10-K 1 y17883e10vk.htm FORM 10-K 10-K
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For fiscal year ended December 31, 2005
Commission file number 1-6571
SCHERING-PLOUGH CORPORATION
(Exact name of registrant as specified in its charter)
     
New Jersey   22-1918501
State or other jurisdiction of
incorporation or organization
  (I.R.S. Employer
identification No.)
 
2000 Galloping Hill Road, Kenilworth, NJ
(Address of principal executive offices)
  07033
Zip Code
Registrant’s telephone number, including area code:
(908) 298-4000
Securities register pursuant to Section 12(b) of the Act:
     
Title of Each Class   Name of Each Exchange on Which Registered
     
Common Shares, $.50 par value   New York Stock Exchange
Mandatory Convertible Preferred Stock   New York Stock Exchange
Preferred Share Purchase Rights*   New York Stock Exchange
 
At the time of filing, the Rights were not traded separately from the Common Shares.
Securities register pursuant to section 12(g) of the Act:
None.
      Indicate if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes þ          No o
      Indicate if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes o          No þ
      Indicate 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 the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o
      Indicate if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of 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.     þ
      Indicate 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     þ Accelerated Filer     o Non-accelerated Filer     o
      Indicate whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     Yes o          No þ
      State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common shares were last sold, or the average bid and asked price of such common equity, as of June 30, 2005 (the last business day of the registrant’s most recently completed second fiscal quarter): $28,123,003,392
      Common Shares outstanding as of January 31, 2006: 1,479,475,643
     
    Part of Form 10-K
Documents Incorporated by Reference   Incorporated into
     
Schering-Plough Corporation Proxy Statement for the Annual Meeting of Shareholders on May 19, 2006   Part III
 
 


 

TABLE OF CONTENTS
             
        Page
         
 PART I
   Business     1  
   Risk Factors     10  
   Unresolved Staff Comments     16  
   Properties     16  
   Legal Proceedings     16  
   Submission of Matters to a Vote of Security Holders     19  
     Executive Officers of the Registrant     20  
 
 PART II
   Market for Registrant’s Common Equity and Related Stockholder Matters     22  
   Selected Financial Data     23  
   Management’s Discussion and Analysis of Financial Condition and Results of Operations     23  
   Quantitative and Qualitative Disclosures about Market Risk     48  
   Financial Statements and Supplementary Data     49  
   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     89  
   Controls and Procedures     89  
     Management’s Report on Internal Control over Financial Reporting     90  
 
 PART III
   Directors and Executive Officers of the Registrant     92  
   Executive Compensation     92  
   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     92  
   Certain Relationships and Related Transactions     93  
   Principal Accountant Fees and Services     93  
 
 PART IV
   Exhibits, Financial Statement Schedules, and Reports on Form 8-K     94  
 SIGNATURES     100  
 EX-10.E.XII: SAVINGS ADVANTAGE PLAN
 EX-10.L: RETIREMENT BENEFITS EQUALIZATION PLAN
 EX-12: Computation of Ratio of Earnings to Fixed Charges
 EX-21: Subsidiaries of the registrant
 EX-23.1: Consent of Deloitte & Touche LLP
 EX-23.2: Independent Auditor's Consent
 EX-24: Power of attorney
 EX-31.1: Certification
 EX-31.2: Certification
 EX-32.1: Certification
 EX-32.2: Certification


Table of Contents

Part I
Item 1. Business
Overview of the Business
      Schering-Plough or the “Company” refers to Schering-Plough Corporation and its subsidiaries, except as otherwise indicated by the context. Schering Corporation, a predecessor company, was incorporated in New York in 1928 and New Jersey in 1935. The trademarks indicated by CAPITAL LETTERS in this 10-K are the property of, licensed to, promoted or distributed by Schering-Plough Corporation, its subsidiaries or related companies.
      Schering-Plough is a global science-based health care company with leading prescription, consumer and animal health products. Through internal research and collaborations with business partners, Schering-Plough discovers, develops, manufactures and markets advanced drug therapies to meet important medical needs. Schering-Plough’s vision is to earn the trust of the physicians, patients, customers and shareholders that it serves around the world. Schering-Plough’s worldwide headquarters is in Kenilworth, New Jersey, and its website is www.schering-plough.com.
      In April 2003, the Board of Directors named Fred Hassan as the new Chairman of the Board and Chief Executive Officer of Schering-Plough Corporation. Under his leadership, the six- to eight-year Action Agenda, a plan directed toward the goals of stabilizing, repairing and turning around Schering-Plough to produce long-term value for shareholders, was established and a new leadership team was recruited.
Segment Information
      The new management team reorganized the business from one managed along geographic lines, with the primary segments being U.S. and rest-of-world, to a business organized around its products. Currently, Schering-Plough has three reportable segments: Prescription Pharmaceuticals, Consumer Health Care and Animal Health. The segment sales and profit data that follow are consistent with Schering-Plough’s current management reporting structure.
Prescription Pharmaceuticals
      The Prescription Pharmaceuticals segment discovers, develops, manufactures and markets human pharmaceutical products. Within the Prescription Pharmaceutical segment there are three customer groups: Primary Care, Specialty Care and the Cholesterol Franchise. Principal products in this segment include:
Primary Care
      Allergy/ Respiratory: NASONEX, a once-daily, nasal-inhaled steroid for nasal allergy symptoms, including congestion, and for the treatment of nasal polyps in patients 18 years of age and older; CLARINEX, a nonsedating antihistamine for the treatment of allergic rhinitis; FORADIL AEROLIZER, a long-acting beta2-agonist marketed by Schering-Plough in the United States for the maintenance treatment of asthma and chronic obstructive pulmonary disease, and for the acute prevention of exercise-induced bronchospasm; and ASMANEX TWISTHALER, an oral dry-powder corticosteroid inhaler for first-line maintenance treatment of asthma.
      Antibiotics: AVELOX, a broad-spectrum fluoroquinolone antibiotic for certain respiratory and skin infections, and CIPRO, a broad-spectrum fluoroquinolone antibiotic for certain respiratory, skin, urinary tract and other infections.
      Dermatologicals: ELOCON, a medium-potency topical steroid cream, lotion and ointment.
      Other Disorders: LEVITRA, a phosphodiesterase type 5 inhibitor (PDE5) co-marketed by Schering-Plough in the United States for the treatment of male erectile dysfunction.

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Specialty Care
      Anti-Virals: PEG-INTRON Powder for Injection, the only pegylated interferon product for chronic hepatitis C approved for dosing according to patient body weight; INTRON A Injection for chronic hepatitis B and C and other antiviral indications; and REBETOL Capsules for use with PEG-INTRON or INTRON A for chronic hepatitis C.
      Anti-Inflammatories: REMICADE, an anti-TNF antibody marketed by Schering-Plough outside the United States for the treatment of rheumatoid arthritis, Crohn’s disease, ankylosing spondylitis, psoriatic arthritis, psoriasis, and as first-line therapy for the treatment of early rheumatoid arthritis.
      Oncology: TEMODAR Capsules for certain types of brain tumors, including newly diagnosed glioblastoma multiforme; CAELYX, a long-circulating pegylated liposomal formulation of the cancer drug doxorubicin marketed by Schering-Plough outside the United States for the treatment of certain ovarian cancers, Kaposi’s sarcoma and metastatic breast cancer; and INTRON A Injection, marketed for numerous anticancer indications worldwide, including as adjuvant therapy for malignant melanoma.
      Acute Coronary Care: INTEGRILIN Injection, a platelet receptor GP IIb/ IIIa inhibitor for the treatment of patients with acute coronary syndrome and those undergoing percutaneous coronary intervention in the United States, as well as for the prevention of early myocardial infarction in patients with acute coronary syndrome in most countries.
      Other Disorders: SUBUTEX, a sublingual tablet formulation of buprenorphine, and SUBOXONE, a sublingual tablet combination of buprenorphine and naloxone, marketed by Schering-Plough in certain countries outside the United States for the treatment of opiate addiction.
Cholesterol Franchise
      ZETIA, a novel cholesterol-absorption inhibitor discovered by Schering-Plough scientists, for use in combination with statin drugs or as monotherapy to lower cholesterol.
      VYTORIN, a cholesterol-lowering tablet combining the dual action of ZETIA and Merck & Co., Inc.’s statin Zocor.
Consumer Health Care
      The Consumer Health Care segment develops, manufactures and markets OTC, foot care and sun care products. Principal products in this segment include:
      Over-the-Counter Products: CLARITIN non-drowsy antihistamines; DRIXORAL cold and allergy, allergy sinus, flu and nasal decongestant tablets; AFRIN nasal decongestant spray and CORRECTOL laxative tablets.
      Foot Care: DR. SCHOLL’S foot care products; LOTRIMIN topical antifungal products; and TINACTIN topical antifungal products and foot and sneaker odor/wetness products.
      Sun Care: COPPERTONE sun care lotions, sprays, dry oils and lip-protection products and sunless tanning products; and SOLARCAINE sunburn relief products.
Animal Health
      The Animal Health segment discovers, develops, manufactures and markets animal health products. Principal products in this segment include:
      Livestock Products: NUFLOR bovine and swine antibiotic; BANAMINE bovine and swine anti-inflammatory; and M+PAC swine pneumonia vaccine.
      Poultry Products: PARACOX and COCCIVAC coccidiosis vaccines for poultry.

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      Companion Animal Products: OTOMAX, a steroid for otitis in dogs; EXSPOT topical insecticide for dogs; HOMEAGAIN pet recovery service; and ZUBRIN, an anti-inflammatory/ analgesic for dogs.
      Aquaculture Products: SLICE parasiticide for sea lice in salmon and AQUAFLOR antibiotic for farm-raised fish.
Net sales by segment
                         
    Year Ended December 31,
     
    2005   2004   2003
             
    (Dollars in millions)
Prescription Pharmaceuticals
  $ 7,564     $ 6,417     $ 6,611  
Consumer Health Care
    1,093       1,085       1,026  
Animal Health
    851       770       697  
                   
Consolidated net sales
  $ 9,508     $ 8,272     $ 8,334  
                   
Profit by segment
                         
    Year Ended December 31,
     
    2005   2004   2003
             
    (Dollars in millions)
Prescription Pharmaceuticals
  $ 733     $ 13     $ 513  
Consumer Health Care
    235       234       199  
Animal Health
    120       88       86  
Corporate and other
    (591 )     (503 )     (844 )
                   
Consolidated profit/(loss) before tax
  $ 497     $ (168 )   $ (46 )
                   
      “Corporate and other” includes interest income and expense, foreign exchange gains and losses, headquarters expenses, special charges and other miscellaneous items. The accounting policies used for segment reporting are the same as those described in Note 1, “Summary of Significant Accounting Policies”, under Item 8, Financial Statements and Supplementary Data, in this 10-K.
      In 2005, “Corporate and other” includes special charges of $294 million, including $28 million of employee termination costs, $16 million of asset impairment and other charges, and an increase in litigation reserves by $250 million resulting in a total reserve of $500 million representing the Company’s current estimate to resolve the Massachusetts investigation as well as the investigations disclosed under “AWP Investigations” and the state litigation disclosed under “AWP Litigation” in Note 19, “Legal, Environmental and Regulatory Matters” in Item 8, Financial Statements and Supplementary Data. It is estimated that the charges relate to the reportable segments as follows: Prescription Pharmaceuticals — $289 million, Consumer Health Care — $2 million, Animal Health — $1 million and Corporate and other — $2 million.
      In 2004, “Corporate and other” includes special charges of $153 million, including $119 million of employee termination costs, as well as $34 million of asset impairment and other charges. It is estimated the charges relate to the reportable segments as follows: Prescription Pharmaceuticals — $135 million, Consumer Health Care — $3 million, Animal Health — $2 million and Corporate and other — $13 million.
      In 2003, “Corporate and other” includes Special charges of $599 million, including $179 million of employee termination costs, a $350 million provision to increase litigation reserves, and $70 million of asset impairment charges. It is estimated the charges relate to the reportable segments as follows: Prescription Pharmaceuticals — $515 million, Consumer Health Care — $25 million, Animal Health — $4 million and Corporate and other — $55 million.

