented. Such right of the holders of the Preferred Shares to elect the Preferred Stock Directors may be exercised until all dividends in default on such Preferred Shares shall have been (i) paid in full or (ii)(A) declared and (B) a sum sufficient for the payment thereof set aside. When so paid or provided for, (i) the right of the holders of Preferred Shares to elect the Preferred Stock Directors shall cease, (ii) the terms of all of the Preferred Stock Directors shall terminate at the next annual meeting, and (iii) the authorized number of directors of the Corporation shall be reduced accordingly. Not later than 40 days after such entitlement arises, the Board will convene a special meeting of the holders of Preferred Shares for the above purpose. If the Board fails to convene such meeting within such 40-day period, the holders of 10% of the outstanding Preferred Shares, considered as a single class, will be entitled to convene such meeting to elect the initial Preferred Stock Directors. Any director who shall have been elected by the holders of Preferred Shares as a class pursuant to this Section 5(c) may be removed at any time, either for or without cause by, and only by, the affirmative vote of the holders of record of a majority of the outstanding Preferred Shares given at a special meeting of such shareholders called for such purpose by the Corporation or at the annual meeting of shareholders, and any vacancy created by such removal may also be filled at such meeting. Any vacancy caused by the death or resignation of a director who shall have been elected by the holders of Preferred Shares as a class pursuant to this Section 5(c) may be filled only by the holders of outstanding Preferred Shares at a meeting called for such purpose by the Corporation. The provisions of the Certificate of Incorporation and By-laws of the Corporation relating to the convening and conduct of special meetings of shareholders and the nomination of directors will apply with respect to any special meeting of the holders of Preferred Shares; provided that the notice of the nomination need only be delivered to the Secretary of the Corporation not more than 10 days after the Corporation (or the holders of 10% of the outstanding Preferred Shares, if applicable) has notified the holders of Preferred Shares of the date of the special meeting to elect the initial Preferred Stock Directors. (d) So long as any of the Convertible Preferred Stock is outstanding, the Corporation will not, without the approval of the Holders of at least two-thirds of the shares of Convertible Preferred Stock then outstanding and any class or series of Parity Securities then outstanding, voting together as a single class, given in person or by proxy either at an annual meeting or at a special meeting called for that purpose: (i) reclassify any of the Corporation's authorized shares into any shares of any class, or any obligation or security convertible into or evidencing a right to purchase such shares, ranking senior to the Convertible Preferred Stock as to payment of dividends or distribution of assets upon the dissolution, liquidation or winding up of the Corporation; or (ii) issue, authorize or increase the authorized amount of, or issue or authorize any obligation or security convertible into or evidencing a right to purchase, any stock of any class or series ranking senior to the Convertible Preferred Stock as to payment of dividends or distribution of assets upon the dissolution, liquidation or winding up of the Corporation; provided that the Corporation may issue, authorize or increase the authorized amount of, or issue or authorize any obligation or security convertible into or evidencing a right to purchase, any shares of capital stock ranking on a B-4 parity with or junior to the Convertible Preferred Stock as to payment of dividends or distribution of assets upon the dissolution, liquidation or winding up of the Corporation without the vote of the Holders of the Convertible Preferred Stock. (e) In exercising the voting rights set forth in this Section 5, each share of Convertible Preferred Stock shall have one vote per share. In any case where the Holders of the Convertible Preferred Stock are entitled to vote as a class with holders of Parity Securities or other classes or series of Preferred Shares, each class or series shall have a number of votes proportionate to the aggregate liquidation preference of its outstanding shares. (6) Liquidation, Dissolution or Winding Up. (a) In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, subject to the rights of holders of any shares of capital stock of the Corporation then outstanding ranking senior to or pari passu with the Convertible Preferred Stock in respect of distributions upon liquidation, dissolution or winding up of the Corporation and before any amount shall be paid or distributed with respect to holders of any shares of capital stock of the Corporation then outstanding ranking junior to the Convertible Preferred Stock in respect of distributions upon liquidation, dissolution or winding up of the Corporation, the Holders of the Convertible Preferred Stock at the time outstanding will be entitled to receive, out of the net assets of the Corporation legally available for distribution to shareholders, a liquidating distribution in the amount of $50.00 per share, subject to adjustment as provided for in Section 18(c), plus an amount equal to the sum of all accrued, cumulated and unpaid dividends, whether or not declared, for the portion of the then-current Dividend Period until the payment date and all prior Dividend Periods and such Holders shall be deemed to be the Holders of record for such Dividend Periods or portions thereof. After the payment to the Holders of the Convertible Preferred Stock of the full amounts provided for in this Section 6(a), the Holders of the Convertible Preferred Stock will have no right or claim to any of the Corporation's remaining assets. (b) For the purpose of this Section 6, none of the following shall constitute or be deemed to constitute a voluntary or involuntary liquidation, dissolution or winding up of the Corporation: (i) the sale, transfer, lease or conveyance of all or substantially all of the Corporation's property or business; (ii) the consolidation or merger of the Corporation with or into any other Person; or (iii) the consolidation or merger of any other Person with or into the Corporation. (c) If, upon any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the amounts payable with respect to the Convertible Preferred Stock then outstanding are not paid in full as provided in Section 6(a) hereof, no distribution shall be made on account of any securities ranking pari passu with the Convertible Preferred Stock as to the distribution of assets upon such liquidation, dissolution or winding up, unless a pro rata distribution is made on the Convertible Preferred Stock. The Holders of the Convertible B-5 Preferred Stock then outstanding and the holders of any such securities then outstanding shall share ratably in any distribution of assets upon such liquidation, dissolution or winding up. The amount allocable to each series of such securities then outstanding will be based on the proportion of their full respective liquidation preference to the aggregate liquidation preference of the outstanding shares of each such series. (d) Written notice of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, stating the payment date or dates when, and the place or places where, the amounts distributable to holders of Convertible Preferred Stock in such circumstances shall be payable, shall be given by first-class mail, postage prepaid, mailed not less than twenty calendar days prior to any payment date stated therein, to the Holders of Convertible Preferred Stock, at the address shown on the books of the Corporation or the Transfer Agent; provided, however, that a failure to give notice as provided above or any defect therein shall not affect the Corporation's ability to consummate a voluntary or involuntary liquidation, dissolution or winding up of the Corporation. (7) Mandatory Conversion on the Mandatory Conversion Date. (a) Each share of Convertible Preferred Stock will automatically convert (unless previously converted at the option of the Holder in accordance with Section 8 hereof, converted at the option of the Corporation pursuant to Section 9 hereof or pursuant to an exercise of a Merger Early Conversion right pursuant to Section 10 hereof) on the Mandatory Conversion Date, into a number of shares of Common Stock equal to the Conversion Rate. (b) The "CONVERSION RATE" shall be as follows: (i) if the Applicable Market Value of the Common Stock is equal to or greater than $22.27 (the "THRESHOLD APPRECIATION PRICE"), then the Conversion Rate shall be equal to 2.2451 shares of Common Stock per share of Convertible Preferred Stock (the "MINIMUM CONVERSION RATE"), which is equal to $50.00 divided by the Threshold Appreciation Price); (ii) if the Applicable Market Value of the Common Stock is less than the Threshold Appreciation Price but greater than $17.96 (the "INITIAL PRICE"), then the Conversion Rate shall be equal to $50.00 divided by the Applicable Market Value of the Common Stock; (iii) if the Applicable Market Value of the Common Stock is less than or equal to the Initial Price, then the Conversion Rate shall be equal to 2.7840 shares of Common Stock per share of Convertible Preferred Stock (the "MAXIMUM CONVERSION RATE"), which is equal to $50.00 divided by the Initial Price; and (iv) the Minimum Conversion Rate, the Maximum Conversion Rate, the Threshold Appreciation Price and the Initial Price are each subject to adjustment in accordance with the provisions of Section 14 hereof. (c) The Holders of Convertible Preferred Stock on the Mandatory Conversion Date shall have the right to receive an amount in cash equal to all accrued, cumulated and unpaid dividends on the Convertible Preferred Stock, whether or not declared prior to that date, for the B-6 then current Dividend Period until the Mandatory Conversion Date and all prior Dividend Periods (other than previously declared dividends on the Convertible Preferred Stock payable to Holders of record as of a prior date), provided that the Corporation is legally permitted to pay such dividends at such time. (8) Early Conversion at the Option of the Holder. (a) Shares of the Convertible Preferred Stock are convertible, in whole or in part at the option of the Holder thereof ("EARLY CONVERSION") at any time prior to the Mandatory Conversion Date, into shares of Common Stock at the Minimum Conversion Rate, subject to adjustment as set forth in Section 14 hereof. (b) Any written notice of conversion pursuant to Section 8 hereof shall be duly executed by the Holder, and specify: (i) the number of shares of Convertible Preferred Stock to be converted; (ii) the name(s) in which such Holder desires the shares of Common Stock issuable upon conversion to be registered and whether such shares of Common Stock are to be issued in book-entry or certificated form (subject to compliance with applicable legal requirements if any of such certificates are to be issued in a name other than the name of the Holder); (iii) if certificates are to be issued, the address to which such Holder wishes delivery to be made of such new certificates to be issued upon such conversion; and (iv) any other transfer forms, tax forms or other relevant documentation required and specified by the Transfer Agent, if necessary, to effect the conversion. (c) If specified by the Holder in the notice of conversion that shares of Common Stock issuable upon conversion of the Convertible Preferred Stock shall be issued to a person other than the Holder surrendering the shares