10-K 1 d10k.htm ANNUAL REPORT FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005 Annual Report for the Fiscal Year Ended December 31, 2005

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 


 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2005

 

Commission File Number 1-1136

 


 

BRISTOL-MYERS SQUIBB COMPANY

(Exact name of registrant as specified in its charter)

 


 

Delaware   22-0790350

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

345 Park Avenue, New York, N.Y. 10154

(Address of principal executive offices)

Telephone: (212) 546-4000

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class


 

Name of each exchange on which registered


Common Stock, $0.10 Par Value  

New York Stock Exchange

Pacific Exchange, Inc.

$2 Convertible Preferred Stock, $1 Par Value  

New York Stock Exchange

Pacific Exchange, Inc.

 

Securities registered pursuant to Section 12(g) of the Act: None

 


 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer    x

  Accelerated filer    ¨           Non-accelerated filer    ¨        

 

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 

The aggregate market value of the 1,958,265,784 shares of voting common equity held by non-affiliates of the registrant, computed by reference to the closing price as reported on the New York Stock Exchange, as of the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2005) was approximately $48,917,479,284. Bristol-Myers Squibb has no non-voting common equity. At February 14, 2006, there were 1,959,073,035 shares of common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Proxy Statement for the registrant’s Annual Meeting of Stockholders to be held May 2, 2006 are incorporated by reference into Part III of this Annual Report on Form 10-K.

 



PART I

 

Item 1. BUSINESS.

 

General

 

Bristol-Myers Squibb Company (which may be referred to as Bristol-Myers Squibb, BMS or the Company) was incorporated under the laws of the State of Delaware in August 1933 under the name Bristol-Myers Company, as successor to a New York business started in 1887. In 1989, Bristol-Myers Company changed its name to Bristol-Myers Squibb Company as a result of a merger. The Company, through its divisions and subsidiaries, is engaged in the discovery, development, licensing, manufacturing, marketing, distribution and sale of pharmaceuticals and other health care related products.

 

Acquisitions and Divestitures

 

In January 2006, the Company completed the sale of its inventory, trademark, patent and intellectual property rights related to DOVONEX*, a treatment for psoriasis in the United States, to Warner Chilcott Company, Inc. for $200 million in cash. In addition, the Company will receive a royalty based on 5% of net sales of DOVONEX* through the end of 2007. As a result of this transaction, the Company expects to recognize a pre-tax gain of approximately $200 million ($126 million net of tax) in the first quarter of 2006, subject to certain post-closing adjustments.

 

In 2005, the Company completed the sale of its U.S. and Canadian Consumer Medicines business and related assets (Consumer Medicines) to Novartis AG (Novartis). Under the terms of the agreement, Novartis acquired the trademarks, patents and intellectual property rights of the U.S. and Canadian Consumer Medicines business and the rights to the U.S. Consumer Medicines brands in Latin America, Europe, the Middle East and Africa. The results of operations of Consumer Medicines are included in the Company’s consolidated statement of earnings up to the date of disposal. As a result of this transaction, the Company recorded a pre-tax gain of $569 million ($370 million net of tax) in the third quarter of 2005 subject to certain post-closing adjustments.

 

In May 2005, the Company completed the sale of Oncology Therapeutics Network (OTN) to One Equity Partners LLC for cash proceeds of $197 million, including the impact of a working capital adjustment. The Company recorded a pre-tax gain of $63 million ($13 million net of tax) that was presented as a gain on sale of discontinued operations in the consolidated statement of earnings. OTN was previously presented as a separate segment.

 

Bristol-Myers Squibb Website

 

The Company’s internet website address is www.bms.com. The Company makes available free of charge on its website its annual, quarterly and current reports, including amendments to such reports, as soon as reasonably practicable after the Company electronically files such material with, or furnishes such material to, the United States Securities and Exchange Commission (SEC).

 

Information relating to corporate governance at Bristol-Myers Squibb, including the Company’s Standards of Business Conduct and Ethics, Code of Ethics for Senior Financial Officers, Code of Business Conduct and Ethics for Directors, (collectively, the “Codes”), Corporate Governance Guidelines, and information concerning the Company’s Executive Committee, Board of Directors, including Board Committees and Committee charters, and transactions in Bristol-Myers Squibb securities by Directors and executive officers, is available on the Company’s website at www.bms.com under the “Investors—Corporate Governance” caption and in print to any stockholder upon request. Any waivers to the Codes by directors or executive officers and any material amendment to the Code of Business Conduct and Ethics for Directors and Code of Ethics for Senior Financial Officers will be posted promptly on the Company’s website. Information relating to stockholder services, including the Company’s Dividend Reinvestment Plan and direct deposit of dividends, is available on the Company’s website at www.bms.com under the “Investors—Stockholder Services” caption.

 

The Company incorporates by reference certain information from parts of its proxy statement for the 2006 Annual Meeting of Stockholders. The SEC allows the Company to disclose important information by referring to it in that manner. Please refer to such information. The Company’s proxy statement for the 2006 Annual Meeting of Stockholders and 2005 Annual Report are available on the Company’s website (www.bms.com) under the “Investors—SEC Filings” caption.

 

Business Segments

 

The Company has three reportable segments—Pharmaceuticals, Nutritionals and Other Health Care. The Pharmaceuticals segment is made up of the global pharmaceutical and international consumer medicines business. The Nutritionals segment consists of Mead Johnson Nutritionals (Mead Johnson), primarily an infant formula and children’s nutritionals business. The Other Health Care segment consists of ConvaTec, Medical Imaging and Consumer Medicines (U.S. and Canada) businesses. For additional information about these segments, see “Item 8. Financial Statements—Note 17. Segment Information.”

 

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Pharmaceuticals Segment

 

The Pharmaceuticals segment competes with other worldwide research-based drug companies, smaller research companies and generic drug manufacturers. The Company is nearing the end of transitioning its pharmaceutical portfolio away from products which have lost or are expected to lose exclusivity towards growth drivers and other new products which have resulted from the Company’s focus on areas with significant unmet medical needs. The Company has experienced substantial revenue losses in the last few years due to the expiration of market exclusivity for certain of its products. For 2006, the Company estimates reductions of net sales in the range of $1.4 billion to $1.5 billion from the 2005 levels for products which have lost or will lose exclusivity in the period from 2003 to 2006, primarily GLUCOPHAGE* XR (Extended Release) and GLUCOVANCE* in the United States, TAXOL® (paclitaxel) in Europe, PRAVACHOL in the United States and Europe and CEFZIL in the United States. In 2007, revenue reductions due to exclusivity losses are anticipated to begin to moderate from 2006 levels, as no major new exclusivity losses are expected. The timing and amounts of sales reductions from exclusivity losses, their realization in particular periods and the eventual levels of remaining sales revenues are uncertain and dependent on the levels of sales at the time exclusivity ends, the timing and degree of development of generic competition (speed of approvals, market entry and impact) and other factors.

 

Anticipated decreases in revenue during 2006 due to continued exclusivity losses are expected to be more or less offset by growth in net sales of the Company’s growth drivers and potential new products during the same period. These products include PLAVIX*, AVAPRO*/AVALIDE*, ABILIFY*, REYATAZ, ERBITUX*, BARACLUDE, ORENCIA and EMSAM*. The Company’s compounds in late stage development include dasatinib for adult chronic mylogenous leukemia, ixabepilone for metastatic breast cancer, belatacept for solid organ transplantation rejection, vinflunine for cancer, ipilimumab for cancer and saxagliptin for diabetes. Expectations of continued sales growth are subject to competitive factors, the outcome of the PLAVIX* patent litigation discussed below, and risks inherent in product development and regulatory approval. Gross margins are expected to stabilize in 2006 as the relatively high margins realized on the sale of the growth drivers and certain new or recently launched products more or less offset lower margins on products that have lost or are expected to lose exclusivity. Earnings will be adversely affected by the Company’s investments to support the introduction of new products and the development and launch of additional new compounds. In 2007, based on management’s current estimates of growth of the Company’s growth drivers and new product launches as well as the expected realization of productivity savings, the Company expects to begin to enter a period of sustained growth.

 

The Company’s expectations of future sales growth include substantial expected increases in sales of PLAVIX*, which had net sales of $3.8 billion for 2005, and is currently the Company’s largest product ranked by net sales. The composition of matter patent for PLAVIX*, which expires in 2011, is currently the subject of litigation in the United States, with a trial scheduled to begin in June 2006. Similar proceedings involving PLAVIX* are ongoing in Canada. There are no patent enforcement proceedings outside of the U.S. and Canada. The Company continues to believe that the patent is valid and that it is infringed, and with its alliance partner and patent-holder Sanofi-Aventis (Sanofi), is vigorously pursuing these cases. It is not possible at this time reasonably to assess the outcome of these litigations, or if there were an adverse determination in these litigations, the timing of potential generic competition for PLAVIX*. Apotex Inc. and Apotex Corporation (Apotex) announced that in January 2006 it had received final approval of its aNDA for clopidogrel bisulfate from the U.S. Food and Drug Administration (FDA). Accordingly, Apotex could decide to launch a generic product at risk at any time. Such generic competition would likely result in substantial decreases in the sales of PLAVIX* in the United States. The loss of market exclusivity of PLAVIX* and the subsequent development of generic competition would be material to the Company’s results of operations and could be material to its financial condition and liquidity.

 

The Company and its subsidiaries are the subject of a number of significant pending lawsuits, claims, proceedings and investigations. It is not possible at this time reasonably to assess the final outcome of these investigations or litigations. Management continues to believe, as previously disclosed, that during the next few years, the aggregate impact, beyond current reserves, of these and other legal matters affecting the Company, if not favorably resolved, is reasonably likely to be material to the Company’s results of operations and cash flows, and may be material to its financial condition and liquidity. The Company’s expectations for 2006 and 2007 described above do not reflect the potential impact of litigation on the Company’s results of operations.

 

For more information about these and other matters, see “—Products,” “—Competition” and “—Research and Development” below, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Outlook,” and “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies.”

 

Products

 

Most of the Company’s pharmaceutical revenues come from products in the following therapeutic classes: cardiovascular; virology, including human immunodeficiency virus (HIV); other infectious diseases; oncology; affective and other (psychiatric) disorders; and metabolics.

 

In the pharmaceutical industry, the majority of an innovative product’s commercial value is usually realized during the period in which the product has market exclusivity. Market exclusivity is based upon patent rights and/or certain regulatory forms of exclusivity. In the U.S. and some other countries, when these patent rights and other forms of exclusivity expire and generic versions

 

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of a medicine are approved and marketed, there are often very substantial and rapid declines in the sales of the original innovative product. The Company’s business is focused on innovative pharmaceutical products, and the Company relies on patent rights and other forms of protection to maintain the market exclusivity of its products. For further discussion of patents rights and regulatory forms of exclusivity, see “—Intellectual Property and Product Exclusivity” below. For further discussion of the impact of generic competition on the Company’s business, see “—Generic Competition” below.

 

The chart below shows the net sales of key products in the Pharmaceuticals segment, together with the year in which the basic exclusivity loss (patent rights or data exclusivity) occurred or is currently estimated to occur in the United States, the European Union (EU) and Japan. The Company also sells its pharmaceutical products in other countries; however, data is not provided on a country-by-country basis because individual country sales are not significant outside the United States, the EU and Japan. In many instances, the basic exclusivity loss date listed below is the expiration date of the patent that claims the active ingredient of the drug or the method of using the drug for the approved indication. In some instances, the basic exclusivity loss date listed in the chart is the expiration date of the data exclusivity period. In situations where there is only data exclusivity without patent protection, a competitor could seek regulatory approval by submitting its own clinical trial data to obtain marketing approval prior to the expiration of data exclusivity.

 

The Company estimates the market exclusivity period for each of its products on a case-by-case basis for the purposes of business planning only. The length of market exclusivity for any of the Company’s products is impossible to predict with certainty because of the complex interaction between patent and regulatory forms of exclusivity and the inherent uncertainties regarding patent litigation. Although the Company provides these estimates for business planning purposes, these are not intended as an indication of how the Company’s patents might fare in any particular patent litigation brought against potential infringers. There can be no assurance that a particular product will enjoy market exclusivity for the full period of time that appears in the estimate or that the exclusivity will be limited to the estimate.

 

Pharmaceutical Products


   2005

   2004

   2003

  

Past or Currently
Estimated
Year of

U.S. Basic
Exclusivity Loss


  

Past or Currently
Estimated

Year of

EU Basic
Exclusivity Loss (a)


 

Past or Currently
Estimated

Year of

Japanese Basic
Exclusivity Loss


(Dollars in Millions)

                  

Cardiovascular

                                  

PLAVIX*

   $ 3,823    $ 3,327    $ 2,467    2011    2013   ++

PRAVACHOL

     2,256      2,635      2,827    2006    2002-2007   ++

AVAPRO*/AVALIDE*

     982      930      757    2011    2007-2012   ++

COUMADIN

     212      255      303    1997    (b)   ++

MONOPRIL

     208      274      470    2003    2001-2008   ++

Virology

                                  

REYATAZ

     696      414      88    2017    2017   2017

SUSTIVA

     680      621      544    2013    2013   ++

ZERIT

     216      272      354    2008    2007-2011   2008

VIDEX/VIDEX EC

     174      274      267    2001/2004    2001   2001

BARACLUDE

     12              2010    ++   ++

Other Infectious Diseases

                                  

CEFZIL

     259      270      327    2005    2004-2009   ++

Oncology

                                  

TAXOL® (paclitaxel)

     747      991      934    2000    2003   2006-2013(c)

ERBITUX*

     413      261         2017    ++   ++

PARAPLATIN

     157      673      905    2004    2000   1998

Affective (Psychiatric) Disorders

                                  

ABILIFY* (total revenue)

     912      593      283    2014    2009   ++

Metabolics

                                  

GLUCOPHAGE* Franchise

     172      336      948    2000-2004    ++   ++

Immunology

                                  

ORENCIA

                  2016    ++   ++

Note: The currently estimated year of basic exclusivity loss includes any statutory extensions of exclusivity that have been earned, but not those that are speculative. In some instances, there may be later-expiring patents that cover particular forms or compositions of the drug, as well as methods of manufacture or methods of using the drug. Such patents may sometimes result in a favorable market position for the Company’s product, but product exclusivity cannot be predicted or assured.

 

*

Indicates brand names of products which are registered trademarks not owned by the Company or its subsidiaries. Specific trademark ownership information can be found on page 133.

 

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++

The Company does not currently market the product in the jurisdiction indicated.

 

(a)

References to the EU throughout this Form 10-K include the following current 25 member states: Austria, Belgium, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom. In some instances the date of basic exclusivity loss will be different in various EU member states. In such instances, the earliest and latest dates of basic exclusivity loss are listed. For those EU countries where the basic patent was not obtained, there may be data protection available.

 

(b)

EU basic exclusivity expired before BMS acquired the product.

 

(c)

The 6 year data exclusivity expired in 2003. A BMS patent in Japan may preclude generic entry in Japan until 2006 or later.

 

Below is a summary of the indication, intellectual property position, licensing arrangements, if any, and third-party manufacturing arrangements, if any, for each of the above products in the United States and where applicable, the EU and Japan.

 

Cardiovascular

    

PLAVIX*

  

Clopidogrel bisulfate is a platelet aggregation inhibitor, which is approved for protection against fatal or non-fatal heart attack or stroke in patients with a history of heart attack, stroke, peripheral arterial disease or acute coronary syndrome.

    

Clopidogrel bisulfate was codeveloped and is jointly marketed with Sanofi. The worldwide alliance operates under the framework of two geographic territories: one in the Americas and Australia (BMS’s primary territory) and the other in Europe and Asia (Sanofi’s primary territory).

    

The composition of matter patent in the United States expires in 2011 (which includes a statutory patent term extension). This patent is currently the subject of litigation. The Company continues to believe that the patent is valid and that it is infringed, and with its alliance partner and patent-holder Sanofi, is vigorously pursuing the litigation. It is not possible at this time reasonably to assess the outcome of this litigation, or if there were an adverse determination in this litigation, the timing of potential generic competition for PLAVIX*. Apotex announced that in January 2006 it had received final approval of its aNDA for clopidogrel bisulfate from the FDA. Accordingly, Apotex could decide to launch a generic product at risk at any time. Such generic competition would likely result in substantial decreases in the sales of PLAVIX* in the United States. For more information about this litigation, see “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies.” For more information about the potential effects of generic competition on PLAVIX*, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Outlook.” In the EU, regulatory data exclusivity extends to 2008 and the key composition of matter patent expires in 2013.

    

Bulk requirements for clopidogrel are supplied to each territory by Sanofi, which produces bulk clopidogrel in its own facilities and obtains a portion of the bulk clopidogrel requirements from a third party, under an arrangement that includes royalty payments based on product sales, and each territory then produces finished product for sale.

    

For more information about the Company’s arrangements with Sanofi, see “—Strategic Alliances” below and “Item 8. Financial Statements—Note 2. Alliances and Investments.”

PRAVACHOL

  

Pravastatin sodium is an HMG Co-A reductase inhibitor indicated as an adjunct to diet and exercise for patients with primary hypercholesterolemia, for lowering the risk of a first heart attack in people without clinically evident coronary heart disease who have elevated cholesterol, and for reducing the risk of heart attack and stroke in patients with clinically evident coronary heart disease.

    

The Company has licensed a patent covering pravastatin, marketed by the Company in the U.S. as PRAVACHOL, from Sankyo Company, Ltd. (Sankyo) of Japan, with the agreement expiring as exclusivity expires on a market-by-market basis. The Company entered into a distribution agreement with Watson Pharmaceutical (Watson) authorizing Watson to distribute pravastatin sodium tablets in the U.S. Exclusivity in the U.S. under the patent (including pediatric extension) lasts until April 2006. Under the terms of the license, the Company may market and sell pravastatin throughout the world, excluding Japan, Korea, Taiwan and Thailand (markets in which Sankyo retains exclusive patent rights). Sankyo also copromotes and comarkets pravastatin in certain European and Latin American countries.

    

The composition of matter patent was scheduled to expire in the United States in October 2005, but has been extended for six months to April 2006 under the law that provides exclusivity extensions for pediatric research. In the EU, the composition of matter patent was not obtained in Greece, Luxembourg or Portugal and expired in Spain in 2002. The composition of matter patent expired in

 

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2004 in Austria, Belgium, Denmark, Finland, Germany, Ireland, the Netherlands and the United Kingdom. In France and Sweden, expiration will occur in August and March 2006, respectively. In Italy, expiration will occur on January 1, 2008.

    

The Company’s bulk requirements for pravastatin are supplied by Sankyo. The Company finishes the product in its own facilities.

AVAPRO*/AVALIDE*

  

Irbesartan/irbesartan-hydrochlorothiazide is an angiotensin II receptor antagonist indicated for the treatment of hypertension and diabetic nephropathy.

    

Irbesartan was codeveloped and is jointly marketed with Sanofi. The worldwide alliance operates under the framework of two geographic territories: one in the Americas and Australia (BMS’s primary territory) and the other in Europe and Asia (Sanofi’s primary territory).

    

The basic composition of matter patent in the United States expires in 2011 and in the EU in 2012. Data exclusivity in the EU expires in 2007.

    

Irbesartan is manufactured by both the Company and Sanofi. Bulk irbesartan is sold to the territory joint ventures at a fixed price per kilogram. Under intellectual property license arrangements, Sanofi collects a royalty based on a percentage of net sales.

    

For more information about the Company’s arrangements with Sanofi, see “—Strategic Alliances” below and “Item 8. Financial Statements—Note 2. Alliances and Investments.”

COUMADIN

  

Warfarin sodium is an oral anti-coagulant used predominantly in patients with atrial fibrillation or deep venous thrombosis/pulmonary embolism.

    

Market exclusivity expired in the United States in 1997. Basic patent protection and regulatory data protection had expired before the Company acquired COUMADIN in 2001.

    

The Company obtains its bulk requirements for warfarin from a third party and produces the majority of finished goods in its own facilities.

MONOPRIL

  

Fosinopril sodium is a second-generation angiotensin converting enzyme (ACE) inhibitor with once-a-day dosing indicated for the treatment of hypertension. MONOPRIL was developed internally.

    

The basic composition of matter patent in the United States expired in June 2003. The basic composition of matter patent expired in Denmark, Greece and Portugal in 2001 and in Spain in October 2002. A composition of matter patent was not obtained in Finland. For the rest of the EU, the composition of matter patent expires on a country-by-country basis through 2008.

Virology

    

REYATAZ

  

Atazanavir sulfate is a protease inhibitor for the treatment of HIV. REYATAZ was launched in the United States in July 2003.

    

The Company developed atazanavir under a worldwide license from Novartis AG (Novartis) for which it pays a royalty based on a percentage of net sales.

    

Market exclusivity for REYATAZ is expected to expire in 2017 in the U.S., in countries in the EU and Japan.

SUSTIVA

  

Efavirenz is an antiretroviral drug used in the treatment of HIV.

    

Rights to market efavirenz in the United States, Canada, the United Kingdom, France, Germany, Ireland, Italy and Spain are licensed from Merck & Co., Inc. (Merck) for a royalty based on a percentage of net sales.

    

The basic composition of matter patent expires in 2013 in the United States. A separate method of use patent expires in 2014. The basic composition of matter patents in the United Kingdom, Ireland, France, Germany, Italy and Spain expire in 2013. Data exclusivity in the EU expires in 2009.

    

The Company obtains its bulk requirements for efavirenz from third parties and produces finished goods in its own facilities.

ZERIT

  

Stavudine is used in the treatment of HIV.

    

The Company holds an exclusive patent license for ZERIT from Yale University pursuant to which it pays a royalty based on product sales. In Japan, the Company has an exclusive license for ZERIT from Yamasa Corporation pursuant to which it pays a royalty based on net sales in Japan.

 

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The use patent expires in the United States in December 2008. The use patent series expires in the EU from 2007 through 2011 (patent applications are pending in Denmark and Finland), and in Japan in December 2008.

VIDEX/VIDEX EC

  

Didanosine is an antiretroviral drug used in the treatment of adult and pediatric patients with HIV. Didanosine is marketed by the Company in three different formulations. The first is for use in an oral solution. The second is a reduced mass tablet. The third is an enteric coated capsule formulation (VIDEX EC).

    

The Company has a license to the U.S. Government’s patent series that claims the method of using didanosine to treat HIV. This patent series covers the approved use of all three of the aforementioned formulations. The Company’s license became non-exclusive in October 2001. Another company has obtained a license from the U.S. Government and is marketing didanosine.

    

The U.S. Government’s method of use patent expires in 2007 in the United States (which includes an earned pediatric extension) and Japan. In Europe, the U.S. Government was granted the use patent in Austria, Belgium, France, Germany, Italy, Luxembourg, the Netherlands, Sweden, the United Kingdom and the patent is pending in Ireland. Expiration of this use patent in the EU occurs between 2006 and 2009 on a country-by-country basis. This method of use patent was not obtained by the U.S. Government in Denmark, Finland, Greece, Portugal or Spain.

    

VIDEX (reduced mass formulation): the Company has patents covering the reduced mass formulation of VIDEX in the United States, the EU and Japan that expire in 2012. Another company may attempt to develop a reduced mass formulation of didanosine that does not infringe these patents.

    

VIDEX EC (enteric coated capsule): the Company also has pending patent applications that cover the VIDEX EC formulation in the United States, the EU and Japan. If these patents are issued, expiration will be in 2018.

    

U.S. data exclusivity for VIDEX EC expired in 2004. Japanese data exclusivity for VIDEX EC expired in March 2005.

    

The Company obtains the materials necessary for bulk manufacture of didanosine from a third party and produces the finished product in its own facilities.

BARACLUDE

  

Entecavir is a potent and selective inhibitor of hepatitis B virus that was approved by the FDA in March 2005 for the treatment of chronic hepatitis B infection. It has also been approved in China and other markets in the Asia-Pacific region. The Company has a composition of matter patent that expires in the United States in 2010.

    

BARACLUDE was developed internally.

Other Infectious Diseases

    

CEFZIL

  

Cefprozil is a semi-synthetic broad-spectrum cephalosporin antibiotic for the treatment of mild to moderately severe bacterial infections of the throat, ear, sinuses, respiratory tract and skin.

    

Cefprozil was discovered and developed internally.

    

The basic composition of matter patent protecting cefprozil in the United States (including patent term extension) expired December 2005. In several European countries including Austria, Finland, Italy, Switzerland and the United Kingdom, the composition of matter patent expires in 2008-2009 (including term extension). In Spain, the patent expired in February 2005, and for other European countries and Japan, the patent expired in 2004.

Oncology

    

TAXOL® (paclitaxel)

  

Paclitaxel is used in the treatment of refractory ovarian cancer, first-line treatment of ovarian cancer in combination with cisplatin, second-line treatment of AIDS related Kaposi’s Sarcoma, treatment of metastatic breast cancer after failure of combination chemotherapy, adjuvant treatment of node positive breast cancer and in the treatment of non-small cell lung carcinoma with cisplatin.

    

Paclitaxel was developed under a collaborative research and development agreement with the U.S. Government. Under the agreement, the Company obtained rights to the U.S. Government’s TAXOL® (paclitaxel) data.

    

The active ingredient in TAXOL® (paclitaxel) did not have patent protection in the United States, the EU or Japan, but did have regulatory protection in the form of data exclusivity. Data exclusivity in the United States expired in 1997. An initial approval for a U.S. generic version was granted in 2000,

 

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revoked by the FDA in 2001 and then reinstated in 2002. Data exclusivity in the EU expired in 2003. Data exclusivity for TAXOL® (paclitaxel) in Japan expired in 2003. A patent claiming the approved dosing and administration schedule expires in Japan in 2013. A nullity action filed in 2004 in the Japanese Patent Office invalidated this patent and the Company is appealing that decision. Numerous factors make it impossible to predict when loss of market exclusivity in Japan will actually occur.

    

The Company is supplied with its bulk requirements for paclitaxel from third parties and produces finished goods in its own facilities.

ERBITUX*

  

ERBITUX* (cetuximab) is an IgG1 monoclonal antibody designed to exclusively target and block the Epidermal Growth Factor Receptor (EGFR), which is expressed on the surface of certain cancer cells in multiple tumor types as well as some normal cells. ERBITUX* is approved for the treatment in combination with irinotecan of patients with EGFR-expressing metastatic colorectal cancer who had failed an irinotecan-based regimen and as monotherapy for patients who are intolerant of irinotecan. On March 1, 2006 the FDA approved ERBITUX* for use in the treatment of squamous cell carcinoma of the head and neck.

    

ERBITUX* is marketed in North America by the Company under a distribution and copromotion agreement with ImClone Systems Incorporated (ImClone). The Company and ImClone will share distribution rights to ERBITUX* with Merck KGaA in Japan. For a description of the Company’s alliance with ImClone, see “—Strategic Alliances” below and “Item 8. Financial Statements—Note 2. Alliances and Investments.”

    

There is no composition of matter patent that specifically claims ERBITUX*. ERBITUX* has been approved for monotherapy, for which there is no use patent. The use of ERBITUX* in combination with an anti-neoplastic agent is approved by the FDA. Such combination use is claimed in a granted U.S. patent that expires in 2017. For more information about biologics patents, see “—Intellectual Property and Product Exclusivity” below. The inventorship of this use patent is being challenged by three scientists from the Weizmann Institute who claim they should have been named as co-inventors. For more information about this litigation, see “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies.” The European equivalent of this use patent has been opposed.

    

The Company purchases all of its bulk requirements for ERBITUX* from ImClone, and ImClone and other third parties produce finished goods in their own facilities. For a description of the Company’s supply agreement with ImClone, see “—Manufacturing and Quality Assurance” below.

PARAPLATIN

  

Carboplatin is a chemotherapeutic agent used in the treatment of ovarian cancer.

    

The patent for carboplatin in the U.S. expired in 2004. Prior to the expiration of the U.S. patent in 2004, the Company held an exclusive patent license for carboplatin from Research Corporation Technologies and the University of Michigan under which the Company had rights to market PARAPLATIN worldwide and paid a royalty based on a percentage of product sales. In the EU, the basic patent covering carboplatin was obtained in France, Germany, the Netherlands, Sweden and the United Kingdom. The last patent to expire in these countries was France in 2000. In Japan, the basic patent expired in 1998.