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      See Note 2 “Special Charges” under Item 8, Financial Statements and Supplementary Data, in this 10-K for additional information.
Global Operations
      Non-U.S. operations generate the majority of the Company’s profits and cash flow. Non-U.S. activities are carried out primarily through wholly-owned subsidiaries wherever market potential is adequate and circumstances permit. In addition, Schering-Plough is represented in some markets through licensees or other distribution arrangements. Currently, Schering-Plough has business operations in more than 120 countries and has approximately 18,900 employees outside the U.S.
      Non-U.S. operations are subject to certain risks that are inherent in conducting business overseas. These risks include possible nationalization, expropriation, importation limitations, pricing and reimbursement restrictions, and other restrictive governmental actions or economic destabilization. Also, fluctuations in foreign currency exchange rates can impact Schering-Plough’s consolidated financial results. For additional information on global operations, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and the segment information described above in this 10-K.
Net sales by geographic area
                         
    2005   2004   2003
             
    (Dollars in millions)
United States
  $ 3,589     $ 3,219     $ 3,559  
Europe and Canada
    4,040       3,595       3,410  
Pacific Area and Asia
    995       676       649  
Latin America
    884       782       716  
                   
Consolidated net sales
  $ 9,508     $ 8,272     $ 8,334  
                   
      The Company has subsidiaries in more than 50 countries outside the U.S. No single international country, except for France, Japan and Italy, accounted for 5 percent or more of consolidated net sales during the past three years. Net sales are presented in the geographic area in which the Company’s customers are located.
                                                 
    2005   2004   2003
             
        % of       % of       % of
        Consolidated   Net   Consolidated   Net   Consolidated
    Net Sales   Net Sales   Sales   Net Sales   Sales   Net Sales
                         
    (Dollars in millions)
Total International net sales
  $ 5,919       62 %   $ 5,053       61 %   $ 4,775       57 %
                                     
France
    771       8 %     729       9 %     691       8 %
Japan
    687       7 %     385       5 %     414       5 %
Italy
    457       5 %     443       5 %     436       5 %
Net sales by customer
                                                 
    2005   2004   2003
             
        % of       % of       % of
        Consolidated   Net   Consolidated   Net   Consolidated
    Net Sales   Net Sales   Sales   Net Sales   Sales   Net Sales
                         
    (Dollars in millions)
McKesson Corporation
  $ 1,073       11 %   $ 868       10 %   $ 667       8 %
      No single customer, except for McKesson Corporation, a major pharmaceutical and health care products distributor, accounted for 10 percent or more of consolidated net sales during the past three years.

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Long-lived assets by geographic location
                         
    2005   2004   2003
             
    (Dollars in millions)
United States
  $ 2,538     $ 2,447     $ 2,507  
Singapore
    840       884       828  
Ireland
    486       449       444  
Puerto Rico
    307       298       317  
Other
    602       768       726  
                   
Total
  $ 4,773     $ 4,846     $ 4,822  
                   
      Long-lived assets shown by geographic location are primarily property.
Supplemental sales information
      Sales of products comprising 10 percent or more of the Company’s U.S. or international sales for the year ended December 31, 2005, were as follows:
                 
    Amount   Percentage
         
    (Dollars in millions)
U.S.
               
NASONEX
  $ 447       12 %
OTC CLARITIN
    375       10 %
International
               
REMICADE
  $ 942       16 %
PEG-INTRON
    567       10 %
      Schering-Plough net sales do not include sales of VYTORIN and ZETIA, which are marketed in partnership with Merck, as the Company accounts for this joint venture under the equity method of accounting. See Note 3, “Equity Income from Cholesterol Joint Venture,” under Item 8, Financial Statements and Supplementary Data, in this 10-K.
      The Company does not disaggregate assets on a segment basis for internal management reporting and, therefore, such information is not presented.
Research and Development
      Schering-Plough’s research activities are primarily aimed at discovering and developing new prescription products and enhancements to existing prescription products of medical and commercial significance. Company-sponsored research and development expenditures were $1,865 million, $1,607 million and $1,469 million in 2005, 2004 and 2003, respectively. Research expenditures represented approximately 20 percent of consolidated net sales in 2005, 19 percent of consolidated net sales in 2004 and approximately 18 percent of consolidated net sales in 2003.
      Schering-Plough’s research activities are concentrated in the therapeutic areas of respiratory diseases, inflammatory diseases, infectious diseases, oncology, cardiovascular and metabolic diseases, and central nervous system disorders. Schering-Plough also has substantial efforts directed toward biotechnology and immunology. Research activities include expenditures for both internal research efforts and research collaborations with various partners.
      While several pharmaceutical compounds are in varying stages of development, it cannot be predicted when or if these compounds will become available for commercial sale. The Company’s product pipeline lists significant products in development and is available on the Schering-Plough website at www.schering-plough.com.

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Patents, Trademarks and Other Intellectual Property Rights
      Overview. Intellectual property protection is critical to Schering-Plough’s ability to successfully commercialize its product innovations. Schering-Plough owns, has applied for, or has licensed rights to, a large number of patents, both in the U.S. and in other countries, relating to molecules, products, product uses, formulations, and manufacturing processes. There is no assurance that the patents Schering-Plough is seeking will be granted or that the patents Schering-Plough has been granted would be found valid if challenged. Moreover, patents relating to particular molecules, products, uses, formulations, or processes do not preclude other manufacturers from employing alternative processes or from marketing alternative products or formulations that might successfully compete with the Company’s patented products.
      Outside the U.S., the standard of intellectual property protection for pharmaceuticals varies widely. While many countries have reasonably strong patent laws, other countries currently provide little or no effective protection for inventions or other intellectual property rights. Under the Trade-Related Aspects of Intellectual Property Agreement (TRIPs) administered by the World Trade Organization (WTO), more than 140 countries have now agreed to provide non-discriminatory protection for most pharmaceutical inventions and to assure that adequate and effective rights are available to all patent owners. It is possible that changes to this agreement will be made in the future that will diminish or further delay its implementation in developing countries. It is too soon to assess how much, if at all, the Company will be impacted commercially from these changes.
      When a product patent expires, the patent holder often loses effective market exclusivity for the product. This can result in a rapid, sharp and material decline in sales of the formerly patented product, particularly in the U.S. However, in some cases the innovator company can obtain additional commercial benefits through manufacturing trade secrets; later-expiring patents on processes, uses, or formulations; trademark use; or exclusivity that may be available under pharmaceutical regulatory laws.
      Schering-Plough’s Intellectual Property Portfolio. Patent protection for certain Schering-Plough molecules, products, processes, and uses are important to Schering-Plough’s business and financial results. For many of the Company’s products, in addition to patents on the compound, Schering-Plough holds other patents on manufacturing processes, formulations, or uses that may extend exclusivity beyond the expiration of the compound patent.
      Schering-Plough’s subsidiaries own (or have licensed rights under) a number of patents and patent applications, both in the U.S. and abroad. Patents and patent applications relating to Schering-Plough’s significant products, including, without limitation, VYTORIN, ZETIA, REMICADE, NASONEX INTRON A, PEG-INTRON, TEMODAR and CLARINEX, are of material importance to Schering-Plough.
      Worldwide, Schering-Plough sells all major products under trademarks that also are material in the aggregate to its business and financial results. Trademark protection varies throughout the world, with protection continuing in some countries as long as the mark is used and in other countries as long as it is registered. Registrations are normally for fixed but renewable terms.
      Patent Challenges Under the Hatch-Waxman Act. The Drug Price Competition and Patent Term Restoration Act of 1984, commonly known as Hatch-Waxman, made a complex set of changes to both patent and new drug approval laws in the U.S. Before Hatch-Waxman, no drug could be approved without providing the U.S. Food and Drug Administration (FDA) complete safety and efficacy studies, known as a complete New Drug Application (NDA). Hatch-Waxman authorizes the FDA to approve generic versions of innovative medicines without such information upon the filing of an Abbreviated New Drug Application (ANDA). In an ANDA, the generic manufacturer must demonstrate only bioequivalence between the generic version and the NDA-approved drug — not safety and efficacy. Hatch-Waxman provides for limited patent term restoration to partially make up for patent term lost during the time an NDA-approved drug is in regulatory review. NDA-approved drugs also receive a limited period of data exclusivity which prevents the approval of ANDA applications for specific time periods after approval of the NDA-approved drug.

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      Absent a successful patent challenge, the FDA cannot approve an ANDA until after the innovator’s patents expire. However, a generic manufacturer may file an ANDA seeking approval after the expiration of the applicable data exclusivity, and alleging that one or more of the patents listed in the innovator’s NDA are invalid or not infringed. This allegation is commonly known as a Paragraph IV certification. The innovator must then file suit against the generic manufacturer to protect its patents. If one or more of the NDA-listed patents are successfully challenged, the first filer of a Paragraph IV certification may be entitled to a 180-day period of market exclusivity over all other generic manufacturers. In recent years, generic manufacturers have used Paragraph IV certifications extensively to challenge patents on a wide array of innovative pharmaceuticals, and it is anticipated that this trend will continue.
Marketing Activities and Competition
      Prescription drugs are introduced and made known to physicians, pharmacists, hospitals, managed care organizations and buying groups by trained professional sales representatives, and are sold to hospitals, certain managed care organizations, wholesale distributors and retail pharmacists. Prescription products are also introduced and made known through journal advertising, direct mail advertising, the distribution of samples to physicians and through television, radio, internet, print and other advertising media.
      Animal health products are promoted to veterinarians, distributors and animal producers.
      Footcare, OTC and suncare products are sold through wholesale and retail drug, food chain and mass merchandiser outlets, and are promoted directly to the consumer through television, radio, internet, print and other advertising media.
      The pharmaceutical industry is highly competitive and includes other large companies, some significantly larger than Schering-Plough, with substantial resources for research, product development, advertising, promotion and field selling support. There are numerous domestic and international competitors in this industry. Some of the principal competitive techniques used by Schering-Plough for its products include research and development of new and improved products, varied dosage forms and strengths and switching prescription products to non-prescription status. In the U.S., many of Schering-Plough’s products are subject to increasingly competitive pricing as managed care groups, institutions, federal and state government entities and agencies and buying groups seek price discounts and rebates. Governmental and other pressures toward the dispensing of generic products may significantly reduce the sales of certain products when they, or competing products in the same therapeutic category, are no longer protected by patents or exclusivity available under pharmaceutical regulatory laws.
      Schering-Plough operates primarily in the prescription pharmaceutical marketplace. However, where appropriate, Schering-Plough has sought and may in the future seek regulatory approval to switch prescription products to over-the-counter (OTC) status as a means of extending a product’s life cycle. In this way, the OTC marketplace is another means of maximizing the return on investments in discovery and development.
Government Regulation
      Each of the Company’s major business segments is subject to significant regulation in multiple jurisdictions. This section describes the general regulatory framework. Additional information about the cost of regulatory compliance and specific impacts on the Company’s business and financial condition are described under the heading “Regulatory And Competitive Environment In Which The Company Operates” in Management’s Discussion and Analysis later in this 10-K. Additional information about other regulatory matters can be found in Item 3, Legal Matters, Note 18, “Consent Decree” and Note 19, “Legal, Environmental and Regulatory Matters,” under Item 8, Financial Statements and Supplementary Data, in this 10-K.
      In the prescription drug segment, regulations apply at all phases of the business including:
  •  regulatory requirements to conduct, and standards for, clinical trials (for example, requiring the use of Good Clinical Practices or GCPs) which apply at the research and development stage;

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  •  regulatory requirements to conduct, and standards for, post-approval clinical trials;
 
  •  required regulatory approval to begin marketing a new drug or to market an existing drug product for new indications;
 
  •  regulations prescribing the manner in which drugs are manufactured, packaged, labeled, advertised, marketed and distributed;
 
  •  regulations impacting the pricing of drugs;
 
  •  regulatory requirements to assess and report adverse impacts and side effects of drugs used in clinical trials, as well as marketed drugs, called “pharmacovigilance;” and
 
  •  the ability of regulatory authorities to remove a product from the market or recall certain batches of products.
      In the U.S., the national regulation of all phases of the prescription drug business except pricing is centralized at the Food and Drug Administration (FDA). The FDA is responsible for protecting the U.S. public health by assuring the safety, efficacy, and security of human and veterinary drugs, biological products, and medical devices. Generally, there is free market pricing in the U.S., although the Centers for Medicare and Medicaid Services (CMS) and Medicare Part B and D include provisions about pricing drugs for the elderly, disabled and indigent who receive federal prescription benefits. The Company is also committed to complying with voluntary best practices of the Pharmaceutical Research and Manufacturers of America (PhRMA), a trade industry group of which it is a member, regarding marketing and advertising practices.
      In the European Union (EU), including the Company’s key markets in the United Kingdom, France, Germany and Italy, there is regulation at the local country level and additional regulation at the EU level, through the European Medicines Agency (EMEA). Pharmaceutical products are regulated at both of these levels through various national, mutual recognition or centralized regulatory procedures. The EMEA coordinates the evaluation and supervision of medicinal products throughout the European Union. There is no pan-EU market pricing system; however, individual member states have various systems/agencies that regulate price at a local level.
      In Japan, there is regulation through the Pharmaceuticals and Medical Device Agency (PMDA). The PMDA regulates pharmaceuticals and medical devices from development through post-marketing use. The Japanese government regulates the pricing/reimbursement of pharmaceutical products in Japan through a complicated pricing process that includes benchmarks with prices in other western countries such as the United States, Canada and select EU countries.
      As all of the major countries have some influence over pricing, even with the CMS in the United States, there is increasing pressure on the pharmaceutical industry to bring products to market that provide differentiation versus existing products. This can lead to more expensive and scientifically challenging clinical trials in order to generate this type of data for new products versus marketed comparators.
Information About the Merck/ Schering-Plough Joint Ventures
      In May 2000, the Company and Merck & Co., Inc. (Merck) entered into two separate sets of agreements to jointly develop and market certain products in the U.S. including (1) two cholesterol-lowering drugs and (2) an allergy/asthma drug. In December 2001, the cholesterol agreements were expanded to include all countries of the world except Japan. In general, the companies agreed that the collaborative activities under these agreements would operate in a virtual joint venture to the maximum degree possible by relying on the respective infrastructures of the two companies. These agreements generally provide for equal sharing of development costs and for co-promotion of approved products by each company.