of Convertible Preferred Stock being converted, the Holder shall pay or cause to be paid any transfer or similar taxes payable in connection with the shares of Common Stock so issued. (d) Upon receipt by the Transfer Agent of a completed and duly executed notice of conversion as set forth in Section 8(b), compliance with Section 8(c), if applicable, and upon surrender of a certificate representing share(s) of Convertible Preferred Stock to be converted (if held in certificated form), the Corporation shall, within three Business Days or as soon as possible thereafter, issue and shall instruct the Transfer Agent to register the number of shares of Common Stock to which such Holder shall be entitled upon conversion in the name(s) specified by such Holder in the notice of conversion. If a Holder elects to hold its shares of Common Stock issuable upon conversion of the Convertible Preferred Stock in certificated form, the Corporation shall promptly send or cause to be sent, by hand delivery (with receipt to be acknowledged) or by first-class mail, postage prepaid, to the Holder thereof, at the address designated by such Holder in the written notice of conversion, a certificate or certificates representing the number of shares of Common Stock to which such Holder shall be entitled upon B-7 conversion. In the event that there shall have been surrendered a certificate or certificates representing shares of Convertible Preferred Stock, only part of which are to be converted, the Corporation shall issue and deliver to such Holder or such Holder's designee in the manner provided in the immediately preceding sentence a new certificate or certificates representing the number of shares of Convertible Preferred Stock that shall not have been converted. (e) The issuance by the Corporation of shares of Common Stock upon a conversion of shares of Convertible Preferred Stock in accordance with the terms hereof shall be deemed effective immediately prior to the close of business on the day of receipt by the Transfer Agent of the notice of conversion and other documents, if any, set forth in Section 8(b) hereof, compliance with Section 8(c), if applicable, and the surrender by such Holder or such Holder's designee of the certificate or certificates representing the shares of Convertible Preferred Stock to be converted (if held in certificated form), duly assigned or endorsed for transfer to the Corporation (or accompanied by duly executed stock powers relating thereto). (f) A Holder of a share of Convertible Preferred Stock on the Early Conversion Date with respect to such share shall have the right to receive all accrued, cumulated and unpaid dividends, whether or not declared, for the portion of the then-current Dividend Period until the Early Conversion Date and all prior Dividend Periods (other than previously declared dividends on the Convertible Preferred Stock payable to Holders of record as of a prior date), provided that the Corporation is then legally permitted to pay such dividends. Except as described above, upon any optional conversion of the Convertible Preferred Stock, the Corporation will make no payment or allowance for unpaid dividends on the Convertible Preferred Stock. (9) Provisional Conversion. (a) Prior to the Mandatory Conversion Date, if the Closing Price of the Common Stock has exceeded 150% of the Threshold Appreciation Price for at least 20 Trading Days within a period of 30 consecutive Trading Days ending on the Trading Day prior to the date (the "PROVISIONAL CONVERSION NOTICE DATE") on which the Corporation notifies the Holders (pursuant to clause (b) below) that it is exercising its option to cause the conversion of the Convertible Preferred Stock pursuant to this Section 9, the Corporation may, at its option, cause the conversion of all, but not less than all, the shares of Convertible Preferred Stock then outstanding into shares of Common Stock at the Minimum Conversion Rate for each share of Convertible Preferred Stock, subject to adjustment as set forth in Section 14. The Corporation shall be able to cause this conversion only if, in addition to issuing the Holders shares of Common Stock, the Corporation is then legally permitted to, and does, pay the Holders in cash (i) an amount equal to any accrued, cumulated and unpaid dividends on the shares of Convertible Preferred Stock then outstanding, whether or not declared (other than previously declared dividends on the Convertible Preferred Stock payable to Holders of record as of a prior date), plus (ii) the present value of all remaining future dividend payments on the shares of Convertible Preferred Stock then outstanding through and including the Mandatory Conversion Date. The present value of the remaining future dividend payments will be computed using a discount rate equal to the Treasury Yield. (b) A written notice (the "PROVISIONAL CONVERSION NOTICE") shall be sent by or on behalf of the Corporation, by first class mail, postage prepaid, to the Holders of record as they appear on the stock register of the Corporation on the Provisional Conversion Notice Date B-8 (i) notifying such Holders of the election of the Corporation to convert and of the Provisional Conversion Date (as defined below), which date shall not be less than 30 days nor be more than 60 days after the Provisional Conversion Notice Date, and (ii) stating the Corporate Trust Office of the Transfer Agent at which the shares of Convertible Preferred Stock called for conversion shall, upon presentation and surrender of the certificate(s) (if such shares are held in certificated form) evidencing such shares, be converted, and the Minimum Conversion Rate to be applied thereto. The Corporation shall also issue a press release containing such information and publish such information on its website on the World Wide Web, provided that failure to issue such press release or publish such information on the Corporation's website shall not act to prevent or delay conversion pursuant to this Section 9. (c) The Corporation shall deliver to the Transfer Agent irrevocable written instructions authorizing the Transfer Agent, on behalf and at the expense of the Corporation, to cause the Provisional Conversion Notice to be duly mailed as soon as practicable after receipt of such irrevocable instructions from the Corporation and in accordance with the above provisions. The shares of Common Stock to be issued upon conversion of the Convertible Preferred Stock pursuant to this Section 9 and all funds necessary for the payment in cash of (i) an amount equal to any accrued, cumulated and unpaid dividends on the shares of Convertible Preferred Stock then outstanding, whether or not declared (other than previously declared dividends on the Convertible Preferred Stock payable to Holders of record as of a prior date), plus (ii) the present value of all remaining future dividend payments on the shares of Convertible Preferred Stock then outstanding through and including the Mandatory Conversion Date, shall be deposited with the Transfer Agent in trust at least one Business Day prior to the Provisional Conversion Date, for the pro rata benefit of the Holders of record as they appear on the stock register of the Corporation, so as to be and continue to be available therefor. Neither failure to mail such Provisional Conversion Notice to one or more such Holders nor any defect in such Provisional Conversion Notice shall affect the sufficiency of the proceedings for conversion as to other Holders. (d) If a Provisional Conversion Notice shall have been given as hereinbefore provided, then each Holder shall be entitled to all preferences and relative, participating, optional and other special rights accorded by this Certificate of Amendment until and including the Provisional Conversion Date. From and after the Provisional Conversion Date, upon delivery by the Corporation of the Common Stock and payment of the funds to the Transfer Agent as described in paragraph (c) above, the Convertible Preferred Stock shall no longer be deemed to be outstanding, and all rights of such Holders shall cease and terminate, except the right of the Holders, upon surrender of certificates therefor, to receive Common Stock and any amounts to be paid hereunder. (e) The deposit of monies in trust with the Transfer Agent up to the amount necessary for the Provisional Conversion shall be irrevocable except that the Corporation shall be entitled to receive from the Transfer Agent the interest or other earnings, if any, earned on any monies so deposited in trust, and the Holders of the shares converted shall have no claim to such interest or other earnings, and any balance of monies so deposited by the Corporation and unclaimed by the Holders entitled thereto at the expiration of two years from the Provisional Conversion Date shall be repaid, together with any interest or other earnings thereon, to the Corporation, and after any such repayment, the Holders of the shares entitled to the funds so repaid to the B-9 Corporation shall look only to the Corporation for such payment without interest. (10) Early Conversion Upon Cash Merger. (a) In the event of a merger or consolidation of the Corporation of the type described in Section 14(e)(i) in which the Common Stock outstanding immediately prior to such merger or consolidation is exchanged for consideration consisting of at least 30% cash or cash equivalents (any such event, a "CASH MERGER"), then the Holders of the Convertible Preferred Stock shall have the right to convert their shares of Convertible Preferred Stock prior to the earlier of the Mandatory Conversion Date and the Provisional Conversion Notice Date, provided that the Provisional Conversion Date occurs within the period contemplated by Section 9(b) hereof, (such right of the Holders to convert their shares pursuant to this Section 10(a) being the "MERGER EARLY CONVERSION") as provided herein. (b) On or before the fifth Business Day after the consummation of a Cash Merger, the Corporation or the corporation surviving the Cash Merger (the "SURVIVING CORPORATION") or, at the request and expense of the Surviving Corporation, the Transfer Agent, shall give all Holders notice of the occurrence of the Cash Merger and of the Merger Early Conversion right arising as a result thereof. The Surviving Corporation shall also deliver a copy of such notice to the Transfer Agent. Each such notice shall contain: (i) the date, which shall be not less than 20 nor more than 35 calendar days after the date of such notice, on which the Merger Early Conversion will be effected (such date being the "MERGER EARLY CONVERSION DATE"); (ii) the date, which shall be on, or one Business day prior to, the Merger Early Conversion Date, by which the Merger Early Conversion right must be exercised; (iii) the Conversion Rate in effect on the Trading Day immediately preceding such Cash Merger (calculated as if the Trading Day immediately preceding such Cash Merger were the Mandatory Conversion Date) and the kind and amount of securities, cash and other property receivable per share of Convertible Preferred Stock by the Holder upon conversion of shares of Convertible Preferred Stock pursuant to Section 10(d); and (iv) the instructions a Holder must follow to exercise the Merger Early Conversion right. (c) To exercise a Merger Early Conversion right, a Holder shall deliver to the Transfer Agent at its Corporate Trust Office by 5:00 p.m., New York City time on or before the date by which the Merger Early Conversion right must be exercised as specified in the notice, the certificate(s) (if such shares are held in certificated form) evidencing the shares of Convertible Preferred Stock with respect to which the Merger Early Conversion right is being exercised, duly assigned or endorsed for