    

The Company entered into an agreement with Teva Pharmaceuticals USA, Inc. (Teva), allowing Teva’s authorized affiliate, Sicor Pharmaceuticals Sales, Inc., to distribute an unbranded version of carboplatin supplied by BMS commencing in 2004. This agreement expired in June 2005.

    

The Company obtains its bulk requirements for carboplatin from a third party and produces finished goods in its own facilities.

Affective (Psychiatric)

Disorders

    

ABILIFY*

  

Aripiprazole is an atypical antipsychotic agent for patients with schizophrenia, acute bipolar mania and Bipolar I disorder. ABILIFY* was introduced in the United States in November 2002 and has been approved for marketing in the EU and Switzerland. Applications are pending in other countries.

    

Aripiprazole is copromoted in the United States by the Company and Otsuka. BMS’s rights to commercialize aripiprazole in the United States terminate in 2012. Thereafter, Otsuka has the sole right to commercialize aripiprazole in the United States. The Company also has the right to distribute and/or copromote ABILIFY* in several European countries (the United Kingdom, France, Germany, Italy and Spain) and to act as exclusive distributor for the product in the rest of the EU. The Company is the exclusive licensee for the product in the rest of the world, excluding Japan and certain other countries. The Company records alliance revenue for its contractual share of the net

 

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sales in these copromotion countries, excluding the United Kingdom, and records all expenses related to the product. Alliance revenue is recorded by the Company as net sales based upon 65% of Otsuka’s net sales in the copromotion countries. The Company recognizes this alliance revenue when ABILIFY* is shipped and all risks and rewards of ownership have transferred to Otsuka’s customers. In the UK, the Company records 100% of the net sales and related cost of products sold. In countries where the Company has an exclusive right to sell ABILIFY*, the Company will record 100% of the net sales and related cost of products sold. For more information about the Company’s arrangement with Otsuka, see “—Strategic Alliances” below and “Item 8. Financial Statements—Note 2. Alliances and Investments.”

    

The basic U.S. composition of matter patent for ABILIFY* expires in 2014 (including the granted patent term extension). In 2004, Otsuka filed with the United States Patent and Trademark Office (USPTO) a Request for Reexamination of a U.S. composition of matter patent (U.S. Patent Number No. 5,006,528, the “‘528 Patent”) covering ABILIFY* (aripiprazole). The USPTO granted the request for reexamination. Otsuka determined that the original ‘528 Patent application mistakenly identified a prior art reference by the wrong patent number. In addition, Otsuka has taken the opportunity to bring other citations to the attention of the USPTO. The Reexamination will allow the USPTO to consider the patentability of the patent claims in light of the correctly identified patent reference and newly cited documents. The USPTO is expected to make a final decision on the reexamination in 2006.

 

The Company and Otsuka believe that the subject matter claimed in the ‘528 Patent is patentable over the prior art and expect that the USPTO will reconfirm this in the reexamination. However, there can be no guarantee as to the outcome. If the patentability of the ‘528 Patent is not reconfirmed following the reexamination, loss of market exclusivity of ABILIFY* in the U.S. may be sooner than expected and the subsequent development of generic competition would be material to the Company.

    

There is no composition of matter patent in Austria, Belgium, Finland, Greece, Ireland, Luxembourg, Portugal, Latvia, Hungary, Cyprus, Czech Republic, Slovenia, Slovakia, Poland, Malta and Lithuania. For the other EU member states, the composition of matter patent expires in 2009, except in those countries where supplemental protection certificates have been granted in which case the composition of matter patent expires in 2014.

    

Otsuka supplies the bulk requirements for aripiprazole and both Otsuka and the Company produce the finished product in their own facilities.

Metabolics

    

GLUCOPHAGE* Franchise

  

Metformin hydrochloride/glyburide and metformin hydrochloride are oral anti-diabetic agents for type 2 diabetes.

    

Metformin was developed by Merck Sante S.A.S. Under the terms of the arrangement, the Company may market and sell metformin in the United States. The Company purchases bulk metformin at a price (including a royalty) based on a percentage of net sales.

    

Data exclusivity for GLUCOPHAGE* IR expired in 2000. Regulatory exclusivity expired for GLUCOPHAGE* XR in 2003 and for GLUCOVANCE* in 2004.

    

The Company obtains its bulk requirements for metformin from Merck Sante S.A.S. and produces the finished product in its own facilities.

Immunology

    

ORENCIA

  

Abatacept, a biological product, is a fusion protein with novel immunosuppressive activity targeted initially at adult patients with moderate to severe rheumatoid arthritis, who have had an inadequate response to certain currently available treatments, was approved by the FDA in December 2005 and made commercially available in the U.S. in February 2006.

    

The Company has a series of patents covering abatacept and its method of use. The latest of the composition of matter patents expires in the United States in 2016. U.S. litigation with Repligen Corporation (Repligen) concerning the inventorship of abatacept has been concluded in favor of the Company. Repligen has received a U.S. patent that claims a use of abatacept to treat specific autoimmune diseases, including rheumatoid arthritis and in January 2006 brought suit against the Company in the Eastern District of Texas alleging patent infringement. For more information about this litigation, see “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies.”

    

Abatacept was developed internally.

 

9


In addition to the pharmaceutical products discussed above, the Company’s Pharmaceuticals segment also includes the Company’s wholly owned UPSA Consumer Medicines business in Europe. The UPSA brand of acetaminophen, EFFERALGAN, is marketed for pain relief across the European continent. The Company also markets ASPIRINE UPSA, DAFALGAN and FERVEX in Europe and other overseas markets.

 

Strategic Alliances and Arrangements

 

The Company enters into strategic alliances and arrangements with third parties, which give the Company rights to develop, manufacture, market and/or sell pharmaceutical products, the rights to which are owned by such third parties. The Company also enters into strategic alliances and arrangements with third parties, which give such third parties the rights to develop, manufacture, market and/or sell pharmaceutical products, the rights to which are owned by the Company. These alliances and arrangements can take many forms, including licensing arrangements, codevelopment and comarketing agreements, copromotion arrangements and joint ventures. Such alliances and arrangements reduce the risk of incurring all research and development expenses that do not lead to revenue-generating products; however, the gross margins on alliance products are generally lower, sometimes substantially so, than the gross margins on the Company’s own products because profits from alliance products are shared with the Company’s alliance partners. While there can be no assurance that new alliances will be formed, the Company actively pursues such arrangements and views alliances as an important complement to its own discovery and development activities.

 

The Company’s most significant current alliances and arrangements for the Company’s in-line products are those with Sanofi for PLAVIX* and AVAPRO*/AVALIDE*, Otsuka for ABILIFY*, ImClone for ERBITUX*, and Sankyo for PRAVACHOL. The Company’s most significant alliances and arrangements for products under development, subject to approval from regulatory authorities, are with Pierre Fabre Medicament S.A. (Pierre Fabre) for vinflunine, the rights to which are owned by Pierre Fabre, with Medarex, Inc. (Medarex) for ipilimumab, the rights to which are owned by Medarex, with Gilead Sciences, Inc. (Gilead) for a fixed dose combination of the Company’s product SUSTIVA and Gilead’s TRUVADA* and with Somerset Pharmaceuticals, Inc. (Somerset) for EMSAM*, the rights to which are owned by Somerset. Each of these significant alliances and arrangements are discussed in more detail below. Additionally, the Company has licensing arrangements with Yale for ZERIT, with the U.S. Government for VIDEX and with Novartis for REYATAZ. In general, the Company’s strategic alliances and arrangements are for periods co-extensive with the periods of market exclusivity protection on a country-by-country basis. Based on the Company’s current expectations with respect to the expiration of market exclusivity in the Company’s significant markets, the licensing arrangements with Yale for ZERIT are expected to expire in 2008 in the U.S., between 2007-2011 in the EU and in 2008 in Japan; with the U.S. Government for VIDEX, which by its terms became non-exclusive in 2001, are expected to expire in 2007 in the U.S. (which includes an earned pediatric extension) and Japan and in EU countries between 2006-2009; and with Novartis for REYATAZ are expected to expire in 2017 in the U.S., the EU and Japan. For further discussion of market exclusivity protection, including a chart showing net sales of key products together with the year in which basic exclusivity loss occurred or is expected to occur in the U.S., the EU and Japan, see “—Products” and “—Intellectual Property and Product Exclusivity.”

 

Each of the Company’s strategic alliances and arrangements with third parties who own the rights to manufacture, market and/or sell pharmaceutical products contain customary early termination provisions typically found in agreements of this kind and are generally based on the other party’s material breach or bankruptcy (voluntary or involuntary) and product safety concerns. The amount of notice required for early termination generally ranges from immediately upon notice to 90 days after receipt of notice. Termination immediately upon notice is generally available where the other party files a voluntary bankruptcy petition. Termination upon 30 to 90 days notice is generally available where an involuntary bankruptcy petition has been filed (and not been dismissed) or a material breach by the other party has occurred (and not been cured). Early termination due to product safety concerns typically arises when a product is determined to create significant risk of harm to patients due to concerns regarding the product’s efficacy or level of toxicity. The Company’s strategic alliances and arrangements typically do not otherwise contain any provisions that provide the other party the right to terminate the alliance on short notice. In general, where the other party to the Company’s strategic alliance and arrangement will continue to have exclusivity protection upon the expiration or termination of the alliance, the Company does not retain any rights to the product or to the other party’s intellectual property. The loss of rights to one or more products that are marketed and sold by the Company pursuant to strategic alliance arrangements with third parties in one or more countries or territories could be material to the Company’s results of operations and cash flows and, in the case of PLAVIX*, could be material to its financial condition and liquidity. As is customary in the pharmaceutical industry, the terms of the Company’s strategic alliances and arrangements generally are co-extensive with the exclusivity period, which as discussed above, may vary on a country-by-country basis.

 

As discussed below, the Company’s strategic alliance with Otsuka expires in November 2012 in the United States and Puerto Rico, which may be prior to expiration of market exclusivity protection for ABILIFY* which is expected to expire in 2014 in the U.S. (including a granted patent term extension).

 

10


Growth Drivers

 

Sanofi  The Company has agreements for the codevelopment and cocommercialization of AVAPRO*/AVALIDE* (irbesartan), an angiotensin II receptor antagonist indicated for the treatment of hypertension and diabetic nephropathy, which is copromoted in certain countries outside the U.S. under the tradename APROVEL*/COAPROVEL* and comarketed in certain countries outside the U.S. by the Company under the tradename KARVEA*/KARVEZIDE*; and PLAVIX* (clopidogrel), a platelet aggregation inhibitor, which is copromoted in certain countries outside the U.S. under the tradename PLAVIX* and comarketed in certain countries outside the U.S. by the Company under the tradename ISCOVER*.

 

The worldwide alliance operates under the framework of two geographic regions, one covering certain European and Asian countries, defined as Territory A, and one covering the U.S., Puerto Rico, Canada, Australia and certain Latin American countries, Territory B. The region covering the U.S., Puerto Rico, Canada, Australia, and certain Latin American countries is managed by two separate territory agreements, one for U.S. and Puerto Rico AVAPRO*/AVALIDE* only, and a second agreement for U.S. and Puerto Rico PLAVIX* only, plus Canada, Australia, Mexico, Brazil, Colombia and Argentina for both products. Within each of Territory A and B, a Territory Partnership exists to supply product to the countries within each territory and to manage certain central expenses such as marketing, research and development and royalties. Countries within Territory A and B are structured so that the Company’s local affiliate and Sanofi either comarket, whereby each affiliate operates independently and sells a competing brand, or copromote a single brand.

 

Within Territory A the comarketing countries include Germany, Spain, Italy (irbesartan only), Greece and China. The Company sells ISCOVER* and KARVEA*/KARVEZIDE* and Sanofi sells PLAVIX* and APROVEL*/COAPROVEL* in these countries. The Company and Sanofi copromote PLAVIX* and APROVEL*/COAPROVEL* in France, the United Kingdom, Ireland, Belgium, Sweden, Denmark, Finland, Norway, Netherlands, Switzerland and Portugal. In addition, the Company and Sanofi copromote PLAVIX* in Austria, Italy, Turkey, Taiwan, Korea, Singapore, Malaysia and Hong Kong, and APROVEL*/COAPROVEL* in certain French export countries. Sanofi acts as the operating partner for Territory A and owns a 50.1% majority financial controlling interest in this territory. The Company’s ownership interest in this territory is 49.9%. The Company accounts for the investment in partnership entities in this territory under the equity method and records its share of the results in equity in net income of affiliates in the consolidated statement of earnings. The Company’s share of net income from these partnership entities before taxes was $345 million in 2005, $269 million in 2004 and $187 million in 2003.

 

Within Territory B the Company and Sanofi copromote PLAVIX* in the U.S., Canada and Puerto Rico and AVAPRO*/AVALIDE* in Canada. The other Territory B countries, Australia, Mexico, Brazil, Colombia (clopidogrel only) and Argentina are comarketing countries. The Company and Sanofi modified their previous exclusive license to the Company for AVAPRO*/AVALIDE* in the U.S. and Puerto Rico to form a copromotion joint venture, as part of which the Company contributed the AVAPRO*/AVALIDE* intellectual property and Sanofi agreed to pay the Company $200 million in 2001 and $150 million in 2002. The Company accounts for these payments as a sale of an interest in a license and defers and amortizes the total amount of $350 million into income over the expected life of the license, which is approximately eleven years from the date of the formation of the copromotion joint venture. The Company acts as the operating partner for Territory B and the U.S./Puerto Rico AVAPRO*/AVALIDE* Territory and owns a 50.1% majority controlling interest in these territories. As such, the Company consolidates all partnership results in these territories and records Sanofi’s share of the results as a minority interest expense, net of taxes, which was $578 million in 2005, $502 million in 2004 and $351 million in 2003. The Company recorded sales in Territory B, the U.S./Puerto Rico AVAPRO*/AVALIDE* Territory and in comarketing countries (Germany, Italy, Spain and Greece) of $4,805 million in 2005, $4,257 million in 2004 and $3,224 million in 2003.

 

The Company has opted-out of comarketing or copromotion arrangements with Sanofi in a number of countries. The Company receives a royalty payment from Sanofi in the amount of 6% of Sanofi’s net sales in these countries. This royalty payment is recorded by the Company as other income and was $23 million in 2005, $17 million in 2004 and $11 million in 2003.

 

The territory partnerships are governed by a series of committees with enumerated functions, powers and responsibilities. Each territory has two senior committees (Senior Committees) which have final decision making authority with respect to that territory as to the enumerated functions, powers and responsibilities within its jurisdiction.

 

The agreements with Sanofi expire on the later of (i) with respect to PLAVIX*, 2013 and, with respect to AVAPRO*/AVALIDE*, 2012 in the Americas and Australia and 2013 in Europe and Asia, and (ii) the expiration of all patents and other exclusivity rights in the applicable territory.

 

The alliance arrangements may be terminated by the Company or Sanofi, either in whole or in any affected country or Territory, depending on the circumstances, in the event of (i) voluntary or involuntary bankruptcy or insolvency, which in the case of involuntary bankruptcy continues for 60 days or an order or decree approving same continues unstayed and in effect for 30 days; (ii) a material breach of an obligation under a major alliance agreement that remains uncured for 30 days following notice of the breach

 

11


except where commencement and diligent prosecution of cure has occurred within 30 days after notice; (iii) deadlocks of one of the Senior Committees which render the continued commercialization of the product impossible in a given country or Territory or, in the case of AVAPRO*/AVALIDE* in the U.S., with respect to advertising and promotion spending levels or the amount of sales force commitment; (iv) an increase in the combined cost of goods and royalty which exceeds a specified percentage of the net selling price of the product; or (v) a good faith determination by the terminating party that commercialization of a product should be terminated for reasons of patient safety.

 

In the case of each of these termination rights, the agreements include provisions for the termination of the relevant alliance with respect to the applicable product in the applicable country or territory or, in the case of a termination due to bankruptcy or insolvency or material breach, both products in the applicable territory. Each of these termination procedures is slightly different; however, in all events, the Company could lose all rights to either or both products, as applicable, in the relevant country or territory even in the case of a bankruptcy or insolvency or material breach where the Company is not the defaulting party. For more information, see “Item 8. Financial Statements—Note 2. Alliances and Investments.”

 

Otsuka  In 1999, the Company entered into a worldwide commercialization agreement with Otsuka, to codevelop and copromote ABILIFY* (aripiprazole) for the treatment of schizophrenia and related psychiatric disorders, except in Japan, China, Taiwan, North Korea, South Korea, the Philippines, Thailand, Indonesia, Pakistan and Egypt. The Company began copromoting the product with Otsuka in the U.S. and Puerto Rico in November 2002. In June 2004, the Company received marketing approval from the European Commission. The product is currently copromoted with Otsuka in the United Kingdom, Spain and Germany, and the Company and Otsuka have the right to copromote it in France. ABILIFY* is currently distributed exclusively by the Company in France on a temporary basis until copromotion with Otsuka commences. The Company records alliance revenue for its contractual share of Otsuka’s net sales in these copromotion countries, excluding the United Kingdom, and records all expenses related to the product. Alliance revenue is recorded by the Company as net sales based upon 65% of Otsuka’s net sales in the copromotion countries. The Company recognizes this alliance revenue when ABILIFY* is shipped and all risks and rewards of ownership have transferred to Otsuka’s customers. In the UK and in France until copromotion with Otsuka commences, the Company records 100% of the net sales and related cost of products sold.

 

The Company also has an exclusive right to sell ABILIFY* in a number of other countries in Europe, the Americas and Asia. In these countries the Company records 100% of the net sales and related cost of products sold. Under the terms of the agreement, the Company purchases the product from Otsuka and performs finish manufacturing for sale by the Company to its customers. The agreement expires in November 2012 in the U.S. and Puerto Rico. For the European Union, the agreement expires in June 2014, or on the later of the tenth anniversary of the first commercial sale in such country or expiration of the applicable patent in such country. Early termination is available based on the other party’s voluntary or involuntary bankruptcy, failure to make minimum payments, failure to commence the first commercial sale with three months after receipt of all necessary approvals and material breach. The amount of notice required for early termination of the strategic alliance is immediately upon notice (i) in the case of voluntary bankruptcy, (ii) where minimum payments are not made to Otsuka, or (iii) if first commercial sale has not occurred within three months after receipt of all necessary approvals, 30 days where a material breach has occurred (and not been cured or commencement of cure has not occurred within 90 days after notice of such material breach) and 90 days in the case where an involuntary bankruptcy petition has been filed (and not been dismissed). In addition, termination is available to Otsuka upon 30 days notice in the event that the Company were to challenge Otsuka’s patent rights or, on a market-by-market basis, the Company were to market a product in direct competition with ABILIFY*. Upon termination or expiration of the alliance, the Company does not retain any rights to ABILIFY*.

 

The Company recorded total revenue for ABILIFY* of $912 million in 2005, $593 million in 2004 and $283 million in 2003. Total milestone payments made to Otsuka from 1999 through 2005 were $217 million, of which $157 million was expensed as acquired in-process research and development in 1999. The remaining $60 million was capitalized in other intangible assets and is amortized into cost of products sold over the remaining life of the agreement in the U.S., ranging from eight to eleven years. The Company amortized in cost of products sold $6 million in 2005 and $5 million each in 2004 and 2003. The unamortized capitalized payment balance was $41 million and $47 million as of December 31, 2005 and 2004, respectively. For more information, see “Item 8. Financial Statements—Note 2. Alliances and Investments.”

 

ImClone  In 2001, the Company purchased 14.4 million shares of ImClone for $70 per share, or $1,007 million, which represented approximately 19.9% of the ImClone shares outstanding just prior to the Company’s commencement of a public tender offer for those ImClone shares. ImClone is a biopharmaceutical company focused on developing targeted cancer treatments, which include growth factor blockers, cancer vaccines and anti-angiogenesis therapeutics. The equity investment in ImClone is part of a strategic agreement between the Company and ImClone that also included an arrangement expiring in September 2018 to codevelop and copromote the cancer drug, ERBITUX*, for a series of payments originally totaling $1 billion. The Company paid ImClone a milestone payment of $200 million in 2001, which was expensed. In 2002, the agreement with ImClone was revised to reduce the total payments to $900 million from $1 billion. In accordance with the agreement, the Company paid ImClone $140 million in 2002, $60 million in 2003, and $250 million in 2004 upon the approval by the FDA of the Biologics License Application (BLA) for

 

12


ERBITUX* for use in combination with irinotecan in the treatment of patients with EGFR–expressing, metastatic colorectal cancer who are refractory to irinotecan–based chemotherapy and for use as a single agent in the treatment of patients with EGFR–expressing, metastatic colorectal cancer who are intolerant to irinotecan–based chemotherapy. In 2004, the FDA approved ImClone’s Chemistry, Manufacturing and Controls supplemental Biologics License Application (sBLA) for licensure of its BB36 manufacturing facility. On March 1, 2006, the FDA approved ERBITUX* for use in the treatment of squamous cell carcinoma of the head and neck. As a result of the FDA approval, the Company will make a $250 million milestone payment to ImClone by March 31, 2006. The Company also has codevelopment and copromotion rights in Canada and Japan to the extent the product is commercialized in such countries. In Japan, the Company and ImClone will share distribution rights to ERBITUX* with Merck KGaA. Under the agreement, ImClone receives a distribution fee based on a flat rate of 39% of product revenues in North America. The Company purchases all of its commercial requirements for bulk ERBITUX* from ImClone at a price equal to manufacturing cost plus 10%.

 

Payments made subsequent to the 2004 approval have been capitalized and are being amortized to cost of products sold over the remaining term of the agreement. With respect to the $200 million of milestone payments the Company paid ImClone in 2002 and 2003, $160 million was expensed in 2002 as acquired in–process research and development, and $40 million was recorded as an additional equity investment to eliminate the income statement effect of the portion of the milestone payment for which the Company has an economic claim through its ownership interest in ImClone. The Company accounts for the $250 million approval milestone paid in 2004 and the additional $250 million milestone expected to be paid by March 31, 2006 as license acquisitions and amortizes the payments into cost of products sold over the expected useful life of the license, which is approximately 14 years. The Company amortized into cost of products sold $17 million and $14 million for 2005 and 2004, respectively. The unamortized portion of the $250 million payment is recorded in intangible assets, net in the consolidated balance sheet and was $219 million and $236 million as of December 31, 2005 and 2004, respectively.

 

The Company determines its equity share in ImClone’s net income or loss by eliminating from ImClone’s results the milestone revenue ImClone recognized for the pre–approval milestone payments that were recorded by the Company as additional equity investment. The Company recorded a net loss of $5 million in 2005, net income of $9 million in 2004 and a net loss of $36 million in 2003 for its share of ImClone’s net income/losses. The Company records its share of the results in equity in net income of affiliates in the consolidated statement of earnings. The Company recorded net sales for ERBITUX* of $413 million in 2005 and $261 million in 2004.

 

The Company’s recorded investment and the market value of its holdings in ImClone common stock as of December 31, 2005 was $66 million and approximately $493 million, respectively. On a per share basis, the carrying value of the ImClone investment and the closing market price of the ImClone shares as of December 31, 2005 were $4.55 and $34.24, respectively.

 

Early termination is available based on material breach and is effective 60 days after notice of the material breach (and such material breach has not been cured or commencement of cure has not occurred), or upon six months’ notice from the Company if there exists a significant concern regarding a regulatory or patient safety issue that would seriously impact the long-term viability of the product. Upon termination or expiration of the alliance, the Company does not retain any rights to ERBITUX*.

 

To help maintain the product quality of ERBITUX*, the product is shipped only to end-users and not to other intermediaries (such as wholesalers) to hold for later sales. During 2004 and through May of 2005, McKesson Corporation (McKesson), one of the Company’s wholesalers, provided warehousing, packing and shipping services for ERBITUX*. McKesson held ERBITUX* inventory on consignment and the Company recognized revenue when McKesson shipped the inventory to the end-users. McKesson also held inventories of ERBITUX* for its own account. Upon divestiture of Oncology Therapeutics Network (OTN) in May 2005, the Company discontinued the consignment arrangement with McKesson. The Company now sells ERBITUX* to intermediaries such as specialty oncology distributors and ships ERBITUX* directly to the end-users of the product who are the customers of these intermediaries. The Company recognizes revenue upon shipment to the end-users.

 

For further discussion of the Company’s strategic alliance with ImClone, see “Item 8. Financial Statements—Note 2. Alliances and Investments.”

 

In Line Products

 

Sankyo  The Company has licensed a patent covering pravastatin, marketed by the Company in the U.S. as PRAVACHOL, from Sankyo, with the agreement expiring as exclusivity expires on a market-by-market basis. Exclusivity in the U.S. under the patent (including pediatric extension) lasts until April 2006. Under the terms of the license, the Company may market and sell pravastatin throughout the world, excluding Japan, Korea, Taiwan and Thailand (markets in which Sankyo retains exclusive patent rights). Sankyo also copromotes and comarkets pravastatin in certain European and Latin American countries. Early termination is available based on the other party’s voluntary or involuntary bankruptcy and material breach. The amount of notice required for early termination of the strategic alliance is immediately upon notice in the case of either voluntary or involuntary bankruptcy and 90 days after notice in the case where a material breach has occurred (and not been cured or commencement of cure has not occurred). Upon termination or expiration of the alliance, the Company does not retain any patent or other exclusivity rights in relation to pravastatin.

 

13


Potential New Products

 

Medarex  In 2004, the Company entered into a worldwide collaboration and share purchase agreement with Medarex to codevelop and copromote ipilimumab, a fully human antibody currently in Phase III development for the treatment of metastatic melanoma. The agreement became effective in January 2005, after the companies received certain governmental clearances and approvals, and the receipt of consent from the U.S. Public Health Service of the sublicense to the Company of Medarex’s rights to MDX–1379 (gp100), a vaccine that is being developed in combination with ipilimumab. The FDA has granted Fast Track status to ipilimumab in combination with MDX-1379 for treatment of patients with late stage unresectable metastatic melanoma who have failed or are intolerant to first line therapy. In January 2005, under the terms of the agreement, the Company made a cash payment of $25 million to Medarex which was expensed as research and development, and an additional $25 million equity investment in Medarex. Further milestone payments are expected to be made upon the successful achievement of various regulatory and sales related stages. The Company and Medarex will also share in future development and commercialization costs. Medarex could receive up to $205 million if all regulatory milestones are met, and up to $275 million in sales-related milestones. Medarex will have an option to copromote and receive up to 45% of the profits with the Company in the United States. The Company will receive an exclusive license outside of the U.S. and pay royalties to Medarex.

 

The agreement with Medarex does not expire unless and until one of the following events occurs: (1) the Company voluntarily terminates the agreement in its entirety or on a country-by-country basis by providing Medarex with six months prior written notice; (2) the Company voluntarily terminates the agreement on a product-by-product basis (but only if a second product is then in GLP toxicology studies or later) or a country-by-country basis by providing Medarex with six months prior written notice depending on the circumstances; (3) the Company terminates Medarex’s co-promotion option and rights in the United States on sixty days written notice after the end of the second calendar year in the event Medarex provides less than sixty percent of certain performance obligations in any two out of three consecutive calendar years (such termination right to be exercised only with respect to those indications as to which Medarex failed to meet such performance obligation). Upon any such termination by the Company via any of the scenarios in (1) – (3) above, Medarex will no longer have a right to share in the profits and losses of the product for the terminated indication(s) and, instead the Company will pay Medarex royalties on net sales of the product; or (4) Medarex terminates the agreement with respect to all products on sixty days written notice if the Company provides less than sixty percent of certain performance obligations in any two out of three consecutive calendar years. Generally, upon termination in (4), the Company will assign all rights to the product to Medarex and receive a royalty thereafter on intellectual property licensed by the Company to Medarex. Medarex may also elect not to copromote a product for one or more indications in the United States, in which event it will receive a royalty on sales of the product for such indication. If there is a material breach to manufacturing by a Party, then the other party shall be limited to termination of such party’s manufacturing rights only.