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      The cholesterol agreements provide for the Company and Merck to jointly develop ezetimibe (marketed as ZETIA in the U.S. and Asia and EZETROL in Europe):
        i. as a once-daily monotherapy;
 
        ii. in co-administration with any statin drug, and;
 
        iii. as a once-daily fixed-combination tablet of ezetimibe and simvastatin (Zocor), Merck’s cholesterol-modifying medicine. This combination medication (ezetimibe/simvastatin) is marketed as VYTORIN in the U.S. and as INEGY in many international countries.
      ZETIA/ EZETROL (ezetimibe) and VYTORIN/ INEGY (the combination of ezetimibe/simvastatin) are approved for use in the U.S. and have been launched in several international markets.
      The Company utilizes the equity method of accounting for the joint venture. The cholesterol agreements provide for the sharing of net income/(loss) based upon percentages that vary by product, sales level and country. In the U.S. market, Schering-Plough receives a greater share of profits on the first $300 million of annual ZETIA sales. Above $300 million of annual ZETIA sales, Merck and Schering-Plough (the Partners) share profits equally. Schering-Plough’s allocation of joint venture income is increased by milestones earned. Further, either Partner’s share of the joint venture’s net income/(loss) is subject to a reduction if the Partner fails to perform a specified minimum number of physician details in a particular country. The Partners agree annually to the minimum number of physician details by country.
      The Partners bear the costs of their own general sales forces and commercial overhead in marketing joint venture products around the world. In the U.S., Canada and Puerto Rico, the cholesterol agreements provide for a reimbursement to each Partner for physician details that are set on an annual basis. This reimbursed amount is equal to each Partner’s physician details multiplied by a contractual fixed fee. Schering-Plough reports the receipt of this reimbursement as part of equity income from cholesterol joint venture. This amount does not represent a reimbursement of specific, incremental, identifiable costs for the Company’s detailing of the cholesterol products in these markets. In addition, this reimbursement amount is not reflective of Schering-Plough’s sales effort related to the joint venture, as Schering-Plough’s sales force and related costs associated with the joint venture are generally estimated to be higher.
      Costs of the joint venture that the Partners contractually share are a portion of manufacturing costs, specifically identified promotion costs (including direct-to-consumer advertising and direct and identifiable out-of-pocket promotion) and other agreed-upon costs for specific services such as market support, market research, market expansion, a specialty sales force and physician education programs.
      Certain specified research and development expenses are generally shared equally by the Partners.
      Due to the virtual nature of the cholesterol joint venture, the Company incurs substantial costs, such as selling, general and administrative costs, that are not reflected in equity income from cholesterol joint venture and are borne by the overall cost structure of the Company. These costs are reported on their respective line items in the Statements of Consolidated Operations. The cholesterol agreements do not provide for any jointly owned facilities and, as such, products resulting from the collaboration are manufactured in facilities owned by either the Company or Merck.
      The allergy/asthma agreements provide for the joint development and marketing by the Partners of a once-daily, fixed-combination tablet containing CLARITIN and Singulair. Singulair is Merck’s once-daily leukotriene receptor antagonist for the treatment of asthma and seasonal allergic rhinitis. In January 2002, the Merck/ Schering-Plough respiratory joint venture reported on results of Phase III clinical trials of a fixed-combination tablet containing CLARITIN and Singulair. This Phase III study did not demonstrate sufficient added benefits in the treatment of seasonal allergic rhinitis. The CLARITIN and Singulair combination tablet does not have approval in any country and remains in clinical development with new Phase III clinical trials planned.

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Raw Materials
      Raw materials essential to Schering-Plough are available in adequate quantities from a number of potential suppliers. Energy is expected to be available to Schering-Plough in sufficient quantities to meet operating requirements.
Seasonality
      Certain of the Company’s products, particularly the respiratory and suncare categories, are seasonal in nature. Seasonal patterns do not have a pronounced effect on the consolidated operations of Schering-Plough.
Environment
      To date, compliance with federal, state and local laws regarding discharge of materials into the environment, or protection of the environment, have not had a material effect on Schering-Plough’s capital expenditures, earnings and competitive position.
Employees
      There were approximately 32,600 people employed by Schering-Plough as of December 31, 2005.
Available Information
      Schering-Plough’s 10-Ks, 10-Qs, 8-Ks, and amendments to those reports, filed with the SEC are available free of charge, on Schering-Plough’s website, as soon as reasonably practicable after such materials are electronically filed with the SEC. Schering-Plough’s address on the World Wide Web is www.schering-plough.com. Since Schering-Plough began this practice in the third quarter of 2002, each such report has been available on Schering-Plough’s website within 24 hours of filing. Reports filed by Schering-Plough with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an internet site at www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.
Item 1A. Risk Factors
      The Company’s future operating results and cash flows may differ materially from the results described in this 10-K due to risks and uncertainties related to the Company’s business, including those discussed below. In addition, these factors represent risks and uncertainties that could cause actual results to differ materially from those implied by forward-looking statements contained in this report.
Key Company products generate a significant amount of the Company’s profits and cash flows, and any events that adversely affect the market for its leading products could have a material and negative impact on results of operations and cash flows.
      The Company’s ability to generate profits and operating cash flow is dependent upon the increasing profitability of the Company’s cholesterol franchise, consisting of VYTORIN and ZETIA. In addition, products such as CLARINEX, PEG-INTRON, REBETOL, REMICADE, TEMODAR, OTC CLARITIN and NASONEX accounted for a material portion of 2005 revenues. As a result of the Company’s dependence on key products, any events that adversely affect the markets for these products could have a significant impact on results of operations. These events include loss of patent protection, increased costs associated with manufacturing, OTC availability of the Company’s product or a competitive product, the discovery of previously unknown side effects, increased competition from the introduction of new, more effective treatments, and discontinuation or removal from the market of the product for any reason.

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      More specifically, the profitability of the Company’s cholesterol franchise may be adversely affected by the introduction of generic forms of two competing cholesterol products that will lose patent protection in 2006. In addition, generic Flonase (fluticasone propionate) was approved in 2006 and may unfavorably impact the corticosteroid nasal spray market.
      Past examples of events in recent years that have adversely affected the market for leading products include events that have affected the market for CLARINEX and PEG-INTRON and REBETOL, particularly in the U.S. CLARINEX continues to experience intense competition in the prescription U.S. allergy market after the launch of CLARITIN OTC and a competing OTC loratadine product in the U.S. in December 2002 and the introduction of generic Allegra (fexofenadine) in the U.S. in September 2005. In addition, as a result of the introduction of a competitor’s product for pegylated interferon and the introduction of generic ribavirin, the value of PEG-INTRON (pegylated interferon) and REBETOL (ribavirin) combination therapy for hepatitis has been severely diminished and earnings and cash flow have been materially and negatively impacted.
There is a high risk that funds invested in research will not generate financial returns because the development of novel drugs requires significant expenditures with a low probability of success.
      There is a high rate of failure inherent in the research to develop new drugs to treat diseases. As a result, there is a high risk that funds invested in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested.
The Company’s success is dependent on the development and marketing of new products, and uncertainties in the regulatory and approval process may result in the failure of products to reach the market.
      Products that appear promising in development may fail to reach market for numerous reasons, including the following:
  •  findings of ineffectiveness or harmful side effects in clinical or pre-clinical testing;
 
  •  failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications;
 
  •  lack of economic feasibility due to manufacturing costs or other factors; and
 
  •  preclusion from commercialization by the proprietary rights of others.
Intellectual property protection is an important contributor to the Company’s profitability and as patents covering the Company’s products expire or if they are found to be invalid, generic forms of the Company’s products may be introduced to the market, which may have a material and negative affect on results of operations.
      Intellectual property protection is critical to Schering-Plough’s ability to successfully commercialize its products. Upon the expiration or the successful challenge of the Company’s patents covering a product, competitors may introduce generic versions of such products, which may include the Company’s well-

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established products. Such generic competition could result in the loss of a significant portion of sales or downward pressures on the prices at which the Company offers formerly patented products, particularly in the U.S. Patents and patent applications relating to Schering-Plough’s significant products are of material importance to Schering-Plough.
      Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies, which could diminish or eliminate sales and profits from those regions and negatively affect the Company’s results of operations.
Patent disputes can be costly to prosecute and defend and adverse judgments could result in damage awards, increased royalties and other similar payments and decreased sales.
      Patent positions can be highly uncertain and patent disputes in the pharmaceutical industry are not unusual. An adverse result in a patent dispute involving the Company’s patents may lead to a loss of market exclusivity and render the Company’s patents invalid. An adverse result in a patent dispute involving patents held by a third party may preclude the commercialization of the Company’s products, force the Company to obtain licenses in order to continue manufacturing or marketing the affected products, negatively affect sales of existing products or result in injunctive relief and payment of financial remedies. For example, the Company’s product, DR. SCHOLL’S FREEZE AWAY wart removal product, is currently the subject of a patent infringement action brought by a third party company, and an adverse outcome in this action may result in the Company’s inability to continue manufacturing the product.
      Even if the Company is ultimately successful in a particular dispute, the Company may incur substantial costs in defending its patents and other intellectual property rights. For example, a generic manufacturer may file an Abbreviated New Drug Application seeking approval after the expiration of the applicable data exclusivity and alleging that one or more of the patents listed in the innovator’s New Drug Application are invalid or not infringed. This allegation is commonly known as a Paragraph IV certification. The innovator then has the ability to file suit against the generic manufacturer to enforce its patents. In recent years, generic manufacturers have used Paragraph IV certifications extensively to challenge patents on a wide array of innovative pharmaceuticals, and it is anticipated that this trend will continue. The potential for litigation regarding Schering-Plough’s intellectual property rights always exists and may be initiated by third parties attempting to abridge Schering-Plough’s rights, as well as by Schering-Plough in protecting its rights.
U.S. and foreign regulations, including those establishing the Company’s ability to price products, may negatively affect the Company’s sales and profit margins.
      The Company faces increased pricing pressure in the U.S. and abroad from managed care organizations, institutions and government agencies and programs that could negatively affect the Company’s sales and profit margins. For example, the Medicare Prescription Drug Improvement and Modernization Act of 2003 contains a prescription drug benefit for individuals who are eligible for Medicare. The prescription drug benefit became effective on January 1, 2006, and it is anticipated that it may result in increased purchasing power of those negotiating on behalf of Medicare recipients.
      In addition to legislation concerning price controls, other trends that could affect the Company’s business include legislative or regulatory action relating to pharmaceutical pricing and reimbursement, health care reform initiatives and drug importation legislation, involuntary approval of medicines for OTC use, consolidation among customers, and trends toward managed care and health care costs containment.
      As a result of the U.S. government’s efforts to reduce Medicaid expenses, managed care organizations continue to grow in influence and the Company faces increased pricing pressure as managed care organizations continue to seek price discounts with respect to the Company’s products.
      In the international markets, cost control methods including restrictions on physician prescription levels and patient reimbursements, emphasis on greater use of generic drugs, and across the board price cuts may decrease revenues internationally.