transfer to the Surviving Corporation, or accompanied by duly executed stock powers relating thereto, or in blank, with a written notice to the Surviving Corporation stating the Holder's intention to convert early in connection with the Cash Merger containing the B-10 information set forth in Section 8(b) and providing the Surviving Corporation with payment instructions. (d) If the Holder exercises its Merger Early Conversion right pursuant to the terms hereof, on the Merger Early Conversion Date the Surviving Corporation shall deliver or cause to be delivered the net cash, securities and other property entitled to be received by such exercising Holder, determined by assuming the Holder had converted its shares of Convertible Preferred Stock immediately before the Cash Merger at the Conversion Rate in effect on the Trading Day immediately preceding such Cash Merger calculated in accordance with Section 7(b) hereof and that such Holder was not the counterparty to the Cash Merger or an affiliate of such other party and did not exercise any rights of election with respect to the kind or amount of consideration to be received. In the event a Merger Early Conversion right is exercised by a Holder in accordance with the terms hereof, (i) all references herein to Mandatory Conversion Date shall be deemed to refer to such Merger Early Conversion Date and (ii) if a Reorganization Event (other than the Cash Merger) has previously occurred, "Applicable Market Value" shall be deemed to refer to the Applicable Market Value of the Exchange Property as determined in accordance with Section 14(e). If a Holder does not elect to exercise the Merger Early Conversion right pursuant to this Section 10, in lieu of shares of Common Stock, the Surviving Corporation shall deliver to such Holder on the Mandatory Conversion Date, the Provisional Conversion Date or an Early Conversion Date, such net cash, securities and other property as determined in accordance with Section 14(e) hereof. (e) Upon a Merger Early Conversion, the Transfer Agent shall, in accordance with the instructions provided by the Holder thereof in the written notice provided to the Surviving Corporation as set forth above, deliver to the Holder such net cash, securities or other property issuable upon such Merger Early Conversion, together with payment in lieu of any fraction of a share, as provided herein. (f) In the event that a Merger Early Conversion is effected with respect to shares of Convertible Preferred Stock representing less than all the shares of Convertible Preferred Stock held by a Holder, upon such Merger Early Conversion the Surviving Corporation shall execute and the Transfer Agent shall, unless otherwise instructed in writing, countersign and deliver to the Holder thereof, at the expense of the Surviving Corporation, a certificate evidencing the shares of Convertible Preferred Stock as to which Merger Early Conversion was not effected. (g) In the event that a Merger Early Conversion is effected with respect to shares of Convertible Preferred Stock, the Holder of such shares on the Merger Early Conversion Date with respect to such share shall have the right to receive an amount in cash equal to all accrued, cumulated and unpaid dividends, whether or not declared prior to the Merger Early Conversion Date, for the portion of the then-current Dividend Period until the Merger Early Conversion Date and all prior Dividend Periods (other than previously declared dividends on the Convertible Preferred Stock payable to Holders of record as of a prior date), provided that at such time the Corporation is then legally permitted to pay such dividends. (11) Conversion Procedures. (a) Upon issuance and delivery to the Transfer Agent of certificates representing shares of the Common Stock to be delivered upon conversion B-11 of the shares of Convertible Preferred Stock on the Mandatory Conversion Date, the Provisional Conversion Date, the Merger Early Conversion Date or any Early Conversion Date (collectively, a "CONVERSION DATE"), dividends on any shares of Convertible Preferred Stock converted to Common Stock shall cease to accrue and cumulate, and such shares of Convertible Preferred Stock shall cease to be outstanding, in each case, subject to the right of Holders of such shares to receive any accrued, cumulated and unpaid dividends on such shares to which they are otherwise entitled pursuant to Section (7), (8) or (10) hereof, as applicable. (b) The person or persons entitled to receive the Common Stock issuable upon such conversion shall be treated for all purposes as the record holder(s) of such shares of Common Stock as of the close of business on the Mandatory Conversion Date, the Merger Early Conversion Date, the Provisional Conversion Date or any Early Conversion Date, as the case may be. No allowance or adjustment, except as set forth in Section 14, shall be made in respect of dividends payable to holders of Common Stock of record as of any date prior to such effective date. Prior to such effective date, shares of Common Stock issuable upon conversion of any shares of Convertible Preferred Stock shall not be deemed outstanding for any purpose, and Holders of shares of Convertible Preferred Stock shall have no rights with respect to the Common Stock (including voting rights, rights to respond to tender offers for the Common Stock and rights to receive any dividends or other distributions on the Common Stock) by virtue of holding shares of Convertible Preferred Stock. (c) Shares of Convertible Preferred Stock duly converted in accordance with this Certificate of Amendment, or otherwise reacquired by the Corporation, will resume the status of authorized and unissued Preferred Stock, undesignated as to series and available for future issuance. (d) In the event that a Holder of shares of Convertible Preferred Stock shall not by written notice designate the name in which shares of Common Stock to be issued upon conversion of such shares should be registered or the address to which the certificate or certificates representing such shares should be sent, the Corporation shall be entitled to register such shares, and make such payment, in the name of the Holder of such Convertible Preferred Stock as shown on the records of the Corporation and to send the certificate or certificates representing such shares to the address of such Holder shown on the records of the Corporation. (12) Reservation of Common Stock. (a) The Corporation shall at all times reserve and keep available out of its authorized and unissued Common Stock or shares held in the treasury of the Corporation, solely for issuance upon the conversion of shares of Convertible Preferred Stock as herein provided, free from any preemptive or other similar rights, such number of shares of Common Stock as shall from time to time be issuable upon the conversion of all the shares of Convertible Preferred Stock then outstanding. For purposes of this Section 12(a), the number of shares of Common Stock that shall be deliverable upon the conversion of all outstanding shares of Convertible Preferred Stock shall be computed as if at the time of computation all such outstanding shares were held by a single Holder. (b) Notwithstanding the foregoing, the Corporation shall be entitled to deliver upon conversion of shares of Convertible Preferred Stock, as herein provided, shares of Common Stock reacquired and held in the treasury of the Corporation (in lieu of the issuance of authorized B-12 and unissued shares of Common Stock), so long as any such treasury shares are free and clear of all liens, charges, security interests or encumbrances (other than liens, charges, security interests and other encumbrances created by the Holders). (c) All shares of Common Stock delivered upon conversion of the Convertible Preferred Stock shall be duly authorized, validly issued, fully paid and non-assessable, free and clear of all liens, claims, security interests and other encumbrances (other than liens, charges, security interests and other encumbrances created by the Holders). (d) Prior to the delivery of any securities that the Corporation shall be obligated to deliver upon conversion of the Convertible Preferred Stock, the Corporation shall use its reasonable best efforts to comply with all federal and state laws and regulations thereunder requiring the registration of such securities with, or any approval of or consent to the delivery thereof by, any governmental authority. (e) The Corporation hereby covenants and agrees that, if at any time the Common Stock shall be listed on the New York Stock Exchange or any other national securities exchange or automated quotation system, the Corporation will, if permitted by the rules of such exchange or automated quotation system, list and keep listed, so long as the Common Stock shall be so listed on such exchange or automated quotation system, all Common Stock issuable upon conversion of the Convertible Preferred Stock; provided, however, that if the rules of such exchange or automated quotation system permit the Corporation to defer the listing of such Common Stock until the first conversion of Convertible Preferred Stock into Common Stock in accordance with the provisions hereof, the Corporation covenants to list such Common Stock issuable upon conversion of the Convertible Preferred Stock in accordance with the requirements of such exchange or automated quotation system at such time. (13) Fractional Shares. (a) No fractional shares of Common Stock will be issued as a result of any conversion of shares of Convertible Preferred Stock. (b) In lieu of any fractional share of Common Stock otherwise issuable in respect of any mandatory conversion pursuant to Section 7 hereof, any conversion at the option of the Corporation pursuant to Section 9 hereof or a conversion at the option of the holder pursuant to Section 8 or Section 10 hereof, the Corporation shall pay an amount in cash (computed to the nearest cent) equal to the same fraction of: (i) in the case of a conversion pursuant to Section 7 or Section 9 hereof or a Merger Early Conversion pursuant to Section 10, the Current Market Price; or (ii) in the case of an Early Conversion pursuant to Section 8 hereof, the Closing Price of the Common Stock determined as of the second Trading Day immediately preceding the effective date of conversion. (c) If more than one share of the Convertible Preferred Stock is surrendered for conversion at one time by or for the same Holder, the number of full shares of Common Stock issuable upon conversion thereof shall be computed on the basis of the aggregate number of shares of the Convertible Preferred Stock so surrendered. B-13 (14) Anti-Dilution Adjustments to the Fixed Conversion Rates. (a) Each Fixed Conversion Rate and the number of shares of Common Stock to be delivered upon conversion shall be subject to the following adjustments. (i) Stock Dividends and Distributions. In case the Corporation shall pay or make a dividend or other distribution on the Common Stock in shares of Common Stock, each Fixed Conversion Rate, as in effect at the opening of business on the day following the date fixed for the determination of shareholders entitled to receive such dividend or other distribution, shall be increased by dividing such Fixed Conversion Rate by a fraction of which the numerator shall be the number of shares of Common Stock outstanding at the close of business on the date fixed for such determination and the denominator shall be the sum of such number of shares of Common Stock outstanding and the total number of shares of Common Stock constituting such dividend or other distribution, such increase to become effective immediately after the opening of business on the day following the date fixed for such determination. For