 

Pierre Fabre  In 2004, the Company and Pierre Fabre entered into three related agreements (a patent and know-how license agreement, a trademark license agreement and a supply agreement) to develop and commercialize vinflunine, a novel investigational anti-cancer agent. Vinflunine is currently in Phase III clinical trials for metastatic bladder cancer as well as under investigation for breast and lung cancer. Under the terms of the agreement, the Company receives an exclusive license to vinflunine in the United States, Canada, Japan, Korea and select Southeast Asian markets. Pierre Fabre will be responsible for the development and marketing of vinflunine in all other countries, including those of Europe, and will supply the Company’s requirements for the product. Under the terms of the agreement, the Company made and expensed upfront and milestone payments of $35 million in 2004 and $10 million in 2005, with the potential for an additional $165 million in milestone payments over time.

 

The patent and know-how license agreement, under which the Company licensed the right to market vinflunine, expires on a country-by-country and product form-by-product form basis, on the date that is the later of: (i) the expiration of applicable patent or data exclusivity for a given product form in a country, or (ii) the tenth anniversary of commercial sale of such product form in such country, at which time the Company may exercise a royalty-free, nonexclusive right to market the product. The Agreement may be terminated sooner, as follows: (1) a party may terminate the agreement for voluntary or involuntary bankruptcy or insolvency of the other party that is not dismissed within a certain period of time; (2) a party may terminate for material breach by the other that is not cured with a specified period. Such termination shall relate only to the countries and product forms relating to the material breach, unless the product form is the IV form (in which case all forms can be terminated) and unless the breach pertains to the United States (in which case all countries can be terminated); (3) by Pierre Fabre, if Pierre Fabre terminates the supply agreement for material breach by the Company; (4) by either party, upon 60 days notice, if justifiable and demonstrable safety, efficacy, technical or regulatory reasons preclude development of the IV form for any indication, as determined by the Joint Steering Committee; (5) by Pierre Fabre, if (a) the Company fails to file or process a registrational filing required to be filed under the Agreement without justifiable and demonstrable safety, efficacy, technical or regulatory reasons; (b) if the Company does not launch the IV product form in a country within a time period required by the agreement (generally, ninety days) following receipt of regulatory (and if applicable, pricing) approval; (c) if the Company should challenge or contest Pierre Fabre Patent Rights; (d) if the Company makes an improper contract assignment; or (e) if the Company fails to meet certain minimum sales levels under the agreement; or (6) by the Company, without cause, on a country-by-country basis, by giving Pierre Fabre at least (i) ninety days’ prior written notice, if such notice is

 

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given prior to the regulatory approval of the first approved indication in the United States, or (ii) one hundred eighty days’ prior written notice after regulatory approval of a first approved indication in the United States. Generally, for any termination made by Pierre Fabre or for termination by the Company without cause, the Company shall retain no rights to the product and all rights shall revert to Pierre Fabre.

 

Gilead  In 2004, the Company and Gilead entered into a joint venture to develop and commercialize a fixed-dose combination of the Company’s SUSTIVA (efavirenz) and Gilead’s TRUVADA* (emtricitabine and tenofovir disoproxil fumarate) in the United States. In February 2006, the FDA approved this treatment, which is the first complete Highly Active Antiretroviral Therapy (HAART) treatment product for HIV available in the United States in a fixed-dose combination taken once daily. Fixed-dose combinations contain multiple medicines formulated together and may help simplify HIV therapy for patients and providers. Guidelines issued by the U.S. Department of Health and Human Services list the combination of emtricitabine, tenofovir disoproxil fumarate and efavirenz as one of the preferred non-nucleoside reverse transcriptase inhibitor (NNRTI)-based treatments for use in appropriate patients that have never taken anti-HIV medicines before.

 

Through the joint venture, the Company and Gilead will work in partnership to complete development and U.S. regulatory filings for this fixed-dose combination regimen. Subject to receiving marketing approval of the fixed-dose combination regimen, the companies would share responsibility for commercializing the product in the United States. Both companies will provide funding and field-based sales representatives in support of promotional efforts for the combination product. The Company and Gilead will receive revenues from future net sales at percentages relative to the contribution represented by their individual products that comprise the fixed-dose combination.

 

The joint venture between the Company and Gilead will continue until terminated by mutual agreement of the parties or otherwise as described below. If no New Drug Application (NDA) for the combination product is filed by December 31, 2006, or no NDA is approved by the FDA by December 31, 2007, then either party may terminate the joint venture. In the event of a material breach by one party, the non-breaching party may terminate the joint venture only if both parties agree that it is both desirable and practicable to withdraw the combination product from the market in the United States. At such time as one or more generic versions of SUSTIVA appear on the market in the United States, Gilead will have the right to terminate the joint venture and thereby acquires all the rights to the combination product; however, the Company will continue for three years to receive a percentage of the net sales based on the contribution of SUSTIVA to the combination product.

 

Somerset  In 2004, the Company and Somerset, a joint venture between Mylan Laboratories Inc. and Watson Pharmaceuticals, Inc., entered into an agreement for the commercialization and distribution of Somerset’s EMSAM* (selegiline transdermal system), an investigational monoamine oxidase inhibitor administered as a transdermal patch for the treatment of patients with major depressive disorder. Somerset received an approvable letter from the FDA for EMSAM* in 2004, and if approved by the FDA, EMSAM* would be the first transdermal treatment for major depressive disorder. In October 2005, an FDA Advisory Committee recommended EMSAM* could be safely administered without dietary modifications at the 6mg./24 hour dose and on February 27, 2006, the FDA approved EMSAM* for use without dietary modifications at the lowest dose for 6mg./24 hour.

 

Under the terms of the agreement, the Company receives exclusive distribution rights to commercialize EMSAM*, if approved, in the U.S. and Canada. The Company made and expensed a $5 million upfront payment in December 2004 and will make a further payment following regulatory approval in the U.S. In addition to the upfront payment, Somerset will receive milestone payments based on achievement of certain sales levels, as well as reimbursement of certain development costs incurred over the terms of the agreement. Somerset will supply products to the Company and receive royalties on the Company’s sales of EMSAM*.

 

Unless earlier terminated or extended in accordance with its terms, the agreement will terminate on the fifth anniversary of the date of the first commercial sale of EMSAM*. The agreement may be earlier terminated by either party in the event of a material breach of the agreement by or the bankruptcy of the other party. In addition to the general rights of termination, the Company has the rights to terminate the agreement (i) prior to the date of first commercial sale of EMSAM* upon the imposition of certain regulatory requirements or restrictions relating to EMSAM*, the failure of the parties to agree with respect to the allocation of specified excess development costs or the failure of Somerset to deliver launch inventories, or (ii) at any time following the launch of a generic product, the occurrence of a material safety issue relating to EMSAM*, or after the date which is 30 months after the date of first commercial sale of EMSAM* upon 180 days prior notice. Somerset also has the right to terminate the agreement prior to the date of first commercial sale of EMSAM* upon failure of the parties to agree with respect to the allocation of specified excess development costs, or at any time following the occurrence of a material safety issue relating to EMSAM* or the failure of the Company to meet specified detailing requirements.

 

For information on alliances relating to drug discovery, see “—Research and Development” below.

 

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HEALTH CARE GROUP

 

The Health Care Group consists of two segments – Nutritionals and Other Health Care that consists of ConvaTec, Medical Imaging and Consumer Medicines (U.S. and Canada). Health Care Group sales accounted for 21% of the Company’s sales in 2005 and 20% of the Company’s sales in 2004 and 2003. U.S. Health Care Group sales accounted for 52%, 54% and 57% of total Health Care Group sales in 2005, 2004 and 2003, respectively, while international Health Care Group sales accounted for 48%, 46% and 43% of total Health Care Group sales in 2005, 2004 and 2003, respectively.

 

Nutritionals Segment

 

The Nutritionals segment, through Mead Johnson, manufactures, markets, distributes and sells infant formulas and other nutritional products, including the entire line of ENFAMIL products. In 2002, the Company commenced sales of ENFAMIL LIPIL, the first infant formula in the United States to contain the nutrients DHA (docosahexaenoic acid) and ARA (arachidonic acid). Also naturally found in breast milk, DHA and ARA are believed to support infant brain and eye development. The Company obtains these nutrients from a sole provider pursuant to a non-exclusive worldwide licensing and supply arrangement, under which there is no guaranty of supply and pricing is subject to change. The agreement expires beginning in 2024 on a country-by-country basis 25 years after the Company commences sales in a country.

 

The Company’s Nutritionals products are generally sold by wholesalers and retailers and are promoted primarily to health care professionals. The Company also promotes Nutritionals products directly to consumers worldwide through advertising. The Company manufactures these products in the United States and in five foreign countries. Nutritionals sales accounted for 12% of the Company’s sales in 2005, 10% of the Company’s sales in 2004 and 11% of the Company’s sales in 2003. U.S. Nutritionals sales accounted for 49%, 50% and 55% of total Nutritionals sales in 2005, 2004 and 2003, respectively, while international Nutritionals sales accounted for 51%, 50% and 45% of total Nutritionals sales in 2005, 2004 and 2003, respectively. Approximately one-half of U.S. gross sales of infant formula are subject to rebates issued under the Women, Infants and Children (WIC) program. Sales subject to WIC rebates have much lower margins than those of non-WIC program sales.

 

Net sales of selected products and product categories in the Nutritionals segment were as follows:

 

(Dollars in Millions)

 

   2005

   2004

   2003

Infant Formulas

   $ 1,576    $ 1,405    $ 1,284

ENFAMIL

     992      859      808

Toddler/Children’s Nutritionals

     529      468      421

 

In February 2004, the Company completed the divestiture of its Adult Nutritional business to Novartis for $386 million, including a $20 million payment contingent on the achievement of contractual requirements, which were satisfied, and a $22 million upfront payment for a supply agreement. In 2003, Adult Nutritional products recorded sales of over $200 million.

 

Other Health Care Segment

 

The Other Health Care segment consists of ConvaTec, Medical Imaging and Consumer Medicines (U.S. and Canada). Other Health Care sales accounted for 9%, 10% and 9% of the Company’s sales in 2005, 2004 and 2003, respectively. U.S. Other Health Care sales accounted for 56%, 58% and 59% of total Other Health Care sales in 2005, 2004 and 2003, respectively, while international Other Health Care sales accounted for 44%, 42% and 41% of total Other Health Care sales in 2005, 2004 and 2003, respectively.

 

ConvaTec

 

ConvaTec manufactures, distributes and sells ostomy and modern wound and skin care products. Principal brands of ConvaTec include NATURA, SUR-FIT, ESTEEM, AQUACEL and DUODERM. These products are marketed worldwide, primarily to hospitals, the medical profession and medical suppliers. The Company mainly relies on an internal sales force, and sales are made through various distributors around the world. The Company manufactures these products in the United States and the United Kingdom, and in the Dominican Republic under a contract manufacturing agreement with a third party.

 

ConvaTec sales accounted for approximately 5% of the Company’s sales in 2005 and 2004, and 4% of the Company’s sales in 2003. U.S. ConvaTec sales accounted for 31%, 32% and 33% of total ConvaTec sales in 2005, 2004 and 2003, respectively, while international ConvaTec sales accounted for 69%, 68% and 67% of total ConvaTec sales in 2005, 2004 and 2003, respectively.

 

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Medical Imaging

 

Medical Imaging manufactures, distributes and sells medical imaging products. Principal brands include CARDIOLITE (Kit for the Preparation of Technetium Tc99m Sestamibi for Injection), a cardiac perfusion imaging agent and DEFINITY (Vial for Perflutren Lipid Microsphere Injectable Suspension), an ultrasound contrast agent. These products are manufactured by the Company in the U.S., and are marketed through an internal sales force in the U.S. CARDIOLITE and other radiopharmaceutical products are primarily sold to and distributed via third-party radiopharmacies to end-customers (e.g., healthcare providers) in the U.S. DEFINITY is distributed directly to end-user customers. In the U.S., the Company is currently one of two suppliers of technetium Tc99m generators, a widely used radioisotope required to compound unit-dose CARDIOLITE injections. The Company relies on a single source for its supply of a key ingredient, molybdenum-99. In connection with the Company’s international business, Medical Imaging owns certain radiopharmacies outside the United States. CARDIOLITE is covered by a series of patents that claim its components. The patent coverage differs somewhat on a country-by-country basis. In the U.S., the patent expiry timeline spans December 2004 into 2008, and the Company’s currently expected year of basic exclusivity loss is 2008. In the EU, the patent expiry timeline spans December 2006 into 2008. In Japan, the patent expiry timeline spans August 2006 into 2008.

 

Medical Imaging sales accounted for 3% of the Company’s sales in 2005, 2004 and 2003. U.S. Medical Imaging sales accounted for 85% of total Medical Imaging sales in 2005, 2004 and 2003, while international Medical Imaging sales accounted for 15% of total Medical Imaging sales in 2005, 2004 and 2003. The Company maintains license and supply agreements with radiopharmacies, including Cardinal Health Nuclear Pharmacy Services, and other independent radiopharmacies, which provide the right to sell CARDIOLITE in the U.S.

 

Consumer Medicines

 

In the third quarter of 2005, the Company completed the sale of its U.S. and Canadian Consumer Medicines businesses and related assets to Novartis AG (Novartis.) The Company’s Consumer Medicines business in Japan, and other consumer medicines products in Asia Pacific, Latin America, Europe, the Middle East and Africa which are included in the Pharmaceuticals segment, were not included in the divestiture. Consumer Medicines sales accounted for 1% of the Company’s sales in 2005 and 2% of the Company’s sales in 2004 and 2003.

 

Sources and Availability of Raw Materials

 

In general, the Company purchases its raw materials, medical devices and supplies required for the production of the Company’s products in the open market. For some products, the Company purchases its raw materials, medical devices and supplies from a single source, which in certain circumstances is specified in the Company’s product registrations thereby requiring the Company to obtain such raw materials and supplies from that particular source. The Company attempts, if possible, to mitigate raw material supply risks to the Company, through inventory management and alternative sourcing strategies. For further discussion of sourcing, see “—Manufacturing and Quality Assurance” below and discussions of particular products.

 

Manufacturing and Quality Assurance

 

The Company seeks to design and operate its manufacturing facilities, manage its third-party manufacturers, and maintain inventory in a way that will allow it to meet all expected product demand while maintaining flexibility to reallocate manufacturing capacity to improve efficiency and respond to changes in supply and demand. Pharmaceutical production processes are complex, highly regulated and vary widely from product to product. Shifting or adding manufacturing capacity can be a very lengthy process requiring significant capital expenditures and regulatory approvals. For further discussion of the regulatory impact on the Company’s manufacturing, see “—Government Regulation and Price Constraints” below.

 

Pharmaceutical manufacturing facilities require significant ongoing capital investment for both maintenance and compliance with increasing regulatory requirements. In addition, as the Company adds to its product line and realigns its focus over the next several years, the Company expects to modify its existing manufacturing networks and devote substantial resources in excess of historical levels to meet heightened processing standards that may be required for sterile or newly introduced products, including biologics. Biologics manufacturing involves more complex processes than those of traditional pharmaceutical operations. Although the Company does have the capacity to manufacture biologics for clinical trials and commercial launch, its capacity to manufacture larger commercial volumes is limited. As biologics become more important to the Company’s product portfolio, the Company may continue to make arrangements with third party manufacturers, and in addition expects to make substantial investments to increase its internal capacity to produce biologics on a commercial scale. In March 2006, the Board of Directors approved a capital expenditure in the amount of $660 million for the construction of an expandable, large-scale multi-product bulk biologics manufacturing facility in the U.S. The facility will be modular in design in order to accommodate future expansion. Construction of this facility is expected to be completed in 2009. Assuming all required regulatory approvals are obtained, the Company expects to begin commercial distribution of materials manufactured at the facility in approximately five years.

 

        The Company relies on third parties to manufacture, or to supply it with active ingredients necessary for it to manufacture certain products, including PRAVACHOL, PLAVIX*, ABILIFY*, ERBITUX*, COUMADIN, PARAPLATIN, SUSTIVA, TAXOL® (paclitaxel) and VIDEX/VIDEX EC. To maintain a stable supply of these products, the Company takes a variety of actions designed to provide that there is a reasonable level of these ingredients held by the third-party supplier, the Company or both, so that the Company’s manufacturing operations are not interrupted. As an additional protection, in some cases, the Company takes steps to maintain an approved back-up source where available.

 

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The Company filed and received approval from the FDA to manufacture ORENCIA at the Company’s Syracuse, New York manufacturing facility for ORENCIA, however, given the Company’s limited capacity for commercial volumes, the Company filed a sBLA with the FDA to approve the Lonza Biologic PLC’s (Lonza) manufacturing facility for the manufacture of ORENCIA and also expects to rely on Celltrion, Inc. (Celltrion) to provide additional capacity for ORENCIA for commercial scale production pending submission of an sBLA to the FDA and approval of the sBLA. The Company will rely initially on third party manufacturers to manufacture belatacept and ipilimumab on a commercial scale if these products are commercialized. Belatacept and ipilimumab are investigational biologics compounds in late stage development. The Company has not made any filings with the FDA seeking approval for Lonza or Celltrion to manufacture belatacept or ipilimumab. The Company has not sought approval from the FDA to market and sell belatacept or ipilimumab, and there can be no assurance that regulatory approval of either of these products will be obtained. The Company has entered into agreements with Lonza and Celltrion that, among other things: (i) reserve portions of their respective biologics manufacturing capacity for the Company’s future requirements of ORENCIA; and (ii) contain certain other rights to negotiate with Lonza and Celltrion for additional biologics manufacturing capacity for other biologics products. The Company has commenced certain discussions with third party manufacturers relating to biologics manufacturing capacity for belatacept and ipilimumab if regulatory approval is obtained. For information about ORENCIA, see “—Products” above. For additional information about belatacept and ipilimumab, see “—Research and Development” below.

 

If the Company or any third-party manufacturer that the Company relies on for existing or future products is unable to maintain a stable supply of products, operate at sufficient capacity to meet its order requirements, comply with government regulations for manufacturing pharmaceuticals or meet the heightened processing requirements for biologics, the Company’s business performance and prospects could be negatively impacted. Additionally, if the Company or any of its third-party suppliers were to experience extended plant shutdowns or substantial unplanned increases in demand or suspension of manufacturing for regulatory reasons, the Company could experience an interruption in supply of certain products or product shortages until production could be resumed or expanded.

 

In connection with divestitures, licensing arrangements or distribution agreements of certain of the Company’s pharmaceuticals or in certain other circumstances, the Company has entered into agreements under which the Company has agreed to supply such products to third parties. In addition to liabilities that could arise from the Company’s failure to supply such products under the agreements, these arrangements could require the Company to invest in facilities for the production of non-strategic products, result in additional regulatory filings and obligations or cause an interruption in the manufacturing of its own products.

 

The Company’s success depends in great measure upon customer confidence in the quality of its products and in the integrity of the data that support their safety and effectiveness. Product quality arises from a total commitment to quality in all parts of the Company’s operations, including research and development, purchasing, facilities planning, manufacturing, and distribution. The Company maintains quality-assurance procedures relating to the quality and integrity of scientific information and production processes.

 

Control of production processes involves rigid specifications for ingredients, equipment and facilities, manufacturing methods, processes, packaging materials, and labeling. The Company performs tests at various stages of production processes and on the final product to assure that the product meets all regulatory requirements and the Company’s standards. These tests may involve chemical and physical chemical analyses, microbiological testing, or a combination of these along with other analyses. Quality control is provided by business unit/site quality assurance groups that monitor existing manufacturing procedures and systems used by the Company, its subsidiaries and third-party suppliers.

 

Intellectual Property and Product Exclusivity

 

The Company owns or licenses under intellectual property a number of patents in the United States and foreign countries primarily covering its pharmaceutical products. The Company has also developed many brand names and trademarks for products in all areas. The Company considers the overall protection of its patent, trademark, license and other intellectual property rights to be of material value and acts to protect these rights from infringement.

 

In the pharmaceutical industry, the majority of an innovative product’s commercial value is usually realized during the period in which the product has market exclusivity. In the U.S. and some other countries, when market exclusivity expires and generic versions of a product are approved and marketed, there can often be very substantial and rapid declines in the product’s sales. The rate of this decline varies by country and by therapeutic category. For a discussion of how generic versions of a product can impact that product’s sales, see “—Generic Competition” below.

 

A product’s market exclusivity is generally determined by two forms of intellectual property: patent rights held by the innovator company and any regulatory forms of exclusivity to which the innovative drug is entitled.

 

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Patents are a key determinant of market exclusivity for most branded pharmaceuticals. Patents provide the innovator with the right to exclude others from practicing an invention related to the medicine. Patents may cover, among other things, the active ingredient(s), various uses of a drug product, pharmaceutical formulations, drug delivery mechanisms and processes for (or intermediates useful in) the manufacture of products. Protection for individual products extends for varying periods in accordance with the expiration dates of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent, its scope of coverage and the availability of meaningful legal remedies in the country.

 

Market exclusivity is also sometimes influenced by regulatory intellectual property rights. Many developed countries provide certain non-patent incentives for the development of medicines. For example, the United States, the EU and Japan each provide for a minimum period of time after the approval of a new drug during which the regulatory agency may not rely upon the innovator’s data to approve a competitor’s generic copy. Regulatory intellectual property rights are also available in certain markets as incentives for research on new indications, on orphan drugs and on medicines useful in treating pediatric patients.

 

Regulatory intellectual property rights are independent of any patent rights that the Company may possess and can be particularly important when a drug lacks broad patent protection. However, most regulatory forms of exclusivity do not prevent a competitor from gaining regulatory approval prior to the expiration of regulatory data exclusivity on the basis of the competitor’s own safety and efficacy data on its drug, even when that drug is identical to that marketed by the innovator.

 

The Company estimates the likely market exclusivity period for each of its products on a case-by-case basis. It is not possible to predict the length of market exclusivity for any of the Company’s products with certainty because of the complex interaction between patent and regulatory forms of exclusivity, and inherent uncertainties concerning patent litigation. There can be no assurance that a particular product will enjoy market exclusivity for the full period of time that the Company currently estimates or that the exclusivity will be limited to the estimate. The Company expects to have continued exclusivity challenges over the next several years. For further discussion of these exclusivity challenges, see “—Pharmaceuticals Segment” above and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Outlook” below.

 

In addition to patents and regulatory forms of exclusivity, the Company also holds intellectual property in the form of trademarks on products such as ENFAMIL. Trademarks have no effect on market exclusivity for a product, but are considered to have marketing value. Worldwide, all of the Company’s important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely.

 

Specific aspects of the law governing market exclusivity for pharmaceuticals vary from country to country. The following summarizes key exclusivity rules in markets representing significant Company sales:

 

United States

 

A company seeking to market an innovative pharmaceutical in the United States must file a complete set of safety and efficacy data to the FDA. The type of application filed depends on whether the drug is a chemical (a small molecule) or a biological product (a large molecule). If the innovative pharmaceutical is a chemical, the company files a NDA. If the medicine is a biological product, a BLA is filed. The type of application filed affects regulatory exclusivity rights.

 

A competitor seeking to launch a generic substitute of a chemical innovative drug in the United States must file an Abbreviated New Drug Application (aNDA) with the FDA. In the aNDA, the generic manufacturer needs to demonstrate only “bioequivalence” between the generic substitute and the approved NDA drug. The aNDA relies upon the safety and efficacy data previously filed by the innovator in its NDA.

 

Medicines approved under an NDA can receive several types of regulatory data protection. An innovative chemical pharmaceutical (also known as a new chemical entity) is entitled to five years of regulatory data protection in the U.S., during which an aNDA cannot be filed with the FDA. If an innovator’s patent is challenged, as described below, the generic manufacturer may file its aNDA after the fourth year of the five-year data protection period. A pharmaceutical drug product that contains an active ingredient that has been previously approved in an NDA, but is approved in a new formulation or for a new indication on the basis of new clinical trials, receives three years of data protection. Finally, an NDA that is designated as an Orphan Drug, which is a drug that gains an indication for treatment of a condition that occurs only rarely in the United States, can receive seven years of exclusivity for the orphan indication. During this time period neither NDAs nor aNDAs for the same drug product can be approved for the same orphan use.

 

Because a significant portion of patent life can be lost during the time it takes to obtain regulatory approval, the innovator can extend one patent to compensate the innovator for the lost patent term, at least in part. More specifically, the innovator may identify one patent, which claims the product or its approved method of use, and, depending on a number of factors, may extend the expiration date of that patent. There are two limits to these extensions. First, the maximum term a patent can be extended is 5 years, and second, the extension cannot cause the patent to be in effect for more than 14 years from the date of NDA approval.

 

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A company may also earn six months of additional exclusivity for a drug where specific clinical trials are conducted at the written request of the FDA to study the use of the medicine to treat pediatric patients, and submission to the FDA is made prior to the loss of basic exclusivity. This six-month period extends most forms of exclusivity (patent and regulatory) that are listed with the FDA at the time the studies are completed and submitted to the FDA.

 

Currently, generic versions of biological products cannot be approved under U.S. law. However, the law could change in the future. Even in the absence of new legislation, the FDA is taking steps toward allowing generic versions of certain biologics. Competitors seeking approval of biological products must file their own safety and efficacy data, and address the challenges of biologics manufacturing, which involves more complex processes and are more costly than those of traditional pharmaceutical operations.

 

Beyond the minimum period of regulatory exclusivity provided by U.S. law, many (but not all) innovative drugs are also covered by patents held by the NDA sponsor.

 

The innovator company is required to list certain of its patents covering the medicine with the FDA in what is commonly known as the Orange Book. Absent a successful patent challenge, the FDA cannot approve an aNDA until after the innovator’s listed patents expire. However, after the innovator has marketed its product for four years, a generic manufacturer may file an aNDA and allege that one or more of the patents listed in the Orange Book under an innovator’s NDA is either invalid or not infringed. This allegation is commonly known as a “Paragraph IV certification.” The innovator then must decide whether to file a patent infringement suit against the generic manufacturer. If one or more of the NDA-listed patents are successfully challenged, or if the innovator chooses not to sue, the first filer of a Paragraph IV certification (or first filers if more than one generic qualifies) may be entitled to a 180-day period of market exclusivity as against all other generic manufacturers. From time to time aNDAs, including Paragraph IV certifications, are filed with respect to certain of the Company’s products. The Company evaluates these aNDAs on a case-by-case basis and, where warranted, files suit against the generic manufacturer to protect its patent rights.

 

Several recent developments in the United States have increased the likelihood of generic challenges to innovators’ intellectual property, and thus, increased the risk of loss of innovators’ market exclusivity. First, generic companies have increasingly sought to challenge innovators’ basic patents covering major pharmaceutical products. For a discussion of one such litigation related to patent challenges by generic companies, see “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies—PLAVIX* Litigation.” Second, recent statutory and regulatory provisions in the United States limit the ability of an innovator company to prevent generic drugs from being approved and launched while patent litigation is ongoing. Third, the FDA is actively considering ways to expand the use of a regulatory mechanism that allows for regulatory approval of drugs that are similar to (but not generic copies of) innovative drugs on the basis of less extensive data than is required for a full NDA. As a result of all of these developments, it is not possible to predict the length of market exclusivity for a particular Company product with certainty based solely on the expiration of the relevant patent(s) or the current forms of regulatory exclusivity. For more information about new legislation, see “—Government Regulation and Price Constraints” below.

 

European Union

 

In the EU, most innovative pharmaceuticals are entitled to ten years of regulatory data protection if marketing approval is obtained via the “centralized procedure.” A product that receives approval under the centralized procedure automatically receives approval in every member state of the EU. However, a company then must obtain pricing and reimbursement for the pharmaceutical product, which is typically subject to member state law. The pricing and reimbursement procedure can take months, and sometimes years, to obtain. Consequently, regardless of whether or not the innovative medicine is covered by patents, generic copies relying on the innovator’s data usually cannot be approved for a minimum of ten years after approval. An additional one year of protection is available in certain circumstances in which the innovator drug receives a substantial new indication after approval. For innovative pharmaceuticals that gain marketing approval using the non-centralized mutual recognition procedure, this period is six or ten years depending on the individual EU member state. However, regardless of regulatory exclusivity, competitors may obtain approval of an identical product on the basis of their own safety and efficacy data at any time. For more information regarding the regulation of pharmaceutical products in the EU, see “—Government Regulation and Price Constraints” below.

