Schering-Plough Corp. Q3 2008 Earnings Conference Call Transcript

Schering Plough Corporation (SGP)

Q3 FY08 Earnings Call

October 21, 2008, 8:00 AM ET

Executives

Janet M. Barth - VP, IR

Fred Hassan - Chairman and CEO

Robert J. Bertolini - EVP and CFO

Carrie S. Cox - EVP and President, Global Pharmaceuticals

Thomas P. Koestler - EVP and President, Schering-Plough Research Institute

Analysts

Chris Schott - J.P. Morgan

Roopesh Patel - UBS

Anthony Butler - Barclays Capital

David Risinger - Merrill Lynch

John Boris - Citigroup

Craig Baskin - Putnam Investment

Barbara Ryan - Deutsche Bank

Robert Hazlett - BMO Capital Markets

Steve Scala - Cowen and Company

David Moskowitz - Caris & Company

Tim Anderson - Sanford Bernstein

Presentation

Operator

Good morning my name is Marsha and I will be your conference operator today. At this time I would like to welcome everyone to the Schering-Plough Third Quarter Earnings Conference Call. All lines have been placed on-mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. [Operator Instructions].

Thank you, I would now like to turn the call over to Janet Barth, Vice President of Investor Relations. Ms. Barth, you may begin your conference.

Janet M. Barth - Vice President, Investor Relations

Thank you Marsha and good morning everyone. Welcome to the Schering-Plough 2008 third quarter conference call. Given that there are other earnings call today, we will be mindful of our time and plan to finish up with the Q and A portion of the call by 9 AM. Before we begin, I would like to cover a few items.

First, some of the statements made on our call may be considered forward-looking statements. The company's SEC filings including our 8-K filed today in Item 8.01 risk factors identifies certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made this morning.

The company's SEC filings, as well as today's earnings release and tables are available at schering-plough.com. I would also note that during the call we may refer to non-GAAP measures, including adjusted net sales or adjusted top line sales, which is a non-GAAP measure that we define as our GAAP net sales, plus an assumed 50% sales contribution from our cholesterol JV. We will also refer to as reconciled amounts or amounts on a reconciled basis as reconciled amounts exclude purchase accounting adjustments, acquisition related items and other specified items. Please refer to the non-U.S. GAAP reconciliation table for a reconciliation of these adjusted figures to our reported GAAP results. These can be found under financial highlights in the Investor Relations section of our website.

This morning, I am joined by Fred Hassan, our Chairman and Chief Executive Officer; Bob Bertolini, our Chief Financial Officer; and Carrie Cox, the Head of Global Pharmaceutical. We also have other members of management available for Q&A. Also as a reminder, our R&D update meeting is scheduled for November 24th, here in Kenilworth, New Jersey. This meeting will be webcast and invitations will be going out soon.

Now, I would like to introduce Fred Hassan.

Fred Hassan - Chairman and Chief Executive Officer

Thank you Janet, and welcome to our call. We're pleased that we've again delivered a strong quarter. Despite the global challenges affecting our industry and the challenges with our U.S. cholesterol joint venture, we continue to execute on our three-pronged strategy. Number one, we continue to grow our top line. Number two, we continue to grow our pipeline. And number three, we continue to reduce costs while continuing to invest wisely, especially in our rich late stage pipeline.

We also had some currency tailwind in the quarter; but the fundamentals were strong. Our good performance in these tough times reflects the strength and diversity we've been building into our company over the past five years. Our good performance also reflects our financial discipline. This is visible in the early success of our Productivity Transformation Program or PTP.

Through PTP, we've been systematically reducing costs and enhancing our productivity for the long term. Step-by-step, we've been advancing the Action Agenda that we set out five years ago to transform our company. It is delivering.

Let me begin by talking about the new strength and diversity we've built. Next month will be the first anniversary of our acquisition of OBS. Now that we've had almost one year of experience, we can see that this is proving to be a powerful combination. We bought a strong R&D based global company with solid products and good cash flows. We have integrated it well. It was the right move at the right time.

As a result, we have further transformed Schering-Plough into a company with the size and scale to be a strong global competitor. Through the OBS combination, we've also created the world's leading animal health company with sales of nearly $2.3 billion year-to-date. Our people have executed with excellence; recreating value from our combination by leveraging our strong combined global platforms.

Let me give you some examples. With sugammadex, we're already launching our first new product from the OBS combination in Europe, using a strong combined sales and marketing platform. Another example, NUVARING. NUVARING is an important innovation that came out of the Organon Labs. We're looking at markets like Spain where NUVARING has an 18% market share. We are leveraging the strong Schering-Plough global sales and marketing network to share these successful experiences in order to drive growth in other markets.

And a third example, our combined global Animal Health platform. The animal health integration is making very good progress. The combined organization is beginning to operate as one team. The depth and breadth of our combined animal health portfolio is making us more relevant to customers. Our combined field process are starting to leverage the new broader portfolio. We're also benefiting from what we believe is the strongest Animal Health R&D platform in the industry.

Now, let me turn to diversity. We're benefiting from our successful long-term strategy to build diversity on many fronts. The OBS combination has been an important part of that strategy. At the macro level, we've been implementing our long-term strategy of business diversification via three pharma based segments; Human Rx, Consumer and Animal Health, which all benefit from a strong science platform. We began investing in the consumer health and animal health back when the fashion was to be a pure play Rx company. We stayed with our strategy and it's proving to be a wise one.

We're building diversity; close to a quarter of our total sales from these units came in the third quarter. At the macro level, we re also seeing our long-term geographic diversification strategy coming through. About 70% of our GAAP sales came from outside the U.S. in the third quarter and delivered strong growth.