the purposes of this sub-section (i), the number of shares of Common Stock at the time outstanding shall not include shares held in the treasury of the Corporation but shall include any shares issuable in respect of any scrip certificates issued in lieu of fractions of shares of Common Stock. The Corporation will not pay any dividend or make any distribution on shares of Common Stock held in the treasury of the Corporation. (ii) Subdivisions, Splits and Combinations of the Common Stock. In case outstanding shares of Common Stock shall be subdivided or split into a greater number of shares of Common Stock, each Fixed Conversion Rate in effect at the opening of business on the day following the day upon which such subdivision or split becomes effective shall be proportionately increased, and, conversely, in case outstanding shares of Common Stock shall each be combined into a smaller number of shares of Common Stock, such Fixed Conversion Rate in effect at the opening of business on the day following the day upon which such combination becomes effective shall be proportionately reduced, such increase or reduction, as the case may be, to become effective immediately after the opening of business on the day following the day upon which such subdivision, split or combination becomes effective. (iii) Issuance of Stock Purchase Rights. In case the Corporation shall issue rights or warrants to all holders of its Common Stock (other than rights or warrants issued pursuant to a dividend reinvestment plan or share purchase plan or other similar plans), entitling such holders, for a period of up to 45 days from the date of issuance of such rights or warrants, to subscribe for or purchase shares of Common Stock at a price per share less than the Current Market Price on the date fixed for the determination of shareholders entitled to receive such rights or warrants, each Fixed Conversion Rate in effect at the opening of business on the day following the date fixed for such determination shall be increased by multiplying such Fixed Conversion Rate by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding at the close of business on the date fixed for such determination plus the number of shares of Common Stock so offered for subscription or purchase and the denominator of which shall be the number of shares of Common Stock outstanding at the close of business on the date fixed for such determination plus the number of shares of B-14 Common Stock which the aggregate offering price of the total number of shares of Common Stock so offered for subscription or purchase would purchase at such Current Market Price, such increase to become effective immediately after the opening of business on the day following the date fixed for such determination. For the purposes of this clause (iii), the number of shares of Common Stock at any time outstanding shall not include shares held in the treasury of the Corporation but shall include any shares issuable in respect of any scrip certificates issued in lieu of fractions of shares of Common Stock. The Corporation shall not issue any such rights or warrants in respect of shares of Common Stock held in the treasury of the Corporation. (iv) Debt or Asset Distribution. (A) In case the Corporation shall, by dividend or otherwise, distribute to all holders of its Common Stock evidences of its indebtedness, shares of capital stock, securities, cash or other assets (excluding any dividend or distribution referred to in Section 14(a)(i) or Section 14(a)(ii) hereof, any rights or warrants referred to in Section 14(a)(iii) hereof, any dividend or distribution paid exclusively in cash, any consideration payable in connection with a tender or exchange offer made by the Corporation or any subsidiary of the Corporation, and any dividend of shares of capital stock of any class or series, or similar equity interests, of or relating to a subsidiary or other business unit in the case of a Spin-Off referred to in Section 14(a)(iv)(B) below), each Fixed Conversion Rate shall be adjusted so that it shall equal the rate determined by multiplying such Fixed Conversion Rate in effect immediately prior to the close of business on the date fixed for the determination of shareholders entitled to receive such distribution by a fraction, the numerator of which shall be the Current Market Price per share of the Common Stock on the date fixed for such determination and the denominator of which shall be such Current Market Price per share of the Common Stock less the then Fair Market Value of the portion of the evidences of indebtedness, shares of capital stock, securities, cash or other assets so distributed applicable to one share of Common Stock, such adjustment to become effective immediately prior to the opening of business on the day following the date fixed for the determination of shareholders entitled to receive such distribution. In any case in which this clause (iv)(A) is applicable, clause (iv)(B) of this Section 14(a) shall not be applicable. (B) In the case of a Spin-Off, each Fixed Conversion Rate in effect immediately before the close of business on the record date fixed for determination of shareholders entitled to receive that distribution will be increased by multiplying each Fixed Conversion Rate by a fraction, the numerator of which is the Current Market Price per share of the Common Stock plus the Fair Market Value of the portion of those shares of capital stock or similar equity interests so distributed applicable to one share of Common Stock and the denominator of which is the Current Market Price per share of the Common Stock. Any adjustment to the Conversion Rate under this clause (iv)(B) of this Section 14(a) will occur on the 15th Trading Day from, but excluding, the "ex-date" with respect to the Spin-Off. (v) Cash Distributions. In case the Corporation shall distribute cash to all holders of the Common Stock immediately after the close of business on such date for determination, each Fixed Conversion Rate will be adjusted by multiplying such Fixed B-15 Conversion Rate in effect immediately prior to the close of business on the date fixed for determination of the shareholders of the Corporation entitled to receive such distribution by a fraction, the numerator of which will be the Current Market Price of the Common Stock on the date fixed for such determination and the denominator of which will be the Current Market Price of the Common Stock on the date fixed for such determination minus the amount per share of such dividend or distribution; provided, that no adjustment will be made to either Fixed Conversion Rate for (i) any cash that is distributed in a Reorganization Event to which Section 14(e) applies or as part of a distribution referred to in paragraph (iv) of this Section 14(a), (ii) any dividend or distribution in connection with the liquidation, dissolution or winding up of the Corporation (iii) any consideration payable in connection with a tender or exchange offer made by the Corporation or any subsidiary of the Corporation or (iv) any cash dividends on the Common Stock to the extent that the aggregate cash dividend per share of Common Stock does not exceed (x) $0.055 in any fiscal quarter in the case of a quarterly dividend or (y) $0.22 in the prior twelve months in the case of an annual dividend (each such number, the "DIVIDEND THRESHOLD AMOUNT"). The Dividend Threshold Amount is subject to an inversely proportional adjustment whenever the Fixed Conversion Rates are adjusted, provided that no adjustment will be made to the Dividend Threshold Amount for any adjustment made to the Fixed Conversion Rates pursuant to this clause (v) or clause (iii), (iv), (vi), (vii) or (viii) of this Section 14(a). If an adjustment is required to be made under this clause (v) as a result of a distribution that is a quarterly or annual dividend, the adjustment shall be based upon the amount by which the distribution exceeds the applicable Dividend Threshold Amount. If an adjustment is required to be made under this clause as a result of a distribution that is not a quarterly or annual dividend, the adjustment shall be based upon the full amount of such distribution. (vi) Self Tender Offers and Exchange Offers. In case a tender or exchange offer made by the Corporation or any subsidiary of the Corporation for all or any portion of the Common Stock shall expire and such tender or exchange offer (as amended upon the expiration thereof) shall require the payment to shareholders (based on the acceptance, up to any maximum specified in the terms of the tender or exchange offer, of Purchased Shares (as defined below in this Section)) of an aggregate consideration per share of Common Stock having a Fair Market Value that exceeds the Current Market Price per share of the Common Stock on the seventh Trading Day next succeeding the last date on which (the "EXPIRATION TIME") tenders or exchanges could have been made pursuant to such tender or exchange offer (as it may be amended), then, and in each such case, immediately prior to the opening of business on the eighth Trading Day after the date of the Expiration Time, each Fixed Conversion Rate shall be adjusted so that the same shall equal the rate determined by dividing such Fixed Conversion Rate in effect immediately prior to the opening of business on the eighth Trading Day after the Expiration Time by a fraction (A) the numerator of which shall be equal to (x) the product of (I) the Current Market Price per share of the Common Stock on the seventh Trading Day after the Expiration Time and (II) the number of shares of Common Stock outstanding (including any shares validly tendered and not withdrawn) at the Expiration Time less (y) the amount of cash plus the Fair Market Value of the aggregate B-16 consideration payable to shareholders in the tender or exchange offer (assuming the acceptance, up to any maximum specified in the terms of the tender or exchange offer, of Purchased Shares), and (B) the denominator of which shall be equal to the product of (x) the Current Market Price per share of the Common Stock on the seventh Trading Day after the Expiration Time and (y) the number of shares of Common Stock outstanding (including any shares validly tendered and not withdrawn) as of the Expiration Time less the number of all shares validly tendered and not withdrawn as of the Expiration Time (the shares deemed so accepted, up to any such maximum, being referred to as the "PURCHASED SHARES"). (vii) Third Party Tender Offers and Exchange Offers. In case any Person other than the Corporation or any subsidiary of the Corporation makes a payment in respect of a tender offer or exchange offer in which, as of the last time (the "OFFER EXPIRATION TIME") that tenders or exchanges may be made pursuant to such tender or exchange offer (as it shall have been amended), the Board of Directors is not recommending rejection of the offer, then each Fixed Conversion Rate will be adjusted by multiplying the Fixed Conversion Rate in effect immediately prior to the close of business on the date of the Offer Expiration Time by a fraction (A) the numerator of which will be the sum of (x) the Fair Market Value of the aggregate consideration payable to all holders of Common Stock based on the acceptance (up to any maximum specified in the terms of the tender or exchange offer) of all shares validly tendered or exchanged and not withdrawn as of the Offer Expiration Time (the shares deemed so accepted, up to any such maximum, being referred to as the "ACCEPTED PURCHASED SHARES") and (y) the product of the number of shares of Common Stock outstanding less any such Accepted Purchased Shares and the Current Market Price of the Common Stock on the seventh Trading Day next succeeding the Offer Expiration Time and (B) the