 

Recent pharmaceutical legislation in the EU has an impact on the procedures for authorization of pharmaceutical products in the EU under both the centralized and mutual recognition procedures. In particular, the legislation contains new data protection provisions. All products (regardless of whether they have been approved under the centralized or the mutual recognition procedures) will be subject to an “8+2+1” regime. Eight years after the innovator has received its first community authorization for a medicinal product, a generic company may file a marketing authorization application for that product with the health authorities. However, the generic company may not commercialize the product until after either ten or eleven years have elapsed from the initial marketing

 

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authorization granted to the innovator. The possible one year extension is available if the innovator, during the first eight years of the marketing authorization, obtains an additional indication that is of significant clinical benefit in comparison with existing treatments. There is a transitional provision for these new data protection requirements, and these provisions will apply as new marketing authorization applications are submitted under the new legislation.

 

Patents on pharmaceutical products are generally enforceable in the EU. However, in contrast to the United States, patents are not listed with regulatory authorities. Generic copies can be approved after data protection expires, regardless of whether the innovator holds patents covering its drug. Thus, it is possible that an innovator may be seeking to enforce its patents against a generic competitor that is already marketing its product. Also, the European patent system has an opposition procedure in which generic manufacturers may challenge the validity of patents covering innovator products within nine months of grant. As in the United States, patents in the EU may be extended to compensate for the patent term lost during the regulatory review process. Such extensions are granted on a country-by-country basis.

 

In general, EU law treats chemically synthesized drugs and biologically derived drugs the same with respect to intellectual property and market exclusivity. A generic biological product has received regulatory marketing authorization in the E.U.

 

Japan

 

In Japan, medicines of new chemical entities are generally afforded six years of protection for approved indications and dosage. Patents on pharmaceutical products are enforceable. Generic copies can receive regulatory approval after data protection and patent expirations. As in the United States, patents in Japan may be extended to compensate for the patent term lost during the regulatory review process.

 

In general, Japanese law treats chemically synthesized and biologically derived drugs the same with respect to intellectual property and market exclusivity.

 

Rest of World

 

In countries outside of the United States, the EU and Japan, there is a wide variety of legal systems with respect to intellectual property and market exclusivity of pharmaceuticals. Most other developed countries utilize systems similar to either the United States (e.g., Canada) or the EU (e.g., Switzerland). Among less developed countries, some have adopted patent laws and/or regulatory exclusivity laws, while others have not. Some less developed nations have formally adopted laws in order to comply with World Trade Organization (WTO) commitments, but have not taken steps to implement these laws in a meaningful way. Enforcement of WTO obligations is a long process, and there is no assurance of the outcome. Thus, in assessing the likely future market exclusivity of the Company’s innovative drugs in less developed countries, the Company takes into account not only formal legal rights but political and other factors as well.

 

Marketing, Distribution and Customers

 

The Company promotes its products in medical journals and directly to health care providers such as doctors, nurse practitioners, physician assistants, pharmacists, technologists, hospitals, Pharmacy Benefit Managers (PBMs), Managed Care Organizations (MCOs) and government agencies. The Company also markets directly to consumers in the United States through direct-to-consumer print, radio and television advertising. In addition, the Company sponsors general advertising to educate the public about its innovative medical research. For a discussion of the regulation of promotion and marketing of pharmaceuticals, see “—Government Regulation and Price Constraints” below.

 

Through the Company’s sales and marketing organizations, the Company explains the approved uses and advantages of its products to medical professionals. The Company works to gain access to health authority, PBM and MCO formularies (lists of recommended or approved medicines and other products), including Medicare Part D plans and reimbursement lists by demonstrating the qualities and treatment benefits of its products. Marketing of prescription pharmaceuticals is limited to the approved uses of the particular product, but the Company continues to develop information about its products and provides such information in response to unsolicited inquiries from doctors and other medical professionals. All drugs must complete clinical trials required by regulatory authorities to show they are safe and effective for treating one or more medical problems. A manufacturer may choose, however, to undertake additional studies, including comparative clinical trials with competitive products, to demonstrate additional advantages of a compound. Those studies can be costly and take years to complete, and the results are uncertain. Balancing these considerations makes it difficult to decide whether and when to undertake such additional studies. But, when they are successful, such studies can have a major impact on approved marketing claims and strategies.

 

The Company’s operations include several pharmaceutical marketing and sales organizations. Each organization markets a distinct group of products supported by a sales force and is typically based on particular therapeutic areas or physician groups. These

 

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sales forces often focus on selling new products when they are introduced, and promotion to physicians is increasingly targeted at specialists and high value primary care physicians. In addition, Ventiv Pharma Services, LLC (Ventiv), a division of Ventiv Health, Inc., provided the Company with a sales force focused on CEFZIL (through December 2005) and TEQUIN. In January 2006, the Company provided notice to Ventiv to terminate its agreement related to the sales force for TEQUIN, effective in the first quarter of 2006.

 

The Company’s prescription pharmaceutical products are sold principally to wholesalers, but the Company also sells directly to retailers, hospitals, clinics, government agencies and pharmacies. In 2005, sales to three pharmaceutical wholesalers in the United States, McKesson, Cardinal Health, Inc. (Cardinal) and AmerisourceBergen Corporation (AmerisourceBergen) accounted for approximately 20%, 19% and 11%, respectively, of the Company’s total net sales. In 2004, sales to McKesson, Cardinal and AmerisourceBergen accounted for approximately 19%, 17% and 10%, respectively, of the Company’s total net sales. In 2003, sales to McKesson, Cardinal and AmerisourceBergen accounted for approximately 17%, 15% and 13%, respectively, of the Company’s total net sales. Sales to these U.S. wholesalers were concentrated in the Pharmaceuticals segment.

 

The Company’s U.S. pharmaceuticals business, through the Inventory Management Agreements (IMAs), has arrangements with substantially all of its direct wholesaler customers that allow the Company to monitor U.S. wholesaler inventory levels and require those wholesalers to maintain inventory levels at approximately one month or less of their demand. In the second and third quarters of 2005, the Company negotiated amendments to its IMAs with its three largest wholesalers. The amendments extended the original agreements through December 31, 2005 and established lower limits than the original agreements for inventory levels of Company pharmaceutical products held by the wholesalers. In December 2005, the Company reached two year agreements in principle with its three largest U.S. wholesalers, which provide the same lower limits of wholesaler inventory levels as the IMA extensions previously negotiated.

 

To help maintain the product quality of ERBITUX*, the product is shipped only to end-users and not to other intermediaries (such as wholesalers) to hold for later sales. During 2004 and through May of 2005, McKesson, one of the Company’s wholesalers, provided warehousing, packing and shipping services for ERBITUX*. McKesson held ERBITUX* inventory on consignment and the Company recognized revenue when McKesson shipped the inventory to the end-users. McKesson also held inventories of ERBITUX* for its own account. Upon divestiture of OTN in May 2005, the company discontinued the consignment arrangement with McKesson. The Company now sells ERBITUX* to intermediaries such as specialty oncology distributors and ships ERBITUX* directly to the end-users of the product who are the customers of these intermediaries. The Company recognizes revenue upon shipment to the end-users.

 

For information on sales and marketing of nutritionals, see “—Nutritionals Segment” above.

 

Competition

 

The markets in which the Company competes are generally broad-based and highly competitive. The principal means of competition vary among product categories and business groups.

 

The Company’s Pharmaceuticals segment competes with other worldwide research-based drug companies, many smaller research companies with more limited therapeutic focus and generic drug manufacturers. Important competitive factors include product efficacy, safety and ease of use, price and demonstrated cost-effectiveness, marketing effectiveness, product labeling, service and research and development of new products and processes. Sales of the Company’s products can be impacted by new studies that indicate a competitor’s product has greater efficacy for treating a disease or particular form of disease than one of the Company’s products. The Company’s sales also can be impacted by additional labeling requirements relating to safety or convenience that may be imposed on its products by the FDA or by similar regulatory agencies in different countries. If competitors introduce new products and processes with therapeutic or cost advantages, the Company’s products can be subject to progressive price reductions or decreased volume of sales, or both. For example, in the growing market for statins, which reduce cholesterol, PRAVACHOL, the Company’s second largest product ranked by 2005 net sales ($2.3 billion), experienced increased competition from established brands and new entrants. U.S. prescriptions for PRAVACHOL declined 17% in 2005 compared to 2004. PRAVACHOL has begun to lose exclusivity in Europe. Between now and its anticipated loss of U.S. exclusivity in April 2006, its expected rate of decline in sales and in share of the statin segment could be accelerated by increased competition.

 

To successfully compete for business with managed care and pharmacy benefits management organizations, the Company must often demonstrate that its products offer not only medical benefits but also cost advantages as compared with other forms of care. Most new products that the Company introduces must compete with other products already on the market or products that are later developed by competitors. Manufacturers of generic pharmaceuticals typically invest far less in research and development than research-based pharmaceutical companies and therefore can price their products significantly lower than branded products. Accordingly, when a branded product loses its market exclusivity, it normally faces intense price competition from generic forms of the product. In certain countries outside the United States, patent protection is weak or nonexistent and the Company must compete with generic versions shortly after it launches its innovative product.

 

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Many other companies, large and small, manufacture and sell one or more products that are similar to those marketed by the Company’s Nutritionals and Other Health Care segments. Sources of competitive advantage include product quality and efficacy, brand identity, advertising and promotion, product innovation, broad distribution capabilities, customer satisfaction and price. Significant expenditures for advertising, promotion and marketing are generally required to achieve both consumer and trade acceptance of these products.

 

The Company believes its long-term competitive position depends upon its success in discovering and developing innovative, cost-effective products that serve unmet medical needs, together with its ability to manufacture the products efficiently and to market them effectively in a highly competitive environment. There can be no assurance that the Company’s research and development efforts will result in commercially successful products or that its products or processes will not become outmoded from time to time as a result of products or processes developed by its competitors.

 

Managed Care Organizations

 

The growth of MCOs in the United States has been a major factor in the competitive make-up of the health care marketplace. Over half the U.S. population now participates in some version of managed care. Because of the size of the patient population covered by MCOs, marketing of prescription drugs to them and the PBMs that serve many of those organizations has become important to the Company’s business. MCOs can include medical insurance companies, medical plan administrators, health-maintenance organizations, Medicare Part D formularies, alliances of hospitals and physicians and other physician organizations. Those organizations have been consolidating into fewer, even larger entities, enhancing their purchasing strength and importance to the Company.

 

A major objective of MCOs is to contain and, where possible, reduce health care expenditures. They typically use formularies, volume purchases and long-term contracts to negotiate discounts from pharmaceutical providers. MCOs and PBMs typically develop formularies to reduce their cost for medications. Formularies can be based on the prices and therapeutic benefits of the available products. Due to their generally lower cost, generic medicines are often favored. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs use a variety of means to encourage patients’ use of products listed on their formularies.

 

Exclusion of a product from a formulary can lead to its sharply reduced usage in the MCO patient population. Consequently, pharmaceutical companies compete aggressively to have their products included. Where possible, companies compete for inclusion based upon unique features of their products, such as greater efficacy, better patient ease of use or fewer side effects. A lower overall cost of therapy is also an important factor. Products that demonstrate fewer therapeutic advantages must compete for inclusion based primarily on price. The Company has been generally, although not universally, successful in having its major products included on MCO formularies.

 

Generic Competition

 

One of the biggest competitive challenges that the Company faces in the United States and, to a lesser extent, internationally is from generic pharmaceutical manufacturers. Upon the expiration or loss of market exclusivity on a product, the Company can lose the major portion of sales of that product in a very short period of time. In the United States, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, and allows generic manufacturers to rely on the safety and efficacy of the pioneer product. Therefore, generic competitors operate without the Company’s large research and development expenses and its costs of conveying medical information about the product to the medical community. For more information about market exclusivity, see “—Intellectual Property and Product Exclusivity” above.

 

The rate of sales decline of a product after the expiration of exclusivity varies by country. In general, the decline in the U.S. market is more rapid than in most other developed countries. Also, the declines in developed countries tend to be more rapid than in less developed countries.

 

The rate of sales decline after the expiration of exclusivity has also historically been influenced by product characteristics. For example, drugs that are used in a large patient population (e.g., those prescribed by primary care physicians) tend to experience more rapid declines than drugs in specialized areas of medicine (e.g., oncology). Drugs that are more complex to manufacture (e.g., sterile injectable products) usually experience a slower decline than those that are simpler to manufacture.

 

As noted above, MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their health care programs. Laws in the United States generally allow, and in many cases require, pharmacists to substitute generic drugs that have been rated under government procedures to be therapeutically equivalent to a brand-name drug. The substitution must be made unless the prescribing physician expressly forbids it. These laws and policies provide an added incentive for generic manufacturers to seek marketing approval as the automatic substitution removes the need for generic manufacturers to incur many of the sales and marketing costs, which innovators must incur.

 

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Research and Development

 

The Company invests heavily in research and development because it believes it is critical to its long-term competitiveness. Pharmaceutical research and development is carried out by the Bristol-Myers Squibb Pharmaceutical Research Institute, which has major facilities in Princeton, Hopewell and New Brunswick, New Jersey and Wallingford, Connecticut. Pharmaceutical research and development is also carried out at various other facilities in the United States and in Belgium, Canada, and the United Kingdom. Management continues to emphasize leadership, innovation, productivity and quality as strategies for success in the Pharmaceutical Research Institute.

 

The Company spent $2,746 million in 2005, $2,500 million in 2004 and $2,279 million in 2003 on Company sponsored research and development activities. Company sponsored pharmaceutical research and development spending (including certain payments under third-party collaborations and contracts), as a percentage of Pharmaceutical sales, was 16.5% in 2005, compared with 14.7% in 2004 and 14.0% in 2003. At the end of 2005, the Company employed approximately 7,800 people in research and development throughout the Company, including over 6,200 in the Pharmaceutical Research Institute, including a substantial number of physicians, scientists holding graduate or postgraduate degrees and higher skilled technical personnel.

 

The Company concentrates its pharmaceutical research and development efforts in the following disease areas with significant unmet medical needs: Affective (psychiatric) disorders, Alzheimer’s/dementia, atherosclerosis/thrombosis, diabetes, hepatitis, human immunodeficiency virus/acquired immune deficiency syndrome (HIV/AIDS), obesity, oncology, rheumatoid arthritis and related diseases and solid organ transplant. However, the Company continues to analyze and may selectively pursue promising leads in other areas. In addition to discovering and developing new molecular entities, the Company looks for ways to expand the value of existing products through new uses and formulations that can provide additional benefits to patients.

 

To supplement the Company’s internal efforts, the Company collaborates with independent research organizations, including educational institutions and research-based pharmaceutical and biotechnology companies, and contracts with others for the performance of research in their facilities. The Company uses the services of physicians, hospitals, medical schools and other research organizations worldwide to conduct clinical trials to establish the safety and effectiveness of new products. The Company actively seeks out investments in external research and technologies that hold the promise to complement and strengthen its own research efforts. These investments can take many forms, including licensing arrangements, codevelopment and comarketing agreements, copromotion arrangements and joint ventures.

 

Drug development is time-consuming, expensive and risky. In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new molecular entities through preclinical tests and controlled clinical evaluation. Before a new drug may be marketed in the United States, recorded data on preclinical and clinical experience are included in the NDA or the BLA to the FDA for the required approval. The development of certain other products is also subject to government regulations covering safety and efficacy in the United States and many foreign countries. There can be no assurance that a compound developed as a result of any program will obtain the regulatory approvals necessary for it to be marketed for any particular disease indication.

 

On average, only about one in ten thousand chemical compounds discovered by pharmaceutical industry researchers proves to be both medically effective and safe enough to become an approved medicine. The process from discovery to regulatory approval typically takes ten years or longer. Drug candidates can fail at any stage of the process, and even late-stage product candidates sometimes fail to receive regulatory approval. The Company believes its investments in research, both internally and in collaboration with others, have been rewarded by the number of new pharmaceutical compounds and indications it has in all stages of development.

 

The Company’s drug discovery program includes many alliances and collaborative agreements. These agreements bring new products into the pipeline or help the Company remain on the cutting edge of technology in the search for novel medicines.

 

Listed below are several investigational compounds that the Company has in the later stages of development. All of these compounds are in Phase III clinical trials or under regulatory review. Whether or not any of these investigational compounds ultimately becomes one of the Company’s marketed products depends on the results of pre-clinical and clinical studies, the competitive landscape of the potential product’s market and the manufacturing processes necessary to produce the potential product on a commercial scale, among other factors. However, as noted above, there can be no assurance that the Company will seek regulatory approval of any of these compounds or that, if such approval is sought, it will be obtained. At this stage of development, the Company cannot determine all intellectual property issues or all the patent protection that may, or may not, be available for these investigational compounds. The patent coverage highlighted below does not include potential patent term extensions.

 

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EMSAM*

  

EMSAM*, an investigational monoamine oxidase inhibitor administered as a transdermal patch for the treatment of patients with major depressive disorder, is being codeveloped with Somerset and has received an approvable letter from the FDA in February 2004. In October 2005, an FDA Advisory Committee recommended EMSAM* could be safely administered without dietary modifications at the 6mg./24 hour dose. On February 27, 2006, the FDA approved EMSAM* for use without dietary modifications at the lowest dose of 6mg./24 hour.

Ixabepilone

  

Ixabepilone, an epothilone B analog, which is being developed internally, is a novel tubulin inhibitor for multiple tumor types. It is developed internally and is currently in Phase III clinical trials for the treatment of metastatic breast cancer and in Phase II clinical trials for the treatment of prostate cancer. The Company has a composition of matter patent in the United States that expires in 2018.

Vinflunine

  

Vinflunine, which is being codeveloped with Pierre Fabre and is currently in Phase III clinical trials, is a novel investigational anti-cancer agent. Pierre Fabre has a composition of matter patent that expires in the U.S. in 2014.

Ipilimumab

  

Ipilimumab, which is being codeveloped with Medarex and is currently in Phase III clinical trials, is a monoclonal antibody being investigated as an anticancer treatment. It is in a novel class of agents intended to potentiate elements of the immunologic response. The Company owns a composition of matter patent that expires in the U.S. in 2016 and has rights to method of use patents owned by Medarex that expire in the U.S. in 2015. The Company also has rights to a Medarex composition of matter patent that expires in 2020 and pending Medarex patent applications covering composition of matter and method of use of ipilimumab.

Belatacept

  

Belatacept, a biological product, which is being developed internally and is in Phase III clinical trials, is a fusion protein with novel immunosuppressive activity targeted at prevention of solid organ transplant rejection. The Company has pending patent applications in the United States and Japan, and a granted patent application in the EU, covering belatacept.

Saxagliptin

  

Saxagliptin, which is being developed internally and is currently in Phase III clinical trials, is an oral compound for the potential treatment of diabetes. A patent application covering the composition of matter has been issued, and will expire in 2021 in the U.S.

Dasatinib

  

Dasatinib, which is being developed internally, is an investigational multi-targeted kinase inhibitor to treat adult chronic myelogenous leukemia in chronic, accelerated or blast phases. In December 2005, the Company submitted an NDA to the FDA and, on March 7, 2006, the NDA was accepted and granted priority review for accelerated approval. The Company submitted an MAA to the EMEA in January 2006. The Company has a composition of matter patent which expires in 2020 in the U.S.

 

Muraglitazar, is a dual PPAR agonist for the treatment of type 2 diabetes and other metabolic disorders. In October 2005, the FDA issued an approvable letter for muraglitazar requesting additional information from ongoing clinical trials to more fully address the cardiovascular safety profile of the product. The Company, while continuing discussions with the FDA, has determined that it will likely have to initiate additional new trials to gain regulatory approval and is considering a range of options, including conducting such additional studies or terminating further development of muraglitazar. The additional studies could take approximately five years to complete. In December 2005, the Company and Merck & Co., Inc. terminated their collaboration agreement for muraglitazar with all rights to muraglitazar returning to the Company as of December 21, 2005. As a result of the termination of the agreement, the Company recognized $143 million of deferred income in the fourth quarter of 2005 which was recorded in “Other expense, net.” The Company has a composition of matter patent which expires in the United States in 2020.

 

The Company’s competitors also devote substantial funds and resources to research and development. In addition, the consolidation that has occurred in the pharmaceutical industry has created companies with substantial research and development resources. The extent to which the Company’s competitors are successful in their research could result in erosion of the sales of its products and unanticipated product obsolescence.

 

Government Regulation and Price Constraints

 

The pharmaceutical industry is subject to extensive global regulation by regional, country, state and local agencies. The Federal Food, Drug, and Cosmetic Act (FDC Act), other federal statutes and regulations, various state statutes and regulations, and laws and regulations of foreign governments govern to varying degrees the testing, approval, production, labeling, distribution, post-market

 

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surveillance, advertising, dissemination of information, and promotion of the Company’s products. The lengthy process of laboratory and clinical testing, data analysis, manufacturing, development, and regulatory review necessary for required governmental approvals is extremely costly and can significantly delay product introductions in a given market. Promotion, marketing, manufacturing, and distribution of pharmaceutical products are extensively regulated in all major world markets. In addition, the Company’s operations are subject to complex federal, state, local, and foreign environmental and occupational safety laws and regulations. The Company anticipates that the laws and regulations affecting the manufacture and sale of current products and the introduction of new products will continue to require substantial scientific and technical effort, time, expense and significant capital investment.

 

Of particular importance is the FDA in the United States. It has jurisdiction over virtually all of the Company’s businesses and imposes requirements covering the testing, safety, effectiveness, manufacturing, labeling, marketing, advertising and post-marketing surveillance of the Company’s pharmaceutical products. The FDA also regulates most of the Company’s Nutritionals and Other Health Care products. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States.

 

The Company’s pharmaceutical products are subject to pre-market approval requirements in the United States. New drugs are approved under, and are subject to, the FDC Act and related regulations. Biological drugs are subject to both the FDC Act and the Public Health Service Act (PHS Act), and related regulations. Biological drugs are licensed under the PHS Act. The Nutritional products are regulated by the FDA primarily under the Infant Formula Act of 1980 and its amendments (IFA).

 

The FDA mandates that drugs be manufactured, packaged and labeled in conformity with current Good Manufacturing Practices (cGMP) established by the FDA. In complying with cGMP regulations, manufacturers must continue to expend time, money and effort in production, record keeping and quality control to ensure that the product meets applicable specifications and other requirements to ensure product safety and efficacy. The FDA periodically inspects drug manufacturing facilities to ensure compliance with applicable cGMP requirements. Failure to comply with the statutory and regulatory requirements subjects the manufacturer to possible legal or regulatory action, such as suspension of manufacturing, seizure of product or voluntary recall of a product. Adverse experiences with the use of products must be reported to the FDA and could result in the imposition of market restrictions through labeling changes or in product removal. Product approvals may be withdrawn if compliance with regulatory requirements is not maintained or if problems concerning safety or efficacy of the product occur following approval.

 

The federal government has extensive enforcement powers over the activities of pharmaceutical manufacturers, including authority to withdraw product approvals, commence actions to seize and prohibit the sale of unapproved or non-complying products, to halt manufacturing operations that are not in compliance with cGMPs, and to impose or seek injunctions, voluntary recalls, and civil monetary and criminal penalties. Such a restriction or prohibition on sales or withdrawal of approval of products marketed by the Company could materially adversely affect its business, financial condition and results of operations.

 

Marketing authorization for the Company’s products is subject to revocation by the applicable governmental agencies. In addition, modifications or enhancements of approved products or changes in manufacturing locations are in many circumstances subject to additional FDA approvals, which may or may not be received and which may be subject to a lengthy application process.

 

The distribution of pharmaceutical products is subject to the Prescription Drug Marketing Act, known as “PDMA,” as part of the FDC Act, which regulates such activities at both the federal and state level. Under the PDMA and its implementing regulations, states are permitted to require registration of manufacturers and distributors who provide pharmaceuticals even if such manufacturers or distributors have no place of business within the state. States are also permitted to adopt regulations limiting the distribution of product samples to licensed practitioners. The PDMA also imposes extensive licensing, personnel record keeping, packaging, quantity, labeling, product handling and facility storage and security requirements intended to prevent the sale of pharmaceutical product samples or other diversions.

 

The marketing practices of all U.S. pharmaceutical manufacturers are subject to federal and state health care laws that are used to protect the integrity of government health care programs. The Office of Inspector General of the United States Department of Health and Human Services (OIG) oversees compliance with applicable federal laws, in connection with the payment for products by government funded programs (primarily Medicaid and Medicare). These laws include the federal anti-kickback statute which criminalizes the offering of something of value to induce the recommendation, order or purchase of products or services reimbursed under a government health care program. The OIG has issued a series of Guidances to segments of the health care industry, including the 2003 Compliance Program Guidance for Pharmaceutical Manufacturers (the “OIG Guidance”), which includes a recommendation that pharmaceutical manufacturers, at a minimum, adhere to the PhRMA Code, a voluntary industry code of marketing practices. The Company subscribes to the PhRMA Code, and has implemented a compliance program to address the requirements set forth in the OIG Guidance and the Company’s compliance with the health care laws. Failure to comply with these health care laws could subject the Company to administrative and legal proceedings, including actions by the state and federal government agencies. Such actions could result in the imposition of civil and criminal sanctions, which may include fines, penalties and injunctive remedies, the impact of which could materially adversely affect the Company’s business, financial condition and results of operations.

 

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The Company is also subject to the jurisdiction of various other federal and state regulatory and enforcement departments and agencies, such as the Federal Trade Commission (FTC), the Department of Justice and the Department of Health and Human Services in the United States. The Company is also licensed by the U.S. Drug Enforcement Agency to procure and produce controlled substances. The Company is, therefore, subject to possible administrative and legal proceedings and actions by those organizations. Such actions may result in the imposition of civil and criminal sanctions, which may include fines, penalties and injunctive or administrative remedies.

 

Various federal and state agencies have regulatory authority regarding the manufacture, storage, transportation and disposal of many Medical Imaging products because of their radioactive nature.

 

The Company’s activities outside the United States are also subject to regulatory requirements governing the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of the Company’s products. These regulatory requirements vary from country to country. In the EU, there are two ways that a company can obtain marketing authorization for a pharmaceutical product. The first route is the “centralized procedure.” This procedure is compulsory for certain pharmaceutical products, in particular those using biotechnological processes, but also is available for certain new chemical compounds and products. The second route to obtain marketing authorization in the EU is the “mutual recognition procedure.” Applications are made to a single member state, and if the member state approves the pharmaceutical product under a national procedure, then the applicant may submit that approval to the mutual recognition procedure of some or all other member states. As set forth above, pricing and reimbursement of the product continues to be the subject of member state law.

 

Whether or not FDA approval or approval of the European Medicines Evaluation Agency has been obtained for a product, approval of the product by comparable regulatory authorities of countries outside of the United States or the EU, as the case may be, must be obtained prior to marketing the product in those countries. The approval process may be more or less rigorous from country to country and the time required for approval may be longer or shorter than that required in the United States. Approval in one country does not assure that such product will be approved in another country.

 

In many markets outside the United States, the Company operates in an environment of government-mandated, cost-containment programs. Several governments have placed restrictions on physician prescription levels and patient reimbursements, emphasized greater use of generic drugs and/or enacted across-the-board price cuts as methods of cost control. Most European countries do not provide market pricing for new medicines, except the United Kingdom and Germany. Pricing freedom is limited in the United Kingdom by the operation of a profit control plan and in Germany by the operation of a reference price system. Companies also face significant delays, mainly in France, Spain, Italy and Belgium, in market access for new products, and more than two years can elapse before new medicines become available on some national markets. Additionally, member states of the EU have regularly imposed new or additional cost containment measures for pharmaceuticals. In recent years, Italy, for example, has imposed mandatory price decreases. The existence of price differentials within Europe due to the different national pricing and reimbursement laws leads to significant parallel trade flows.

 

In recent years, Congress and some state legislatures have considered a number of proposals and have enacted laws that could effect major changes in the health care system, either nationally or at the state level. Driven in part by budget concerns, Medicaid access and reimbursement restrictions have been implemented in some states and proposed in many others. Similar cost containment issues exist in many foreign countries where the Company does business.