We've become much stronger in the other established markets, like Japan, the world's second largest market. In Japan, we've almost doubled our sales in the past five years, and we have a chain of new drugs coming through the pipeline for Japan. This makes us excited about our future in this market.

We're also becoming strong in a group of newer markets that we've been prioritizing; markets, such as China, Russia, Brazil, Central-Eastern Europe. Their relatively fast growth is contributing to our company's overall growth. So our diversification strategy is working at the macro level, it's also working at the micro level with product diversity in our Rx unit. We continue to be committed to our cholesterol franchise. VYTORIN and ZETIA are very effective in getting people to their LDLC goals in countries around the world.

We continue to be committed to these products, because they are so important to physicians and their patients. Meantime, however we've built strength with many other products from REMICADE to TEMODAR to NASONEX and to our new women's health franchise.

We've build special strength in biologics, led by our biologic REMICADE which is now annualizing at over $2 billion in sales. Overall, biologics now account for nearly 30% of our total Rx sales and growing.

Today, we're among the top companies in biologics. So, we've built diversity on multiple fronts. Given the challenges in today's environments, this diversity is an important strength.

Now, let me turn to our financial management and our progress to the Productivity Transformation Program, PTP that we launched in April. Our strong quarterly performance reflects sound financial management. Our company is generating good cash flow. Bob will talk more about our financial strength in a moment.

About PTP; we launched PTP in early April this year to achieve important savings in our cost structure and to make it even more effective as a company. We've moved quickly and decisively. Our goals have been to take costs out of the system, to become more efficient, to make Schering-Plough even more resilient and even more nimble.

We're looking at every part of our business and at every process, including sales, R&D, our supply chain and our global functions. Earlier this month, we completed a strategic realignment of our U.S. sales force. The realignment is one of the many actions to reduce our cost base in the US. The realignment is designed to give us even more flexibility in a fast changing environment.

Looking ahead, we continue to be very excited about the strength and diversity of our late stage Human Rx pipeline. With 10 projects in Phase III, we believe we have the strongest late stage pipeline for our size in our peer group. We also have relatively long expected pattern exclusivity on key Rx projects; mostly well into the next decade.

Thus our late stage pipeline is expected to be additive to the current inline portfolio. So at a time when there's a lot of anxiety in the industry about the approaching patents flip [ph] in pharma for many of our peers, we are a company that has a lot of positives to work with. We look forward to talking more about the pipeline at our R&D day next month.

So overall, in a tough and changing environment, we've again come through with a very good quarter. This reflects the diverse strength that we have built in our company, strengths that also give us confidence that we can continue to power through.

Now let me turn over to Bob.

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

Thanks Fred and good morning everyone. Our performance in the third quarter continues to reflect our diverse and broad-base portfolio as well as our ability to manage the challenges in our business. As Fred mentioned, we are pleased with the positive impact that Organon Biosciences is having on our business. On a reconcile basis, we are in $0.39 per share in the third quarter. This amount excludes purchase accounting adjustments, special and acquisition related items, about $90 million of income from the termination of our respiratory joint venture with Merck and the gain of $160 million from the acquired divestiture of certain animal health products.

Now, turning to our results. First, I'd like to discuss the key drivers of our quarterly sales and operating performance. I'll also provide an update on PTP and the ongoing OBS integration.

First, our sale performance for the quarter. On a GAAP basis, our net sales increased to $4.6 billion and include about $1.4 billion in sales of products from OBS. Excluding sales of price from OBS, net sales for Schering-Plough on a standalone basis would have been $3.2 billion, an increase of about 13% compared to the prior year.

Currency was again favorable this quarter. Excluding sales from OBS products, currency contributed approximately 6% to the Schering-Plough standalone sales growth. If we include and assume 50% contribution from the cholesterol joint venture, our adjusted net sales were $5.1 billion this quarter.

Global sales of the cholesterol franchise were down about 13% compared to the prior year period. Overall, our prescription pharma sales this quarter benefited from nearly $900 million in sales from Organon, including contributions from FOLLISTIM and NUVARING and higher sales of REMICADE and TEMODAR. Offsetting this growth were declines in our U.S. prescription respiratory business. Our sales also benefited from foreign exchange.

Carrie will talk more about the performance of our global prescription brands in a few minutes.

As Fred mentioned, our overall business diversity is stronger today than a year ago, with Animal Health and Consumer Healthcare contributing a combine 23% of sales. These important businesses provide solid revenue and generally positive cash flow while extending the value of our R&D investments.

In Animal Health, third quarter sales were $759 million including more than $500 million from the acquired Animal Health business. Our Animal Health sales this quarter were roughly split between vaccines and pharmaceuticals, including a wide range of products to treat livestock and companion animals.

Turning now to Consumer Healthcare; our sales this quarter were about $278 million, up 2%. Sales of OTC MiraLAX continue to be strong and nearly doubled in the quarter to $31 million. In fact, within just two years of being on the market, OTC MiraLAX is already a category leader, vying neck-in-neck with Metamucil.

Let me now review our third quarter operating performance. On a reconciled basis, our gross margin in the third quarter was 66.9% roughly flat with last year. Sequentially the gross margin decline was primarily due to the seasonality of our business.

Moving to SG&A; this quarter, SG&A expenses were $1.7 billion. On a year-over-year basis, the increase related primarily to the OBS acquisition. Also, as we continue to focus on controlling cost with the PTP program, we're seeing the benefit in our cost base.

Moving to R&D. Our R&D expenses were higher on a year-over-year basis this quarter and totaled $893 million. The increase relates to the addition of OBS and continued investment in our R&D pipeline. Sequentially, R&D spending was slightly lower. However, we do expect R&D spending in the fourth quarter to be higher than the levels this quarter.