denominator of which will be the product of the number of shares of Common Stock outstanding, including any such Accepted Purchased Shares, and the Current Market Price of the Common Stock on the seventh Trading Day next succeeding the Offer Expiration Time. Such adjustment shall become effective as of the opening of business on the eighth Trading Day following the Offer Expiration Time. The adjustment referred to in this clause (vii) will only be made if (1) the tender offer or exchange offer is for an amount that increases the offeror's ownership of common stock to more than 30% of the total shares of Common Stock outstanding; and (2) the cash and Fair Market Value of any other consideration included in the payment per share of Common Stock exceeds the Current Market Price of the Common Stock on the seventh Trading Day next succeeding the Offer Expiration Time. However, the adjustment referred to in this clause will not be made if as of the Offer Expiration Time, the offering documents disclose a plan or an intention to cause the Corporation to engage in a consolidation or merger or a sale of all or substantially all of the Corporation's assets. In the event the offeror is obligated to purchase shares pursuant to any such tender or exchange offer, but such Person is permanently prevented by applicable law from effecting any such purchases or all such purchases are rescinded, each Fixed Conversion Rate shall be readjusted to what would have been in effect if such tender or exchange offer had not been made. B-17 (viii) Rights Plans. To the extent that the Corporation has a rights plan in effect on any Conversion Date, upon conversion of any Convertible Preferred Stock, Holders shall receive, in addition to the Common Stock, the rights under such rights plan, unless, prior to such Conversion Date, the rights have separated from the Common Stock, in which case each Fixed Conversion Rate will be adjusted at the time of separation of such rights as if the Corporation made a distribution to all holders of the Common Stock as described in clause (iv) above, subject to readjustment in the event of the expiration, termination or redemption of such rights. (b) Adjustment for Tax Reasons. The Corporation may make such increases in each Fixed Conversion Rate, in addition to any other increases required by this Section 14, if the Board deems it advisable to avoid or diminish any income tax to holders of the Common Stock resulting from any dividend or distribution of shares (or issuance of rights or warrants to acquire shares) or from any event treated as such for income tax purposes or for any other reasons; provided that the same proportionate adjustment must be made to each Fixed Conversion Rate. (c) Calculation of Adjustments. (i) All adjustments to the Conversion Rate shall be calculated to the nearest 1/10,000th of a share (or, if there is not a nearest 1/10,000th of a share, to the next lower 1/10,000th of a share) of Common Stock. Prior to the Mandatory Conversion Date, no adjustment in the Conversion Rate shall be required unless such adjustment would require an increase or decrease of at least one percent therein; provided, that any adjustments which by reason of this subparagraph are not required to be made shall be carried forward and taken into account in any subsequent adjustment; provided further that on the Mandatory Conversion Date, adjustments to the Conversion Rate will be made with respect to any such adjustment carried forward and which has not been taken into account before such date. If an adjustment is made to the Conversion Rate pursuant to Sections 14(a)(i), 14(a)(ii), 14(a)(iii), 14(a)(iv), 14(a)(v), 14(a)(vi), 14(a)(vii) or 14(b), an inversely proportional adjustment shall also be made to the Threshold Appreciation Price and the Initial Price solely for purposes of determining which of clauses (i), (ii) and (iii) of Section 7(b) will apply on the Conversion Date. Such adjustment shall be made by dividing each of the Threshold Appreciation Price and the Initial Price by a fraction, the numerator of which shall be the Conversion Rate immediately after such adjustment pursuant to Sections 14(a)(i), 14(a)(ii), 14(a)(iii), 14(a)(iv), 14(a)(v), 14(a)(vi) or 14(a)(vii) or 14(b) and the denominator of which shall be the Conversion Rate immediately before such adjustment; provided, that if such adjustment to the Conversion Rate is required to be made pursuant to the occurrence of any of the events contemplated by Sections 14(a)(i), 14(a)(ii), 14(a)(iii), 14(a)(iv), 14(a)(v), 14(a)(vi) or 14(a)(vii) or 14(b) during the period taken into consideration for determining the Applicable Market Value, appropriate and customary adjustments shall be made to the Conversion Rate. (ii) No adjustment to the Conversion Rate need be made if Holders may participate in the transaction that would otherwise give rise to an adjustment, so long as the distributed assets or securities the Holders would receive upon conversion of the Convertible Preferred Stock, if convertible, exchangeable, or exercisable, are convertible, exchangeable or exercisable, as applicable, without any loss of rights or privileges for a period of at least 45 days following conversion of the Convertible Preferred Stock. The applicable Conversion Rate shall not be adjusted: B-18 (A) upon the issuance of any shares of the Common Stock pursuant to any present or future plan providing for the reinvestment of dividends or interest payable on the Corporation's securities and the investment of additional optional amounts in shares of Common Stock under any plan; (B) upon the issuance of any shares of the Common Stock or rights or warrants to purchase those shares pursuant to any present or future employee, director or consultant benefit plan or program of or assumed by the Corporation or any of its subsidiaries; (C) upon the issuance of any shares of the Common Stock pursuant to any option, warrant, right or exercisable, exchangeable or convertible security outstanding as of the date shares of the Convertible Preferred Stock were first issued; (D) for a change in the par value or no par value of the Common Stock; or (E) for accrued, cumulated and unpaid dividends. (iii) The Corporation shall have the power to resolve any ambiguity or correct any error in this Section 14 and its action in so doing, as evidenced by a resolution of the Board, or a duly authorized committee thereof, shall be final and conclusive. (d) Notice of Adjustment. Whenever each Fixed Conversion Rate is to be adjusted in accordance with Section 14(a) or (b), the Corporation shall: (i) compute each Fixed Conversion Rate in accordance with Section 14(a) or (b) and prepare and transmit to the Transfer Agent an Officer's Certificate setting forth each Fixed Conversion Rate, the method of calculation thereof in reasonable detail, and the facts requiring such adjustment and upon which such adjustment is based; (ii) as soon as practicable following the occurrence of an event that requires an adjustment to each Fixed Conversion Rate pursuant to Section 14(a) or (b) hereof (or if the Corporation is not aware of such occurrence, as soon as practicable after becoming so aware), provide, or cause to be provided, a written notice to the Holders of the Convertible Preferred Stock of the occurrence of such event; and (iii) as soon as practicable following the determination of each revised Fixed Conversion Rate in accordance with Section 14(a) or (b) hereof, a statement setting forth in reasonable detail the method by which the adjustment to each Fixed Conversion Rate was determined and setting forth each revised Fixed Conversion Rate. (e) Reorganization Events. In the event of: (i) any consolidation or merger of the Corporation with or into another Person (other than a merger or consolidation in which the Corporation is the continuing corporation and in which the Common Stock outstanding immediately prior to the merger or consolidation is not exchanged for cash, securities or other property of the Corporation or another Person); (ii) any sale, transfer, lease or conveyance to another Person of all or substantially all of the property and assets of the Corporation; B-19 (iii) any reclassification of Common Stock into securities including securities other than Common Stock; or (iv) any statutory exchange of securities of the Corporation with another Person (other than in connection with a merger or acquisition) (any such event specified in this Section 14(e), a "REORGANIZATION EVENT"); each share of Convertible Preferred Stock outstanding immediately prior to such Reorganization Event shall, after such Reorganization Event, be convertible into the kind of securities, cash and other property receivable in such Reorganization Event (without any interest thereon and without any right to dividends or distribution thereon which have a record date that is prior to the Conversion Date) per share of Common Stock (the "EXCHANGE PROPERTY") by a holder of Common Stock that (1) is not a person with which the Corporation consolidated or into which the Corporation merged or which merged into the Corporation or to which such sale or transfer was made, as the case may be (any such person, a "CONSTITUENT PERSON"), or an Affiliate of a Constituent Person to the extent such Reorganization Event provides for different treatment of Common Stock held by Affiliates of the Corporation and non-Affiliates, and (2) failed to exercise his rights of election, if any, as to the kind or amount of securities, cash and other property receivable upon such Reorganization Event (provided that if the kind or amount of securities, cash and other property receivable upon such Reorganization Event is not the same for each share of Common Stock held immediately prior to such Reorganization Event by other than a Constituent Person or an Affiliate thereof and in respect of which such rights of election shall not have been exercised ("NON-ELECTING SHARE"), then, for the purpose of this Section 14(e) the kind and amount of securities, cash and other property receivable upon such Reorganization Event by each Non-electing Share shall be deemed to be the kind and amount so receivable per share by a plurality of the Non-electing Shares). The amount of Exchange Property receivable upon conversion of any Convertible Preferred Stock in accordance with Section 7, 8 or 9 hereof shall be determined based upon the Conversion Rate in effect on such Conversion Date. The applicable Conversion Rate shall be (x) the Minimum Conversion Rate, in the case of an Early Conversion Date or a Provisional Conversion Date, and (y) determined based upon the definition of Conversion Rate set forth in Section 7, in the case of the Mandatory Conversion Date. For purposes of this Section 14(e), "APPLICABLE MARKET VALUE" shall be deemed to refer to the Applicable Market Value of the Exchange Property and such value shall be determined (A) with respect to any publicly traded securities that compose all or part of the Exchange Property, based on the Closing Price of such securities, (B) in the case of any cash that composes all or part of the Exchange Property, based on the amount of such cash and (C) in the case of any other property that composes all or part of the Exchange Property, based on the value of such property, as determined by a nationally recognized independent investment banking firm retained by the Corporation for this purpose. For purposes of this Section 14(e), the term "CLOSING PRICE" shall be deemed to refer to the closing sale price, last quoted bid price or mid-point of the last bid and ask prices, as the case may be, of any publicly traded securities that comprise all or part of the Exchange Property. For purposes of this Section 14(e), references to Common Stock in the definition