 

Federal and state governments also have pursued direct methods to reduce the cost of drugs for which they pay. The Company participates in state government-managed Medicaid programs as well as certain other qualifying federal and state government programs whereby discounts and rebates are provided to participating state and local government entities. Rebates under Medicaid and related state programs reduced revenues by $595 million in 2005, $673 million in 2004 and $523 million in 2003. The Company also participates in prime vendor programs with government entities, the most significant of which are the U.S. Department of Defense and the U.S. Department of Veterans Affairs. These entities receive minimum discounts based off a defined “non-federal average manufacturer price” for purchases. Other prime vendor programs in which the Company participates provide discounts for outpatient medicines purchased by certain Public Health Service entities and “disproportionate share” hospitals (hospitals meeting certain criteria). The Company recorded discounts related to the prime vendor programs of $1,090 million in 2005, $1,319 million in 2004 and $1,228 million in 2003.

 

In the United States, governmental cost containment efforts have extended to the federally funded Special Supplemental Nutrition Program for WIC. All states participate in the WIC program and have sought and obtained rebates from manufacturers of infant formula whose products are used in the program. All states have conducted competitive bidding for infant formula contracts, which require the use of specific infant formula products by the state WIC program, unless a physician requests a non-contract formula for a WIC customer. States participating in the WIC program are required to engage in competitive bidding or to use other cost containment measures that yield savings equal to or greater than the savings generated by a competitive bidding system. Mead Johnson participates in this program and approximately half of its gross U.S. sales are subject to rebates under the WIC program. Rebates under the WIC program reduced revenues by $843 million in 2005, $846 million in 2004 and $854 million in 2003.

 

27


The merger of two separate Japanese pharmaceutical regulatory offices may lead to gains in efficiency and timeliness of drug registration in Japan. However, the pricing environment for pharmaceuticals in Japan remains challenging due to reference pricing and biennial government mandated price reductions.

 

Environmental Regulation

 

The Company’s facilities and operations are subject to extensive U.S. and foreign laws and regulations relating to environmental protection and human health and safety, including those governing discharges of pollutants into the air and water, the use, management and disposal of hazardous, radioactive and biological materials and wastes, and the cleanup of contamination. Pollution controls and permits are required for many of the Company’s operations, and these permits are subject to modification, renewal or revocation by the issuing authorities.

 

An environment, health and safety group within the Company monitors operations around the world, providing the Company with an overview of regulatory requirements and overseeing the implementation of Company standards for compliance. The Company also incurs operating and capital costs for such matters on an ongoing basis. The Company expended approximately $55 million, $27 million and $38 million on capital environmental projects undertaken specifically to meet environmental requirements in 2003, 2004 and 2005, respectively, and expects to spend approximately $69 million in 2006. Although the Company believes that it is in substantial compliance with applicable environmental, health and safety requirements and the permits required for its operations, the Company nevertheless could incur additional costs, including civil or criminal fines or penalties, clean-up costs, or third-party claims for property damage or personal injury, for violations or liabilities under these laws.

 

Many of the Company’s current and former facilities have been in operation for many years, and, over time, the Company and other operators of those facilities have generated, used, stored or disposed of substances or wastes that are considered hazardous under federal, state and foreign environmental laws, including the U.S. Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA). As a result, the soil and groundwater at or under certain of these facilities is or may be contaminated, and the Company may be required to make significant expenditures to investigate, control and remediate such contamination, and in some cases to provide compensation and/or restoration for damages to natural resources. Currently, the Company is involved in investigation and remediation at approximately 10 current or former Company facilities. The Company has also been identified as a “potentially responsible party” (PRP) under applicable laws for environmental conditions at approximately 30 waste disposal or reprocessing facilities operated by third parties at which investigation and/or remediation activities are ongoing.

 

The Company may face liability under CERCLA and other federal, state and foreign laws for the entire cost of investigation or remediation of contaminated sites, or for natural resource damages, regardless of fault or ownership at the time of the disposal or release. In addition, at certain sites the Company bears remediation responsibility pursuant to contract obligations. Generally, at third-party operator sites involving multiple PRPs, liability has been or is expected to be apportioned based on the nature and amount of hazardous substances disposed of by each party at the site and the number of financially viable PRPs. For additional information about these matters, see “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies.”

 

Employees

 

The Company employed approximately 43,000 people at December 31, 2005.

 

Foreign Operations

 

The Company has significant operations outside the United States. They are conducted both through the Company’s subsidiaries and through distributors, and involve all three of the same business segments as the Company’s U.S. operations —Pharmaceuticals, Nutritionals and Other Health Care.

 

Revenues from operations outside the United States of $8.7 billion accounted for 46% of the Company’s total revenues in 2005. In 2005, revenues exceeded $500 million in each of France, Japan, Spain, Canada, Italy, and Germany. No single country outside the United States contributed more than 10% of the Company’s total revenues. For a geographic breakdown of net sales, see the table captioned Geographic in “Item 8. Financial Statements—Note 17. Segment Information” and for further discussion of the Company’s sales by geographic area see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Geographic Areas.”

 

International operations are subject to certain risks, which are inherent in conducting business abroad, including, but not limited to, currency fluctuations, possible nationalization or expropriation, price and exchange controls, counterfeit, limitations on foreign participation in local enterprises and other restrictive governmental actions. The Company’s international businesses are also subject to government-imposed constraints, including laws on pricing or reimbursement for use of products.

 

28


Depending on the direction of change relative to the U.S. dollar, foreign currency values can increase or reduce the reported dollar value of the Company’s net assets and results of operations. In 2005, the change in foreign exchange rates had a favorable impact on the growth rate of revenues. While the Company cannot predict with certainty future changes in foreign exchange rates or the effect they will have on it, the Company attempts to mitigate their impact through operational means and by using various financial instruments. See the discussion under “Item 8. Financial Statements—Note 16. Financial Instruments.”

 

29


Item 1A. RISK FACTORS.

 

Any of the factors described below could significantly and negatively affect our business, prospects, financial condition, operating results, or our credit ratings, which could cause the trading price of our common stock to decline. Additional risks and uncertainties not presently known to the Company, or risks that the Company currently considers immaterial, may also impair the Company’s operations.

 

Litigation—PLAVIX*

 

The Company cannot predict the outcome of the PLAVIX* litigation in the U.S., which is scheduled to go to trial in June 2006. Although the plaintiffs intend to vigorously pursue enforcement of their patent rights in PLAVIX*, it is not possible at this time reasonably to assess the outcome of this litigation, or, if the Company were not to prevail in the litigation, or, if Apotex Inc. and Apotex Corp. (Apotex), which now has final approval of its sNDA in the U.S. were to enter the market with a generic product at risk, the timing of potential generic competition for PLAVIX*. However, loss of market exclusivity for PLAVIX* and the subsequent development of generic competition and/or a decision by Apotex to launch generic clopidogrel at risk, would be material to the Company’s sales of PLAVIX* and results of operations and cash flows, and could be material to its financial condition and liquidity.

 

The Company has recorded deferred tax assets related to U.S. foreign tax credit and research tax credit carryforwards, which expire in varying amounts beginning in 2012. Realization of the foreign tax credit and research tax credit carryforwards is dependent on generating sufficient taxable income prior to their expiration. Although realization is not assured, management believes it is more likely than not that these deferred tax assets will be realized. The amount of foreign tax credit and research tax credit carryforwards considered realizable, however, could be reduced in the near term if the outcome of the PLAVIX* litigation in the U.S. is unfavorable, and/or if the timing of successful generic competition for PLAVIX* were to be accelerated. If such events occur, the Company may need to record significant additional valuation allowances against these deferred tax assets. For additional information on PLAVIX* litigation see “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies.”

 

Competition

 

Competition from manufacturers of generic versions of our products is a major challenge as our products mature and patents expire on products. Generic companies are also increasingly seeking to challenge patents. Other competitive factors the Company faces include (i) new products developed by competitors that have lower prices or superior performance features or that are otherwise competitive with our current products; (ii) technological advances and patents attained by competitors; (iii) results of clinical studies related to our products or a competitor’s products; (iv) problems with licensors, suppliers and distributors; and (v) business combinations among our competitors or major customers.

 

Manufacturing

 

The Company may experience difficulties and delays inherent in product development, manufacturing and sale, such as (i) products that may appear promising in development but fail to ever reach market or to be approved for additional indications for any number of reasons, including efficacy or safety concerns, the delay or denial of necessary regulatory approvals and the difficulty or excessive cost to manufacture; (ii) failure of one or more of the Company’s products to achieve or maintain commercial viability; (iii) seizure or recalls of pharmaceutical products or forced closings of manufacturing plants; (iv) the failure to obtain, the imposition of limitations on the use of, or loss of patent and other intellectual property rights; (v) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other application regulations and quality assurance guidelines that could lead to temporary manufacturing shutdowns, product shortages and delays in product manufacturing; and (vi) other manufacturing or distribution problems including changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, such as biologics, or physical limitations that could impact continuous supply.

 

Other Litigation

 

The Company has continuing obligations under the Deferred Prosecution Agreement and United States Securities and Exchange Commission (SEC) Consent Order relating to wholesaler inventory and various accounting matters, pursuant to which the Company agreed to implement certain remedial measures, including all recommendations made by the Independent Monitor under with the Deferred Prosecution Agreement, undertake corporate reforms, and include additional disclosure in its periodic reports filed with the SEC and annual report to shareholders.

 

The Company may experience legal difficulties, including lawsuits, claims, proceedings and government investigations, any of which can preclude or delay commercialization of products or adversely affect operations, profitability, liquidity or financial condition, including (i) intellectual property disputes; (ii) sales and marketing practices in the U.S. and internationally; (iii) adverse decisions in litigation, including product liability and commercial cases; (iv) the Company’s determination to self-insure for product liabilities effective July 1, 2004; (v) recalls or withdrawals of pharmaceutical products or forced closings of manufacturing plants; (vi) the failure to fulfill obligations under supply contracts with the government and other customers which may result in liability; (vii) product pricing and promotion matters; (viii) claims asserting violations of securities, antitrust, federal and state pricing and other laws; (ix) environmental, health and safety matters; and (x) tax liabilities. There can be no assurance that there will not be an increase in scope of these matters or that any future lawsuits, claims, proceedings or investigations will not be material.

 

Regulation

 

        The Company could become subject to new government laws and regulations, such as (i) health care reform initiatives in the United States at the state and federal level and in other countries; (ii) changes in the FDA and foreign regulatory approval processes that may cause delays in approving, or preventing the approval of, new products; (iii) tax changes such as the phasing out of tax benefits heretofore available in the United States and certain foreign countries; (iv) new laws, regulations and judicial decisions affecting pricing or marketing within or across jurisdictions; and (v) changes in intellectual property law.

 

Pricing Pressures

 

Pharmaceutical products are subject to increasing price pressures and other restrictions in the United States and worldwide, including (i) rules and practices of managed care groups and institutional and governmental purchasers, (ii) judicial decisions and governmental laws and regulations related to Medicare, Medicaid and healthcare reform, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, and (iii) the potential impact of importation restrictions, legislative or otherwise, pharmaceutical reimbursement, Medicare Part D Formularies, and product pricing in general.

 

Reliance on Third Parties

 

The Company relies on vendors, partners and other third parties to meet their contractual, regulatory and other obligations in relation to their arrangements with the Company.

 

Economic Factors

 

The Company is exposed to changes in interest rates and fluctuation of foreign currency exchange rates and other economic factors over which the Company has no control.

 

Execution of the Company’s Strategy

 

The Company may not be able to fully execute the strategic transformation of our business to attain a new period of sustainable revenue and earnings growth. The Company continues to invest in our growth drivers and pipeline as part of our focus on addressing areas of significant unmet medical needs. Failure to realize additional cost savings in 2007 and 2008 or to successfully transition the product portfolio, however, could materially and adversely affect the Company’s results of operations.

 

Changes in the Company’s structure, operations, revenues, costs, staffing or efficiency resulting from acquisitions, divestitures, mergers, alliances, restructurings or other strategic initiatives, could result in greater than expected costs and other difficulties, including the need for regulatory approvals, as appropriate.

 

Spending

 

Changes to advertising and promotional spending and other categories of spending may affect sales.

 

Information Technology

 

The Company is increasingly dependent on information technology systems and any significant breakdown, invasion, destruction or interruption of these systems could negatively impact operations.

 

Although the Company believes that it has been prudent in its plans and assumptions, no assurance can be given that any goal or plan set forth in forward-looking statements can be achieved and readers are cautioned not to place undue reliance on such statements, which speak only as of the date made. The Company undertakes no obligation to release publicly any revisions to forward-looking statements as a result of new information, future events or otherwise.

 

30


Item 1B. UNRESOLVED STAFF COMMENTS.

 

None.

 

31


Item 2. PROPERTIES.

 

The Company’s world headquarters is located at 345 Park Avenue, New York, New York, where it leases approximately 375,000 square feet of floor space, approximately 215,000 square feet of which is sublet to others.

 

The Company manufactures products at 36 major worldwide locations with an aggregate floor space of approximately 11.6 million square feet. All facilities are owned by the Company. The following table illustrates the geographic location of the Company’s significant manufacturing facilities by business segment.

 

     Total
Company


   Pharmaceuticals

   Nutritionals

   Other
Health Care


United States

   10    6    2    2

Europe, Middle East and Africa

   13    11    1    1

Other Western Hemisphere

   6    5    1   

Pacific

   7    4    3   
    
  
  
  

Total

   36    26    7    3
    
  
  
  

 

Portions of these facilities and other facilities owned or leased by the Company in the United States and elsewhere are used for research, administration, storage and distribution. For further information about the Company’s facilities, see “Item 1. Business—Manufacturing and Quality Assurance.”

 

Item 3. LEGAL PROCEEDINGS.

 

Information pertaining to legal proceedings can be found in “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies” and is incorporated by reference herein.

 

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

 

No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2005.

 

32


PART IA

 

Executive Officers of the Registrant

 

Listed below is information on executive officers of the Company as of March 13, 2006. Executive officers are elected by the Board of Directors for an initial term, which continues until the first Board meeting following the next annual meeting of stockholders and thereafter are elected for a one-year term or until their successors have been elected. All executive officers serve at the pleasure of the Board of Directors.

 

Name and Current Position


   Age

  

Employment History for the Past 5 Years


Lamberto Andreotti

Executive Vice President and President,

Worldwide Pharmaceuticals

Member of the Executive Committee

  

55

  

2000 to 2002 - President, Europe, Worldwide Medicines Group, a division of the Company.

2002 to 2005 – Senior Vice President and President International, Worldwide Medicines Group, a division of the Company.

2005 to present – Executive Vice President and President, Worldwide Pharmaceuticals, a division of the Company.

Stephen E. Bear

Senior Vice President, Human Resources,

Corporate Staff

Member of the Executive Committee

  

55

  

1999 to 2001 – Vice President, Marketing and Business Development of the New York Botanical Gardens, a non-profit organization.

2001 to present – Senior Vice President, Human Resources, Corporate Staff of the Company.

Andrew G. Bodnar, M.D.

Senior Vice President, Strategy and

Medical & External Affairs, Corporate Staff

Member of the Executive Committee

  

58

  

2000 to 2001 – Vice President, Medical and External Affairs, Corporate Staff of the Company.

2001 to 2002 – Senior Vice President, Medical and External Affairs, Corporate Staff of the Company.

2002 to present – Senior Vice President, Strategy and Medical & External Affairs, Corporate Staff of the Company.

Andrew R. J. Bonfield

Chief Financial Officer,

Corporate Staff

Member of the Executive Committee

  

43

  

2000 to 2002 – Executive Director, Finance, BG Group PLC.

2002 to present – Chief Financial Officer, Corporate Staff of the Company.

Joseph C. Caldarella

Vice President and Corporate Controller,

Corporate Staff

  

50

  

1998 to 2005 – Vice President, Finance, Pharmaceutical Research Institute, a division of the Company.

2005 to present – Vice President and Corporate Controller, Corporate Staff of the Company.

John E. Celentano

President, Health Care Group

Member of the Executive Committee

  

46

  

2000 to 2002 – Vice President and General Manager, Northern Europe, International Medicines, a division of the Company.

2002 to 2002 – Senior Vice President, Operations Planning, Worldwide Medicines Group, a division of the Company.

2002 to 2002 – President, Canada, Mexico, and Puerto Rico, Worldwide Medicines Group, a division of the Company.

2002 to 2005 – President, Latin America and Canada, Worldwide Medicines Group, a division of the Company.

2005 to present – President, Health Care Group, a division of the Company.

Carlo de Notaristefani, CIRM

President, Technical Operations

Member of the Executive Committee

  

48

  

2000 to 2001 – Vice President, IO International, Aventis Pharma.

2001 to 2003 – Vice President, IO International, Latin America and Japan, Aventis Pharma.

2003 to 2004 – Senior Vice President, Global Finishing Solids, Aventis Pharma.

2004 to 2004 – President, Pharmaceutical Group/Technical Operations, a division of the Company.

2004 to present – President, Technical Operations, a division

of the Company.

 

33


Wendy L. Dixon, Ph.D.

Chief Marketing Officer and President, Global Marketing

Member of the Executive Committee

  

50

  

1996 to 2001 – Vice President, Marketing, Merck & Co.

2001 to 2001 – Senior Vice President, Merck & Co.

2001 to present – Chief Marketing Officer and President, Global Marketing, Worldwide Medicines Group, a division of the Company.

Peter R. Dolan

Chief Executive Officer

Member of the Executive Committee

  

50

  

2000 to 2001 – President and Director of the Company.

2001 to 2005 – Chairman of the Board and Chief Executive Officer of the Company.

2005 to present – Chief Executive Officer and Director of the Company.

Edward M. Dwyer

Vice President and Treasurer, Corporate Staff

  

49

  

1997 to 2004 – Vice President and Treasurer, AT&T.

2004 to present – Vice President and Treasurer, Corporate Staff of the Company.

Anthony C. Hooper

President, U.S. Pharmaceuticals

Member of the Executive Committee

  

51

  

2000 to 2001 – President, Asia-Pacific, Middle East & Southern Africa, International Medicines, a division of the Company.

2001 to 2002 – President, Intercontinental, International Medicines, a division of the Company.

2002 to 2004 – President, Europe, Middle East & Africa, Worldwide Medicines Group, a division of the Company.

2004 to present – President, U.S. Pharmaceuticals, Worldwide Medicines Group, a division of the Company.

Tamar D. Howson

Senior Vice President, Corporate and Business Development, Corporate Staff

Member of the Executive Committee

  

57

  

2000 to 2001 – Biotechnology consultant to chief executive officers and other business executives.

2001 to present – Senior Vice President, Corporate and Business Development, Corporate Staff of the Company.

Sandra Leung

Vice President and Corporate Secretary,

Corporate Staff

  

45

  

1999 to 2002 – Corporate Secretary, Corporate Staff of the Company.

2002 to present – Vice President and Corporate Secretary, Corporate Staff of the Company.

John L. McGoldrick

Executive Vice President, Corporate Staff

Member of the Executive Committee

  

65

  

2000 to 2001 – Executive Vice President and General Counsel, Corporate Staff of the Company and President, Medical Devices Group, a division of the Company.

2001 to 2005 – Executive Vice President and General Counsel, Corporate Staff of the Company.

2005 to present – Executive Vice President, Corporate Staff of the Company.

Elliott Sigal, M.D., Ph.D.

Chief Scientific Officer and President,

Pharmaceutical Research Institute

Member of the Executive Committee

  

54

  

1999 to 2001 – Senior Vice President, Early Discovery and Applied Technology, Pharmaceutical Research Institute, a division of the Company.

2001 to 2002 – Senior Vice President, Drug Discovery & Exploratory Development, Pharmaceutical Research Institute, a division of the Company.

2002 to 2004 – Senior Vice President, Global Clinical and Pharmaceutical Development, Pharmaceutical Research Institute, a division of the Company.

2004 to present – Chief Scientific Officer and President, Pharmaceutical Research Institute, a division of the Company.

Richard K. Willard

Senior Vice President and General Counsel,

Corporate Staff

Member of the Executive Committee

  

57

  

1999 to 2005 – Senior Vice President and General Counsel, The Gillette Company.

2005 to present – Senior Vice President and General Counsel, Corporate Staff of the Company.

Richard L. Wolgemuth, Ph.D.

Senior Vice President, Global Regulatory Sciences

Member of the Executive Committee

  

60

  

2000 to 2003 – Vice President, CEDD Global Regulatory Affairs, GlaxoSmithKline.

2003 to present – Senior Vice President, Global Regulatory Sciences, Pharmaceutical Research Institute, a division of the Company.

 

34


David L. Zabor

Vice President, Strategic Business Initiatives,

Corporate Staff

Member of the Executive Committee

  

51

  

2000 to 2001 – Vice President, Finance, Technical Operations, Worldwide Medicines Group, a division of the Company.

2001 to 2002 – Vice President, Financial Analysis, Corporate Staff of the Company.

2002 to 2002 – Vice President and Acting Controller, Corporate Staff of the Company.

2002 to 2003 – Vice President and Controller, Corporate Staff of the Company.

2003 to 2004 – Vice President and Operations Controller, Corporate Staff of the Company.

2004 to 2005 – Vice President, Financial Operations and Controller, Corporate Staff of the Company.

2005 to present – Vice President, Strategic Business Initiatives, Corporate Staff of the Company.

Robert T. Zito

Senior Vice President, Corporate and Business

Communications and Chief Communications Officer

Member of the Executive Committee

  

52

  

1999 to 2004 – Executive Vice President, Communications, New York Stock Exchange.

2004 to present – Senior Vice President, Corporate Affairs, Corporate Staff of the Company.

 

35


PART II

 

Item 5. MARKET FOR THE REGISTRANT’S COMMON STOCK AND OTHER STOCKHOLDER MATTERS.

 

Market Prices

 

Bristol-Myers Squibb common and preferred stocks are traded on the New York Stock Exchange and the Pacific Exchange, Inc. (symbols: BMY; BMYPR). A quarterly summary of the high and low market prices is presented below:

 

Common:

                           
     2005

   2004

     High

   Low

   High

   Low

First Quarter

   $ 25.54    $ 23.44    $ 30.64    $ 24.00

Second Quarter

     26.48      24.90      26.18      24.02

Third Quarter

     25.27      23.97      24.68      22.50

Fourth Quarter

     23.95      21.03      25.83      22.95

Preferred:

                           
     2005

   2004

     High

   Low

   High

   Low

First Quarter

     *      *    $ 525.00    $ 485.00

Second Quarter

     *      *      *      *

Third Quarter

     *      *      *      *

Fourth Quarter

   $ 364.00    $ 364.00      *      *

*

During the first, second and third quarters of 2005, and the second, third and fourth quarters of 2004, there were no trades of the Company’s preferred stock. The preferred stock pays a quarterly dividend of $.50 per share.

 

Holders of Common Stock

 

The number of record holders of common stock at December 31, 2005 was 81,024.

 

The number of record holders is based upon the actual number of holders registered on the books of the Company at such date and does not include holders of shares in “street names” or persons, partnerships, associations, corporations or other entities identified in security position listings maintained by depository trust companies.

 

Voting Securities and Principal Holders

 

Reference is made to the 2006 Proxy Statement to be filed on or about March 22, 2006 with respect to voting securities and principal holders, which is incorporated herein by reference and made a part hereof in response to the information required by this Item 5.

 

Dividends

 

Dividends declared per share in 2005 and 2004 were:

 

     Common

   Preferred

     2005

   2004

   2005

   2004

First Quarter

   $ .28    $ .28    $ .50    $ .50

Second Quarter

     .28      .28      .50      .50

Third Quarter

     .28      .28      .50      .50

Fourth Quarter

     .28      .28      .50      .50
    

  

  

  

     $ 1.12    $ 1.12    $ 2.00    $ 2.00
    

  

  

  

 

In December 2005, the Board of Directors of the Company declared a quarterly dividend of $.28 per share on the common stock of the Company, which was paid on February 1, 2006 to shareholders of record as of January 6, 2006.

 

36


Unregistered Sales of Equity Securities and Use of Proceeds

 

The following table summarizes the surrenders of the Company’s equity securities in connection with stock option and restricted stock programs during the twelve-month period ended December 31, 2005:

 

Period


  

Total Number of

Shares Purchased(a)


   Average Price
Paid per Share(a)


   Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs(b)


   Approximate Dollar
Value of Shares that
May Yet Be Purchased
Under the Plans or
Programs(b)


(Dollars in Millions Except Per Share Data)

                   

January 1 to 31, 2005

   31,445    $ 25.38    372,351,413    $ 2,220

February 1 to 28, 2005

   42,276    $ 24.11    372,351,413    $ 2,220

March 1 to 31, 2005

   246,720    $ 25.44    372,351,413    $ 2,220
    
         
      

Three months ended March 31, 2005

   320,441           372,351,413       
    
         
      

April 1 to 30, 2005

   9,798    $ 25.52    372,351,413    $ 2,220

May 1 to 31, 2005

   9,880    $ 25.77    372,351,413    $ 2,220

June 1 to 30, 2005

   5,162    $ 25.43    372,351,413    $ 2,220
    
         
      

Three months ended June 30, 2005

   24,840           372,351,413       
    
         
      

July 1 to 31, 2005

   30,322    $ 25.17    372,351,413    $ 2,220

August 1 to 31, 2005

   43,398    $ 25.09    372,351,413    $ 2,220

September 1 to 30, 2005

   4,648    $ 24.60    372,351,413    $ 2,220
    
         
      

Three months ended September 30, 2005

   78,368           372,351,413       
    
         
      

October 1 to 31, 2005

   17,876    $ 24.02    372,351,413    $ 2,220

November 1 to 30, 2005

   7,947    $ 21.12    372,351,413    $ 2,220

December 1 to 31, 2005

   29,400    $ 21.74    372,351,413    $ 2,220
    
         
      

Three months ended December 31, 2005

   55,223           372,351,413       
    
         
      

Twelve months ended December 31, 2005

   478,872           372,351,413       
    
         
      

 

(a)

Reflects the following transactions during the twelve months ended December 31, 2005: (i) the deemed surrender to the Company of 343,968 shares of Common Stock to pay the exercise price and to satisfy tax withholding obligations in connection with the exercise of employee stock options, and (ii) the surrender to the Company of 134,904 shares of Common Stock to satisfy tax withholding obligations in connection with the vesting of restricted stock issued to employees.

(b)

In June 2001, the Company announced that the Board of Directors authorized the purchase of up to $14 billion of Company common stock. During the twelve months ended December 31, 2005, no shares were repurchased pursuant to this program and no purchases of any shares under this program are expected in 2006.

 

37


Item 6. SELECTED FINANCIAL DATA.

 

Five-Year Financial Summary

 

(Amounts in Millions Except Per Share Data)

 

   2005

   2004

   2003

   2002

   2001

Income Statement Data:(1)(2)

                                  

Net Sales

   $ 19,207    $ 19,380    $ 18,653    $ 16,208    $ 16,612

Earnings from Continuing Operations Before Minority Interest and Income Taxes

     4,516      4,418      4,680      2,748      2,252

Earnings from Continuing Operations

     2,992      2,378      3,097      2,059      1,866

Earnings from Continuing Operations per Common Share:

                                  

Basic

   $ 1.53    $ 1.23    $ 1.60    $ 1.07    $ .96

Diluted

   $ 1.52    $ 1.21    $ 1.59    $ 1.06    $ .95

Average common shares outstanding:

                                  

Basic

     1,952      1,942      1,937      1,936      1,940

Diluted

     1,983      1,976      1,950      1,942      1,965

Dividends paid on common and preferred stock

   $ 2,186    $ 2,174    $ 2,169    $ 2,168    $ 2,137

Dividends declared per Common Share

   $ 1.12    $ 1.12    $ 1.12    $ 1.12    $ 1.11

Financial Position Data at December 31:(3)

                                  

Total Assets

   $ 28,138    $ 30,435    $ 27,448    $ 25,106    $ 27,864

Cash and cash equivalents

     3,050      3,680      2,549      2,451      4,552

Marketable securities

     2,749      3,794      3,013      1,622      1,102

Long-term debt

     8,364      8,463      8,522      6,261      6,237

Stockholders’ Equity

     11,208      10,202      9,786      8,756      8,762

 

(1)

The Company recorded items that affected the comparability of results, which are set forth in the table under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Expenses” for the years 2005, 2004 and 2003. For a discussion of these items, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Expenses,” “Item 8. Financial Statements—Note 2. Alliances and Investments,” “—Note 3. Restructuring and Other Items,” “—Note 4. Acquisitions and Divestitures,” “—Note 5. Discontinued Operations” and “—Note 20. Legal Proceedings and Contingencies.”