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There are material pending investigations against the Company, the outcome of which could include the commencement of civil and/or criminal proceedings involving the imposition of substantial fines, penalties and injunctive or administrative remedies, including exclusion from government reimbursement programs.
      The Company cannot predict with certainty the outcome of the pending investigations to which it is subject, any of which may lead to a judgment or settlement involving a significant monetary award or restrictions on its operations.
      The pricing, sales and marketing programs and arrangements, and related business practices of the Company and other participants in the health care industry are under increasing scrutiny from federal and state regulatory, investigative, prosecutorial and administrative entities. These entities include the Department of Justice and its U.S. Attorney’s Offices, the Office of Inspector General of the Department of Health and Human Services, the FDA, the Federal Trade Commission and various state Attorneys General offices. Many of the health care laws under which certain of these governmental entities operate, including the federal and state anti-kickback statutes and statutory and common law false claims laws, have been construed broadly by the courts and permit the government entities to exercise significant discretion. In the event that any of those governmental entities believes that wrongdoing has occurred, one or more of them could institute civil or criminal proceedings, which, if instituted and resolved unfavorably, could subject the Company to substantial fines, penalties and injunctive or administrative remedies, including exclusion from government reimbursement programs. The Company also cannot predict whether any investigations will affect its marketing practices or sales. Any such result could have a material adverse impact on the Company’s results of operations, cash flows, financial condition, or its business.
      Regardless of the merits or outcomes of these investigations, government investigations are costly, divert management’s attention from the Company’s business and may result in substantial damage to the Company’s reputation. Please refer to Item 3. Legal Proceedings in this report for descriptions of these pending investigations.
There are other legal matters in which adverse outcomes could negatively affect the Company’s business.
      Unfavorable outcomes in other pending litigation matters, including litigation concerning product pricing, securities law violations, product liability claims, ERISA matters, patent and intellectual property disputes, and antitrust matters could preclude the commercialization of products, negatively affect the profitability of existing products, materially and adversely affect the Company’s financial condition and results of operations, or subject the Company to conditions that affect business operations, such as exclusion from government reimbursement programs.
      Please refer to Item 3. Legal Proceedings in this report for descriptions of significant pending litigation.
The Company is subject to governmental regulations, and the failure to comply with, as well as the costs of compliance of, these regulations may adversely affect the Company’s financial position and results of operations.
      The Company’s manufacturing facilities must meet stringent regulatory standards and are subject to regular inspections. The cost of regulatory compliance, including that associated with compliance failures, can materially affect the Company’s financial position and results of operations. Failure to comply with regulations, which include pharmacovigilance reporting requirements and standards relating to clinical, laboratory and manufacturing practices, can result in delays in the approval of drugs, seizure or recalls of drugs, suspension or revocation of the authority necessary for the production and sale of drugs, fines and other civil or criminal sanctions.
      For example, in May 2002, the Company agreed with the FDA to the entry of a Consent Decree to resolve issues related to compliance with current Good Manufacturing Practices at certain of the Company’s facilities in New Jersey and Puerto Rico. The Consent Decree work placed significant additional controls on production and release of products from these sites, which increased costs and

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slowed production and led to a reduction in the number of products produced at the sites. Further, the Company’s research and development operations were negatively impacted by the Consent Decree because these operations share common facilities with the manufacturing operations.
      The Company also is subject to other regulations, including environmental, health and safety and labor regulations.
Developments following regulatory approval may decrease demand for the Company’s products.
      Even after a product reaches market, certain developments following regulatory approval may decrease demand for the Company’s products, including the following:
  •  the re-review of products that are already marketed;
 
  •  uncertainties concerning safety labeling changes; and
 
  •  greater scrutiny in advertising and promotion.
      Recently, clinical trials and post-marketing surveillance of certain marketed drugs of competitors within the industry have raised safety concerns that have led to recalls, withdrawals or adverse labeling of marketed products. These situations also have raised concerns among some prescribers and patients relating to the safety and efficacy of pharmaceutical products in general, which have negatively affected the sales of such products.
      In addition, following the wake of recent product withdrawals of other companies and other significant safety issues, health authorities such as the FDA, the European Medicines Agency and the Pharmaceuticals and Medicines Device Agency have increased their focus on safety, when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications and are re-reviewing select products which are already marketed, adding further to the uncertainties in the regulatory processes. There is also greater regulatory scrutiny, especially in the United States, on advertising and promotion and in particular direct-to-consumer advertising.
      If previously unknown side effects are discovered or if there is an increase in the prevalence of negative publicity regarding known side effects of any of the Company’s products, it could significantly reduce demand for the product or may require the Company to remove the product from the market.
New products and technological advances developed by the Company’s competitors may negatively affect sales.
      The Company operates in a highly competitive industry. Many of the Company’s competitors have been conducting research and development in areas both served by the Company’s current products and by those products the Company is in the process of developing. Competitive developments that may impact the Company include technological advances by, patents granted to, and new products developed by competitors or new and existing generic, prescription and/or OTC products that compete with products of Schering-Plough or the Merck/ Schering-Plough Cholesterol Partnership. In addition, it is possible that doctors, patients and providers may favor those products offered by competitors due to safety, efficacy, pricing or reimbursement characteristics, and as a result the Company will be unable to maintain its sales for such products.
Because the Company often competes with other companies to acquire or license products (whether in early stage development or already approved for commercial sale) that the Company believes to be clinically or commercially attractive, it may be difficult for the Company to enter into such transactions.
      One aspect of the Company’s business is to acquire or license rights to develop or sell products from other companies. It may be challenging to acquire or license products that the Company believes to be clinically or commercially attractive on acceptable terms or at all because the Company competes for these opportunities against companies that often have far greater financial resources than the Company. The Company’s prospects may be adversely affected if it is unable to obtain rights to additional products on acceptable terms.

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The Company relies on third party relationships for its key products and changes to the third parties that are outside its control may impact the business.
      The Company relies on third party relationships for many of its key products. Any time that third parties are involved, there may be changes to or influences or impact on the third parties that are outside the control of the Company that may also, directly or indirectly, impact the Company’s business operation.
      The Company does not have operational or financial control over these third parties and may only have limited influence, if any, with respect to the manner in which they conduct their businesses or behave in their relationships with the Company. Also, in many cases, these third parties may offer or develop products that may compete with the Company’s products or have other conflicting interests relative to the Company.
The Company operates a global business that exposes the Company to additional risks, and any adverse events could have a material negative impact on results of operations.
      The Company operates in over 120 countries, and non-U.S. operations generate the majority of the Company’s profit and cash flow. Non-U.S. operations are subject to certain risks, which are inherent in conducting business overseas. These risks include possible nationalization, expropriation, importation limitations, pricing and reimbursement restrictions, and other restrictive governmental actions or economic destabilization. Also, fluctuations in inflation, interest rate, and foreign currency exchange rates can impact Schering-Plough’s consolidated financial results.
      In addition, there may be changes to the Company’s business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease.
Insurance coverage for product liability may become unavailable or cost prohibitive.
      The Company maintains insurance coverage with such deductibles and self-insurance to reflect market conditions (including cost and availability) existing at the time it is written, and the relationship of insurance coverage to self-insurance varies accordingly. However, as a result of increased product liability claims in the pharmaceutical industry, the availability of third party insurance may become unavailable or cost prohibitive.
The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations.
      The Company is subject to evolving and complex tax laws in the U.S. and in foreign jurisdictions. Significant judgment is required for determining the Company’s tax liabilities, and the Company’s tax returns are periodically examined by various tax authorities. The Company’s U.S. federal income tax returns for the 1997-2002 period are currently under audit by the Internal Revenue Service. The Company may be challenged by the IRS and other tax authorities on positions it has taken in its income tax returns. Although the Company believes that its accrual for tax contingencies is adequate for all open years, based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities, due to the complexity of tax contingencies, the ultimate resolution may result in payments that materially affect shareholders’ equity, liquidity and/or cash flow.
      In addition, the Company may be impacted by changes in tax laws including tax rate changes, new tax laws and revised tax law interpretations in domestic and foreign jurisdictions.

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Item 1B.      Unresolved Staff Comments
      None.
Item 2. Properties
      Schering-Plough’s corporate headquarters is located in Kenilworth, New Jersey. Principal research facilities are located in Kenilworth, Union and Summit, New Jersey; Palo Alto, California; and Elkhorn, Nebraska. Principal manufacturing facilities are as follows:
     
Location   Product Type
     
Kenilworth, New Jersey
  Pharmaceuticals, Consumer Products
Omaha, Nebraska
  Animal Health
Cleveland, Tennessee
  Consumer Products
Puerto Rico
  Pharmaceuticals
Belgium
  Pharmaceuticals
Ireland
  Pharmaceuticals, Consumer Products, Animal Health
Mexico
  Pharmaceuticals
Singapore
  Pharmaceuticals
      The Company anticipates capital expenditures of up to $300 million over the next several years for a U.S. pharmaceutical sciences center.
Item 3. Legal Proceedings
      Material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which Schering-Plough Corporation or any of its subsidiaries or to which any of their property is subject, are disclosed below.
      Additional information on legal proceedings, including important financial information, can be found in the Litigation Charges discussion in Note 2, “Special Charges” and Note 19, “Legal, Environmental and Regulatory Matters” contained in Item 8, Financial Statements and Supplementary Data, and in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in this 10-K.
Patent Matters
      As described in “Patents, Trademarks, and Other Intellectual Property Rights” under Part I, Business in this 10-K, intellectual property protection is critical to Schering-Plough’s ability to successfully commercialize its product innovations. The potential for litigation regarding Schering-Plough’s intellectual property rights always exists and may be initiated by third parties attempting to abridge Schering-Plough’s rights, as well as by Schering-Plough in protecting its rights. Patent matters described below have a potential material effect on the Company.
      DR. SCHOLL’S FREEZE AWAY Patent. On July 26, 2004, OraSure Technologies filed an action in the U.S. District Court for the Eastern District of Pennsylvania alleging patent infringement by Schering-Plough Healthcare Products by its sale of DR. SCHOLL’S FREEZE AWAY wart removal product. The complaint seeks a permanent injunction and unspecified damages, including treble damages.
Investigations
      Massachusetts Investigation. The U.S. Attorney’s Office for the District of Massachusetts is investigating a broad range of the Company’s sales, marketing and clinical trial practices and programs along with those of Warrick Pharmaceuticals (Warrick), the Company’s generic subsidiary. The investigation is focused on the following alleged practices: providing remuneration to managed care organizations, physicians and others to induce the purchase of Schering pharmaceutical products; off-label marketing of drugs; and submitting false pharmaceutical pricing information to the government for

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purposes of calculating rebates required to be paid to the Medicaid program. The Company is cooperating with this investigation.
      The outcome of this investigation could include the commencement of civil and/or criminal proceedings involving the imposition of substantial fines, penalties and injunctive or administrative remedies, including exclusion from government reimbursement programs. The Company has recorded a liability of $500 million related to this investigation as well as the investigations described below under “AWP Investigations” and the state litigation described below under “AWP Litigation.” It is reasonably possible that a settlement of the investigation could involve amounts materially in excess of this accrual.
      AWP Investigations. The Company continues to respond to existing and new investigations by the Department of Health and Human Services, the Department of Justice and several states into industry and Company practices regarding average wholesale price (AWP). These investigations relate to whether the AWP used by pharmaceutical companies for certain drugs improperly exceeds the average prices paid by providers and, as a consequence, results in unlawful inflation of certain government drug reimbursements that are based on AWP. The Company is cooperating with these investigations. The outcome of these investigations could include the imposition of substantial fines, penalties and injunctive or administrative remedies.
      NITRO-DUR Investigation. In August 2003, the Company received a civil investigative subpoena issued by the Office of Inspector General of the U.S. Department of Health and Human Services, seeking documents concerning the Company’s classification of NITRO-DUR for Medicaid rebate purposes, and the Company’s use of nominal pricing and bundling of product sales. The Company is cooperating with the investigation. It appears that the subpoena is one of a number addressed to pharmaceutical companies concerning an inquiry into issues relating to the payment of government rebates.
Pricing Matters
      AWP Litigation. The Company continues to respond to existing and new litigation by certain states and private payors into industry and Company practices regarding average wholesale price (AWP). These litigations relate to whether the AWP used by pharmaceutical companies for certain drugs improperly exceeds the average prices paid by providers and, as a consequence, results in unlawful inflation of certain reimbursements for drugs by state programs and private payors that are based on AWP. The complaints allege violations of federal and state law, including fraud, Medicaid fraud and consumer protection violations, among other claims. In the majority of cases, the plaintiffs are seeking class certifications. In some cases, classes have been certified. The outcome of these litigations could include substantial damages, the imposition of substantial fines, penalties and injunctive or administrative remedies.
Securities and Class Action Litigation
      Federal Securities Litigation. Following the Company’s announcement that the FDA had been conducting inspections of the Company’s manufacturing facilities in New Jersey and Puerto Rico and had issued reports citing deficiencies concerning compliance with current Good Manufacturing Practices, several lawsuits were filed against the Company and certain named officers. These lawsuits allege that the defendants violated the federal securities law by allegedly failing to disclose material information and making material misstatements. Specifically, they allege that the Company failed to disclose an alleged serious risk that a new drug application for CLARINEX would be delayed as a result of these manufacturing issues, and they allege that the Company failed to disclose the alleged depth and severity of its manufacturing issues. These complaints were consolidated into one action in the U.S. District Court for the District of New Jersey, and a consolidated amended complaint was filed on October 11, 2001, purporting to represent a class of shareholders who purchased shares of Company stock from May 9, 2000 through February 15, 2001. The complaint seeks compensatory damages on behalf of the class. The Court certified the shareholder class on October 10, 2003. Discovery is ongoing.
      Shareholder Derivative Actions. Two lawsuits were filed in the U.S. District Court for the District of New Jersey, against the Company, certain officers, directors and a former director seeking damages on