Now let me provide an update on our ongoing PTP program, which includes the integration of OBS. After nearly one year of intense work on integration, the acquisition of OBS is proving to be a powerful combination. Our combined operations are benefiting from new product and geographic strength, new strength with our customers and new strength in R&D including a late-stage pipeline that we believe is now one of the strongest in our industry.

We are also making steady progress to achieving our $1.5 billion PTP target. To-date, we have achieved more than $300 million in savings. Now we are seeing savings across all business units with most of the savings this quarter in SG&A.

Before closing, I also want to comment on our solid financial position and how this relates to the current global financial environment. While a number of global companies may be challenged to their meet liquidity needs, Schering-Plough does not have any current need to access the capital markets. Additionally, we are not relying on commercial paper to fund our liquidity needs.

We do not have any debt maturities coming up in either 2008 or 2009. We currently have more than $3 billion in cash on hand, which represents an increase of about $300 million since last quarter. With our positive cash flow, we have also made progress on paying down debt; in fact we've already paid down approximately $1 billion in debt this year.

From a cash perspective, we remain invested in highly liquid and highly rated securities. Primarily instruments such as bank term deposits and government backed money-market funds. So, you can see, we have a solid financial position.

In closing, our strong top line and bottom line performance this quarter shows that the integration is working. We are building diversity on our business and making steady progress with our PTP program. Together with our robust R&D pipeline, we believe we can continue to manage the challenges in our business.

With that I'll now turn the call over to Carrie.

Carrie S. Cox - Executive Vice President and President, Global Pharmaceuticals

Thank you, Bob. Good morning. Despite continue challenges in our global pharmaceutical business, our core strategy remains the same; driving top line growth advancing the pipeline and reducing cost.

With long periods of expected exclusivity on many of our core brands, we can leverage our investments in our existing portfolio. We are also focused on capturing opportunity through our continuing geographic expansion program, and we've seen a number of success stories around the globe.

Our international business continues to perform well with solid growth in both emerging and established markets. Outside the U.S., our international product portfolio is broader and includes product like REMICADE, CAELYX, CERAZETTE, SUBOXONE, and now BRIDION. Along the same line product like NASONEX, PEGINTRON, and NOXAFIL have even broader indications in international markets, which may provide additional growth potential for these brands over time.

Maximizing geographic opportunity is a critical component of our lifecycle management plans. As Fred mentioned, we've seen our country performance in Japan transformed through the launches of PEGINTRON, TEMODAR, ZETIA and most recently NASONEX. Combined with future opportunities, including REMERON, ASMANEX, and sugammadex, each currently under regulatory review in Japan, we believe there may be good growth potential over time in this important market.

In the U.S., our business environment is particularly challenging. We have recently taken steps to address some of these marketplace dynamics through PTP, including the reduction in the size of our U.S. sales force and the launch of a new selling model for our primary care sales team. This new approach is tailored to individual prescribers' interests and focuses on better capturing local opportunity. Because we place such a high value on our sales professionals, we worked hard to retain high performers and to preserve the important customer relationships that they have built over time.

Turning to product results for the quarter. Sales from our Global Cholesterol franchise were down 13% to $1.1 billion. We continue to see sharp differences between the U.S. and international markets in sales of our cholesterol products. Outside the U.S., franchise sales increased 37%, driven by strong performance across much of Europe as well as Japan.

We are pleased to report that ZETIA is benchmarking well with other major launches in Japan. In the U.S., franchise sales were down 29% versus the prior year, consistent with declines in prescription volumes. We have seen a continued shift towards generic preference in U.S. managed markets, including Medicare Part D.

For 2009, we expect both VYTORIN and ZETIA to have competitive second-tier access in line with other branded cholesterol-lowering medicines. VYTORIN and ZETIA each continue to have an important role in lowering LDL cholesterol. VYTORIN gets more patients to goal than the competition. In head-to-head clinical trials using comparable doses, 52% of patients taking VYTORIN achieved their LDL cholesterol goal versus only 35% with Crestor. More than twice the number of VYTORIN patients achieved their LDL goal versus LIPITOR, and more than six times the number of VYTORIN patients achieved their LDL goal versus simvastatin.

ZETIA used alone or in combination provides physicians flexibility to help get their patients to goal, especially for those patients who cannot tolerate higher dose statin. We will continue to remain focused on the many patients who require the dramatic LDL cholesterol lowering that VYTORIN and ZETIA can both provide.

Turning to immunology, we are delighted with the strong performance of REMICADE with sales increasing 32% to $564 million. A key to this excellent performance has been the good growth across all indications despite increasing competition. Although the utilization of biologics has increased, market penetration in Europe is still substantially lower than in the U.S. and with our growing strength and expertise in this segment we believe that REMICADE and in the future once monthly golimumab, position us for long-term in both the hospital and office based settings. We're very excited about participating in the 70% of the market which is currently occupied by subcutaneous anti-TNF therapies.

In allergy, global NASONEX sales increased 6% with our international markets continuing to deliver strong double-digit growth. NASONEX remains the leader among all nasal and health steroids with a global value share of more than 45%.

Our teams have done an excellent job, blunting the uptake of Veramyst. We are also excided about the opportunity to extend our leadership position with the launch of NASONEX in Japan just a few weeks ago.

In the U.S., NASONEX sales fell 8%. We are pleased however that NASONEX market share has held firm against increasing competitive pressures. I also want to cover our new portfolio in women's healthcare and CNS.

I've been very pleased to see the enthusiasm of our people and the strong performance of our women's healthcare franchise in many countries around the world. In first half IMS data, we have seen NUVARING, CERAZETTE and IMPLANON each deliver strong double digit growth versus the prior year.

From contraception to fertility, our women's healthcare franchise is among the broadest in the world today and our pipeline should keep us in a leadership role in the future. In CNS, sugammadex or BRIDION as it is called in Europe is in the very early stages of its launch roll-out as an agent to reverse muscle blockade during anesthesia.