 

 

(2)

Excludes discontinued operations of OTN in all years; and Clairol and Zimmer in 2001 and 2002.

 

 

(3)

Includes discontinued operations for years 2001 through 2004.

 

38


Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

EXECUTIVE SUMMARY

 

About the Company

 

Bristol-Myers Squibb Company (BMS, the Company or Bristol-Myers Squibb) is a worldwide pharmaceutical and related health care products company whose mission is to extend and enhance human life by providing the highest quality pharmaceutical and related health care products. The Company is engaged in the discovery, development, licensing, manufacturing, marketing, distribution and sale of pharmaceuticals and related health care products.

 

The Company has three reportable segments—Pharmaceuticals, Nutritionals and Other Health Care. The Pharmaceuticals segment is made up of the global pharmaceutical and international consumer medicines business. The Nutritionals segment consists of Mead Johnson Nutritionals (Mead Johnson), primarily an infant formula and children’s nutritionals business. The Other Health Care segment consists of the ConvaTec, Medical Imaging and Consumer Medicines (U.S. and Canada) businesses. In the third quarter of 2005, the Company completed the sale of its Consumer Medicines business. The Nutritionals and Other Health Care segments are also collectively known as the Health Care Group. For additional information about these segments, see “Item 8. Financial Statements—Note 17. Segment Information.”

 

Business Environment

 

The Company conducts its business primarily within the pharmaceutical industry, which is highly competitive and subject to numerous government regulations. Many competitive factors may significantly affect the Company’s sales of its products, including product efficacy, safety, price and cost-effectiveness, marketing effectiveness, product labeling, quality control and quality assurance of its manufacturing operations, and research and development of new products. To successfully compete for business in the health care industry, the Company must not only demonstrate its products offer medical benefits, but also cost advantages. Currently, most of the Company’s new product introductions compete with other products already on the market in the same therapeutic category. The Company manufactures branded products, which are priced higher than generic products. Generic competition is one of the Company’s leading challenges globally.

 

In the pharmaceutical industry, the majority of an innovative product’s commercial value is usually realized during the period in which the product has market exclusivity. When a product loses exclusivity, it is no longer protected by a patent and is subject to new competing products in the form of generic brands. Upon exclusivity loss of a product, the Company can lose a major portion of that product’s sales in a short period of time. For further discussion on product exclusivity, see “Item 1. Business–Intellectual Property and Product Exclusivity.”

 

Both in the U.S. and internationally, the health care industry is subject to various government-imposed regulations that authorize prices or price controls that have and will continue to have an impact on the Company’s sales. In the U.S., Congress and some state legislatures have considered a number of proposals and have enacted laws that could effect major changes in the health care system, either nationally or at the state level. Driven in part by budget concerns, Medicaid access and reimbursement restrictions have been implemented in some states and proposed in many others. In addition, in December 2003, the Medicare Prescription Drug Improvement and Modernization Act (MMA) was enacted to provide outpatient prescription drug coverage to senior citizens in the United States. The MMA became effective in January 2006. The Company cannot predict the potential impact that this legislation will have on its business; however it could have a negative impact on the Company’s U.S. pharmaceutical business as greater federal involvement and budget constraints may increase the likelihood of pricing pressures or controls in the future. In many markets outside the United States, the Company operates in environments of government-mandated, cost-containment programs, or under other regulatory regimes that can exert downward pressure on pricing. Pricing freedom is limited in the United Kingdom, for instance, by the operation of a profit control plan and in Germany by the operation of a reference price system. Companies also face significant delays in market access for new products and more than two years can elapse before new medicines become available in some national markets.

 

The growth of Managed Care Organizations (MCOs) in the U.S. has played a large role in the competition that surrounds the health care industry. MCOs seek to reduce health care expenditures for participants by making volume purchases and entering into long-term contracts to negotiate discounts with various pharmaceutical providers. Because of the market potential created by the large pool of participants, marketing prescription drugs to MCOs has become an important part of the Company’s strategy. Companies compete for inclusion in a MCO formulary and the Company has generally been successful in having its major products included. The Company believes that developments in the managed care industry, including continued consolidation, have had and will continue to have a generally downward pressure on prices.

 

39


Pharmaceutical production processes are complex, highly regulated and vary widely from product to product. Shifting or adding manufacturing capacity can be a lengthy process requiring significant capital expenditures and regulatory approvals. Biologics manufacturing involves more complex processes than those of traditional pharmaceutical operations. As biologics become more important to the Company’s product portfolio, the Company may continue to make arrangements with third party manufacturers, and expects to make substantial investments to increase its internal capacity to produce biologics on a commercial scale.

 

The Company has maintained a competitive position in the market and strives to uphold this position, which is dependent on its success in discovering and developing innovative, cost-effective products that serve unmet medical needs.

 

The Company and its subsidiaries are the subject of a number of significant pending lawsuits, claims, proceedings and investigations. It is not possible at this time reasonably to assess the final outcome of these investigations or litigations. Management continues to believe, as previously disclosed, that during the next few years, the aggregate impact, beyond current reserves, of these and other legal matters affecting the Company is reasonably likely to be material to the Company’s results of operations and cash flows, and may be material to its financial condition and liquidity. For additional discussion of legal matters, see “Item 8. Financial Statements and Supplementary Data—Note 20. Legal Proceedings and Contingencies.”

 

Strategy

 

The Company continues to execute its strategy for long term growth and is currently on track to complete its strategic transition in 2006 and to attain a period of sustainable sales and earnings growth starting in 2007. This strategy consists of increasing investments behind growth drivers, focusing the Company’s research and development programs on products in the pharmaceutical pipeline in disease areas that address significant unmet medical needs, aligning sales and marketing emphasis on specialists and high value primary care prescribers, and implementing initiatives designed to achieve and maintain a more efficient cost base.

 

The Company is in the process of transforming its pharmaceutical portfolio in favor of growth drivers and specialty products, which include PLAVIX*, AVAPRO*/AVALIDE*, ABILIFY*, REYATAZ, ERBITUX* and BARACLUDE. U.S. net sales of these products accounted for 35% of the Company’s worldwide pharmaceutical net sales in 2005, compared to 29% in 2004, while worldwide net sales of these products accounted for 36% of the Company’s worldwide net sales in 2005 as compared to 29% in 2004.

 

In December 2005, the U.S. Food and Drug Administration (FDA) approved ORENCIA (abatacept) and it became commercially available in the U.S. in February 2006. ORENCIA is targeted initially at adult patients with moderate to severe rheumatoid arthritis, who have had an inadequate response to certain currently available treatments. A marketing authorization application (MAA) has also been submitted for the product with the European Medicines Evaluation Agency (EMEA). In January 2006, a supplemental Biologics License Application (sBLA) was filed with the FDA for the approval of a third-party manufacturing facility to support increased production capacity for ORENCIA. The sBLA is part of the Company’s plan to engage in third-party manufacturing arrangements to meet future commercial demand expected to be generated from the approval and commercialization of a variety of biologics.

 

Also in December 2005, the Company completed the submission of its New Drug Application (NDA) to the FDA for dasatinib, a kinase inhibitor for the potential treatment of chronic myelogenous leukemia (CML). On March 7, 2006, the NDA was accepted and granted priority review for accelerated approval. In January 2006, the Company submitted an MAA for dasatinib to the EMEA. In October 2005, an FDA Advisory Committee recommended EMSAM*, a transdermal patch treatment of adults with major despressive disorder, could be safely administered without dietary modifications at the 6mg./24 hour dose. On February 27, 2006, the FDA approved EMSAM* for use without dietary modifications at the lowest dose of 6mg./24 hour.

 

In keeping with its strategy, the Company invested $2.7 billion in research and development, representing a 10% growth rate over 2004. Research and development dedicated to pharmaceutical products, including milestone payments for in-licensing and development programs, was $2.5 billion, or 16.5% of Pharmaceutical sales in 2005 compared to $2.3 billion, or 14.7% of Pharmaceutical sales in 2004.

 

Another major aspect of the Company’s strategy relates to how it does business, specifically in its marketing and sales approaches. Specialists are playing an even greater role in decisions related to patient treatment and care, particularly in the 10 critical disease areas where the Company is focusing its efforts. The Company has realigned its U.S. and European sales forces with a focus on specialists as well as with those primary care physicians who are involved in treating patients in these disease areas.

 

As part of its strategy, the Company is re-examining its operating costs to achieve and maintain a more efficient cost base. At the end of 2005, the Company launched an initiative to identify and realize productivity savings. Through this initiative, the Company will re-examine its operating model to focus resources on high value priorities; simplify and streamline business processes, governance and decision making; and build the capabilities to sustain these cost reductions for the long term. The Company’s goal is to realize a minimum of $500 million in productivity savings in 2007, an incremental $100 million in 2008 and implement lasting changes that will make the Company more productive, efficient and effective.

 

40


RESULTS OF OPERATIONS

 

The following discussion of the Company’s results of continuing operations excludes the results related to the Oncology Therapeutics Network (OTN) business, which were previously presented as a separate segment, and has been segregated from continuing operations and reflected as discontinued operations for all periods presented. See “—Discontinued Operations” below.

 

                 % Change

 

(Dollars in Millions)

 

   2005

    2004

    2003

    2005 to 2004

    2004 to 2003

 

Net Sales

   $ 19,207     $ 19,380     $ 18,653     (1 )%   4 %

Earnings from Continuing Operations Before Minority Interest and Income Taxes

   $ 4,516     $ 4,418     $ 4,680     2 %   (6 )%

% of net sales

     23.5 %     22.8 %     25.1 %            

Provision for income taxes

   $ 932     $ 1,519     $ 1,210     (39 )%   26 %

Effective tax rate

     20.6 %     34.4 %     25.8 %            

Earnings from Continuing Operations

   $ 2,992     $ 2,378     $ 3,097     26 %   (23 )%

% of net sales

     15.6 %     12.3 %     16.6 %            

 

Net Sales

 

Net sales from continuing operations for 2005 decreased 1% to $19.2 billion compared to 2004. U.S. net sales in 2005 decreased 1% to $10.5 billion compared to 2004, while international net sales of $8.7 billion remained relatively constant in 2005 as compared to 2004, including a 2% favorable foreign exchange impact.

 

In 2004, net sales from continuing operations increased 4% to $19.4 billion from $18.7 billion in 2003. U.S. net sales in 2004 remained relatively constant at $10.6 billion compared to 2003 and international net sales increased 10% to $8.8 billion in 2004, including a 8% favorable foreign exchange impact, from $8.0 billion in 2003.

 

The composition of the change in sales is as follows:

 

         Analysis of % Change

     Total Change

  Volume

  Price

   Foreign
Exchange


2005 vs. 2004

   (1)%   (2)%      1%

2004 vs. 2003

   4%        4%

 

In general, the Company’s business is not seasonal. For information on U.S. pharmaceuticals prescriber demand, reference is made to the table within Business Segments under the Pharmaceuticals section below, which sets forth a comparison of changes in net sales to the estimated total prescription growth (for both retail and mail order customers) for certain of the Company’s pharmaceutical products.

 

The Company operates in three reportable segments—Pharmaceuticals, Nutritionals and Other Health Care. In May 2005, the Company completed the sale of OTN, which was previously presented as a separate segment. As such, the results of operations for OTN are presented as part of the Company’s results from discontinued operations in accordance with Statement of Financial Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Accordingly, OTN results of operations in prior periods have been reclassified to discontinued operations to conform with current year presentations. The percent of the Company’s net sales by segment were as follows:

 

     Net Sales

    % Change

 

(Dollars in Millions)

 

   2005

    2004

    2003

    2005 to 2004

    2004 to 2003

 

Pharmaceuticals

   $ 15,254     $ 15,564     $ 15,025     (2 )%   4 %

% of net sales

     79 %     80 %     80 %            

Nutritionals

     2,205       2,001       2,023     10 %   (1 )%

% of net sales

     12 %     10 %     11 %            

Other Health Care

     1,748       1,815       1,605     (4 )%   13 %

% of net sales

     9 %     10 %     9 %            

Total

   $ 19,207     $ 19,380     $ 18,653     (1 )%   4 %

 

41


The Company recognizes revenue net of various sales adjustments to arrive at net sales as reported on the Consolidated Statement of Earnings. These adjustments are referred to as gross-to-net sales adjustments and are further described in “—Critical Accounting Policies” below. The following table sets forth the reconciliation of the Company’s gross sales to net sales by each significant category of gross-to-net sales adjustments:

 

     For the Year Ended December 31,

 

(Dollars in Millions)

 

   2005

    2004

    2003

 

Gross Sales

   $ 23,003     $ 23,896     $ 22,992  

Gross-to-Net Sales Adjustments

                        

Prime Vendor Charge-Backs

     (1,090 )     (1,319 )     (1,228 )

Women, Infants and Children (WIC) Rebates

     (843 )     (846 )     (854 )

Managed Health Care Rebates and Other Contract Discounts

     (514 )     (660 )     (710 )

Medicaid Rebates

     (595 )     (673 )     (523 )

Cash Discounts

     (271 )     (311 )     (319 )

Sales Returns

     (164 )     (276 )     (348 )

Other Adjustments

     (319 )     (431 )     (357 )
    


 


 


Total Gross-to-Net Sales Adjustments

     (3,796 )     (4,516 )     (4,339 )
    


 


 


Net Sales

   $ 19,207     $ 19,380     $ 18,653  
    


 


 


 

The decrease in prime vendor charge-backs and managed health care rebates in 2005 was primarily due to lower relative sales volume in this segment due to product mix. The decrease in sales returns was primarily due to lower returns for certain products including TEQUIN, PRAVACHOL and SUSTIVA. The decrease in other adjustments was due to lower sales discounts and government rebates in the international businesses.

 

In 2004, the increases from 2003 for prime vendor charge-backs and Medicaid rebates were primarily due to a shift in sales to products with higher discounts in prime vendor and Medicaid programs while the decrease in sales returns was primarily attributable to higher sales returns in 2003 resulting from discontinued products and product conversions.

 

The following table sets forth the activities and ending balances of each significant category of gross-to-net sales adjustments:

 

(Dollars in Millions)

 

   Prime
Vendor
Charge-
Backs


    Women,
Infants and
Children
(WIC)
Rebates


    Managed
Health Care
Rebates and
Other
Contract
Discounts


    Medicaid
Rebates


    Cash
Discounts


    Sales Returns

    Other
Adjustments


    Total

 

Balance at December 31, 2003

   $ 101     $ 208     $ 249     $ 233     $ 30     $ 268     $ 124     $ 1,213  

Provision related to sales made in current period

     1,314       843       646       618       311       270       463       4,465  

Provision related to sales made in prior periods

     5       3       14       55             6       (32 )     51  

Returns and payments

     (1,314 )     (820 )     (711 )     (534 )     (308 )     (316 )     (385 )     (4,388 )

Impact of foreign currency translation

                                   1       6       7  
    


 


 


 


 


 


 


 


Balance at December 31, 2004

     106       234       198       372       33       229       176       1,348  

Provision related to sales made in current period

     1,096       843       509       558       269       191       351       3,817  

Provision related to sales made in prior periods

     (6 )           5       37       2       (27 )     (32 )     (21 )

Returns and payments

     (1,089 )     (825 )     (542 )     (641 )     (278 )     (206 )     (364 )     (3,945 )

Impact of foreign currency translation

                 (3 )                 (2 )     (7 )     (12 )
    


 


 


 


 


 


 


 


Balance at December 31, 2005

   $ 107     $ 252     $ 167     $ 326     $ 26     $ 185     $ 124     $ 1,187  
    


 


 


 


 


 


 


 


 

        In 2005, the Company recorded gross-to-net sales adjusting charges and credits related to sales made in prior periods. The significant items included charges of $37 million for Medicaid rebates primarily as a result of higher than expected Medicaid utilization of various products; credits of $32 million for other adjustments primarily as a result of lower than expected rebates to foreign governments; and credits of $27 million for sales returns resulting from lower returns for certain products including TEQUIN, AVAPRO*/AVALIDE* and PLAVIX*.

 

In 2004, the Company recorded charges of $55 million for Medicaid rebates related to sales made in prior periods. These charges include $34 million for rebate claims from prior years by certain states, primarily in relation to Medicaid utilization of oncology products not previously reported to the Company, and other revisions resulting from the availability of additional information. In addition, the Company recorded $32 million for other adjustments as a result of lower than expected rebates to foreign governments.

 

42


No other significant revisions were made to the estimates for gross-to-net sales adjustments in 2005 and 2004.

 

Pharmaceuticals

 

The composition of the change in pharmaceutical sales is as follows:

 

         Analysis of % Change

     Total Change

  Volume

  Price

  Foreign
Exchange


2005 vs. 2004

   (2)%   (3)%     1%

2004 vs. 2003

   4%   1%   (1)%   4%

 

In 2005, Worldwide Pharmaceuticals sales decreased 2% to $15,254 million. U.S. pharmaceutical sales in 2005 decreased 3% to $8,190 million compared to $8,446 million in 2004, primarily due to the continued impact of exclusivity losses of PARAPLATIN and the GLUCOPHAGE* franchise and increased competition for PRAVACHOL, partially offset by increased sales of growth drivers including PLAVIX*, ABILIFY*, ERBITUX* and REYATAZ. In aggregate, estimated wholesaler inventory levels of the Company’s key pharmaceutical products sold by the U.S. Pharmaceutical business at the end of 2005 were down from the end of 2004 by approximately three-tenths of a month to approximately two and a half weeks. The decline in inventory levels negatively impacted the sales performance of certain products in 2005.

 

International pharmaceutical sales in 2005 decreased 1%, including a 1% favorable foreign exchange impact to $7,064 million, primarily due to increased generic competition for PRAVACHOL and TAXOL®(paclitaxel), partially offset by increased sales of newer products including REYATAZ and ABLILFY*, as well as growth of PLAVIX*.

 

In 2004, Worldwide Pharmaceuticals sales increased 4% to $15,564 million. U.S. pharmaceutical sales in 2004 remained constant at $8,446 million compared to $8,431 million in 2003. U.S. sales were negatively affected by increased competition for PRAVACHOL and exclusivity losses of PARAPLATIN and the GLUCOPHAGE* franchise, offset by increased sales of PLAVIX* and newer products, including ABILIFY*, REYATAZ and ERBITUX*. International pharmaceutical sales in 2004 increased 8% to $7,118 million, including a 9% favorable foreign exchange impact, primarily due to generic competition for PRAVACHOL and TAXOL®(paclitaxel), partially offset by the launches of ABILIFY*, REYATAZ and continued growth in PLAVIX* and AVAPRO*/AVALIDE*.

 

Key pharmaceutical products and their sales, representing 80%, 80% and 78% of total pharmaceutical sales in 2005, 2004 and 2003, respectively, are as follows:

 

(Dollars in Millions)

 

  

2005


  

2004


   2003

   % Change

 
            2005 to 2004

    2004 to 2003

 

Cardiovascular

                                 

PLAVIX*

   $ 3,823    $ 3,327    $ 2,467    15 %   35 %

PRAVACHOL

     2,256      2,635      2,827    (14 )%   (7 )%

AVAPRO*/AVALIDE*

     982      930      757    6 %   23 %

COUMADIN

     212      255      303    (17 )%   (16 )%

MONOPRIL

     208      274      470    (24 )%   (42 )%

Virology

                                 

REYATAZ

     696      414      88    68 %     **

SUSTIVA

     680      621      544    10 %   14 %

ZERIT

     216      272      354    (21 )%   (23 )%

VIDEX/VIDEX EC

     174      274      267    (36 )%   3 %

BARACLUDE

     12                   

Other Infectious Diseases

                                 

CEFZIL

     259      270      327    (4 )%   (17 )%

Oncology

                                 

TAXOL® (paclitaxel)

     747      991      934    (25 )%   6 %

ERBITUX*

     413      261         58 %    

PARAPLATIN

     157      673      905    (77 )%   (26 )%

Affective (Psychiatric) Disorders

                                 

ABILIFY* (total revenue)

     912      593      283    54 %   110 %

Metabolics

                                 

GLUCOPHAGE* Franchise

     172      336      948    (49 )%   (65 )%

Other Pharmaceuticals

                                 

EFFERALGAN

     283      274      244    3 %   12 %

 

**

Change is in excess of 200%

 

43


 

 

Sales of PLAVIX*, a platelet aggregation inhibitor sold by the Company primarily in the U.S., increased 15%, including a 1% favorable foreign exchange impact, to $3,823 million in 2005 from 2004, primarily due to prescription growth of approximately 13% in the U.S. market. The rate of growth in 2005 reflects a deceleration in the growth rate of PLAVIX* sales, compared to a growth rate of 35%, including a 2% favorable foreign exchange impact in 2004 from 2003, primarily due to prescription growth of 24% in the U.S. in 2004. The Company is seeking to enhance the growth rate through several measures, including an expansion of a related direct to consumer (DTC) campaign, and the recently-filed sNDA for the results from the COMMIT and CLARITY trials, although there can be no assurance that those efforts will be successful. Sales in 2004 were $3,327 million and sales were $2,467 million in 2003. PLAVIX* is a cardiovascular product that was launched from the alliance between the Company and Sanofi-Aventis (Sanofi). Market exclusivity for PLAVIX* is expected to expire in 2011 in the U.S. and 2013 in the European Union (EU). Statements on exclusivity are subject to any adverse determination that may occur with respect to the PLAVIX* patent litigation. For additional information on the PLAVIX* patent litigation, see “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies.”

 

 

 

Sales of PRAVACHOL, an HMG Co-A reductase inhibitor, decreased 14% to $2,256 million in 2005 from 2004. U.S. sales decreased 10% to $1,274 million in 2005, primarily due to lower demand resulting from increased competition and the related reduction in wholesaler inventory levels, partially offset by lower managed health care rebates in 2005. Estimated U.S. prescriptions declined by approximately 17% compared to 2004. International sales decreased 19%, including a 1% favorable foreign exchange impact, to $982 million, reflecting generic competition in key European markets. In 2004, sales for PRAVACHOL decreased 7%, including a 4% favorable foreign exchange impact, to $2,635 million from $2,827 million in 2003, primarily due to a decrease in U.S. prescription demand of approximately 10% and exclusivity loss in select European markets, including Germany and the UK. The Company entered into a distribution agreement with Watson Pharmaceutical (Watson) authorizing Watson to distribute pravastatin sodium tablets in the U.S. Market exclusivity protection for PRAVACHOL is expected to expire on April 20, 2006 in the U.S. Market exclusivity in the EU expired in 2004, with the exception of France and Sweden, for which expiration will occur in August and March 2006, respectively, and in Italy, where expiration will occur in January 2008.

 

 

 

Sales of AVAPRO*/AVALIDE*, an angiotensin II receptor blocker for the treatment of hypertension, also part of the Sanofi alliance, increased 6%, including a 1% favorable foreign exchange impact, to $982 million in 2005 from 2004. U.S. sales increased 2% to $574 million in 2005 compared to 2004, primarily due to increased demand, partially offset by a reduction in wholesaler inventory levels in 2005. Estimated total U.S. prescription demand increased approximately 11% compared to 2004. International sales increased 11%, including a 3% favorable foreign exchange impact, to $408 million from $368 million in 2004, primarily due to increased sales in Canada, France and Germany. In 2004, sales increased 23%, including a 5% favorable foreign exchange impact, to $930 million from $757 million in 2003, primarily due to increased sales in Europe and strong U.S. prescription growth of approximately 15%. U.S. sales increased 19% to $562 million in 2004 compared to $474 million in 2003, while international sales increased 30%, including a 12% favorable foreign exchange impact, to $368 million from $283 million in 2003. Market exclusivity for AVAPRO*/AVALIDE* (known in the EU as APROVEL*/KARVEA*) is expected to expire in 2011 in the U.S. and in 2012 in countries in the EU; AVAPRO*/AVALIDE* is not currently marketed in Japan.

 

 

 

Sales of COUMADIN, an oral anti-coagulant used predominantly in patients with atrial fibrillation or deep venous thrombosis/pulmonary embolism, decreased 17% to $212 million in 2005 compared to 2004 sales, due to continued competition. Estimated total U.S. prescription demand decreased approximately 19% compared to 2004. Sales in 2004 decreased 16% to $255 million from $303 million in 2003, due to increased generic competition. Market exclusivity for COUMADIN expired in the U.S. in 1997.

 

 

 

Sales of MONOPRIL, a second generation angiotesin converting enzyme (ACE) inhibitor for the treatment of hypertension, decreased 24%, including a 2% favorable foreign exchange impact, to $208 million in 2005 due to increased generic competition in key European markets. Sales in 2004 were $274 million, a decrease of 42%, including a 4% favorable foreign exchange impact, from $470 million in 2003, due to the impact of market exclusivity loss. Market exclusivity protection for MONOPRIL expired in 2003 in the U.S. and has expired or is expected to expire between 2001 and 2008 in countries in the EU. MONOPRIL is not currently marketed in Japan.

 

 

 

Sales of REYATAZ, a protease inhibitor for the treatment of human immunodeficiency virus (HIV), which was launched in the U.S. in the third quarter of 2003 and in Europe in the second quarter of 2004, increased 68% to $696 million in 2005, primarily due to increased demand. European sales increased 174% to $203 million in 2005 from $74 million in 2004. REYATAZ has achieved an estimated monthly new prescription share of the U.S. protease inhibitors market of approximately 28%. Sales in 2004 were $414 million compared to $88 million in 2003. Market exclusivity for REYATAZ is expected to expire in 2017 in the U.S., in countries in the EU and Japan.

 

 

 

Sales of SUSTIVA, a non-nucleoside reverse transcriptase inhibitor for the treatment of HIV, increased 10% to $680 million in 2005 from 2004, primarily due to estimated total U.S. prescription growth of approximately 5%, higher average selling prices and lower sales returns. In 2004, SUSTIVA sales increased 14%, including a 5% favorable foreign exchange

 

44


 

impact, to $621 million from $544 million in 2003, primarily due to increased demand in 2004 and higher prices. Market exclusivity protection for SUSTIVA is expected to expire in 2013 in the U.S. and in countries in the EU; the Company does not, but others do, market SUSTIVA in Japan.

 

 

 

Sales of ZERIT, an antiretroviral agent used in the treatment of HIV, decreased 21%, including a 1% favorable foreign exchange impact, to $216 million in 2005, primarily as a result of a decrease in estimated total U.S. prescriptions of approximately 31% compared to 2004. In 2004, ZERIT sales decreased 23%, including a 4% favorable foreign exchange impact, to $272 million from $354 million in 2003, primarily as a result of continued decrease in demand due to potential adverse side effects. Market exclusivity protection for ZERIT is expected to expire in 2008 in the U.S., between 2007 and 2011 in countries in the EU and in 2008 in Japan.

 

 

 

Sales of VIDEX/VIDEX EC, an antiretroviral agent used in the treatment of HIV, decreased 36% to $174 million in 2005 from 2004, primarily due to generic competition in the U.S., which began in the fourth quarter of 2004. In 2004, VIDEX/VIDEX EC sales increased 3%, including a 6% favorable foreign exchange impact, to $274 million in 2004 from $267 million in 2003 due to increased sales in Europe, partially offset by sale declines in the U.S. The Company has a licensing arrangement with the U.S. Government for VIDEX/VIDEX EC, which by its terms became non-exclusive in 2001. The U.S. Government’s intellectual property protection expires in 2007 in the U.S. (which includes an earned pediatric extension) and in Japan, and between 2006 and 2009 in countries in the EU. The license to the Company is non-exclusive, which has allowed another company to obtain a license from the U.S. Government and receive approval for marketing. With respect to VIDEX/VIDEX EC, the Company has patents covering the reduced mass formulation of VIDEX/VIDEX EC that expire in 2012 in the U.S., the EU and Japan. However, these patents apply only to the type of reduced mass formulation specified in the patent. Other reduced mass formulations may exist. There is currently no issued patent covering the VIDEX EC formulation.