of "TRADING DAY" shall be replaced by references to any publicly traded securities that comprise all or part of the Exchange Property. B-20 The above provisions of this Section 14(e) shall similarly apply to successive Reorganization Events and the provisions of Section 14 shall apply to any shares of capital stock of the Corporation (or any successor) received by the holders of Common Stock in any such Reorganization Event. The Corporation (or any successor) shall, within 20 days of the occurrence of any Reorganization Event, provide written notice to the Holders of such occurrence of such event and of the kind and amount of the cash, securities or other property that constitutes the Exchange Property. Failure to deliver such notice shall not affect the operation of this Section 14(e). (15) Replacement Stock Certificates. (a) If physical certificates are issued, and any of the Convertible Preferred Stock certificates shall be mutilated, lost, stolen or destroyed, the Corporation shall, at the expense of the Holder, issue, in exchange and in substitution for and upon cancellation of the mutilated Convertible Preferred Stock certificate, or in lieu of and substitution for the Convertible Preferred Stock certificate lost, stolen or destroyed, a new Convertible Preferred Stock certificate of like tenor and representing an equivalent amount of shares of Convertible Preferred Stock, but only upon receipt of evidence of such loss, theft or destruction of such Convertible Preferred Stock certificate and indemnity, if requested, satisfactory to the Corporation and the Transfer Agent. (b) The Corporation is not required to issue any certificates representing the Convertible Preferred Stock on or after the Mandatory Conversion Date or any Provisional Conversion Date. In lieu of the delivery of a replacement certificate following the Mandatory Conversion Date or any Provisional Conversion Date, the Transfer Agent, upon delivery of the evidence and indemnity described above, will deliver the shares of Common Stock issuable pursuant to the terms of the Convertible Preferred Stock formerly evidenced by the certificate. (16) Transfer Agent, Registrar and Paying Agent. The duly appointed Transfer Agent, Registrar and Paying Agent for the Convertible Preferred Stock shall be The Bank of New York. The Corporation may, in its sole discretion, remove the Transfer Agent in accordance with the agreement between the Corporation and the Transfer Agent; provided that the Corporation shall appoint a successor transfer agent who shall accept such appointment prior to the effectiveness of such removal. Upon any such removal or appointment, the Corporation shall send notice thereof by first-class mail, postage prepaid, to the Holders of the Convertible Preferred Stock. (17) Form. (a) Convertible Preferred Stock shall be issued in the form of one or more permanent global shares of Convertible Preferred Stock in definitive, fully registered form with the global legend (the "GLOBAL SHARES LEGEND"), as set forth on the form of Convertible Preferred Stock certificate attached hereto as Exhibit A (each, a "GLOBAL PREFERRED SHARE"), which is hereby incorporated in and expressly made a part of this Certificate of Amendment. The Global Preferred Share may have notations, legends or endorsements required by law, stock exchange rules, agreements to which the Corporation is subject, if any, or usage (provided that any such notation, legend or endorsement is in a form acceptable to the Corporation). The Global Preferred Share shall be deposited on behalf of the holders of the Convertible Preferred Stock represented thereby with the Registrar, at its New York office, as custodian for DTC or a Depositary, and registered in the name of the Depositary or a nominee of B-21 the Depositary, duly executed by the Corporation and countersigned and registered by the Registrar as hereinafter provided. The aggregate number of shares represented by each Global Preferred Share may from time to time be increased or decreased by adjustments made on the records of the Registrar and the Depositary or its nominee as hereinafter provided. This Section 17(a) shall apply only to a Global Preferred Share deposited with or on behalf of the Depositary. The Corporation shall execute and the Registrar shall, in accordance with this Section, countersign and deliver initially one or more Global Preferred Shares that (i) shall be registered in the name of Cede & Co. or other nominee of the Depositary and (ii) shall be delivered by the Registrar to Cede & Co. or pursuant to instructions received from Cede & Co. or held by the Registrar as custodian for the Depositary pursuant to an agreement between the Depositary and the Registrar. Members of, or participants in, the Depositary ("AGENT MEMBERS") shall have no rights under this Certificate with respect to any Global Preferred Share held on their behalf by the Depositary or by the Registrar as the custodian of the Depositary or under such Global Preferred Share, and the Depositary may be treated by the Corporation, the Registrar and any agent of the Corporation or the Registrar as the absolute owner of such Global Preferred Share for all purposes whatsoever. Notwithstanding the foregoing, nothing herein shall prevent the Corporation, the Registrar or any agent of the Corporation or the Registrar from giving effect to any written certification, proxy or other authorization furnished by the Depositary or impair, as between the Depositary and its Agent Members, the operation of customary practices of the Depositary governing the exercise of the rights of a holder of a beneficial interest in any Global Preferred Share. The Holder of the Convertible Preferred Shares may grant proxies or otherwise authorize any Person to take any action that a Holder is entitled to take pursuant to the Convertible Preferred Shares, this Certificate of Amendment or the Certificate of Incorporation. Owners of beneficial interests in Global Preferred Shares shall not be entitled to receive physical delivery of certificated shares of Convertible Preferred Stock, unless (x) the Depositary is unwilling or unable to continue as Depositary for the Global Preferred Share and the Corporation does not appoint a qualified replacement for the Depositary within 90 days, (y) the Depositary ceases to be a "clearing agency" registered under the Exchange Act and the Corporation does not appoint a qualified replacement for the Depositary within 90 days or (z) the Corporation decides to discontinue the use of book-entry transfer through the Depositary. In any such case, the Global Preferred Share shall be exchanged in whole for definitive shares of Convertible Preferred Stock in registered form, with the same terms and of an equal aggregate Liquidation Preference. Definitive shares of Convertible Preferred Stock shall be registered in the name or names of the Person or Person specified by the Depositary in a written instrument to the Registrar. (b) (i) An Officer shall sign the Global Preferred Share for the Corporation, in accordance with the Corporation's bylaws and applicable law, by manual or facsimile signature. (ii) If an Officer whose signature is on a Global Preferred Share no longer holds that office at the time the Transfer Agent countersigned the Global Preferred Share, the Global Preferred Share shall be valid nevertheless. (iii) A Global Preferred Share shall not be valid until an authorized signatory of the Transfer Agent manually countersigns Global Preferred Share. Each Global Preferred Share shall be dated the date of its countersignature. B-22 (18) Miscellaneous. (a) All notices referred to herein shall be in writing, and, unless otherwise specified herein, all notices hereunder shall be deemed to have been given upon the earlier of receipt thereof or three Business Days after the mailing thereof if sent by registered or certified mail (unless first-class mail shall be specifically permitted for such notice under the terms of this Certificate of Amendment) with postage prepaid, addressed: (i) if to the Corporation, to its office at 2000 Galloping Hill Road, Kenilworth, NJ 07033 (Attention: the Secretary) or to the Transfer Agent at its Corporate Trust Office, or other agent of the Corporation designated as permitted by this Certificate of Amendment, or (ii) if to any Holder of the Convertible Preferred Stock or holder of shares of Common Stock, as the case may be, to such Holder at the address of such Holder as listed in the stock record books of the Corporation (which may include the records of any transfer agent for the Convertible Preferred Stock or Common Stock, as the case may be), or (iii) to such other address as the Corporation or any such Holder, as the case may be, shall have designated by notice similarly given. (b) The Corporation shall pay any and all stock transfer and documentary stamp taxes that may be payable in respect of any issuance or delivery of shares of Convertible Preferred Stock or shares of Common Stock or other securities issued on account of Convertible Preferred Stock pursuant hereto or certificates representing such shares or securities. The Corporation shall not, however, be required to pay any such tax that may be payable in respect of any transfer involved in the issuance or delivery of shares of Convertible Preferred Stock or Common Stock or other securities in a name other than that in which the shares of Convertible Preferred Stock with respect to which such shares or other securities are issued or delivered were registered, or in respect of any payment to any person other than a payment to the registered holder thereof, and shall not be required to make any such issuance, delivery or payment unless and until the person otherwise entitled to such issuance, delivery or payment has paid to the Corporation the amount of any such tax or has established, to the satisfaction of the Corporation, that such tax has been paid or is not payable. (c) The Liquidation Preference and the annual dividend rate set forth herein each shall be subject to equitable adjustment whenever there shall occur a stock split, combination, reclassification or other similar event involving the Convertible Preferred Stock. Such adjustments shall be determined in good faith by the Board and submitted by the Board to the Transfer Agent. (19) Definitions. Unless otherwise defined herein, capitalized terms used in this Certificate of Amendment shall have the following meanings: "ACCEPTED PURCHASED SHARES" shall have the meaning set forth in Section 14(a)(vii) hereof. "AFFILIATE" shall have the meaning given to that term in Rule 405 of the Securities Act of 1933, as amended, or any successor rule thereunder. "AGENT MEMBERS" shall have the meaning set forth in Section 17(a) hereof. B-23 "APPLICABLE MARKET VALUE" means the average of the Closing Prices per share of the Common Stock on each of the 20 consecutive Trading Days ending on the third Trading Day immediately preceding the Mandatory Conversion Date. "BANKRUPTCY LAW" means Title 11, United States Code, or any similar federal or state law for the relief of debtors. "BOARD" means the Board of Directors of the Corporation. "BUSINESS DAY" means any day other than a Saturday or Sunday or any other day on which banks in The City of New York are authorized or required by law or executive order to close. "CASH MERGER" shall have the meaning set forth in Section 10(a) hereof. "CERTIFICATE OF AMENDMENT" means the Certificate of Amendment of the Certificate of Incorporation dated August 5, 2004. "CERTIFICATE OF INCORPORATION" means the Certificate of Incorporation of the Corporation, as amended. "CLOSING PRICE" means, as of any date of determination, the closing sale price or, if no closing sale price is reported, the last reported sale