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behalf of the Company, including disgorgement of trading profits made by defendants allegedly obtained on the basis of material non-public information. The complaints allege a failure to disclose material information and breach of fiduciary duty by the directors, relating to the FDA inspections and investigations into the Company’s pricing practices and sales, marketing and clinical trials practices. These lawsuits are shareholder derivative actions that purport to assert claims on behalf of the Company. The two shareholder derivative actions pending in the U.S. District Court for the District of New Jersey were consolidated into one action on August 20, 2001, which is in its very early stages.
      Product Liability. The Company previously disclosed that it was a defendant in putative class action lawsuits involving alleged claims for personal injuries arising from the plaintiffs’ ingestion of phenylpropanolamine-containing cough/cold remedies (“PPA” products), and other class action lawsuits in which plaintiffs asserted claims for personal injuries arising from their use of laxative products and sought a refund of the purchase price of laxatives they purchased. These lawsuits have been dismissed or resolved. Any amounts paid to resolve these matters were immaterial. While no class action lawsuits currently exist concerning PPA claims, individual lawsuits involving PPA products are still pending. The Company deems the pending lawsuits to be immaterial in the aggregate. The Company also previously disclosed that it was the defendant in individual lawsuits relating to recalled albuterol/ VANCERIL/ VANCENASE inhalers. These lawsuits have been dismissed or resolved. Any amounts paid to resolve these lawsuits were immaterial.
      ERISA Litigation. On March 31, 2003, the Company was served with a putative class action complaint filed in the U.S. District Court in New Jersey alleging that the Company, retired Chairman, CEO and President Richard Jay Kogan, the Company’s Employee Savings Plan (Plan) administrator, several current and former directors, and certain corporate officers (Messrs. LaRosa and Moore) breached their fiduciary obligations to certain participants in the Plan. The complaint seeks damages in the amount of losses allegedly suffered by the Plan. The complaint was dismissed on June 29, 2004. The plaintiffs appealed. On August 19, 2005 the U.S. Court of Appeals for the Third Circuit reversed the dismissal by the District Court and the matter has been remanded back to the District Court for further proceedings.
      K-DUR Antitrust litigation. K-DUR is Schering-Plough’s long-acting potassium chloride product supplement used by cardiac patients. Following the commencement of the FTC administrative proceeding described below, alleged class action suits were filed in federal and state courts on behalf of direct and indirect purchasers of K-DUR against Schering-Plough, Upsher-Smith and Lederle. These suits claim violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. These suits seek unspecified damages. Discovery is ongoing.
Antitrust Matters
      K-DUR. Schering-Plough had settled patent litigation with Upsher-Smith, Inc. (Upsher-Smith) and ESI Lederle, Inc. (Lederle), relating to generic versions of K-DUR for which Lederle and Upsher Smith had filed Abbreviated New Drug Applications. On April 2, 2001, the FTC started an administrative proceeding against Schering-Plough, Upsher-Smith and Lederle alleging anti-competitive effects from those settlements. The administrative law judge issued a decision that the patent litigation settlements complied with the law in all respects and dismissed all claims against the Company. The FTC Staff appealed that decision to the full Commission. The Commission reversed the decision of the administrative law judge, ruling that the settlements did violate the antitrust laws. The full Commission issued a cease and desist order imposing various injunctive restraints. The federal court of appeals set aside that 2003 Commission ruling and vacated the cease and desist order. On August 29, 2005, the FTC filed a petition seeking a hearing by the U.S. Supreme Court.
Senate Finance Committee Inquiry
      In January 2006, the United States Senate Committee on Finance followed up on previous requests to the Company with a request for further information on the Company’s practices relating to educational and other grants. The Company understands that the Committee has directed similar follow-up requests to

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other pharmaceutical companies. The Company is cooperating with the Committee and is in the process of responding to its requests.
Tax Matters
      In October 2001, IRS auditors asserted that two interest rate swaps that the Company entered into with an unrelated party should be recharacterized as loans from affiliated companies, resulting in additional tax liability for the 1991 and 1992 tax years. In September 2004, the Company made payments to the IRS in the amount of $194 million for income tax and $279 million for interest. The Company filed refund claims for the tax and interest with the IRS in December 2004. Following the IRS’s denial of the Company’s claims for a refund, the Company filed suit in May 2005 in the U.S. District Court for the District of New Jersey for refund of the full amount of the tax and interest. This refund litigation is currently in the discovery phase. The Company’s tax reserves were adequate to cover the above-mentioned payments.
Pending Administrative Obligations
      In connection with the settlement of an investigation with the U.S. Department of Justice and the U.S. Attorney’s Office for the Eastern District of Pennsylvania, the Company entered into a five-year corporate integrity agreement (CIA). As disclosed in Note 18 “Consent Decree,” the Company is subject to obligations under a Consent Decree with the FDA. Failure to comply with the obligations under the CIA or the Consent Decree can result in financial penalties.
      For a discussion of pending pharmacovigilance matters resulting from pharmacovigilance inspections by officials of the British and French medicines agencies conducted at the request of the European Agency for the Evaluation of Medicinal Products (EMEA), refer to “Regulatory and Competitive Environment in Which the Company Operates” in Management’s Discussion and Analysis in this 10-K.
Other Matters
      Biopharma Contract Dispute. Biopharma S.r.l. filed a claim in the Civil Court of Rome on July 21, 2004 (docket no. 57397/2004, 9th Chamber), against certain Schering-Plough subsidiaries. The complaint alleges that Schering-Plough did not fulfill its duties under distribution and supply agreements between Biopharma and a Schering-Plough subsidiary for distribution by Schering-Plough of generic products manufactured by Biopharma to hospitals and to pharmacists in France.
Item 4. Submission of Matters to a Vote of Security Holders
      Not applicable.

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Executive Officers of the Registrant
      Listed below are the executive officers and corporate officers of the Company. Unless otherwise indicated, each has held the position indicated for the past five years. Officers serve for one year and until their successors have been duly appointed.
             
Name   Title   Age
         
Robert J. Bertolini*
  Executive Vice President and Chief Financial Officer(1)     44  
C. Ron Cheeley*
  Senior Vice President, Global Human Resources(2)     55  
Carrie S. Cox*
  Executive Vice President and President, Global Pharmaceuticals(3)     48  
William J. Creelman
  Vice President, Tax(4)     51  
Douglas J. Gingerella*
  Vice President and Controller(5)     47  
Fred Hassan*
  Chairman and Chief Executive Officer(6)     60  
Thomas H. Kelly
  Vice President, Corporate Business Development(7)     56  
Raul E. Kohan*
  Group Head, Global Specialty Operations, and President, Animal Health     53  
Joseph J. LaRosa
  Vice President, Legal Affairs(8)     47  
Ian A.T. McInnes
  Senior Vice President, Global Supply Chain(9)     53  
E. Kevin Moore
  Vice President and Treasurer     53  
Cecil B. Pickett, Ph.D.*
  Senior Vice President and President, Schering-Plough Research Institute Division(10)     60  
Anne Renahan
  Vice President, Global Internal Audits(11)     47  
Thomas J. Sabatino, Jr.*
  Executive Vice President and General Counsel(12)     47  
Karl Salnoske
  Vice President and Chief Information Officer(13)     52  
Brent Saunders*
  Senior Vice President, Global Compliance and Business Practices(14)     36  
Susan Ellen Wolf
  Corporate Secretary, Associate General Counsel and Vice President, Corporate Governance(15)     51  
 
  * Officers as defined in Rule 16a-1(f) under the Securities Exchange Act of 1934.
  (1)  Mr. Bertolini joined the Company in 2003 as Executive Vice President and Chief Financial Officer. Mr. Bertolini was a partner at PricewaterhouseCoopers from 1993 to 2003.
 
  (2)  Mr. Cheeley joined the Company in 2003 as Senior Vice President, Global Human Resources. Mr. Cheeley was Group Vice President, Global Compensation and Benefits, Pharmacia Corporation from 1998 to 2003.
 
  (3)  Ms. Cox joined the Company in 2003 as Executive Vice President and President, Global Pharmaceuticals. Ms. Cox was Executive Vice President and President, Global Prescription Business, Pharmacia Corporation from 1999 to 2003.

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  (4)  Mr. Creelman joined the Company in 2004 as Vice President, Tax. Mr. Creelman was Senior Tax Counsel, Pfizer from 2003 to 2004. Mr. Creelman was Assistant Vice President — International Tax, CIGNA Corporation from 2002 to 2003 and Vice President Tax — U.S., SmithKline Beecham from 1996 to 2001.
 
  (5)  Mr. Gingerella was named Vice President and Controller in 2004. Mr. Gingerella was Vice President, Corporate Audits from 1999 to 2004.
 
  (6)  Mr. Hassan joined the Company in 2003 as Chairman of the Board and Chief Executive Officer. Mr. Hassan was Chairman of the Board and Chief Executive Officer of Pharmacia Corporation from 2001 to 2003.
 
  (7)  Mr. Kelly became Vice President, Corporate Business Development in 2004. Mr. Kelly was Vice President and Controller from 1991 to 2004.
 
  (8)  Mr. LaRosa became Vice President, Legal Affairs in 2004. Mr. LaRosa was Staff Vice President, Secretary and Associate General Counsel from 2001 to 2004.
 
  (9)  Dr. McInnes joined the Company in 2004 as Senior Vice President, Global Supply Chain. Dr. McInnes was Senior Vice President, Global Supply Chain, Pharmacia Corporation from 1994 to 2003 and Executive Vice President, Supply Chain, Watson Pharmaceuticals, Inc. from 2003 to 2004.
(10)  Dr. Pickett was named Senior Vice President in 2004. Dr. Pickett joined Schering-Plough Research Institute in 1993 as Executive Vice President, Discovery Research, Schering-Plough Research Institute and in 2002 was named President of Schering-Plough Research Institute.
 
(11)  Ms. Renahan joined the Company in 2004 as Vice President, Global Internal Audits. Ms. Renahan was Executive Director and Controller, Eisai Inc. from 1999 to 2004.
 
(12)  Mr. Sabatino joined the Company in 2004 as Executive Vice President and General Counsel. Mr. Sabatino was Senior Vice President and General Counsel, Baxter International, Inc. from 2001 to 2004.
 
(13)  Mr. Salnoske joined the Company in 2004 as Vice President and Chief Information Officer. Mr. Salnoske was CEO of Adaptive Trade from 2001 to 2004.
 
(14)  Mr. Saunders joined the Company in 2003 as Senior Vice President, Global Compliance and Business Practices. Mr. Saunders was a partner at PricewaterhouseCoopers from 2000 to 2003.
 
(15)  Ms. Wolf was named Vice President, Corporate Secretary and Associate General Counsel in 2004. She held various positions in Schering-Plough’s Law Department from 2002 to 2004. She was Senior Attorney, Delta Airlines from 2000 to 2002.