BRIDION has the potential to modernize and transform the practice of anesthesia around the world though changing paradigm takes time. Early feedback from physicians already using BRIDION has been extremely positive. We are proud to be associated with such an important treatment innovation for anesthesiologists, for surgeons and for their patients.

In the U.S., our CNS product asenapine remains under review with the FDA. Review of asenapine has taken longer than we expected. We look forward to FDA response, but we do not have any additional information at this time.

In summary, we continue to execute on our core strategy. We will optimize our product investments to build new growth drivers over time and our people are committed to continuing to build a high performance company for the long-term. Now, let me turn the call back to Janet.

Janet M. Barth - Vice President, Investor Relations

Thank you Carrie, Marsha, we would now like to open up the call for the question and answer session.

Question And Answer

Operator

Thank you ma'am. [Operator Instructions]. Your first question comes from the line of Chris Schott with J.P. Morgan.

Chris Schott - J.P. Morgan

Great. Thank you. Just a couple of questions on ZETIA-VYTORIN franchise, can you talk a little bit more on your outlook for the formulary status in the U.S., I guess, specifically as it relates to Medicare part D looking out to 2009? And I guess just what percent accounts you are targeting to get to tier II with this franchise looking out to next year? And along the same lines, talk about the investment associated with cholesterol JV right now, are you rescaling any of your investment level on this business given what appears to be lower sales base on the U.S. side? Thanks.

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

Very good questions Chris. Carrie?

Carrie S. Cox - Executive Vice President and President, Global Pharmaceuticals

In general if you look at the availability of the products going forward currently and as we anticipate it could be for 2009, we feel very comfortable that there is good access. As I mentioned, we believe we have very competitive second tier access for our products, and we are quite comfortable with that. We also are continuing to have a market leading share with [ph] the sales force promotion with these products and again we're comfortable with the promotional levels we have; we reassess them continually, but we think we are in a good position now.

It's clear there's continuing generic pressure across the entire market; we see this to be similar to other large categories in the U.S. but there continues to be a strong role for the high performance products with significant impact on LDL like VYTORIN and ZETIA.

Fred Hassan - Chairman and Chief Executive Officer

So, I think Chris what really is needed is more work on LDL and I think when it comes to be stronger product, the more effective products, they have a very important role to play. And we do not see any big new products following the category of product that are on the market at this time. So our goal really is to expand the population that gets to their LDL goal. And next question please.

Operator

Your next question comes from the line of Roopesh Patel with UBS.

Roopesh Patel - UBS

Thanks for taking my questions. I just have a couple of questions, the first one for Fred. If we do experience a global economic slowdown, I was wondering if you could give us your perspective on how deeply that might impact the industry and the company at this time around relative to what we've seen in the past? And then my second question is for Bob. On a year-to-date basis, I see... by my calculations the FX benefit to net income is somewhere in the $0.17 to $0.18 range, that's about 12% to 13% of net income reported so far. I was wondering if you could discuss how the company plans to manage net income exposure to FX headwinds potentially as we look forward to 2009? Thanks.

Fred Hassan - Chairman and Chief Executive Officer

Thank you Roopesh, a very good question. So first, we are encouraged to see the governments are working together around the world to make sure that the downturn is moderate or a mild one. And this interaction is very helpful as you'll recall in the past, this kind of interdependence and interaction has not been very good. So this is a new model and we hope that it will be a mild downturn globally.

We are one of the defensive sectors, and that is one of the advantages of being in the healthcare industry. And within this sector, those companies that have diversity and innovation will always do well. There is always an innovation premium for important products for example a product like REMICADE has done very well in already price controlled economies, because there is a need for a product like that. It creates dramatic results for the patients that benefit from that medicine.

So, we really are working very hard at managing for the new events. We have already demonstrated that we can move with speed and inflexibility when circumstances change around us. And we do believe that if there are more government price controls we will deal with those, but in the end it's the innovation that really drives the premium that companies deserve for their products. And next question please.

Roopesh Patel - UBS

I think the... that was my FX question Fred?

Fred Hassan - Chairman and Chief Executive Officer

So Bob... yes, please.

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

So Roopesh let me talk about FX a little bit. Clearly we have been benefiting both on the top and the bottom line from FX. Now this go to the quarter, the impact on Schering-Plough's standalone this quarter on a top line was about 6% or so or roughly $170 million. And while the percentage that drops to the bottom line will vary based on country and product mix of expenses and inventory movements, and that we estimate that roughly half of that drop to the bottom line.

Now on OBS, remember OBS was not in our sales base in 2007. So that's not included in the 6% SP standalone base. But if you look at the expense base for OBS it's more weighted to outside the U.S., so we would estimate that less than half at 50% would drop for the OBS business on an overall basis when you start to see that contributing starting in the fourth quarter.

Now on a cash flow perspective... on an economic perspective, our largest exposure is to the euro, and given our euro debt and our anticipated euro debt repayments and our euro expense base, those are fairly well balanced from a cash flow perspective. Now there is a P&L impact but from a cash-flow perspective, we are generally well balanced given that euro debt and that euro expense base.

Fred Hassan - Chairman and Chief Executive Officer

Thank you very much. And next question please.

Operator

Your next question comes from the line of Tony Butler with Barclays Capital.

Anthony Butler - Barclays Capital

Thank you very much. The growth of REMICADE continues to be quite strong and really two questions around that. Carrie, what is it about, which in sub indication, can you give us some level of comfort that really is the principle driver, I realize there may be all indications. Which one really is generating the principle driving force there?

And number two you alluded to 70% of the market occupied by subcu therapies, is that also true internationally? And then the third question's around the non-U.S., non-European strategy of the products that you sell in Brazil, China, or Central or Eastern Europe. Can you tell me, what the top three to five products actually are in those countries? Thanks very much.