 

 

 

BARACLUDE, the Company’s internally developed oral antiviral agent for the treatment of chronic hepatitis B, was approved by the FDA in March 2005, and generated sales of $12 million primarily in the U.S. since its U.S. launch in April 2005. BARACLUDE received approvals from international authorities including China, Mexico, Brazil, Indonesia and Argentina during the second half of 2005. The Company believes that the primary markets for BARACLUDE will be outside the U.S. The Company has a composition of matter patent that expires in the U.S. in 2010.

 

 

 

Sales of CEFZIL, an antibiotic for the treatment of mild to moderately severe bacterial infections, decreased 4%, including a 1% favorable foreign exchange impact, to $259 million in 2005 from 2004, primarily due to lower demand. In 2004, CEFZIL sales decreased 17%, including a 2% favorable foreign exchange impact, to $270 million from $327 million in 2003, primarily due to decreased demand in the U.S., partially offset by higher international sales. Market exclusivity expired in December 2005 in the U.S. and is expected to expire between 2007 and 2009 in the EU.

 

 

 

Sales of TAXOL® (paclitaxel), an anti-cancer agent sold almost exclusively in the non-U.S. markets, were $747 million in 2005 compared to $991 million in 2004. Sales of TAXOL® (paclitaxel) decreased 25%, including a 1% favorable foreign exchange impact, primarily as a result of increased generic competition in Europe. Generic competition for TAXOL® (paclitaxel) in a majority of the major European markets began in the second quarter of 2004 and increased in the second half of 2004. In 2004, TAXOL® (paclitaxel) sales increased 6%, including a 9% favorable foreign exchange impact, to $991 million from $934 million in 2003, primarily due to generic competition in Europe. Market exclusivity protection for TAXOL® (paclitaxel) expired in 2002 in the U.S., in 2003 in the EU and is expected to expire between 2006 and 2013 in Japan.

 

 

 

ERBITUX*, used to treat refractory metastatic colorectal cancer, was approved by the FDA in February 2004. Sales of ERBITUX*, which is sold almost exclusively in the U.S., increased 58% to $413 million in 2005 compared to $261 million in 2004. ERBITUX* is marketed by the Company under a distribution and copromotion agreement with ImClone Systems Incorporated (ImClone). A patent relating to combination therapy with ERBITUX* expires in 2017. The Company’s right to market ERBITUX* in North America and Japan expires in September 2018. The Company does not, but others do, market ERBITUX* in countries in the EU.

 

 

 

Sales of PARAPLATIN, an anti-cancer agent, decreased 77% to $157 million in 2005 from 2004 due to generic competition in the U.S. that began in mid-2004 and increased with the entry of multiple generic competitors in the fourth quarter of 2004. U.S. sales of PARAPLATIN decreased 95% to $28 million in 2005 from 2004. In 2004, PARAPLATIN sales decreased 26%, including a 1% favorable foreign exchange impact, to $673 million from $905 million in 2003, primarily due to generic competition in the U.S. Market exclusivity protection for PARAPLATIN expired in October 2004 in the U.S., in 2000 in the EU and in 1998 in Japan.

 

 

 

Total revenue for ABILIFY*, an antipsychotic agent for the treatment of schizophrenia, acute bipolar mania and Bipolar Disorder, increased 54% to $912 million in 2005 from 2004, primarily due to demand growth in the U.S. and the continued

 

45


 

growth in Europe, which achieved sales of $140 million in 2005. Estimated U.S. prescription demand grew approximately 42% compared to 2004, partially offset by a reduction in wholesaler inventory levels in 2005. Sales growth in the future could be impacted by a trend involving an overall decrease in the rate of growth in demand for antipsychotic agents in the U.S. In 2004, total revenue for ABILIFY* was $593 million, compared to $283 million in 2003. Total revenue for ABILIFY* primarily consists of alliance revenue representing the Company’s 65% share of net sales in copromotion countries with Otsuka Pharmaceutical Co., Ltd. (Otsuka). Otsuka’s market exclusivity protection for ABILIFY* is expected to expire in 2014 in the U.S. (including the granted patent term extension). The Company also has the right to copromote ABILIFY* in several European countries (the United Kingdom, France, Germany and Spain) and to act as exclusive distributor for the product in the rest of the EU. Market exclusivity protection for ABILIFY* is expected to expire in 2009 for the EU (and may be extended until 2014 if pending supplemental protection certificates are granted). The Company’s contractual right to market ABILIFY* expires in November 2012 in the U.S. and Puerto Rico and, for the countries in the EU where the Company has the exclusive right to market ABILIFY* until June 2014. Statements on exclusivity are subject to any adverse determination that may occur with respect to the ABILIFY* patent reexamination. For additional information on this matter, see “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies.” For additional information on revenue recognition of ABILIFY*, see “Item 8. Financial Statements—Note 2. Alliances and Investments.”

 

 

 

Sales for the GLUCOPHAGE* franchise decreased 49% to $172 million in 2005, compared to a 65% decrease to $336 million in 2004 from $948 million in 2003. The decrease in sales in both 2005 and 2004 primarily resulted from increased generic competition. Market exclusivity protection expired in March 2000 for GLUCOPHAGE* IR, in October 2003 for GLUCOPHAGE* XR and in January 2004 for GLUCOVANCE*. The Company does not, but others do, market these products in the EU and Japan.

 

 

 

Sales of EFFERALGAN, a formulation of acetaminophen for pain relief, increased 3%, including a 1% favorable foreign exchange impact, to $283 million in 2005, primarily due to increased sales in Italy and Spain as a result of a strong flu season in 2005. In 2004, sales increased 12%, including a 12% favorable foreign exchange impact, to $274 million from $244 million in 2003.

 

The estimated U.S. prescription and U.S. prescription growth data provided above includes information only from the retail and mail order channels and do not reflect information from other channels, such as hospitals, institutions and long-term care, among others. The estimated prescription and prescription growth data are based on National Prescription Audit (NPA) data provided by IMS Health (IMS), a supplier of market research for the pharmaceutical industry, as described below.

 

In most instances, the basic exclusivity loss date indicated above is the expiration date of the patent that claims the active ingredient of the drug or the method of using the drug for the approved indication. In some instances, the basic exclusivity loss date indicated is the expiration date of the data exclusivity period. In situations where there is only data exclusivity without patent protection, a competitor could seek regulatory approval prior to the expiration of the data exclusivity period by submitting its own clinical trial data to obtain marketing approval. The Company assesses the market exclusivity period for each of its products on a case-by-case basis. The length of market exclusivity for any of the Company’s products is difficult to predict with certainty because of the complex interaction between patent and regulatory forms of exclusivity and other factors. There can be no assurance that a particular product will enjoy market exclusivity for the full period of time that the Company currently anticipates. The estimates of market exclusivities reported above are for business planning purposes only and are not intended to reflect the Company’s legal opinion regarding the strength or weakness of any particular patent or other legal position. For further discussion of market exclusivity protection, including a chart showing net sales of key products together with the year in which basic exclusivity loss occurred or is expected to occur in the U.S., the EU and Japan, see “Item 1. Business—Products” and “—Intellectual Property and Product Exclusivity.”

 

Estimated End-User Demand

 

The following tables set forth for each of the Company’s top 15 pharmaceutical products sold by the U.S. Pharmaceuticals business (based on 2004 annual net sales), for the years ended December 31, 2005, 2004 and 2003 compared to the same periods in the prior year: (a) changes in reported U.S. net sales for the period; (b) estimated total U.S. prescription growth for the retail and mail order channels and the estimated U.S. therapeutic category share of the applicable product, calculated by the Company based on NPA data provided by IMS; and (c) estimated total U.S. prescription growth for the retail and mail order channels and the estimated U.S. therapeutic category share of the applicable product, calculated by the Company based on Next-Generation Prescription Services (NGPS) data provided by IMS.

 

46


    

Year Ended

December 31, 2005


   

Month Ended

December 31, 2005


    

% Change
in U.S.

Net Sales (a)


   

% Change

in U.S. Total Prescriptions


   

Estimated TRx

Therapeutic Category Share %(e)


       NPA Data (b)

    NGPS Data (c)

    NPA Data (b)

   NGPS Data (c)

ABILIFY* (total revenue)

   35     42     40     11    11

AVAPRO*/AVALIDE*

   2     11     12     15    15

CEFZIL

   (5 )   (10 )   (11 )   2    2

COUMADIN

   (20 )   (19 )   (20 )   21    20

DOVONEX*

   (7 )   (7 )   (8 )   3    3

ERBITUX* (d)

   58     N/A     N/A     N/A    N/A

GLUCOPHAGE* Franchise

   (52 )   (63 )   (62 )   2    2

PARAPLATIN (d)

   (95 )   N/A     N/A     N/A    N/A

PLAVIX*

   14     13     13     86    86

PRAVACHOL

   (10 )   (17 )   (16 )   7    7

REYATAZ

   33     39     37     31    31

SUSTIVA

   11     5     8     24    23

TEQUIN

   (17 )   (30 )   (28 )   1    1

VIDEX/VIDEX EC

   (73 )   (65 )   (65 )   2    2

ZERIT

   (18 )   (31 )   (30 )   7    6

 

    

Year Ended

December 31, 2004


   

Month Ended

December 31, 2004


    

% Change
in U.S.

Net Sales (a)


   

% Change

in U.S. Total Prescriptions


   

Estimated TRx

Therapeutic Category Share %(e)


       NPA Data (b)

    NGPS Data (c)

    NPA Data (b)

   NGPS Data (c)

ABILIFY* (total revenue)

   98     103     103     9    9

AVAPRO*/AVALIDE*

   19     15     18     15    15

CEFZIL

   (31 )   (30 )   (29 )   2    2

COUMADIN

   (18 )   (17 )   (21 )   27    27

DOVONEX*

   11     (7 )   (6 )   3    3

ERBITUX* (d)

       N/A     N/A     N/A    N/A

GLUCOPHAGE* Franchise

   (66 )   (60 )   (61 )   3    3

PARAPLATIN (d)

   (30 )   N/A     N/A     N/A    N/A

PLAVIX*

   36     24     27     85    85

PRAVACHOL

   (12 )   (10 )   (9 )   9    9

REYATAZ

  

              **

   

              **

   

                **

    12    12

SUSTIVA

   9     4     11     24    23

TEQUIN

   (27 )   (24 )   (23 )   2    2

VIDEX/VIDEX EC

   (3 )   (4 )   3     9    9

ZERIT

   (32 )   (29 )   (27 )   9    9

 

    

Year Ended

December 31, 2003


 

Month Ended

December 31, 2003


    

% Change
in U.S.

Net Sales (a)


   

% Change

in U.S. Total Prescriptions


 

Estimated TRx

Therapeutic Category Share %(e)


       NPA Data (b)

    NGPS Data (c)

  NPA Data (b)

   NGPS Data (c)

ABILIFY* (total revenue)

  

              **

   

              **

    ***   6    ***

AVAPRO*/AVALIDE*

   24     15     ***   15    ***

CEFZIL

   14     (4 )   ***   3    ***

COUMADIN

   1     (15 )   ***   33    ***

DOVONEX*

       (5 )   ***   3    ***

ERBITUX* (d)

       N/A     N/A   N/A    N/A

GLUCOPHAGE* Franchise

   22     (16 )   ***   14    ***

PARAPLATIN (d)

   26     N/A     N/A   N/A    N/A

PLAVIX*

   27     29     ***   82    ***

PRAVACHOL

   22     2     ***   12    ***

REYATAZ

           ***   3    ***

SUSTIVA

   13     17     ***   11    ***

TEQUIN

   7     (21 )   ***   2    ***

VIDEX/VIDEX EC

   (11 )   3     ***   6    ***

ZERIT

   (29 )   (25 )   ***   7    ***

 

47



(a)

Reflects percentage change in net sales in dollar terms, including change in average selling prices and wholesaler buying patterns.

(b)

Based on a simple average of the estimated number of prescriptions in the retail and mail order channels as provided by IMS.

(c)

Based on a weighted average of the estimated number of prescription units (pills) in each of the retail and mail order channels based on data provided by IMS.

(d)

ERBITUX* and PARAPLATIN specifically, and parenterally administered oncology products in general, do not have prescription-level data because physicians do not write prescriptions for these products. The Company believes therapeutic category share information provided by third parties for these products may not be reliable and accordingly, none is presented here.

(e)

The therapeutic categories are determined by the Company as those products considered to be in direct competition with the Company’s own products. The products listed above compete in the following therapeutic categories: ABILIFY* (antipsychotics), AVAPRO*/AVALIDE* (angiotensin receptor blockers), CEFZIL (branded oral solid and liquid antibiotics), COUMADIN (warfarin), DOVONEX* (anti-inflamatory-antipsoriasis), GLUCOPHAGE* Franchise (oral antidiabetics), PLAVIX* (antiplatelet agents), PRAVACHOL (HMG CoA reductase inhibitors), REYATAZ (protease inhibitors), SUSTIVA (antiretrovirals - third agents), TEQUIN (branded oral solid antibiotics), VIDEX/VIDEX EC (nucleoside reverse transcriptase inhibitors) and ZERIT (nucleoside reverse transcriptase inhibitors).

**

In excess of 200%.

***

Data for 2003 are not available, therefore this section is omitted.

 

The Company has historically reported estimated total U.S. prescription growth and estimated therapeutic category share based on NPA data, which IMS makes available to the public on a subscription basis, and a simple average of the estimated number of prescriptions in the retail and mail order channels. In the third quarter of 2005, the Company began disclosing estimated total U.S. prescription growth and estimated therapeutic category share based on both NPA and NGPS data. NGPS data is collected by IMS under a new, revised methodology and has been released by IMS on a limited basis through a pilot program. IMS has publicly announced it expects to make NGPS data available to the public on a subscription basis in 2007. The Company believes that the NGPS data provided by IMS provides a superior estimate of prescription data for the Company’s products in the retail and mail order channels. The Company has calculated the estimated total U.S. prescription growth and estimated therapeutic category share based on NGPS data on a weighted average basis to reflect the fact that mail order prescriptions include a greater volume of product supplied compared with retail prescriptions. The Company believes that calculation of the estimated total U.S. prescription growth and estimated therapeutic category share based on the NGPS data and the weighted average approach with respect to the retail and mail order channels provides a superior estimate of total prescription demand. The Company now uses this methodology for its internal demand forecasts.

 

The estimated prescription growth data and estimated therapeutic category share provided above only include information from the retail and mail order channels and do not reflect information from other channels, such as hospitals, institutions and long-term care, among others. The data provided by IMS are a product of IMS’s own record-keeping processes and are themselves estimates based on sampling procedures, subject to the inherent limitations of estimates based on sampling. In addition, the NGPS data is part of a pilot program that is still being refined by IMS.

 

The Company continuously seeks to improve the quality of its estimates of prescription growth amounts, therapeutic category share percentages and ultimate patient/consumer demand through review of its methodologies and processes for calculation of these estimates and review and analysis of its own and third parties’ data used in such calculations. The Company expects that it will continue to review and refine its methodologies and processes for calculation of these estimates and will continue to review and analyze its own and third parties’ data used in such calculations.

 

The following table sets forth for each of the Company’s key pharmaceutical products sold by the Company’s International Pharmaceuticals reporting segment, including the top 15 pharmaceutical products sold in the Company’s major non-U.S. countries (based on 2004 net sales), and for each of the key products sold by the other reporting segments listed below, the percentage change in the Company’s estimated ultimate patient/consumer demand for the month of December 2005 compared to the month of September 2005, the month of September 2005 compared to the month of June 2005, and the month of June 2005 compared to the month of March 2005.

 

48


    

% Change in Demand on a

Constant U.S. Dollar Basis


 
    

December 2005

vs. September 2005


   

September 2005

vs. June 2005


   

June 2005

vs. March 2005


 

International Pharmaceuticals

                  

ABILIFY* (total revenue)

   19     1     50  

AVAPRO*/AVALIDE*

       (13 )   14  

BUFFERIN*

   24     2     (21 )

CAPOTEN

       (10 )    

DAFALGAN

   18     (4 )   (17 )

EFFERALGAN

   (2 )   39     (43 )

MAXIPIME

   8     (13 )   (15 )

MONOPRIL

   4     (26 )   (2 )

PARAPLATIN

   (1 )   (4 )   2  

PERFALGAN

   19     (13 )   5  

PLAVIX*

   1     (1 )   2  

PRAVACHOL

   (4 )   (16 )   7  

REYATAZ

   2     4     5  

SUSTIVA

   (1 )   (1 )   (7 )

TAXOL® (paclitaxel)

   (4 )   (4 )   (17 )

VIDEX/VIDEX EC

   3     (14 )   3  

ZERIT

   (6 )   (21 )   (5 )

Nutritionals

                  

ENFAMIL

       1     6  

NUTRAMIGEN

   1     (2 )   5  

Other Health Care

                  

ConvaTec

                  

Ostomy

   7     7      

Wound Therapeutics

   4     (3 )   14  

Medical Imaging

                  

CARDIOLITE

   (7 )   (6 )   (5 )

Consumer Medicines

                  

EXCEDRIN*

   N/A     N/A     (13 )

 

Estimated Inventory Months on Hand in the Distribution Channel

 

The following table sets forth for each of the Company’s top 15 pharmaceutical products sold by the Company’s U.S. Pharmaceuticals business (based on 2004 annual net sales), the U.S. Pharmaceuticals net sales of the applicable product for each of the six quarters ended September 30, 2004 through December 31, 2005, and the estimated number of months on hand of the applicable product in the U.S. wholesaler distribution channel as of the end of each of the six quarters.

 

     December 31, 2005

   September 30, 2005

   June 30, 2005

  

Net Sales

(Dollars in Millions)


   Months
on Hand


  

Net Sales

(Dollars in Millions)


   Months
on Hand


  

Net Sales

(Dollars in Millions)


    Months
on Hand


ABILIFY* (total revenue)

   $ 175    0.6    $ 214    0.9    $ 200     0.7

AVAPRO*/AVALIDE*

     168    0.6      147    0.5      157     0.6

CEFZIL

     46    0.7      27    0.7      30     0.8

COUMADIN

     50    0.8      49    0.6      42     0.7

DOVONEX*

     33    0.5      31    0.6      36     0.7

ERBITUX*

     121         106         97    

GLUCOPHAGE* Franchise

     29    0.7      38    0.7      44     0.8

PARAPLATIN

     5    0.9      9    1.1      (1 )   0.8

PLAVIX*

     906    0.6      833    0.4      823     0.6

PRAVACHOL

     366    0.6      297    0.5      353     0.7

REYATAZ

     110    0.5      105    0.6      98     0.8

SUSTIVA

     102    0.6      101    0.6      97     0.8

TEQUIN

     22    0.9      21    0.9      22     0.8

VIDEX/VIDEX EC

     7    0.9      7    1.1      5     1.0

ZERIT

     21    0.8      24    0.8      26     0.8

 

49


     March 31, 2005

  December 31, 2004

   September 30, 2004

    

Net Sales

(Dollars in Millions)


   Months
on Hand


 

Net Sales

(Dollars in Millions)


    Months
on Hand


  

Net Sales

(Dollars in Millions)


   Months
on Hand


ABILIFY* (total revenue)

   $ 161    0.7   $ 170     0.9    $ 152    0.6

AVAPRO*/AVALIDE*

     102    0.8     154     0.9      148    0.6

CEFZIL

     50    0.7     60     1.1      30    0.6

COUMADIN

     42    1.0     69     1.0      58    0.9

DOVONEX*

     30    0.6     40     0.9      34    0.7

ERBITUX*

     87   

              **

    88     0.2      83    0.2

GLUCOPHAGE* Franchise

     39    1.0     48     1.1      39    1.0

PARAPLATIN

     15    0.9     (12 )   1.2      145    1.2

PLAVIX*

     673    0.8     816     0.9      781    0.6

PRAVACHOL

     258    0.8     433     1.0      318    0.6

REYATAZ

     92    0.8     99     0.9      75    0.6

SUSTIVA

     103    0.8     103     0.8      95    0.7

TEQUIN

     38    0.7     39     0.9      31    0.7

VIDEX/VIDEX EC

     10    1.2     25     0.9      27    0.6

ZERIT

     26    0.8     31     0.9      34    0.7

**

Less than 0.1 months on hand.

 

At December 31, 2004, the estimated value of CEFZIL inventory in the U.S. wholesaler distribution channel exceeded one month on hand by approximately $1.6 million. Prescriptions for CEFZIL, an antibiotic, are typically higher in the winter months in the U.S. As a result, the Company’s U.S. wholesalers built higher inventories of the product in the fourth quarter of 2004 to meet that expected higher demand. At March 31, 2005, the Company had worked down U.S. wholesaler inventory levels of CEFZIL to less than one month on hand, and remained at less than one month on hand in subsequent quarters.

 

At December 31, 2004, the estimated value of GLUCOPHAGE* Franchise products inventory (GLUCOPHAGE* XR, GLUCOPHAGE* IR, GLUCOVANCE* and METAGLIP*) in the U.S. wholesaler distribution channel exceeded one month on hand by approximately $1.6 million. As with all products, the months on hand estimate for the GLUCOPHAGE* Franchise products is an average of months on hand for all stock-keeping units (SKUs) of the product group. The increase in months on hand of the GLUCOPHAGE* Franchise products at the end of the fourth quarter of 2004 to above one month on hand resulted primarily from the purchase by wholesalers of certain SKUs. After giving effect to these purchases, the increased months on hand for these SKUs were less than one month on hand. However, when the increased months on hand for these SKUs were averaged with all SKUs for the GLUCOPHAGE* Franchise products, the aggregate estimated months on hand exceeded one month. At March 31, 2005, the estimated value of GLUCOPHAGE* Franchise products inventory in the U.S. wholesaler distribution channel had been worked down to approximately one month on hand, and has been worked down to, and remained at, less than one month on hand in subsequent quarters.

 

In October 2004, the U.S. pediatric exclusivity period for PARAPLATIN (carboplatin) expired. The resulting entry of multiple generic competitors for PARAPLATIN led to a significant decrease in demand for PARAPLATIN, which in turn led to the months on hand of the product in the U.S. wholesaler distribution channel exceeding one month at September 30, 2004, December 31, 2004 and September 30, 2005. The estimated value of PARAPLATIN inventory in the U.S. wholesaler distribution channel over one month on hand was approximately $6.6 million at September 30, 2004, $6.0 million at December 31, 2004 and $0.7 million at September 30, 2005. During this time, the Company continued to monitor PARAPLATIN sales with the intention of working down wholesaler inventory levels to less than one month on hand, and by December 31, 2005, the Company had worked down U.S. wholesaler inventory levels of PARAPLATIN to less than one month on hand.

 

At March 31 and September 30, 2005, the estimated value of VIDEX/VIDEX EC inventory in the U.S. wholesaler distribution channel exceeded one month on hand by approximately $1.1 million and $0.2 million, respectively. As a result of generic competition in the U.S. commencing in the fourth quarter of 2004, demand for VIDEX/VIDEX EC decreased significantly. During this time, the Company continued to monitor VIDEX/VIDEX EC sales with the intention of working down wholesaler inventory levels to less than one month on hand, and by December 31, 2005, the Company had worked down U.S. wholesaler inventory levels of VIDEX/VIDEX EC to less than one month on hand.

 

        For all products other than ERBITUX*, the Company determines the above months on hand estimates by dividing the estimated amount of the product in the U.S. wholesaler distribution channel by the estimated amount of out-movement of the product from the U.S. wholesaler distribution channel over a period of 31 days, all calculated as described below. Factors that may influence the Company’s estimates include generic competition, seasonality of products, wholesaler purchases in light of increases in wholesaler list prices, new product launches, new warehouse openings by wholesalers and new customer stockings by wholesalers. In addition, such estimates are calculated using third party data, which represent their own record-keeping processes and as such, may also reflect estimates.

 

50


The Company maintains inventory management agreements (IMAs) with most of its U.S. pharmaceutical wholesalers, which account for nearly 100% of total gross sales of U.S. pharmaceutical products. Under the current terms of the IMAs, the Company’s three largest wholesaler customers provide the Company with weekly information with respect to inventory levels of product on hand and the amount of out-movement of products. These three wholesalers currently account for over 90% of total gross sales of U.S. pharmaceutical products. The inventory information received from these wholesalers excludes inventory held by intermediaries to whom they sell, such as retailers and hospitals, and excludes goods in transit to such wholesalers. The Company uses the information provided by these three wholesalers as of the Friday closest to quarter end to calculate the amount of inventory on hand for these wholesalers at the applicable quarter end. This amount is then increased by the Company’s estimate of goods in transit to these wholesalers as of the applicable Friday, which have not been reflected in the weekly data provided by the wholesalers. Under the Company’s revenue recognition policy, sales are recorded when substantially all the risks and rewards of ownership are transferred, which in the U.S. Pharmaceutical business is generally when product is shipped. In such cases, goods in transit to a wholesaler are owned by the applicable wholesaler and, accordingly, are reflected in the calculation of inventories in the wholesaler distribution channel. The Company estimates the amount of goods in transit by using information provided by these wholesalers with respect to their open orders as of the applicable Friday and the Company’s records of sales to these wholesalers with respect to such open orders. The Company determines the out-movement of a product from these wholesalers over a period of 31 days by using the most recent four weeks of out-movement of a product as provided by these wholesalers and extrapolating such amount to a 31 day basis. The Company estimates inventory levels on hand and out-movements for its U.S. Pharmaceutical business’s wholesaler customers other than the three largest wholesalers for each product based on the assumption that such amounts bear the same relationship to the three largest wholesalers’ inventory levels and out-movements for such product as the percentage of aggregate sales for all products to these other wholesalers in the applicable quarter bears to aggregate sales for all products to the Company’s three largest wholesalers in such quarter. Finally, the Company considers whether any adjustments are necessary to these extrapolated amounts based on such factors as historical sales of individual products made to such other wholesalers and third-party market research data related to prescription trends and patient demand. In addition, the Company receives inventory information from these other wholesalers on a selective basis for certain key products.

 

The Company’s U.S. pharmaceuticals business, through the IMAs discussed above, has arrangements with substantially all of its direct wholesaler customers that allow the Company to monitor U.S. wholesaler inventory levels and require those wholesalers to maintain inventory levels at approximately one month or less of their demand. In the second and third quarters of 2005, the Company negotiated amendments to its IMAs with its three largest wholesalers. The amendments extended the original agreements through December 31, 2005 and established lower limits than the original agreements for inventory levels of Company pharmaceutical products held by the wholesalers. In December 2005, the Company reached two year IMAs in principle with its three largest U.S. wholesalers, which provide the same lower limits of wholesaler inventory levels as the IMA extensions previously negotiated.

 

To help maintain the product quality of the Company’s biologic oncology product, ERBITUX*, the product is shipped only to end-users and not to other intermediaries (such as wholesalers) to hold for later sales. During 2004 and through May 2005, one of the Company’s wholesalers provided warehousing, packing and shipping services for ERBITUX*. Such wholesaler held ERBITUX* inventory on consignment and, under the Company’s revenue recognition policy, the Company recognized revenue when such inventory was shipped by the wholesaler to the end-user. The above estimates of months on hand for the three months ended March 31, 2005, were calculated by dividing the inventories of ERBITUX* held by the wholesaler for its own account as reported by the wholesaler as of the end of the quarter by the Company’s net sales for the last calendar month of the quarter. The inventory levels reported by the wholesaler are a product of the wholesaler’s own record-keeping process. Upon the divestiture of OTN in May 2005, the Company discontinued the consignment arrangement with the wholesaler and thereafter did not have ERBITUX* consignment inventory. Following the divestiture, the Company sells ERBITUX* to intermediaries (such as specialty oncology distributors) and ships ERBITUX* directly to the end users of the product who are the customers of those intermediaries. The Company recognizes revenue upon such shipment consistent with its revenue recognition policy. Accordingly, subsequent to June 30, 2005, there was no ERBITUX* inventory held by wholesalers.