price, of the Common Stock or any securities distributed in a Spin-Off, as the case may be, on the New York Stock Exchange on that date. If the Common Stock or any such securities distributed in a Spin-Off, as the case may be, is not then traded on the New York Stock Exchange on any date of determination, the Closing Price of the Common Stock or such securities on any date of determination means the closing sale price as reported in the composite transactions for the principal U.S. national or regional securities exchange on which the Common Stock or such securities is so listed or quoted, or if the Common Stock or such securities is not so listed or quoted on a U.S. national or regional securities exchange, as reported by the Nasdaq stock market, or, if no closing price for the Common Stock or such securities is so reported, the last quoted bid price for the Common Stock or such securities in the over-the-counter market as reported by the National Quotation Bureau or similar organization, or, if that bid price is not available, the market price of the Common Stock or such securities on that date as determined by a nationally recognized independent investment banking firm retained for this purpose by the Corporation. For the purposes of this Certificate of Amendment, all references herein to the closing sale price of the Common Stock on the New York Stock Exchange shall be such closing sale price as reflected on the website of the New York Stock Exchange (www.nyse.com) and as reported by Bloomberg Professional Service; provided that in the event that there is a discrepancy between the closing sale price as reflected on the website of the New York Stock Exchange and as reported by Bloomberg Professional Service, the closing sale price on the website of the New York Stock Exchange shall govern. "COMMON STOCK" as used in this Certificate of Amendment means the Corporation's Common Shares, par value $0.50 per share, as the same exists at the date of filing of this Certificate of Amendment relating to the Convertible Preferred Stock, or any other class of stock resulting from successive changes or reclassifications of such Common Shares consisting solely of changes in par value, or from par value to no par value, or from no par value B-24 to par value. However, subject to the provisions of Section 14(e), shares of Common Stock issuable on conversion of shares of Convertible Preferred Stock shall include only shares of the class designated as Common Shares of the Corporation at the date of the filing of this Certificate of Amendment with the Secretary of State of the State of New Jersey or shares of any class or classes resulting from any reclassification or reclassifications thereof and which have no preference in respect of dividends or of amounts payable in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation and which are not subject to redemption by the Corporation; provided that if at any time there shall be more than one such resulting class, the shares of each such class then so issuable shall be substantially in the proportion which the total number of shares of such class resulting from all such reclassifications bears to the total number of shares of all classes resulting from all such reclassifications. "CONVERSION DATE" shall have the meaning set forth in Section 11(a) hereof. "CONVERSION RATE" shall have the meaning set forth in Section 7(b) hereof. "CONVERTIBLE PREFERRED STOCK" shall have the meaning set forth in Section 1 hereof. "CORPORATE TRUST OFFICE" means the principal corporate trust office of the Transfer Agent at which, at any particular time, its corporate trust business shall be administered. "CURRENT MARKET PRICE" per share of Common Stock on any date means the average of the daily Closing Prices for the five consecutive Trading Days preceding the earlier of the day preceding the date in question and the day before the "ex date" with respect to the issuance or distribution requiring such computation. The term "ex date," when used with respect to any issuance or distribution, means the first date on which the Common Stock trades without the right to receive the issuance or distribution. For the purposes of determining the adjustment to the Conversion Rate for the purposes of Section 14(a)(iv)(B) hereof the Current Market Price per share of Common Stock means the average of the Closing Prices over the first ten Trading Days commencing on and including the fifth Trading Day following the "ex-date" for such distribution. "CUSTODIAN" means any receiver, trustee, assignee, liquidator, custodian or similar official under any Bankruptcy Law. "DEPOSITARY" means DTC or its nominee or any successor appointed by the Corporation. "DIVIDEND PAYMENT DATE" means (i) the 15th calendar day of March, June, September and December of each year, or the following Business Day if such day is not a Business Day, prior to the Mandatory Conversion Date and (ii) the Mandatory Conversion Date. "DIVIDEND PERIOD" means the period ending on the day before a Dividend Payment Date and beginning on the preceding Dividend Payment Date or, if there is no preceding Dividend Payment Date, on the first date of issuance of the Convertible Preferred Stock. B-25 "DIVIDEND THRESHOLD AMOUNT" shall have the meaning set forth in Section 14(a)(v) hereof. "DTC" means The Depository Trust Company. "EARLY CONVERSION" shall have the meaning set forth in Section 8(a) hereof. "EARLY CONVERSION DATE" means the effective date of any early conversion of Convertible Preferred Stock pursuant to Section 8 hereof. "EXCHANGE PROPERTY" shall have the meaning set forth in Section 14(e) hereof. "EXPIRATION TIME" shall have the meaning set forth in Section 14(a)(vi) hereof. "FAIR MARKET VALUE" means (a) in the case of any Spin-Off, the fair market value of the portion of those shares of capital stock or similar equity interests so distributed applicable to one share of Common Stock as of the fifteenth Trading Day after the "ex-date" for such Spin-Off, and (b) in all other cases the fair market value as determined in good faith by the Board, whose determination shall be conclusive and described in a resolution of the Board. "FIXED CONVERSION RATES" means the Maximum Conversion Rate and the Minimum Conversion Rate. "GLOBAL PREFERRED SHARE" shall have the meaning set forth in Section 17(a) hereof. "GLOBAL SHARES LEGEND" shall have the meaning set forth in Section 17(a) hereof. "HOLDER" means the person in whose name the shares of the Convertible Preferred Stock are registered, which may be treated by the Corporation and the Transfer Agent as the absolute owner of the shares of Convertible Preferred Stock for the purpose of making payment and settling conversions and for all other purposes. "INITIAL PRICE" shall have the meaning set forth in Section 7(b) hereof. "JUNIOR SECURITIES" shall have the meaning set forth in Section 2 hereof. "LIQUIDATION PREFERENCE" means, as to the Convertible Preferred Stock, $50.00 per share. "MANDATORY CONVERSION DATE" means September 14, 2007 or as otherwise treated as having occurred pursuant to Section 10(b)(iii), 10(d) or 14(e), as applicable. "MAXIMUM CONVERSION RATE" shall have the meaning set forth in Section 7(b)(iii) hereof. "MERGER EARLY CONVERSION" shall have the meaning set forth in Section 10(a) hereof. B-26 "MERGER EARLY CONVERSION DATE" shall have the meaning set forth in Section 10(b) hereof. "MINIMUM CONVERSION RATE" shall have the meaning set forth in Section 7(b)(i) hereof. "NON-ELECTING SHARE" shall have the meaning set forth in Section 14(e) hereof. "OFFER EXPIRATION TIME" shall have the meaning set forth in Section 14(a)(vii) hereof. "OFFICER" means the Chief Executive Officer, the Chief Operating Officer, any Vice President, the Chief Financial Officer, the Treasurer, any Assistant Treasurer, the Secretary or any Assistant Secretary of the Corporation. "OFFICER'S CERTIFICATE" means a certificate of the Corporation, signed by any duly authorized Officer of the Corporation. "PARITY SECURITIES" shall have the meaning set forth in Section 2 hereof. "PERSON" means a legal person, including any individual, corporation, estate, partnership, joint venture, association, joint-stock company, limited liability company or trust. "PREFERRED STOCK DIRECTOR" shall have the meaning set forth in Section 5(c) hereof. "PROVISIONAL CONVERSION DATE" means the date fixed for conversion of shares of Convertible Preferred Stock into shares of Common Stock pursuant to Section 9 above or, if the Corporation shall default in the cash payment of (1) an amount equal to any accrued, cumulated and unpaid dividends on the shares of Convertible Preferred Stock then outstanding, whether or not declared (other than previously declared dividends on the Convertible Preferred Stock payable to Holders of record as of a prior date), plus (2) the present value of all remaining future dividend payments on the shares of Convertible Preferred Stock then outstanding, through and including the Mandatory Conversion Date, in each case, when the Corporation is legally permitted to and makes such payment. "PROVISIONAL CONVERSION NOTICE" shall have the meaning set forth in Section 9(b) hereof. "PROVISIONAL CONVERSION NOTICE DATE" shall have the meaning set forth in Section 9(a) hereof. "PURCHASED SHARES" shall have the meaning set forth in Section 14(a)(vi) hereof. "RECORD DATE" means the later of (i) the 1st calendar day (or the following Business Day if the 1st calendar day is not a Business Day) of the calendar month in which the applicable Dividend Payment Date falls and (ii) the close of business on the day on which the Board, or an authorized committee of the Board, declares the dividend payable. B-27 "RECORD HOLDER" means the Holder of record of the Convertible Preferred Stock as they appear on the stock register of the Corporation at the close of business on a Record Date. "REORGANIZATION EVENT" shall have the meaning set forth in Section 14(e) hereof. "SENIOR SECURITIES" shall have the meaning set forth in Section 2 hereof. "SERIES A PREFERRED STOCK" means the Series A Junior Participating Preferred Stock, par value $1.00 per share, of the Corporation. "SPIN-OFF" means a dividend or other distribution of shares of capital stock of any class or series, or similar equity interests, of or relating to a subsidiary or other business unit of the Corporation. "SURVIVING CORPORATION" shall have the meaning set forth in Section 10(b) hereof. "THRESHOLD APPRECIATION PRICE" shall have the meaning set forth in Section 7(b) hereof. "TRADING DAY" means a day on which the Common Stock: (a) is not suspended from trading on any national or regional securities exchange or association or over-the-counter market at the close of business; and (b) has traded at least once on the national or regional securities exchange or association or over-the-counter market that is the primary market for the trading of the Common Stock. "TRANSFER AGENT" means The Bank of New York acting as transfer agent, registrar and paying agent for the Convertible Preferred Stock, and its successors and assigns. "TREASURY YIELD" means the yield to maturity at the time of computation of U.S. Treasury securities with a constant maturity (as compiled and published in the most recent Federal Reserve Statistical Release H.15 (519) that has become publicly available at least two Business Days prior to the Provisional Conversion Date (or, if such Statistical Release is no longer published, any publicly available source for similar market data)) most nearly equal to the then remaining term to the Mandatory Conversion Date; provided, however, that if the then remaining term to the Mandatory Conversion Date is not equal to the constant maturity of a U.S. Treasury security for which a weekly average yield is given, the