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

Carrie?

Carrie S. Cox - Executive Vice President and President, Global Pharmaceuticals

Thanks. I think one of the things that we are most excided about with the growth of REMICADE is that we see good growth across all of the indications. And as you know the penetration of use of Biologics in Europe particularly is right now only in a range of about half of that we see in the U.S. and more develop markets. So, we think that there is still potential for the entire category to continue to grow.

Rheumatoid arthritis has been the largest segment of the market and continues of course to be the largest portion of our sales as well. But, we have been delighted to see again consistent growth but I think the GI indications, the use in Crohn's and in ulcerative colitis are some of the others there; they are most exciting because the potential for life changing therapy for patients is there. But also the impact in terms of the available patient force the size of the afflicted populations for those markets is fairly substantial. Sorry, I think Arthritis is important; Psoriasis again the impact that REMICADE can have on patients suffering from severe Psoriasis is pretty outstanding.

So, it's very motivating to physicians and frankly to our people to be able to be part of a product that has such a potential to change people's lives. When you look at the subcu portion of the market that is essentially that 70% refers to the portion where you see Enbrel and Humira sales today.

The reason that's important for us is because, in Europe, particularly the hospitals channel is often where you find REMICADE because of the need for infusion. Now we believe that REMICADE may have the best efficacy profile of all the products out there today. But it does require infusion.

So the opportunity with golimumab in the future to participate in the subcutaneous portion of the market is exciting to us because in some country that takes us into a whole new channel and a new set of prescribers. We think we have built such strength already that we clearly have potential to take that strength into the other portion of the market.

Looking into our emerging market sales, we tend to see particularly in those markets where there's a substantial amount of government business, that the specialty products generally are the ones that are doing the best. These are new areas of treatment for many of these countries where the depths of use of products in these areas such as hepatitis is still fairly low. So there is now more opportunity for treatment.

Our market for example like China represents one third of the hepatitis B opportunity in the world. We do have the hep B indication there as well and you see clearly PEGINTRON is one of the major opportunities for continuing growth in all of those emerging markets.

I was in Russia not too long ago and I was just delighted to see though in a country like that that we are doing extremely well not only with the specialty products but also in growing the primary care portfolio and particularly in women's healthcare. We have a very strong franchise opportunity in China and we're doing well in all those emerging markets. So I'm delighted to see that the potential there continues to be strong.

Fred Hassan - Chairman and Chief Executive Officer

Carrie, I think there is a reimbursed component in every market and there is a private base component and we let our country managers customize the local portfolio to take advantage of the local opportunity.

Carrie S. Cox - Executive Vice President and President, Global Pharmaceuticals

Yes.

Fred Hassan - Chairman and Chief Executive Officer

But, it's good to have a broad range of products available.

Carrie S. Cox - Executive Vice President and President, Global Pharmaceuticals

Yes.

Fred Hassan - Chairman and Chief Executive Officer

Okay. Thank you Tony and next one please.

Operator

Your next question comes from the line of David Risinger with Merrill Lynch.

Fred Hassan - Chairman and Chief Executive Officer

David?

David Risinger - Merrill Lynch

Yes, hi. Thanks so much for taking the question. In terms of currency you provided a little bit more color this quarter, but Bob I was hoping you could be a little bit more specific about the currency benefit for Organon's top line you said less than half would drop to the bottom line, but if you could characterize that for us so that we can understand the Organon piece? And then in terms of the joint venture, there is obviously a currency benefit there given that the IP is in Singapore, if you could help us understand the currency benefit for the joint venture also. Thank you.

Fred Hassan - Chairman and Chief Executive Officer

Bob.

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

Yes, I am always talking Organon first. If you look at the overall percentage impact which is roughly 6% for Schering-Plough on a standalone basis, while the skewing maybe a little bit weighted outside the U.S for Organon, it wouldn't change that 6% materially. And so there is a bit of an incremental revenue base if we were to do on a pro forma basis David, that would drop but again it would be less than the 50%, obviously what we're seeing right now. Now going forward that could vary, it could vary by inventory movements, it could vary by inventory mix that's kind of what we're seeing right now.

Fred Hassan - Chairman and Chief Executive Officer

And I think Bob, it is fair to say, that country makes matters a lot. We have for example a very important animal health business that happens to be a very large business in a country like Brazil, which is not in the Euro zone. So, we need to be looking at a... the diverse portfolio that we have here that gives us lot of shelter.

David Risinger - Merrill Lynch

And inter-company sourcing... inter-company product sourcing also impacted [ph].

Fred Hassan - Chairman and Chief Executive Officer

Yes. And, we'll give more color David next year on this subject as we also understand the full cost base of Organon in countries outside the U.S., but there is a lot of natural hedges here in our company as we go forward. But, we do recognize that foreign exchange is going to affect all companies with international operations. And next question please.

Operator

Your next question comes from the line of John Boris with Citi.

John Boris - Citigroup

Thanks for taking the questions. Bob, can you just remind us exiting 2007 what NOLs were and through third quarter of '08 what cumulative NOLs were through 3Q '08? And then on R&D, is it possible to get any update on your response on sugammadex to the non approvable and what additional work you might have to on sugammadex in the U.S.? And then also on asenapine, was there no official action on asenapine and what is the status of asenapine around the world? Thanks.

Fred Hassan - Chairman and Chief Executive Officer

I will ask Bob to answer the first question and our head of R&D Tom Koestler who is overseas at this time but calling in, he will answer the R&D questions. Bob?