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Part II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
      The common share dividends, share price data and the approximate number of holders of record are set forth under Item 8, Financial Statements and Supplementary Data, in this 10-K.
      The following table provides information with respect to purchases by the Company of its common shares during the fourth quarter of 2005.
ISSUER PURCHASES OF EQUITY SECURITIES
                                 
            Total Number of   Maximum Number
            Shares Purchased as   of Shares that May
        Average   Part of Publicly   Yet Be Purchased
    Total Number of   Price Paid   Announced Plans or   Under the Plans or
Period   Shares Purchased   per Share   Programs   Programs
                 
October 1, 2005 through October 31, 2005
    8,577 (1)   $ 20.49       N/A       N/A  
November 1, 2005 through November 30, 2005
    1,850 (1)   $ 19.69       N/A       N/A  
December 1, 2005 through December 31, 2005
    357,331 (1)   $ 19.72       N/A       N/A  
Total October 1, 2005 through December 31, 2005
    367,758 (1)   $ 19.74       N/A       N/A  
 
(1)  All of the shares included in the table above were repurchased pursuant to the Company’s stock incentive program and represent shares delivered to the Company by option holders for payment of the exercise price and tax withholding obligations in connection with stock options and stock awards.

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Item 6. Selected Financial Data
                                         
    2005   2004   2003   2002   2001
                     
    (In millions, except per share figures and percentages)
Operating Results
                                       
Net sales
  $ 9,508     $ 8,272     $ 8,334     $ 10,180     $ 9,762  
Income/(loss) before income taxes(1)
    497       (168 )     (46 )     2,563       2,523  
Net income/(loss)(1)
    269       (947 )     (92 )     1,974       1,943  
Net income/(loss) available to common shareholders
    183       (981 )     (92 )     1,974       1,943  
Diluted earnings/(loss) per common share(1)
    0.12       (0.67 )     (0.06 )     1.34       1.32  
Basic earnings/(loss) per common share(1)
    0.12       (0.67 )     (0.06 )     1.35       1.33  
Research and development expenses
    1,865       1,607       1,469       1,425       1,312  
Depreciation and amortization expenses
    486       453       417       372       320  
Financial Position and Cash Flows
                                       
Property, net
  $ 4,487     $ 4,593     $ 4,527     $ 4,236     $ 3,814  
Total assets
    15,469       15,911       15,271       14,136       12,174  
Long-term debt
    2,399       2,392       2,410       21       112  
Shareholders’ equity
    7,387       7,556       7,337       8,142       7,125  
Capital expenditures
    478       489       711       776       759  
Financial Statistics
                                       
Net income/(loss) as a percent of net sales
    2.8 %     (11.4 )%     (1.1 )%     19.4 %     19.9 %
Return on average shareholders’ equity
    3.6 %     (12.7 )%     (1.2 )%     25.9 %     29.3 %
Net book value per common share(2)
  $ 4.77     $ 4.91     $ 4.99     $ 5.55     $ 4.86  
Other Data
                                       
Cash dividends per common share
  $ .22     $ .22     $ .565     $ .67     $ .62  
Cash dividends on common shares
    324       324       830       983       911  
Cash dividends on preferred shares
    86       30                    
Average shares outstanding used in calculating diluted earnings/(loss) per common share
    1,484       1,472       1,469       1,470       1,470  
Average shares outstanding used in calculating basic earnings/(loss) per common share
    1,476       1,472       1,469       1,466       1,463  
Common shares outstanding at year-end
    1,479       1,474       1,471       1,468       1,465  
 
(1)  2005, 2004, 2003, 2002 and 2001 include Special charges of $294, $153, $599, $150 and $500, respectively. See Note 2, “Special Charges,” under Item 8, Financial Statements and Supplementary Data, in this 10-K for additional information.
 
(2)  Assumes conversion of all preferred shares into approximately 69 million common shares for 2005 and 65 million common shares for 2004.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE SUMMARY
Overview of the Company
      Schering-Plough (the Company) discovers, develops, manufactures and markets medical therapies and treatments to enhance human health. The Company also markets leading consumer brands in the over-the-counter (OTC), foot care and sun care markets and operates a global animal health business.

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      As a research-based pharmaceutical company, a core strategy of Schering-Plough is to invest substantial funds in scientific research with the goal of creating therapies and treatments with important medical and commercial value. Consistent with this core strategy, the Company has been increasing its investment in research and development, and this trend is expected to continue at historic levels or greater. Research and development activities focus on mechanisms to treat serious diseases. There is a high rate of failure inherent in such research and, as a result, there is a high risk that the funds invested in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to the commercial phase may take a decade or more.
      There are two sources of new products: products acquired through acquisition and licensing arrangements, and products in the Company’s late-stage research pipeline. With respect to acquisitions and licensing, there are limited opportunities for obtaining or licensing critical late-stage products, and these limited opportunities typically require substantial amounts of funding. The Company competes for these opportunities against companies often with greater financial resources. Accordingly, it may be challenging for the Company to acquire or license critical late-stage products that will have a positive material financial impact.
      The Company supports commercialized products with manufacturing, sales and marketing efforts. The Company is also moving forward with additional investments to enhance its infrastructure and business, including capital expenditures for the development process, where products are moved from the drug discovery pipeline to markets, information technology systems, and post-marketing studies and monitoring.
      The Company’s financial situation continues to improve, as discussed below. The Company’s cholesterol franchise products, VYTORIN and ZETIA, are the primary drivers of this improvement. ZETIA is the Company’s novel cholesterol absorption inhibitor. VYTORIN is the combination of ZETIA and Zocor, Merck & Co., Inc.’s (Merck) statin medication. These two products have been launched through a joint venture between the Company and Merck. ZETIA (ezetimibe), marketed in Europe as EZETROL, is marketed for use either by itself or together with statins for the treatment of elevated cholesterol levels. ZETIA/ EZETROL has been launched in more than 60 countries. VYTORIN (ezetimibe/simvastatin), marketed as INEGY internationally, has been launched in over 20 countries, including the United States.
      The Company currently expects its cholesterol franchise to continue to grow. The financial commitment to compete in the cholesterol reduction market is shared with Merck and profits from the sales of VYTORIN and ZETIA are also shared with Merck. The operating results of the joint venture with Merck are recorded using the equity method of accounting. Outside of the joint venture with Merck, in the Japanese market, Bayer Healthcare will co-market the Company’s cholesterol-absorption inhibitor, ZETIA, upon approval. Due to a backlog of new drug applications in Japan, the Company cannot precisely predict the timing of this approval.
      The cholesterol-reduction market is the single largest pharmaceutical category in the world. VYTORIN and ZETIA are competing in this market, and on a combined basis, these products continued to grow in terms of market share during 2005. As a franchise, the two products together have captured more than 14 percent of new prescriptions for the U.S. cholesterol management market (based on January 2006 IMS data). VYTORIN currently ranks as the third-leading prescription product for treating patients with high cholesterol (based on new prescriptions). To date, physicians have written more than 11 million total prescriptions for VYTORIN in the U.S. ZETIA sales continue to grow even as VYTORIN grows its market share.
      During 2005, the Company’s results of operations and cash flows were driven significantly by the performance of VYTORIN and ZETIA. As a result, the Company’s ability to generate profits is predominantly dependent upon the performance of the VYTORIN and ZETIA cholesterol franchise, which dependence is expected to continue for some time. For 2005, equity income from the cholesterol joint venture was $873 million and net income available to common shareholders was $183 million. Additional information regarding the joint venture with Merck is also included in Note 3, “Equity Income

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from Cholesterol Joint Venture,” under Item 8, Financial Statements and Supplementary Data, in this 10-K. Although it is expected that operating cash flow, existing cash and investments, including funds repatriated under the American Jobs Creation Act of 2004 (AJCA), will fund the Company’s operations for the near and intermediate term, as discussed in more detail below, future cash flows are also dependent upon the performance of VYTORIN and ZETIA. The Company must generate profits and cash flows to maintain and enhance its infrastructure and business as discussed above.
      Sales of the products may be impacted by the introduction of new innovative competing treatments and generic versions of existing products. In this regard, the Company expects that generic forms of Pravachol and Zocor, two existing well-established cholesterol-management products, will be introduced in the U.S. as they lose patent protection beginning in 2006 (generics have been introduced during 2005 in some international markets). The Company cannot reasonably predict what effect the introduction of generic forms of cholesterol management products may have on VYTORIN and ZETIA, although the decisions of government entities, managed care groups and other groups concerning formularies and reimbursement policies could potentially negatively impact the dollar size and/or growth of the cholesterol management market, including VYTORIN and ZETIA. A material change in the sales or market share of VYTORIN and ZETIA would have a significant impact on the Company’s operations and cash flow.
      REMICADE is prescribed for the treatment of rheumatoid arthritis, early rheumatoid arthritis, psoriatic arthritis, Crohn’s disease and ankylosing spondylitis, and recently gained approval in Europe for psoriasis. REMICADE is the Company’s second largest marketed pharmaceutical product line (after the cholesterol franchise). This product is licensed from and manufactured by Centocor, Inc., a Johnson & Johnson company. The Company has the exclusive marketing rights to this product outside of the U.S., Japan, China (including Hong Kong), Taiwan and Indonesia. During the third quarter of 2005, the Company exercised an option under its contract with Centocor for license rights to develop and commercialize golimumab, a fully human monoclonal antibody, in the same territories as REMICADE. Golimumab is currently under Phase III trials. Centocor believes these rights to golimumab expire in 2014, while the Company believes these rights extend beyond 2014. The parties are working together to move forward with their collaboration on golimumab, and steps are being taken to resolve the difference of opinion as to the expiration date.
      As is typical in the pharmaceutical industry, the Company licenses manufacturing, marketing and/or distribution rights to certain products to others, and also manufactures, markets and/or distributes products owned by others pursuant to licensing and joint venture arrangements. Any time that third parties are involved, there are additional factors relating to the third party and outside the control of the Company that may create positive or negative impacts on the Company. VYTORIN, ZETIA and REMICADE are subject to such arrangements and are key to the Company’s current business and financial performance.
      In addition, any potential strategic alternatives may be impacted by the change of control provisions in those arrangements, which could result in VYTORIN and ZETIA being acquired by Merck or REMICADE reverting back to Centocor. The change in control provision relating to VYTORIN and ZETIA is included in the contract with Merck, filed as Exhibit 10(q) to the Company’s 10-K, and the change of control provision relating to REMICADE is contained in the contract with Centocor, filed as Exhibit 10(u) to the Company’s 10-K.
      During the period from 2002 to 2004, the Company experienced a number of negative events that have strained and continue to strain the Company’s financial resources. While as explained below, the Company’s overall financial situation began to improve in 2005, these negative events remain relevant to understand the Company’s current challenges. These negative events included, but were not limited to, the following matters:
  •  Entered into a formal Consent Decree with the FDA in 2002 and agreed to implement a cGMP Work Plan and revalidate manufacturing processes at certain manufacturing sites in the U.S. and Puerto Rico. The Company has completed all of the significant steps of the cGMP Work Plan and validation actions required by December 31, 2005, under the Consent Decree. These are subject to certification by an external third party and review and approval by the FDA. Under the terms of

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  the Decree, provided that the FDA has not notified the Company of a significant violation of FDA law, regulations, or the Decree in the five year period since the Decree’s entry, May 2002 through May 2007, the Company may petition the court to have the Decree dissolved and the FDA will not oppose the Company’s petition. The Company has incurred significant costs associated with manufacturing compliance efforts as part of the Consent Decree. Incremental compliance costs will be incurred through the completion of the third party certification and FDA review and approval process. In addition, the Company has found it necessary to discontinue certain older profitable products and outsource other products.
 
  •  Switch of CLARITIN in the U.S., beginning in December 2002, from prescription to OTC status. This switch coupled with private label competition has resulted in substantially lower overall sales of this product starting in 2003 as well as lower average unit selling price for this product and ongoing intense competition. The Company’s exposure to powerful retail purchasers has also increased.
 
  •  Market shares and sales levels of certain other Company products fell significantly and have experienced increased competition. Some of these products continue to compete in declining or volatile markets.
 
  •  Investigations into certain of the Company’s sales and marketing practices by the U.S. Attorney’s Offices in Massachusetts and Pennsylvania. During 2004, the Company made payments totaling $294 million to the U.S. Attorney’s Office for the Eastern District of Pennsylvania in settlement of that investigation.