Treasury Yield shall be obtained by linear interpolation (calculated to the nearest one-twelfth of a year) from the weekly average yields of U.S. Treasury securities for which such yields are given, except that if the then remaining term to the Mandatory Conversion Date is less than one year, the weekly average yield on actually traded U.S. Treasury securities adjusted to a constant maturity of one year shall be used. B-28 EXHIBIT A FORM OF 6.00% MANDATORY CONVERTIBLE PREFERRED STOCK SEE REVERSE FOR LEGEND Number: [-] 6.00% Mandatory Convertible Preferred Stock [-] Shares SCHERING-PLOUGH CORPORATION CUSIP NO.: [-] FACE OF SECURITY This certifies that Cede & Co. is the owner of fully paid and non-assessable shares of the 6.00% Mandatory Convertible Preferred Stock, par value $1.00 each of Schering-Plough Corporation (hereinafter called the Corporation), transferable on the books of the Corporation by the holder hereof in person or by duly authorized attorney, upon surrender of this Certificate properly endorsed. This Certificate and the shares represented hereby are issued and shall be held subject to all the provisions of the Certificate of Incorporation of Schering-Plough Corporation and all amendments thereto (copies of which are on file at the office of the Transfer Agent) to all of which the holder of this Certificate by acceptance hereof assents. This Certificate is not valid until countersigned by the Transfer Agent and registered by the Registrar. Witness the facsimile seal of the Corporation and the facsimile signatures of its duly authorized officers. Dated Countersigned and Registered The Bank of New York Transfer Agent and Registrar By -------------------------------- ------------------ --------------------------- Authorized Signature Secretary Chairman and Chief Executive Officer
B-29 REVERSE OF SECURITY SCHERING-PLOUGH CORPORATION The shares of 6.00% Mandatory Convertible Preferred Stock (the "MANDATORY CONVERTIBLE PREFERRED STOCK") will automatically convert on September 14, 2007 into a number of common shares, par value $0.50 per share, of the Corporation (the "COMMON SHARES") as provided in the Certificate of Amendment of the Certificate of Incorporation of the Corporation relating to the Mandatory Convertible Preferred Stock (the "CERTIFICATE OF AMENDMENT"). The shares of the Mandatory Convertible Preferred Stock are also convertible at the option of either the holder or the Corporation, respectively, into Common Shares at any time prior to September 14, 2007 as provided in the Certificate of Amendment. The preceding description is qualified in its entirety by reference to the Certificate of Amendment, a copy of which will be furnished by the Corporation to any shareholder without charge upon request addressed to the Secretary of the Corporation at its principal office in Kenilworth, New Jersey, or to the Transfer Agent named on the face of this certificate. The Corporation will furnish to any shareholders, upon request, and without charge, a full statement of the designations, relative rights, preferences and limitations of the shares of each class and series authorized to be issued so far as the same have been determined and of the authority of the Board to divide the shares into classes or series and to determine and change the relative rights, preferences and limitations of any class or series. Any such request should be addressed to the Secretary of the Corporation at its principal office in Kenilworth, New Jersey, or to the Transfer Agent named on the face of this certificate. UNLESS THIS CERTIFICATE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITORY TRUST COMPANY, A NEW YORK CORPORATION ("DTC"), TO THE CORPORATION OR THE TRANSFER AGENT NAMED ON THE FACE OF THIS CERTIFICATE, AND ANY CERTIFICATE ISSUED IS REGISTERED IN THE NAME OF CEDE & CO. OR IN SUCH OTHER NAME AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC (AND ANY PAYMENT IS MADE TO CEDE & CO., OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC), ANY TRANSFER, PLEDGE OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL IN AS MUCH AS THE REGISTERED OWNER HEREOF, CEDE & CO. HAS AN INTEREST HEREIN. TRANSFERS OF THIS GLOBAL SECURITY SHALL BE LIMITED TO TRANSFERS IN WHOLE, BUT NOT IN PART, TO NOMINEES OF DTC OR TO A SUCCESSOR THEREOF OR SUCH SUCCESSOR'S NOMINEE AND TRANSFERS OF PORTIONS OF THIS GLOBAL SECURITY SHALL BE LIMITED TO TRANSFERS MADE IN ACCORDANCE WITH THE RESTRICTIONS SET FORTH IN THE CERTIFICATE OF AMENDMENT. IN CONNECTION WITH ANY TRANSFER, THE HOLDER WILL DELIVER TO THE TRANSFER AGENT NAMED ON THE FACE OF THIS CERTIFICATE SUCH CERTIFICATES AND OTHER INFORMATION AS SUCH TRANSFER AGENT MAY REASONABLY REQUIRE TO CONFIRM THAT THE TRANSFER COMPLIES WITH THE FOREGOING RESTRICTIONS. B-30 ASSIGNMENT For value received, -------------------hereby sell, assign and transfer unto Please Insert Social Security or Other Identifying Number of Assignee - -------------------------------------------- - -------------------------------------------------------------------------------- (Please Print or Typewrite Name and Address, Including Zip Code, of Assignee) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- shares of the capital stock represented by the within Certificate, and do hereby irrevocably constitute and appoint Attorney to transfer the said stock on the books of the within named Corporation with full power of substitution in the premises. Dated ------------------- ---------------------- NOTICE: The Signature to this Assignment Must Correspond with the Name As Written Upon the Face of the Certificate in Every Particular, Without Alteration or Enlargement or Any Change Whatever. SIGNATURE GUARANTEED - ---------------------------------------------- (Signature Must Be Guaranteed by a Member of a Medallion Signature Program) EX-12 3 y67941exv12.txt COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES Exhibit 12 SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (Dollars in millions)
Nine Months Ended September 30, Years Ended December 31 2004 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- ---- (Loss)/Income Before Income Taxes $ (140) $(46) $ 2,563 $2,523 $3,188 $2,795 Less: Equity Income 249 54 - - - - -------- ---- ------- ------ ------ ------ (Loss)/Income Before Income Taxes and Equity Income (389) (100) 2,563 2,523 3,188 2,795 Add Fixed Charges: Preference Dividends 15 - - - - - Interest Expense 130 81 28 40 44 29 One-third of Rental Expense 24 30 27 24 24 22 Capitalized Interest 14 11 24 25 20 12 -------- ---- ------- ------ ------ ------ Total Fixed Charges 183 122 79 89 88 63 Less: Capitalized Interest 14 11 24 25 20 12 Less: Preference Dividends 15 - - - - - Add: Amortization of Capitalized Interest 8 9 8 7 7 7 Add: Distributed Income of Equity Investees 146 32 - - - - -------- ---- ------- ------ ------ ------ (Loss)/Earnings Before Income Taxes and Fixed Charges (other than Capitalized Interest) $ (81) $ 52 $ 2,626 $2,594 $3,263 $2,853 ======== ==== ======= ====== ====== ====== Ratio of Earnings to Fixed Charges (0.4)* 0.4 ** 33.2 29.1 37.1 45.3 ======== ==== ======= ====== ====== ======
* For the nine months ended September 30, 2004, earnings were insufficient to cover fixed charges by $264. ** For the year ended December 31, 2003, earnings were insufficient to cover fixed charges by $70. "Earnings" consist of (loss)/income before income taxes and equity income, plus fixed charges (other than capitalized interest and preference dividends), amortization of capitalized interest and distributed income of equity investee. "Fixed charges" consist of interest expense, capitalized interest, preference dividends and one-third of rentals which Schering-Plough believes to be a reasonable estimate of an interest factor on leases. EX-15 4 y67941exv15.txt AWARENESS LETTER Exhibit 15 October 28, 2004 To the Shareholders and Board of Directors of Schering-Plough Corporation: We have made a review, in accordance with standards of the Public Company Accounting Oversight Board (United States), of the unaudited interim financial information of Schering-Plough Corporation and subsidiaries for the periods ended September 30, 2004 and 2003, as indicated in our report dated October 27, 2004; because we did not perform an audit, we expressed no opinion on that information. We are aware that our report referred to above, which is included in your Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, is incorporated by reference in Registration Statements No. 2-83963, No. 33-19013, No. 33-50606, No. 333-30331, No. 333-87077, No. 333-91440, No. 333-104714, No. 333-105567, No. 333-105568 and No. 333-112421 on Form S-8, Post Effective Amendment No. 1 to Registration Statement No. 2-84723 on Form S-8, Post Effective Amendment No. 1 to Registration Statement No. 333-105567 on Form S-8, Post Effective Amendment No. 1 to Registration Statement No. 2-80012 on Form S-3, Post Effective Amendment No. 1 to Registration Statement No. 2-77740 on Form S-3, Post Effective Amendment No. 1 to Registration Statement No. 333-102970 on Form S-3 and Registration Statements No. 333-12909, No. 333-853, No. 333-30355, No. 333-102970, No. 333-110690 and No. 333-113222 on Form S-3. We also are aware that the aforementioned report, pursuant to Rule 436(c) under the Securities Act of 1933, is not considered a part of the Registration Statements prepared or certified by an accountant or a report prepared or certified by an accountant within the meaning of Sections 7 and 11 of that Act. /s/Deloitte & Touche LLP Parsippany, New Jersey EX-31.1 5 y67941exv31w1.txt CERTIFICATION Exhibit 31.1 CERTIFICATION I, Fred Hassan, Chairman of the Board, Chief Executive Officer and President, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Schering-Plough Corporation (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) [paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: October 28, 2004 /s/ Fred Hassan - --------------- Fred Hassan Chairman of the Board, Chief Executive Officer and President EX-31.2 6 y67941exv31w2.txt CERTIFICATION Exhibit 31.2 CERTIFICATION I, Robert J. Bertolini, Executive Vice President and Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Schering-Plough Corporation (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) [paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: October 28, 2004 /s/ Robert J. Bertolini - ----------------------- Robert J. Bertolini Executive Vice President and Chief Financial Officer EX-32.1 7 y67941exv32w1.txt CERTIFICATION Exhibit 32.1 CERTIFICATION I, Fred Hassan, Chairman of the Board, Chief Executive Officer and President of Schering-Plough Corporation, certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004 (the "Periodic Report") which this statement accompanies fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m); and (2) information contained in the Periodic Report fairly presents, in all material respects, the financial condition and results of operations of Schering-Plough Corporation. Dated: October 28, 2004 /s/ Fred Hassan - --------------- Fred Hassan Chairman of the Board, Chief Executive Officer and President EX-32.2 8 y67941exv32w2.txt CERTIFICATION Exhibit 32.2 CERTIFICATION I, Robert J. Bertolini, Executive Vice President and Chief Financial Officer of Schering-Plough Corporation, certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004 (the "Periodic Report") which this statement accompanies fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m); and (2) information contained in the Periodic Report fairly presents, in all material respects, the financial condition and results of operations of Schering-Plough Corporation. Dated: October 28, 2004 /s/ Robert J. Bertolini - ----------------------- Robert J. Bertolini Executive Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----