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

First up John, on the NOL coming into the year at the end of '07, we had roughly 1.7 billion or so of net operating losses. Now as we indicate in our SEC and 10-Q filings some of that could be used to settle ongoing lot of issues and we have disclosed that. With respect to where we are, we do that once a year John. So that will be in the 10-K cause I think it's very bogged [ph] throughout each individual quarter. And those tax updates on a tax basis gets done once a year. So, we will disclose that at the end of the year. But we have not need from a cash standpoint to access international cash to fund U.S. operation of that option.

John Boris - Citigroup

And, Tom Koestler?

Thomas P. Koestler - Executive Vice President and President, Schering-Plough Research Institute

Yes John, thanks for the question on sugammadex. This is... as you know, we are fully committed to working with FDA to bring sugammadex to market in the U.S. over time. But it's a process, and the first step will be to have a meeting with the agency, we have not yet had that meeting with agency but we will in fact have one. And at that meeting we just learn about the FDA's expectation and work with them to find a common pathway forward. So that will be a process and we'll keep you updated along the way as we go forward.

With reference to asenapine, yes, the FDA has missed their PDUFA date, their action date. The application remains under review. And as we've mentioned before in terms of outside the U.S., the European Union requires a very specific trial called arevas [ph] maintenance trial and that trial is still underway, and we expect to get results from that trial sometime early next year and hopefully by the time we get... may perhaps by the time we get the R&D date we might be able to give you a little more color on that. Thanks for the question.

Fred Hassan - Chairman and Chief Executive Officer

Thank you, Tom and next question please.

Operator

Your next question comes from the line of Craig Baskin with Putnam Investment.

Fred Hassan - Chairman and Chief Executive Officer

Hi, Craig.

Craig Baskin - Putnam Investment

Thanks for taking my question. I only have one left that's not been asked. Bob, you talked about $1 billion of debt being retired this year, but if I look at interest expense over the last three quarters it was pretty flat. So, I am hoping that you could explain why that's so, if that has been retired?

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

Sure, Craig. The majority of $600 million that was done just this quarter... this past quarter

Craig Baskin - Putnam Investment

Okay.

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

So, if you look at it today Craig, we have roughly $8.4 billion of debt outstanding

Craig Baskin - Putnam Investment

Yes.

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

And I would say the current annual run rate on interest is going to be in the low five... there's some variable debt there that can move around, but in the low $500 million range.

Craig Baskin - Putnam Investment

Okay, great. Thank you.

Fred Hassan - Chairman and Chief Executive Officer

And Bob do you want to draw a bit public information about the next front that has to be repaid?

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

Next maturity... we don't have maturities until 2010 and that's a €500 million debenture.

Craig Baskin - Putnam Investment

So, our free cash flow is quite strong?

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

We have no maturities due in 2008 and 2009.

Fred Hassan - Chairman and Chief Executive Officer

Thank you. And next question please.

Operator

Your next question comes from the line of Barbara Ryan with Deutsche Bank.

Fred Hassan - Chairman and Chief Executive Officer

Barbara?

Barbara Ryan - Deutsche Bank

Good morning. I guess, Fred you highlighted for us a number of things, I mean number one that the industry is defensive and number two within the industry you are more diversified and don't have the punishing impact at generic competition that many of your peers face. And so I am just wondering in light of those things and the uncertain environment, don't you feel some sort of obligation to give some earnings guidance. I mean you are the only one of your peers that hasn't done that?

Fred Hassan - Chairman and Chief Executive Officer

Barbara, if you'll recall I have been CEO elsewhere and I did have guidance there, so I am not against guidance. It's just that under the circumstances and given the fact that Schering-Plough has been through a lot of transition and has important alliances with large products with partners and the fact that we did OBS, that's just caused us to pause when it comes to giving numerical guidance.

But the issue is going to be looked at repeatedly inside the company and at the right time we'll certainly see if we would want to do that. We're not totally opposed to it even though some companies have said that it promotes short-term behavior, we're much more pragmatic about it. But at this point this is not the right time, especially in light of what's happened in the global environment in the last month or so. But, hopefully in the future we might be able to give more color on our policy and guidance.

Barbara Ryan - Deutsche Bank

Thank you for your honest answer. I appreciate it.

Fred Hassan - Chairman and Chief Executive Officer

Thank you Barbara. Next one.

Operator

Your next question comes from the line of Bert Hazlett with BMO Capital Markets.

Robert Hazlett - BMO Capital Markets

Thanks I've got a couple. First, when should we see the impact or begin to see the impact of the most recent sales force changes or alignment in the U.S. And then two pipeline questions; Fred, specifically to you, Novartis continues to mention in their pipeline and in the presentation, a respiratory collaboration with you. Our tracking indicates that's in Phase III and it's in wrap... it's wrapping up here, maybe a filing in 2009 and another one in 2010. So, my question is given the significance of this combination, a potential significance, is this meaningful to Schering-Plough, when do we get clarity on terms and more importantly when do we get clarity on data for this?

And then the last, given the golimumab and another pipeline question, given the significance of the GO-AFTER data, should we be considering golimumab for second line initially in RA, thanks.

Fred Hassan - Chairman and Chief Executive Officer

Very good questions. A lot of these are going to be answered in some detail at the R&D Day. But I can show you that we are very excited about the MFF product, which as you'll recall is a product in the Advair space and we have had a successful launch of ASMANEX in the U.S., we also have a product called FORADIL on the market in the U.S., this would be a combination product similar to the category that Advair belongs to and we are absolutely committed to the respiratory space.

We are one of the innovators in this area from the past, and the way we've invested in this area and especially new approaches like the GRAZAX vaccine that we're working on just shows our commitment to this space. And you'll learn a lot more on this in R&D day. Tom Koestler, anything you would like to add to these questions [ph] that were asked?