      In response to these matters, beginning in April 2003, the Board of Directors named Fred Hassan as the new Chairman of the Board and Chief Executive Officer of Schering-Plough Corporation. Under his leadership, a new leadership team was recruited and a six- to eight-year, five-phase Action Agenda was formulated with the goal of stabilizing, repairing and turning around the Company. In October 2005, the Company announced that it has entered the third, Turnaround, phase of the Action Agenda. The beginning of the Turnaround phase had been defined as achieving three consecutive quarters of sales and earnings growth, excluding special items.
Current State of the Business
      Net sales in 2005 were $9.5 billion, an increase of $1.2 billion, or 15 percent, over the 2004 period. The increase was driven primarily by the growth of REMICADE, PEG-INTRON, NASONEX, TEMODAR and the Animal Health business, and the U.S. sales contribution from the antibiotics AVELOX and CIPRO and other products under the agreement with Bayer that became effective in October 2004. Foreign exchange contributed 1 percent to the sales increase.
      Sales and marketing costs have increased due to the addition of Bayer sales representatives, increased selling expenses in Europe to support the continued launches of VYTORIN and ZETIA, and increased promotional spending, primarily for NASONEX, ASMANEX and the products under the agreement with Bayer.
      The Company had net income available to common shareholders of $183 million for 2005, compared to a net loss available to common shareholders of $981 million in 2004. Net income available to common shareholders for 2005 included a charge to increase the litigation reserves by $250 million resulting in a total reserve of $500 million representing the Company’s current estimate to resolve the Massachusetts investigation as well as the investigations disclosed under “AWP Investigations” and the state litigation disclosed under “AWP Litigation” in Note 19, “Legal, Environmental and Regulatory Matters,” in Item 8, Financial Statements and Supplementary Data. In addition, net income available to common shareholders also included research and development expense of approximately $124 million (or $118 million net of tax) for the license rights to develop and commercialize golimumab. Net loss available to common shareholders for 2004 included a pre-tax research and development charge of $80 million for the license of garenoxacin from Toyama Chemical Company Ltd., tax expense of $779 million which included a

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provision for taxes related to the planned repatriation of unremitted foreign earnings during 2005 under the American Jobs Creation Act, and a valuation reserve for net deferred tax assets in the U.S.
      Many of the Company’s manufacturing sites operate below capacity. The Company’s manufacturing sites subject to the Consent Decree remained open while the Company was performing its revalidation and cGMP Work Plan obligations under decree. However, the Consent Decree work placed significant additional controls on production and release of products from these sites, which increased costs and slowed production and led to a reduction in the product mix at the sites. Further, the Company’s research and development operations were negatively impacted by the Consent Decree because these operations share common facilities with the manufacturing operations. Although certain costs, such as those associated with third party certifications, will decrease when the completion of the Work Plan is certified, other financial impacts will continue, such as the costs of the new processes that will continue to be used and the reduced product mix and volumes at the sites.
      The Company’s manufacturing cost base is relatively fixed. Actions on the part of management to significantly reduce the Company’s manufacturing infrastructure involve complex issues. In most cases, shifting products between manufacturing plants can take many years due to construction, revalidation and registration requirements. Management continues to review the carrying value of certain manufacturing assets for indications of impairment. Future events and decisions may lead to asset impairments and/or related costs.
      During 2005, the Company repatriated approximately $9.4 billion of previously unremitted foreign earnings at a reduced tax rate as provided by the American Jobs Creation Act (AJCA). Repatriating funds under the AJCA benefits the Company in the following ways:
  •  The Company’s U.S. operations currently incur significant negative cash flow. Operating cash flows, existing cash and investments, including repatriations made during 2005 under the AJCA, are expected to provide the Company with the ability to fund U.S. cash needs for the near and intermediate term. The Company will continue to use repatriated funds for AJCA qualified spending.
 
  •  The U.S. operations during 2005 and 2004 produced U.S. tax net operating loss (U.S. NOL) carryforwards of approximately $1.5 billion. Under the AJCA, qualifying repatriations do not reduce U.S. tax losses. As such, the Company has both the cash necessary to fund its U.S. cash needs and the potential benefit of being able to carry forward U.S. NOLs to reduce future U.S. taxable income. This potential future benefit could be significant but is dependent on the Company achieving profitability in the U.S.
DISCUSSION OF OPERATING RESULTS
Net Sales
      A significant portion of net sales is made to major pharmaceutical and health care product distributors and major retail chains in the U.S. Consequently, net sales and quarterly growth comparisons may be affected by fluctuations in the buying patterns of major distributors, retail chains and other trade buyers. These fluctuations may result from seasonality, pricing, wholesaler buying decisions or other factors.
      Consolidated net sales in 2005 totaled $9.5 billion, an increase of $1.2 billion or 15 percent compared with 2004. Consolidated net sales reflected higher volumes of REMICADE, PEG-INTRON, NASONEX, TEMODAR and the inclusion of a full year of sales of AVELOX and CIPRO. In addition, foreign exchange had a favorable impact of 1 percent.
      Consolidated 2004 net sales of $8.3 billion had decreased $62 million or 1 percent as compared to 2003, primarily reflecting volume declines offset by a favorable foreign exchange rate impact of 4 percent.

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      Net sales for the years ended December 31, 2005, 2004 and 2003 were as follows:
                                           
                % Increase (Decrease)
                 
    2005   2004   2003   2005/2004   2004/2003
                     
    (Dollars in millions)        
PRESCRIPTION PHARMACEUTICALS
  $ 7,564     $ 6,417     $ 6,611       18 %     (3 )%
 
REMICADE
    942       746       540       26       38  
 
PEG-INTRON
    751       563       802       33       (30 )
 
NASONEX
    737       594       500       24       19  
 
CLARINEX/ AERIUS
    646       692       694       (7 )     0  
 
TEMODAR
    588       459       324       28       42  
 
CLARITIN Rx(a)
    371       321       328       16       (2 )
 
REBETOL
    331       287       639       15       (55 )
 
INTEGRILIN
    315       325       306       (3 )     6  
 
INTRON A
    287       318       409       (10 )     (22 )
 
AVELOX
    228       44             N/M       N/M  
 
SUBUTEX
    197       185       144       6       29  
 
CAELYX
    181       150       111       21       35  
 
CIPRO
    146       43             N/M       N/M  
 
ELOCON
    144       168       154       (14 )     9  
 
Other Pharmaceutical
    1,700       1,522       1,660       12       (8 )
CONSUMER HEALTH CARE
    1,093       1,085       1,026       1       6  
 
OTC(b)
    556       578       588       (4 )     (2 )
 
Foot Care
    333       331       292       1       13  
 
Sun Care
    204       176       146       16       20  
ANIMAL HEALTH
    851       770       697       11       10  
                               
CONSOLIDATED NET SALES
  $ 9,508     $ 8,272     $ 8,334       15 %     (1 )%
                               
 
Certain prior year amounts have been reclassified to conform to current year presentation.
N/ M — Not a meaningful percentage.
(a) Amounts shown include international sales of CLARITIN Rx only.
 
(b) Includes OTC CLARITIN of $394, $419, and $432 in 2005, 2004 and 2003, respectively.
      International net sales of REMICADE, for the treatment of immune-mediated inflammatory disorders such as rheumatoid arthritis, early rheumatoid arthritis, psoriatic arthritis, Crohn’s disease, ankylosing spondylitis and plaque psoriasis, were up $196 million or 26 percent in 2005 to $942 million due to greater demand, expanded indications and continued market growth. Sales of REMICADE in 2004 were $746 million, up $206 million or 38 percent compared with 2003, due to greater medical use and expanded indications in European markets. In the near future, additional competitive products for the indications referred to above are likely to be introduced.
      Global net sales of PEG-INTRON Powder for Injection, a pegylated interferon product for treating hepatitis C, increased $188 million or 33 percent to $751 million compared with 2004 due to the December 2004 launch of the PEG-INTRON and REBETOL combination therapy in Japan. Sales in Japan benefited from the significant number of patients who were waiting for approval of PEG-INTRON before beginning treatment (patient warehousing). Comparisons in 2006 will be unfavorably impacted by the absence of this patient warehousing and anticipated government mandated price reductions in Japan. As a result of these factors, sales may decline materially. Sales of PEG-INTRON in the U.S. in 2005 have decreased, primarily reflecting a decline in the overall market. Sales of PEG-INTRON decreased

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$239 million or 30 percent to $563 million in 2004, due primarily to loss of market share reflecting the entrance of a competitor’s new products in the hepatitis C market in 2003.
      Global net sales of NASONEX Nasal Spray, a once-daily corticosteroid nasal spray for allergies, rose 24 percent to $737 million in 2005 as the product captured greater U.S. and international market share versus the 2004 period. U.S. sales benefited from an increased promotional effort and the introduction, beginning in January 2005, of a new scent-free, alcohol-free formulation of NASONEX nasal spray. 2004 sales of NASONEX increased 19 percent versus 2003 to $594 million primarily due to international sales growth and favorable prior year trade inventory comparisons in the U.S., tempered by a decline in U.S. market share. Generic Flonase (fluticasone propionate) was approved in 2006 and may unfavorably impact the corticosteroid nasal spray market.
      Global net sales of CLARINEX (marketed as AERIUS in many countries outside the U.S.), for the treatment of seasonal outdoor allergies and year-round indoor allergies, decreased $46 million, or 7 percent, versus 2004. Sales in the U.S. decreased $95 million or 23 percent versus 2004 due to reduced market share in a declining market. In September 2005, generic Allegra (fexofenadine) was introduced to the U.S., which will continue to negatively affect the antihistamine market including CLARINEX. Sales outside the U.S. increased $49 million or 18 percent to $321 million in 2005 due primarily to market share gains. Global net sales of CLARINEX were $692 million in 2004, essentially flat versus 2003. Sales outside the U.S. increased 39 percent to $272 million in 2004 due to market share gains and continued conversion from prescription CLARITIN. U.S. sales decreased 16 percent to $420 million in 2004 due to the continued contraction in the U.S. prescription antihistamine market following the launch of OTC CLARITIN and other branded and non-branded non-sedating antihistamines coupled with market share declines.
      Global net sales of TEMODAR Capsules, a treatment for certain types of brain tumors, increased $129 million or 28 percent to $588 million in 2005 due to increased utilization for treating newly diagnosed glioblastoma multiforme (GBM), which is the most prevalent form of brain cancer. This new indication was granted U.S. FDA approval in March 2005 and was rapidly adopted by U.S. physicians. In June 2005, TEMODAR received approval from the European Commission for use in combination with radiotherapy for GBM patients in 25 member states as well as in Iceland and Norway. In Japan, TEMODAR was granted a priority review of the regulatory application to treat malignant glioma in the 2005 fourth quarter. Sales of TEMODAR increased $135 million or 42 percent to $459 million in 2004 due to increased market penetration. The growth rates for TEMODAR may moderate going forward, as significant market penetration has already been achieved in the treatment of GBM, especially in the U.S.
      International net sales of prescription CLARITIN increased $50 million or 16 percent to $371 million in 2005 due to the launch of CLARITIN REDITABS in Japan coupled with an unusually severe Japanese allergy season that may not recur in 2006. In 2004, international sales of prescription CLARITIN were $321 million, a decrease of 2 percent compared to 2003 due to continued conversion to CLARINEX.
      Global net sales of REBETOL Capsules, for use in combination with INTRON A or PEG-INTRON for treating hepatitis C, increased $44 million or 15 percent to $331 million in 2005 due primarily to the launch of the PEG-INTRON and REBETOL combination therapy in Japan in December 2004. Sales in Japan benefited from the significant number of patients who were waiting for approval of PEG-INTRON before beginning treatment (patient warehousing). Comparisons in 2006 will be unfavorably impacted by the absence of this patient warehousing and, as a result, sales may decline materially. REBETOL may also be subject to larger than average government mandated price reductions in Japan. Sales of REBETOL in 2004 decreased 55 percent to $287 million due to the launch of generic versions of REBETOL in the U.S. in April 2004 and increased price competition outside the U.S.
      Global net sales of INTEGRILIN Injection, a glycoprotein platelet aggregation inhibitor for the treatment of patients with acute coronary syndrome, which is sold primarily in the U.S. by the Company, were $315 million in 2005 compared with $325 million in 2004. While sales of INTEGRILIN in the U.S. were essentially flat versus 2004, sales outside the U.S. decreased $8 million, reflecting the return of