 

As previously disclosed, for the Company’s Pharmaceuticals business outside of the United States, Nutritionals and Other Health Care business units around the world, the Company has significantly more direct customers, limited information on direct customer product level inventory and corresponding out–movement information and the reliability of third party demand information, where available, varies widely. Accordingly, the Company relies on a variety of methods to estimate direct customer product level inventory and to calculate months on hand for these business units.

 

The following table, which was posted on the Company’s website and furnished on Form 8-K, sets forth for each of the Company’s key products sold by the reporting segments listed below, the net sales of the applicable product for each of the four quarters ended March 31, 2005 through December 31, 2005, and the estimated number of months on hand of the applicable product in the direct customer distribution channel for the reporting segment as of the end of each of the four quarters. The estimates of months

 

51


on hand for key products described below for the International Pharmaceuticals reporting segment are based on data collected for all of the Company’s significant business units outside of the United States. Also described further below is information on non-key product(s) where the amount of inventory on hand at direct customers is more than approximately one month and the impact is not de minimis. For the other reporting segments, estimates are based on data collected for the United States and all significant business units outside of the United States.

 

     December 31, 2005

   September 30, 2005

    

Net Sales

(Dollars in Millions)


  

Months

on Hand


  

Net Sales

(Dollars in Millions)


  

Months

on Hand


International Pharmaceuticals

                       

ABILIFY* (total revenue)

   $ 49    0.6    $ 46    0.8

AVAPRO*/AVALIDE*

     109    0.6      104    0.5

BUFFERIN*

     36    0.7      31    0.6

CAPOTEN

     38    0.8      38    0.9

DAFALGAN

     34    1.2      34    1.3

EFFERALGAN

     74    1.0      66    1.1

MAXIPIME

     48    0.8      40    0.7

MONOPRIL

     43    0.9      48    1.0

PARAPLATIN

     33    0.8      33    0.6

PERFALGAN

     43    0.6      38    0.7

PLAVIX*

     155    0.6      147    0.6

PRAVACHOL

     218    0.8      230    0.8

REYATAZ

     78    0.6      71    0.9

SUSTIVA

     68    0.6      69    0.6

TAXOL® (paclitaxel)

     176    0.8      171    0.5

VIDEX/VIDEX EC

     34    0.9      34    0.9

ZERIT

     26    0.7      27    0.7

Nutritionals

                       

ENFAMIL

     277    1.0      230    0.9

NUTRAMIGEN

     48    1.1      44    1.1

Other Health Care

                       

ConvaTec

                       

Ostomy

     145    1.0      139    0.9

Wound Therapeutics

     112    0.9      104    0.8

Medical Imaging

                       

CARDIOLITE

     100    1.0      106    0.8

Consumer Medicines

                       

EXCEDRIN*

     N/A    N/A      29    N/A

 

52


     June 30, 2005

   March 31, 2005

    

Net Sales

(Dollars in Millions)


  

Months

on Hand


  

Net Sales

(Dollars in Millions)


  

Months

on Hand


International Pharmaceuticals

                       

ABILIFY* (total revenue)

   $ 40    0.6    $ 27    0.6

AVAPRO*/AVALIDE*

     101    0.4      94    0.4

BUFFERIN*

     32    1.0      26    0.5

CAPOTEN

     42    0.8      42    0.8

DAFALGAN

     33    0.8      40    1.3

EFFERALGAN

     55    0.5      88    0.9

MAXIPIME

     52    0.8      46    0.7

MONOPRIL

     52    0.7      56    0.6

PARAPLATIN

     34    0.6      29    0.6

PERFALGAN

     42    0.6      42    0.5

PLAVIX*

     145    0.5      141    0.7

PRAVACHOL

     272    0.7      262    0.7

REYATAZ

     85    0.8      57    0.6

SUSTIVA

     70    0.6      70    0.5

TAXOL® (paclitaxel)

     182    0.5      201    0.5

VIDEX/VIDEX EC

     38    0.9      39    0.8

ZERIT

     33    0.6      33    0.6

Nutritionals

                       

ENFAMIL

     250    0.9      235    0.9

NUTRAMIGEN

     47    1.0      44    1.0

Other Health Care

                       

ConvaTec

                       

Ostomy

     139    0.9      127    0.9

Wound Therapeutics

     103    0.8      97    0.8

Medical Imaging

                       

CARDIOLITE

     108    0.7      102    0.7

Consumer Medicines

                       

EXCEDRIN*

     39    1.5      38    1.6

 

The above months on hand information represents the Company’s estimates of aggregate product level inventory on hand at direct customers divided by the expected demand for the applicable product. Expected demand is the estimated ultimate patient/consumer demand calculated based on estimated end-user consumption or direct customer out-movement data over the most recent 31 day period or other reasonable period. Factors that may affect the Company’s estimates include generic competition, seasonality of products, direct customer purchases in light of price increases, new product launches, new warehouse openings by direct customers, new customer stockings by direct customers and expected direct customer purchases for governmental bidding situations.

 

The Company relies on a variety of methods to calculate months on hand for these reporting segments. Where available, the Company relies on information provided by third parties to determine estimates of aggregate product level inventory on hand at direct customers and expected demand. For the reporting segments listed above, however, the Company has limited information on direct customer product level inventory, end-user consumption and direct customer out-movement data. Further, the quality of third party information, where available, varies widely. In some circumstances, such as the case with new products or seasonal products, such historical end-user consumption or out-movement information may not be available or applicable. In such cases, the Company uses estimated prospective demand. In cases where direct customer product level inventory, ultimate patient/consumer demand or out-movement data do not exist or are otherwise not available, the Company has developed a variety of other methodologies to calculate estimates of such data, including using such factors as historical sales made to direct customers and third party market research data related to prescription trends and end-user demand.

 

As of December 31, 2005, September 30, 2005 and March 31, 2005, DAFALGAN, an analgesic product sold principally in Europe, had approximately 1.2, 1.3 and 1.3 months of inventory on hand, respectively, at direct customers. The level of inventory on hand is due primarily to private pharmacists purchasing DAFALGAN approximately once every eight weeks and the seasonality of the product.

 

As of September 30, 2005, EFFERALGAN, an analgesic product sold principally in Europe, had approximately 1.1 months of inventory on hand, at direct customers. The level of inventory on hand is due primarily to private pharmacists purchasing EFFERALGAN approximately once every eight weeks and the seasonality of the product.

 

53


As of December 31, 2005 and September 30, 2005, NUTRAMIGEN and PROSOBEE, infant nutritional products sold principally in the United States, had approximately 1.1 months of inventory on hand at direct customers. The level of inventory on hand at the end of December 2005 is due primarily to holiday stocking by retailers and at the end of September 2005 is due primarily to the impact of retailers holding higher levels of inventory in response to Hurricane Katrina. The Company plans to continue to monitor sales of NUTRAMIGEN and PROSOBEE with the intention of working down wholesaler inventory levels to less than one month on hand.

 

As of June 30, 2005 and March 31, 2005, EXCEDRIN*, an analgesic product sold principally in the U.S., had approximately 1.5 months and 1.6 months, respectively, of inventory on hand at direct customers. The level of inventory on hand is due to the customary practice of direct customers holding within their warehouses and stores one and one-half to two months of product on hand. Inventory on hand and percentage change in demand data as of and for the month of September 30, 2005, respectively, is not available for EXCEDRIN*, which was included in the third quarter 2005 sale of the Company’s Consumer Medicines business.

 

The Company continuously seeks to improve the quality of its estimates of months on hand of inventories held by its direct customers including thorough review of its methodologies and processes for calculation of these estimates and review and analysis of its own and third parties’ data used in such calculations. The Company expects that it will continue to review and refine its methodologies and processes for calculation of these estimates and will continue to review and analyze its own and third parties’ data in such calculations. The Company also has and will continue to take steps to expedite the receipt and processing of data for the non-U.S. Pharmaceuticals business.

 

HEALTH CARE GROUP

 

Nutritionals

 

The composition of the change in Nutritional sales is as follows:

 

         Analysis of % Change

     Total Change

  Volume

  Price

  Foreign Exchange

2005 vs. 2004

   10%   7%   2%   1%

2004 vs. 2003

   (1)%   (7)%   6%  

 

Key Nutritional product lines and their sales, representing 95%, 94% and 84% of total Nutritional sales in 2005, 2004 and 2003, respectively, are as follows:

 

(Dollars in Millions)

 

  

2005


  

2004


   2003

   % Change

 
            2005 to 2004

    2004 to 2003

 

Infant Formulas

   $ 1,576    $ 1,405    $ 1,284    12 %   9 %

ENFAMIL

     992      859      808    15 %   6 %

Toddler/Children’s Nutritionals

     529      468      421    13 %   11 %

 

Worldwide Nutritional sales increased 10%, including a 1% favorable foreign exchange impact and a 2% unfavorable impact from the divestiture of the Adult Nutritional business, to $2,205 million in 2005 from 2004. In 2004, Worldwide Nutritional sales were $2,001 million, a decrease of 1%, including a 10% unfavorable impact from the divestiture of the Adult Nutritional business, from $2,023 million in 2003. In the first quarter of 2004, the Company divested its Adult Nutritional business.

 

International sales increased 12%, including a 2% favorable foreign exchange impact and a 1% unfavorable impact from the divestiture of the Adult Nutritional business, to $1,135 million in 2005 from 2004, primarily due to increased sales of ENFAMIL, ENFAGROW and toddler and children’s nutritional products. In 2004, international sales increased 11%, including a 4% unfavorable impact from the divestiture of the Adult Nutritional business, to $1,010 million from $910 million in 2003, primarily due to the increased sales of infant formula and children’s nutritional products.

 

U.S. sales increased 8%, including a 3% unfavorable impact from the divestiture of the Adult Nutritional business, to $1,070 million in 2005 from 2004, primarily due to increased sales of ENFAMIL. In 2004, U.S. sales decreased 11%, including a 14% unfavorable impact from the divestiture of the Adult Nutritional business, to $991 million from $1,113 million in 2003.

 

Sales of ENFAMIL, the Company’s best-selling infant formula, increased 15%, including a 1% favorable foreign exchange impact, to $992 million in 2005 from 2004, primarily due to strong sales growth and the launch of ENFAMIL GENTLEASE LIPIL infant formula in August 2005. In 2004, ENFAMIL sales increased 6%, including a 1% favorable foreign exchange impact, to $859 million from $808 million in 2003, primarily due to an increase in international sales.

 

54


Other Health Care

 

The Other Health Care segment includes ConvaTec and the Medical Imaging business. The composition of the change in Other Health Care segment sales is as follows:

 

     Total Change

  Analysis of % Change

       Volume

  Price

  Foreign Exchange

2005 vs. 2004

   (4)%   (4)%   (1)%   1%

2004 vs. 2003

   13%   7%   1%   5%

 

Other Health Care sales by business and their key products for the years ended December 31, were as follows:

 

(Dollars in Millions)

 

   2005

   2004

   2003

   % Change

 
            2005 to 2004

    2004 to 2003

 

ConvaTec

   $ 992    $ 954    $ 843    4 %   13 %

Ostomy

     550      551      512        8 %

Wound Therapeutics

     416      391      319    6 %   23 %

Medical Imaging

     602      589      508    2 %   16 %

CARDIOLITE

     416      406      324    2 %   25 %

Consumer Medicines

     154      272      254    (43 )%   7 %

 

 

Worldwide ConvaTec sales increased 4%, including a 1% favorable foreign exchange impact, to $992 million in 2005 from 2004, primarily due to the increase in worldwide sales of wound therapeutic products. Sales of wound therapeutic products increased 6%, including a 1% favorable foreign exchange impact, to $416 million in 2005 from $391 million in 2004, primarily due to increased sales of AQUACEL. Ostomy sales remained constant at $550 million in 2005, including a 1% favorable foreign exchange impact. In 2004, ConvaTec sales increased 13%, including an 8% favorable foreign exchange impact, to $954 million from $843 million in 2003, primarily due to a 23% increase in worldwide sales of wound therapeutic products.

 

 

Worldwide Medical Imaging sales increased 2% to $602 million in 2005 from 2004. Sales of CARDIOLITE (Kit for the Preparation of Technetium Tc99m Sestamibi for Injection) increased 2% to $416 million in 2005 from $406 million in 2004, primarily due to increased demand. In 2004, Medical Imaging sales increased 16%, including a 1% favorable foreign exchange impact, to $589 million from $508 million, driven by increased sales of CARDIOLITE. This increase was partially due to a change in the timing of revenue recognition as a result of new distribution agreements entered into in January 2004.

 

Geographic Areas

 

In general, the Company’s products are available in most countries in the world. The largest markets are in the United States, France, Japan, Spain, Canada, Italy, Germany and Mexico. The Company’s sales by geographic areas were as follows:

 

(Dollars in Millions)

 

         % Change

 
   2005

    2004

    2003

    2005 to 2004

    2004 to 2003

 

United States

   $ 10,461     $ 10,613     $ 10,656     (1 )%    

% of Total

     54 %     55 %     57 %            

Europe, Middle East and Africa

     5,136       5,470       4,985     (6 )%   10 %

% of Total

     27 %     28 %     27 %            

Other Western Hemisphere

     1,592       1,425       1,333     12 %   7 %

% of Total

     8 %     7 %     7 %            

Pacific

     2,018       1,872       1,679     8 %   11 %

% of Total

     11 %     10 %     9 %            
    


 


 


           

Total

   $ 19,207     $ 19,380     $ 18,653     (1 )%   4 %
    


 


 


           

 

        Sales in the United States decreased 1% in 2005, as a result of lower sales of PARAPLATIN and the GLUCOPHAGE* franchise due to the continuing impact of earlier exclusivity losses, and PRAVACHOL, due to lower demand resulting from increased competition. This decrease in sales was mostly offset by increased sales of growth drivers including PLAVIX*, ABILIFY*, ERBITUX* and REYATAZ, and strong sales growth of ENFAMIL. In 2004, sales in the United States remained constant with growth in prescription demand for key brands including PLAVIX*, AVAPRO*/AVALIDE*, and SUSTIVA, and newer products including ABILIFY*, REYATAZ, and ERBITUX*, offset by lower sales of other products as a result of exclusivity losses for MONOPRIL, PARAPLATIN, and the GLUCOPHAGE* franchise.

 

Sales in Europe, Middle East and Africa decreased 6%, including a 1% favorable foreign exchange impact, as a result of sales decline of TAXOL® (paclitaxel), due to increased generic competition, and PRAVACHOL, due to exclusivity loss in select markets, including the UK and the Netherlands. This decrease in sales was partially offset by increased sales in major European markets of

 

55


REYATAZ and ABILIFY*, which were both launched in Europe in the second quarter of 2004. In 2004, sales increased 10%, including an 11% favorable foreign exchange impact, as a result of sales decline of PRAVACHOL, due to exclusivity loss in select markets, including Germany and the UK, and TAXOL® (paclitaxel), where generic competition in a majority of the major European markets began in the second quarter of 2004. This decrease in sales was mostly offset by increased sales of PLAVIX* in Germany and Spain, AVAPRO*/AVALIDE* in Italy and Spain, and SUSTIVA in the majority of the major markets.

 

Sales in the Other Western Hemisphere countries increased 12%, including a 7% favorable foreign exchange impact, primarily due to increased sales of PLAVIX* in Canada and Mexico, REYATAZ in Brazil and Canada, and AVAPRO*/AVALIDE* in Canada. In 2004, sales increased 7%, including a 2% favorable foreign exchange impact, primarily due to increased sales of PLAVIX* and AVAPRO*/AVALIDE* in Canada.

 

Sales in the Pacific region increased 8%, as a result of increased sales of TAXOL® (paclitaxel) in Japan, and ENFAGROW and ENFAMIL in China. In 2004, sales increased 11%, including a 5% favorable foreign exchange impact, as a result of increased sales of TAXOL® (paclitaxel) and PARAPLATIN in Japan, and PLAVIX* and AVAPRO*/AVALIDE* in Australia.

 

Expenses

 

(Dollars in Millions)

 

  

2005


   

2004


   

2003


    % Change

 
         2005 to 2004

    2004 to 2003

 

Cost of products sold

   $ 5,928     $ 5,989     $ 5,406     (1 )%   11 %

% of net sales

     30.9 %     30.9 %     29.0 %            

Marketing, selling and administrative

   $ 5,106     $ 5,016     $ 4,620     2 %   9 %

% of net sales

     26.6 %     25.9 %     24.7 %            

Advertising and product promotion

   $ 1,476     $ 1,411     $ 1,415     5 %    

% of net sales

     7.7 %     7.3 %     7.6 %            

Research and development

   $ 2,746     $ 2,500     $ 2,279     10 %   10 %

% of net sales

     14.3 %     12.9 %     12.2 %            

Acquired in-process research and development

   $     $ 63     $     (100 )%    

% of net sales

           0.3 %                  

Provision for restructuring, net

   $ 32     $ 104     $ 26     (69 )%   **  

% of net sales

     0.1 %     0.5 %     0.1 %            

Litigation charges, net

   $ 269     $ 420     $ 199     (36 )%   111 %

% of net sales

     1.4 %     2.2 %     1.1 %            

Gain on sale of business

   $ (569 )   $ (320 )   $     (78 )%    

% of net sales

     (3.0 )%     (1.7 )%                  

Equity in net income of affiliates

   $ (334 )   $ (273 )   $ (151 )   (22 )%   (81 )%

% of net sales

     (1.7 )%     (1.4 )%     (0.8 )%            

Other expense, net

   $ 37     $ 52     $ 179     (29 )%   (71 )%

% of net sales

     0.2 %     0.3 %     1.0 %            

Total Expenses, net

   $ 14,691     $ 14,962     $ 13,973     (2 )%   7 %

% of net sales

     76.5 %     77.2 %     74.9 %            

**

Change is in excess if 200%

 

 

 

Cost of products sold, as a percentage of sales, were 30.9% in 2005 and 2004, and 29.0% in 2003. In 2005, the unfavorable impact on gross margins resulting from the change in the U.S. pharmaceutical sales mix was offset by $76 million of net litigation charges recorded in 2004. In 2004, the increase over 2003 was due to the unfavorable impact of U.S. pharmaceutical sales mix due to the impact of generic competition in the U.S. for the GLUCHOPHAGE* franchise and PARAPLATIN, and the launch of lower margin ERBITUX*, partially offset by sales growth of ABILIFY*, REYATAZ and PLAVIX*. Gross margins in 2004 were also negatively impacted by $76 million of net litigation charges and higher accelerated depreciation charges compared with 2003.

 

 

 

Marketing, selling and administrative expenses, as a percentage of sales, were 26.6% in 2005, 25.9% in 2004, and 24.7% in 2003. In 2005, marketing, selling and administrative expenses increased 2% to $5,106 million from 2004, primarily due to higher legal costs and higher pension expenses, reflecting increased amortization of unrecognized net losses as well as change in actuarial assumptions, partially offset by lower sales force expenses resulting from a focus on specialists and high value primary care physicians. Marketing, selling and administrative expenses increased 9% to $5,016 million in 2004 from $4,620 million in 2003, primarily due to increased sales and marketing support for newer products, including additional sales representatives supporting ABILIFY*. In addition, the increase was also related to costs associated with the compliance with the Sarbanes-Oxley Act of 2002 and unfavorable foreign exchange driven by the strengthening of the euro.

 

56


 

 

Advertising and product promotion expenditures increased 5% to $1,476 million as compared to 2004, primarily due to increased investments in direct-to-consumer marketing campaigns for PLAVIX* and ABILIFY*, increased costs associated with pre-launch activities for ORENCIA and the launch of BARACLUDE, partially offset by lower spending on mature products. In 2004, advertising and promotion expenses remained relatively constant at $1,411 million as compared to $1,415 million in 2003, with increased investments in ABILIFY*, REYATAZ and PLAVIX* offset by lower spending on in-line and non-exclusive products.

 

 

 

The Company’s investment in research and development totaled $2,746 million in 2005, an increase of 10% over 2004 and an increase in 2004 of 10% over 2003. As a percentage of sales, research and development expenses were 14.3% in 2005 compared with 12.9% in 2004 and 12.2% in 2003. In 2005, the increase in research and development expenses reflects continued investments in late-stage compounds. Research and development costs also included $72 million of charges primarily related to milestone payments for licensing agreements in 2005, $58 million of charges consisting primarily of upfront and milestone payments in 2004 and $102 million of charges related to the upfront payments for licensing agreements in 2003. In 2005, research and development spending dedicated to pharmaceutical products increased to 16.5% of Pharmaceuticals sales compared with 14.7% in 2004 and 14.0% in 2003.

 

 

 

Acquired in-process research and development of $63 million in 2004 was related to the purchase of Acordis, a UK-based company that is expected to strengthen the Company’s leadership position in wound therapeutics. For additional information on the acquisition, see “Item 8. Financial Statements—Note 4. Acquisitions and Divestitures.”

 

 

 

Restructuring programs have been implemented to downsize, realign and streamline operations in order to increase productivity, reduce operating expenses and to rationalize the Company’s manufacturing network, research facilities, and the sales and marketing organizations. Actions under the 2005 restructuring program are expected to be complete by 2006 while actions under the 2004 and 2003 restructuring programs were substantially completed at December 31, 2005. As a result of these actions, the Company expects the future annual benefit to earnings from continuing operations before minority interest and income taxes to be approximately $77 million, $186 million and $64 million for the 2005, 2004 and 2003 programs, respectively. For additional information on restructuring, see “Item 8. Financial Statements—Note 3. Restructuring.”

 

 

 

Litigation charges, net of settlement income, were $269 million in 2005, compared to $420 million in 2004 and $199 million in 2003. The $269 million charge in 2005 consisted of increases to the reserves of $590 million for liabilities primarily related to private litigations and governmental investigations and partially offset by insurance recoveries of $321 million. The $420 million in 2004 consisted of $336 million related to private litigation and governmental investigations related to wholesaler inventory issues and accounting matters, $50 million related to the PLATINOL litigation settlement and $34 million related to pharmaceutical pricing and sales practices. In 2003, the Company established reserves for liabilities in the total amount of $250 million, comprised of $150 million in relation to wholesaler inventory issues and certain other accounting matters, and $100 million in relation to pharmaceutical pricing and sales and marketing practices. In addition, the Company recorded charges of $31 million for other litigation matters and recognized income of $82 million. The $82 million of income consists primarily of $30 million of income for patent defense cost reimbursement, $27 million in litigation settlement income and $21 million from the settlement of anti-trust litigation involving vitamin manufacturers. For additional information on litigation, see “Item 8. Financial Statements—Note 20. Legal Proceedings and Contingencies.”

 

 

 

The gain on sale of business of $569 million ($370 million net of tax) in 2005 was related to the sale of the U.S. and Canadian Consumer Medicines business and related assets. The gain on sale of business of $320 million ($198 million net of tax) in 2004 was related to the sale of the Adult Nutritional business. For additional information on these transactions, see “Item 8. Financial Statements—Note 4. Acquisitions and Divestitures.”

 

 

 

Equity in net income of affiliates for 2005 was $334 million, compared with $273 million and $151 million in 2004 and 2003, respectively. Equity in net income of affiliates is principally related to the Company’s joint venture with Sanofi and investment in ImClone. In 2005, the $61 million increase in equity in net income of affiliates from 2004 primarily reflects an increase in net income in the Sanofi joint venture, partially offset by a net loss from the investment in ImClone. The $122 million increase in 2004 from 2003 primarily reflects an increase in net income in the Sanofi joint venture. For additional information on equity in net income of affiliates, see “Item 8. Financial Statements—Note 2. Alliances and Investments.”

 

 

 

Other expenses, net of income, were $37 million, $52 million and $179 million in 2005, 2004 and 2003, respectively. Other expenses include net interest expense, foreign exchange gains and losses, income from third-party contract manufacturing, royalty income and expense, deferred income and debt retirement costs. The $15 million decrease in other expenses in 2005 from 2004 was primarily due to deferred income recognized from the termination of the collaborative agreement for muraglitazar, partially offset by debt retirement costs in connection with the repurchase of the $2.5 billion Notes due 2006 and higher net foreign exchange losses. The favorability in 2004 compared to 2003 was primarily due to higher income from third-party contract manufacturing, lower net interest expense and lower net foreign exchange losses. For additional information, see “Item 8. Financial Statements—Note 7. Other Expense, Net.”

 

57


During the years ended December 31, 2005, 2004 and 2003, the Company recorded several (income)/expense items that affected the comparability of results of the periods presented herein, which are set forth in the following table. For a discussion of these items, see “Item 8. Financial Statements—Note 2. Alliances and Investments,” “—Note 3. Restructuring and Other Items,” “—Note 4. Acquisitions and Divestitures,” “—Note 5. Discontinued Operations” and “—Note 20. Legal Proceedings and Contingencies.”

 

Year ended December 31, 2005

 

(Dollars in Millions)

 

   Cost of
products
sold


   Research
and
development


   Provision for
restructuring


  

Gain on sale

of business


   

Litigation
settlement
expense /

(income)


    Other
(income) /
expense, net


    Total

 

Litigation Matters

                                                     

Private litigations and governmental
investigations

   $    $    $    $     $ 558     $     $ 558  

Pharmaceutical pricing and sales litigation

                          12             12  

ERISA liability and other matters

                          20             20  

Insurance recoveries

                          (321 )           (321 )
    

  

  

  


 


 


 


                            269             269  

Other:

                                                     

Gain on sale of equity investment

                                (27 )     (27 )

Loss on sale of fixed assets

                                18       18  

Accelerated depreciation and asset
impairment

     96      14                             110  

Gain on sale of Consumer Medicines
businesses

                    (569 )                 (569 )

Upfront and milestone payments

          44                             44  

Debt retirement costs

                                69       69  

Downsizing and streamlining of
worldwide operations

     1      14      32                        47  

Termination of muraglitazar agreement

     5                            (143 )     (138 )
    

  

  

  


 


 


 


     $ 102    $ 72    $ 32    $ (569 )   $ 269     $ (83 )     (177 )
    

  

  

  


 


 


       

Income taxes on items above

                                                  126  

Adjustment to taxes on repatriation of foreign earnings

                                                  (135 )
                                                 


Increase to Net Earnings from Continuing Operations

                                                $ (186 )
                                                 


 

Year ended December 31, 2004

 

(Dollars in Millions)

 

   Cost of
products
sold


    Research and
development


   Acquired
in-process
research and
development


   Gain on
sale of
business


    Provision for
restructuring
and other
items, net


   Litigation
settlement
expense /
(income)


   Other
expense,
net


   Total

 

Litigation Matters:

        

Private litigation and governmental investigations

   $     $    $    $     $    $ 336    $    $ 336  

Product liability

     75                                 11      86  

Pharmaceutical pricing and sales litigation

                                34           34  

Commercial litigation

     26                                      26  

Anti-trust litigation

                                50           50  

Product liability insurance recovery

     (25 )                                    (25 )
    


 

  

  


 

  

  

  


       76                            420      11      507  

Other:

                                                           

Gain on sale of Adult Nutritional business

                     (320 )                    (320 )

Accelerated depreciation

     100       3                           4      107  

Downsizing and streamlining of
worldwide operations

     1                       104                105  

Upfront and milestone payments

           55                                55  

Acordis IPR&D write-off

                63                           63  
    


 

  

  


 

  

  

  


     $ 177     $ 58    $ 63    $ (320 )   $ 104    $ 420    $ 15      517  
    


 

  

  


 

  

  

        

Income taxes on items above

                                                        (130 )
                                                             

Deferred taxes in anticipation of
repatriation of foreign earnings

                                                        575  
                                                             

Other tax adjustments

                                                        10  
                                                       


Reduction to Net Earnings from Continuing Operations

                                                      $ 972  
                                                       


 

58


Year ended December 31, 2003

 

(Dollars in Millions)

 

   Cost of
products
sold


   Research and
development


   Provision for
restructuring
and other
items, net


    Litigation
settlement
expense /
(income)


    Total

 

Litigation Matters:

                                      

Private litigation and governmental investigations

   $    $    $     $ 150     $ 150  

Product liability

                     15       15  

Pharmaceutical pricing and sales litigation

                     100       100  

Litigation settlement income

                     (66 )     (66 )
    

  

  


 


 


                       199       199  

Other:

                       &nbs