Thomas P. Koestler - Executive Vice President and President, Schering-Plough Research Institute

No, Fred I think you covered the MFF, we will provide some color on that market at the R&D day next month. So I would... we'll be... I will give you some good color on that. And then as far as the... to go after your question on second line and first line positioning for golimumab, golimumab is under regulatory review as you know and... for both RA, starting with rheumatoid arthritis and ankylosing spondylitis and we have an ongoing trial in ulcerative colitis as well.

So that's under regulatory review. So I think it will pretty mature for us to make any comment on online positioning and total regulators get through their review but maybe we will also be able to provide some more color at the R&D day. Thanks for you question.

Fred Hassan - Chairman and Chief Executive Officer

And, Carrie will give a brief response to the field force question. Carrie?

Carrie S. Cox - Executive Vice President and President, Global Pharmaceuticals

The changes in the U.S. field force were done to be effective for October 1st. We are nearly through the training stages and the alignments that are necessary and I think right now our people are feeling pretty good, pretty energized and very focused on the future.

Fred Hassan - Chairman and Chief Executive Officer

Thank you. And next question, please.

Operator

Your next question comes from the line of Jamie Loubens [ph] with Goldman Sachs.

Fred Hassan - Chairman and Chief Executive Officer

Hi Jamie.

Unidentified Analyst

Hi, just a quick question on gross margins. The gross margins were about flat with where they were last year in the third quarter and while I understand there's seasonality, I am just curious to know why you weren't able to show some improvement?

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

Okay, I would be happy to. Thank you, Jamie for the question. Here is what really happened. You look at it, Jamie, we had REMICADE, we had AVELOX and CIPRO from there, I would say some higher animal health kind of pulling down the margins, that's some of the product mix issues. While saying that was generally a higher margin on the Organon products that we had. When you look at those two net together, it roughly was flattening out. Going forward, Jamie, as we have said, gross margins are going to be a function of product mix and as REMICADE and animal health business grow we will put some downward pressure on the gross margin. I think longer term we are looking at gaining manufacturing efficiencies from our PTP program and also our new product launches going forward should help the product margin.

Unidentified Analyst

Thank you.

Fred Hassan - Chairman and Chief Executive Officer

Jamie, we are fortunate that some of the newer products that have entered our portfolio are high margin products. The women's health products have very good margins.

Unidentified Analyst

Okay. Just as a follow... can I just follow up. Is it safe to assume that without those new product launches in the U.S. and with the growing contribution of REMICADE and the expected launch of golimumab next year and the change in royalty rate, is it safe to assume that we should continue to see sort of flattish to potentially pressure on the gross margin line at least until we start to see new product launches in U.S.?

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

I think that's right Jamie, but just keep in mind though, as we grow REMICADE we make bottom-line profits, so our margin line may get a little pressure, the operating margin line improves, so just keep that in mind as you go forward.

Unidentified Analyst

Right. Okay, thank you.

Fred Hassan - Chairman and Chief Executive Officer

Next question please.

Operator

Your next question comes from the line of Steve Scala with Cowen.

Steve Scala - Cowen and Company

Thank you, I've two questions. First, traditionally Q3 has not been the strongest quarter for non-ethical businesses and there would appear to be both seasonal and economic reasons why Animal Health would not have had a great quarter yet you delivered a quarter-over-quarter acceleration, so is there anything unusual in Q3, not known as of the revenue such as maybe new launches or stocking that boosted this quarter?

And secondly has Schering looked at all available public and non-public data on VYTORIN including registrational trials to see if there's a cancer signal. The recent New England Journal of Medicine article did not consider all available data, so I am wondering if you've done that analysis? Thank you.

Fred Hassan - Chairman and Chief Executive Officer

So I'll ask Tom Koestler to answer the second question. Bob, I guess it's fair to say that at least in consumer healthcare this year the allergy season has not been that great. So VYTORIN has been affected on the... in the unfavorable direction. In Animal Health I think it's been innovation driven. Yes.

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

There's also a couple of things in Animal Health that we still have still increasing market penetration for the bluetongue vaccine which started in Q2. We've also had a patented fish vaccine that was launched in the quarter. So those are two areas in animal health and are helping us, really new product launches.

Fred Hassan - Chairman and Chief Executive Officer

Yes. It's too early to tell what the economic cycle is going to be when it comes to farm animals, but we're in very good shape because of the strong innovation cycle that we have in that space. And Tom Koestler if you can answer the second question please?

Thomas P. Koestler - Executive Vice President and President, Schering-Plough Research Institute

Hello, Steve. The way I would answer your question is that as you know Sir Richard Peto and his colleagues in Oxford concluded that if you take the randomized control trials which you see is sharp and improve it together, there's no evidence to provide any credible evidence on the adverse effect on cancer. So it's the joint venture's belief right now that cancer finding and seize is likely to be an anomaly. They are taken in light of all the available data, does not support an association at all with VYTORIN. In fact, the meta-analysis conducted by Petoand his colleagues in over 20,000 patients in these going trials is pretty persuasive.

I'd also add that there's no preclinical evidence of oncogenecity and is out of my carcinogenicity studies. So, as appropriate, the BSMBs will depend at monitoring review boards will continue to monitor these trials going forward. But just to conclude again, we don't... we think that this is an anomaly.

Fred Hassan - Chairman and Chief Executive Officer

Okay, thank you. And next question please.

Operator

Your next question comes from the line of David Moskowitz with Caris & Company.

David Moskowitz - Caris & Company

Yes, thanks. Good morning guys. Fred, you had mentioned something... there was something I had read in the press about the global credit crisis having an impact on international sales. I know, there was an earlier question about that, but could you specifically talk about what you meant when you were making those comments? Are there... is there anything out there in Europe or other markets internationally that we need to think about, from my perspective its government sponsored coverage; so, like some clarification on that? And also just on some pipeline questions, number one, is ZETIA atorvastatin product, is ZETIA a Lipitor product, is that still moving, could you give us an update on where that stands, and also could you just quickly name the products that you're most excited about in the late-stage pipeline, the top 10 products that you talked about? Thanks.

Fred Hassan - Chairman and Chief Executive Officer

Okay. So, in terms of the product that are the most exciting as far as I am concerned, it's obviously TRA that looks like very, very interesting product. And the Phase II trials have been very encouraging and it is a large space; if you look at the global rank order of sales in products you are looking at Lipitor and then you're looking at Plavix, so we are in here in a space that looks very interesting to us and the Phase II trials give us a lot of encouragement. When it comes to the comment on the global economy, in fact, I do claim a little credit for being a little early on the comments regarding Europe because at that time we were focusing entirely on the U.S. and we are a global economy and things happen around the world.

On the positive side, the European governments are very sensitive about the access to healthcare in their own populations and when we have important products like NOXAFIL, like sugammadex, like REMICADE in environments like these, we feel pretty secure that these are the kinds of products that will be protected even as healthcare budgets get tighter and Tom Koestler any comments on the last question?

Thomas P. Koestler - Executive Vice President and President, Schering-Plough Research Institute

No, but I think that what I would add just Fred is that we are pretty excited, we are looking forward to the R&D day and I think you will get a good flavor at our R&D day. We will update you on our rate phase portfolio and we will also give you some insight into some of our earlier programs that we haven't talked about before as well as the Biologics. So, I would just say that's all... only a month away and we will have an opportunity to share that information with you then.

David Moskowitz - Caris & Company

And ZETIA atorvastatin?

Fred Hassan - Chairman and Chief Executive Officer

Yes. So, Tom, anything on the combo?

Thomas P. Koestler - Executive Vice President and President, Schering-Plough Research Institute

Yes, the combination is, the joint venture is working towards the goal as we have reported in the past, that full process is underway and our goal is to have that program viable at the time prior to the patent exploration.

David Moskowitz - Caris & Company

Will that be something that you'll talk about at the R&D day?

Thomas P. Koestler - Executive Vice President and President, Schering-Plough Research Institute

We will see.

Fred Hassan - Chairman and Chief Executive Officer

We do note that now the timing of that event might be November 2011, so, there is some time for Tom and his colleagues have more to work on this project. I think we have time for one more question.

Operator

Your final question comes from the line of Tim Anderson with Sanford Bernstein.

Thomas P. Koestler - Executive Vice President and President, Schering-Plough Research Institute

Tim?

Tim Anderson - Sanford Bernstein

Hi, thanks. There's been concern the some sort new negative analysis may surface at the upcoming HA [ph] related to SEAS data that first came out in July and I'm wondering if you are aware any such analyses being performed, if you can otherwise talk about SEAS news flow that we may have over the next few months, if any from Schering or Merck or otherwise? And a question going back to Carrie's comments on formulary positioning, are you saying you don't expect any disproportionate slippage in tier II formulary coverage for VYTORIN for ZETIA relative to the other cholesterol drugs as you go into 2009 needed for Medicare's commercial plan?

Fred Hassan - Chairman and Chief Executive Officer

So I will ask Carrie to answer the second question first and then we will come back to Tom.

Thomas P. Koestler - Executive Vice President and President, Schering-Plough Research Institute

Okay.

Carrie S. Cox - Executive Vice President and President, Global Pharmaceuticals

When you look at the formulary access going forward and the availability of the products and remember formulary is only one type of availability, we feel confident that we have good access that is competitive to the other branded statins. It is clear, however, that across the entire category there is a growing preference in the managed care segment for the use of generics compared to other branded products however, we've remained in a competitive position.

Tim Anderson - Sanford Bernstein

And Carrie it's fair to say that at some point people are going to become more aware again of the need to get people to the LDL goals. And in that regard there are very, very few products that can do that.

Carrie S. Cox - Executive Vice President and President, Global Pharmaceuticals

Yes, so...

Tim Anderson - Sanford Bernstein

In the high risk patients.

Carrie S. Cox - Executive Vice President and President, Global Pharmaceuticals

We do see that there is some diminution in second tier access compared to 2008; we are very comfortable that that also has occurred across the category for the branded products and therefore we remain competitive.

Tim Anderson - Sanford Bernstein

Thank you Carrie. And Tom?

Thomas P. Koestler - Executive Vice President and President, Schering-Plough Research Institute

Yes Tim, we are not aware of any data being presented in the near term. As you know, we had full data presentation from SEAS which is already presented of the European society of Cardiology and it was published in the New England Journal of Medicine just this September. So, we are not aware of any new negative data and if of course that there is some information that is going to be presented we would trust that would be handled in a appropriate scientific fashion and given the appropriate scientific process.

Tim Anderson - Sanford Bernstein

And, how about just rehashing the prior data that was presented July, because I think that's the concern?

Thomas P. Koestler - Executive Vice President and President, Schering-Plough Research Institute

Yes, Tim, but again, as I said there's really no new data. There's been pretty good transparency on the full disclosure of the SEAS trial already and so we are not aware of any new data being presented.

Tim Anderson - Sanford Bernstein

Thank you,Thanks.

Robert J. Bertolini - Executive Vice President and Chief Financial Officer

Yes. So, Tom if I can just add to that while there is... we are not aware of any new data being presented and there's always a chance that people could rehash data and present it before.

Fred Hassan - Chairman and Chief Executive Officer

Yes. And I think we're now at the end of our call. I just like to say that the OBS Integration is succeeding and adding value with better strength and diversity on many fronts. Our strong late stage pipeline and exclusivity profile on key products gives us special edge as we look ahead. And in a tough environment we are showing that we can power through. Thank you very much for joining us in this morning's call.

Operator

This concludes today's Schering-Plough third quarter earnings conference call. You may now disconnect. .

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