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European marketing rights to Millennium Pharmaceuticals, Inc. (Millennium). Sales of INTEGRILIN in 2004 increased $19 million or 6 percent versus 2003 due to increased patient utilization.
      Effective September 1, 2005, the Company restructured its INTEGRILIN co-promotion agreement with Millennium. Under the terms of the restructured agreement, the Company acquired exclusive U.S. development and commercialization rights to INTEGRILIN in exchange for an upfront payment of $36 million and royalties on INTEGRILIN sales. The restructured agreement calls for minimum royalty payments of $85 million per year to Millennium for 2006 and 2007.
      Global net sales of INTRON A Injection, for chronic hepatitis B and C and other antiviral and anticancer indications, decreased 10 percent in 2005 to $287 million due to the conversion to PEG-INTRON in Japan. Sales of INTRON A decreased 22 percent in 2004 to $318 million due primarily to lower demand.
      Net sales of AVELOX, a fluoroquinolone antibiotic for the treatment of certain respiratory and skin infections, sold primarily in the U.S. by Schering-Plough as a result of the Company’s license agreement with Bayer, were $228 million in 2005. Sales of AVELOX in 2004 represented the initial three months of sales under the agreement with Bayer, which was effective October 1, 2004.
      International net sales of SUBUTEX Tablets, for the treatment of opiate addiction, increased 6 percent to $197 million in 2005 due to increased market penetration. Sales of SUBUTEX were $185 million in 2004, an increase of 29 percent over 2003 due to increased market penetration. It is expected that SUBUTEX will encounter generic competition in the near future.
      International sales of CAELYX, for the treatment of ovarian cancer, metastatic breast cancer and Kaposi’s sarcoma, increased 21 percent to $181 million, reflecting further adoption of the ovarian cancer and metastatic breast cancer indications. Sales of CAELYX in 2004 increased 35 percent versus 2003 to $150 million, reflecting initial adoption of the metastatic breast cancer indication.
      Net sales of CIPRO, a fluoroquinolone antibiotic for the treatment of certain respiratory, skin, urinary tract and other infections, sold primarily in the U.S. by Schering-Plough as a result of the Company’s license agreement with Bayer, were $146 million in 2005. Sales of CIPRO in 2004 represented the initial three months of sales under the agreement with Bayer.
      Global net sales of ELOCON cream, a medium-potency topical steroid, decreased 14 percent to $144 million, reflecting generic competition introduced in the U.S. during the first quarter of 2005. Generic competition is expected to continue to adversely affect sales of this product.
      Other pharmaceutical net sales include a large number of lower sales volume prescription pharmaceutical products. Several of these products are sold in limited markets outside the U.S., and many are multiple source products no longer protected by patents. The products include treatments for respiratory, cardiovascular, dermatological, infectious, oncological and other diseases.
      Global net sales of Consumer Health Care products, which include OTC, foot care and sun care products, were $1.1 billion in 2005 and 2004. Sales of OTC CLARITIN were $394 million in 2005, a decrease of $25 million or 6 percent from 2004, reflecting the adverse impact on sales of CLARITIN-D due to restrictions on the retail sale of OTC products containing pseudoephedrine (PSE) that came into effect during 2005. Sales of CLARITIN-D may continue to be adversely affected by both recent and future restrictions on the retail sale of such products. In addition, OTC CLARITIN continues to face competition from private label and branded loratadine. Net sales of sun care products increased $28 million or 16 percent in 2005, primarily due to the launch of new COPPERTONE CONTINUOUS SPRAY products coupled with a stronger overall suncare season in the U.S. Net sales of foot care products increased $2 million or 1 percent in 2005, due primarily to the new MEMORY FIT and FOR HER INSOLES and other insole products. Net sales of Consumer Health Care products in 2004 increased $59 million or 6 percent compared to 2003, due primarily to the strong performance of DR. SCHOLL’S FREEZE AWAY and other foot care products.

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      The Company sells numerous non-prescription upper respiratory products that contain PSE, an FDA-approved ingredient for the relief of nasal congestion. The Company’s annual North American sales of non-prescription upper respiratory products that contain PSE totaled approximately $277 million in 2005, $305 million in 2004 and approximately $160 million in 2003. These products include all CLARITIN-D products as well as some DRIXORAL, CORICIDIN and CHLOR-TRIMETON products. The Company understands that PSE has been used in the illicit manufacture of methamphetamine, a dangerous and addictive drug. As of December 31, 2005, 26 states, Canada and Mexico have enacted regulations concerning the non-prescription sale of products containing PSE, including limiting the amount of these products that can be purchased at one time or requiring that these products be located behind the pharmacist’s counter, with the stated goal of deterring the illicit/illegal manufacture of methamphetamine. An additional 12 states have enacted limits on the quantity of PSE any person can possess. One state has recently enacted legislation that regulates all PSE products to prescription status. Also, the U.S. federal government has proposed legislation placing restrictions on the sale of products containing PSE. Further, major U.S. retailers that are customers of the Company have voluntarily placed non-prescription products containing PSE behind the pharmacy counter at all of their stores, whether or not required by local law. Sales of non-prescription PSE products were down $28 million or approximately 9 percent as compared to 2004. The Company continues to monitor developments in this area that could have a further negative impact on operations or financial results. It should be noted that these regulations do not relate to the sale of prescription products, such as CLARINEX-D products, that contain PSE.
      Global net sales of Animal Health products increased 11 percent in 2005 to $851 million. The increased sales reflected strong growth of core brands across most geographic and species areas, led by products serving the U.S. cattle market, including NUFLOR, and the vaccine business. The increased sales were also due in part to better product supply in the U.S. The sales growth included a favorable foreign exchange impact of 1 percent. The Company expects this growth rate to moderate due to increased competition, including generic products. Global net sales of Animal Health products increased 10 percent in 2004, which included a favorable foreign exchange impact of 6 percent.
      Certain situations that had a positive impact on sales and net income in 2005 may not recur in 2006. These include the favorable effect of foreign exchange, the patient warehousing benefit to PEG-INTRON and REBETOL related to the launch of PEG-INTRON in Japan, and an unusually severe allergy season in Japan that benefited the reported sales of prescription CLARITIN. Generic Allegra (fexofenadine) was introduced in the U.S. during 2005, which is expected to have a negative impact on U.S. CLARINEX sales in 2006. Generic Flonase (fluticasone propionate) was approved in 2006 and may unfavorably impact the corticosteroid nasal spray market. The growth of REMICADE may also be affected by increased competition. In addition, the Company expects the growth rate for the Animal Health business to moderate due to increased competition, including generic products.

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Costs, Expenses and Equity Income
      A summary of costs, expenses and equity income for the years ended December 31, 2005, 2004 and 2003 is as follows:
                                         
                % Increase (Decrease)
                 
    2005   2004   2003   2005/2004   2004/2003
                     
    (Dollars in millions)        
Cost of sales
  $ 3,346     $ 3,070     $ 2,833       9 %     8 %
Selling, general and administrative (SG&A)
    4,374       3,811       3,474       15 %     10 %
Research and development (R&D)
    1,865       1,607       1,469       16 %     9 %
Other expense/(income), net
    5       146       59       N/M       N/M  
Special charges
    294       153       599       N/M       N/M  
Equity income from cholesterol joint venture
    (873 )     (347 )     (54 )     N/M       N/M  
N/ M — Not a meaningful percentage
Substantially all the sales of cholesterol products are not included in the Company’s net sales. The results of these sales are reflected in equity income from cholesterol joint venture. In addition, due to the virtual nature of the joint venture, the Company incurs substantial selling, general and administrative expenses that are not captured in equity income but are included in the Company’s Statements of Consolidated Operations. As a result, the Company’s gross margin, and ratios of SG&A expenses and R&D expenses as a percentage of net sales do not reflect the impact of the joint venture’s operating results.
 
Gross margin
      Gross margin increased in 2005 as compared to 2004 from 62.9 percent to 64.8 percent, primarily due to supply chain process improvements, increased sales of higher-margin products and a favorable impact from foreign exchange, partly offset by higher royalties related to the Bayer products and beginning September 1, 2005, royalties for INTEGRILIN. The restructuring of the INTEGRILIN agreement has substantially offsetting effects, generally increasing cost of sales due to increased royalties offset by reduced selling, general and administrative expenses. Gross margin in 2006 will be unfavorably impacted by a full year of the increased royalties from this restructured agreement. Gross margin in 2004 decreased as compared to 2003 from 66.0 percent to 62.9 percent, primarily due to lower production volumes coupled with increased spending related to the FDA Consent Decree, other manufacturing compliance spending and efforts to upgrade the Company’s global infrastructure. The absence of European LOSEC revenues and a change in product sales mix, including sales of Bayer licensed products, contributed to the unfavorable comparison as well.
Selling, general and administrative
      Selling, general and administrative expenses (SG&A) increased 15 percent to $4.4 billion in 2005 versus $3.8 billion in 2004. This increase was primarily due to the addition in the 2004 fourth quarter of Bayer sales representatives, increased selling expenses in Europe to support the continued launch of VYTORIN and ZETIA, and increased promotional spending, primarily for NASONEX, ASMANEX and the products under the agreement with Bayer. SG&A expenses increased 10 percent to $3.8 billion in 2004 from $3.5 billion in 2003 primarily due to the expansion of the sales field force, higher employee-related costs and the unfavorable impact of foreign exchange, partially offset by lower promotional spending.
Research and development
      Research and development (R&D) spending increased 16 percent to $1.9 billion, representing 19.6 percent of net sales in 2005, and included a $124 million charge in conjunction with the Company’s exercise of its rights to develop and commercialize golimumab. R&D spending for 2004 included an $80 million charge in conjunction with the license from Toyama Chemical Company Ltd. for garenoxacin. Generally, changes in R&D spending reflect the timing of the Company’s funding of both internal research

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efforts and research collaborations with various partners to discover and develop a steady flow of innovative products.
      The Company believes it has a strong Early Development pipeline across a wide-range of therapeutic areas with 14 preclinical/ Phase I compounds in 2005. Additionally, as the later phase growth-drivers of the pipeline enter Phase III (e.g., Thrombin Receptor Antagonist, vicriviroc and HCV protease inhibitor), the Company anticipates an approximate doubling of annual patient enrollment in clinical trials over the next 2-4 years versus 2005 levels.
      The Company expects R&D spending to increase as compared to prior years due to the progression of the Company’s early-stage pipeline and increased clinical trial activity. To maximize the Company’s chances for the successful development of new products, the Company began a Development Excellence initiative in 2005 to build talent and critical mass, create a uniform level of excellence and deliver on high-priority programs within R&D.
Other expense/(income), net
      In 2005, Other expense/(income), net, of $5 million was lower than 2004 as it reflected higher net interest income due to higher interest rates on cash equivalents and short-term investments. The increase in Other expense/(income), net, in 2004 versus 2003 was primarily the result of higher net interest expense due to debt issuances in 2003.
Special charges
      The components of special charges are as follows:
                         
    2005   2004   2003
             
    (Dollars in millions)
Litigation charges
  $ 250     $     $ 350  
Employee termination costs
    28       119       179  
Asset impairment and other charges
    16       34       70  
                   
    $ 294     $ 153     $ 599  
                   
Litigation charges
      In 2005, litigation reserves were increased by $250 million. This increase resulted in a total reserve of $500 million for the Massachusetts investigation as well as the investigations disclosed under “AWP Investigations” and the state litigation disclosed under “AWP Litigation” in Note 19, “Legal, Environmental and Regulatory Matters,” representing the Company’s current estimate to resolve this matter. Additional information regarding litigation reserves is also included in Note 19, “Legal, Environmental and Regulatory Matters,” under Item 8, Financial Statements and Supplementary Data, in this 10-K.
      In 2003, litigation reserves were increased by $350 million, primarily as a result of the investigations into the Company’s sales and marketing practices.
Employee termination costs
      In August 2003, the Company announced a global workforce reduction initiative. The first phase of this initiative was a Voluntary Early Retirement Program (VERP) in the U.S. Under this program, eligible employees in the U.S. had until December 15, 2003 to elect early retirement and receive an enhanced retirement benefit. Approximately 900 employees elected to retire under the program, all of which have retired by December 31, 2005. The total cost of this program was approximately $191 million, comprised of increased pension costs of $108 million, increased post-retirement health care costs of $57 million, vacation payments of $4 million and costs related to accelerated vesting of stock grants of

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$22 million. Amounts recognized in 2005, 2004 and 2003 for this program were $7 million, $20 million and $164 million, respectively. No additional amounts are expected to be recognized under this program.
      Termination costs not associated with the VERP totaled $21 million, $99 million and $15 million in 2005, 2004 and 2003, respectively.
      The following summarizes the activity in the accounts related to employee termination costs:
         
    Employee
    Termination Costs
     
    (Dollars in millions)
Special charges incurred during 2003
  $ 179  
Credit to retirement benefit plan liability
    (144 )
Disbursements
    (6 )
       
Special charges liability balance at December 31, 2003
  $ 29  
       
Special charges incurred during 2004
  $ 119  
Credit to retirement benefit plan liability
    (20 )
Disbursements
    (110 )
       
Special charges liability balance at December 31, 2004
  $ 18  
       
Special charges incurred during 2005
  $ 28  
Credit to retirement benefit plan liability
    (7 )
Disbursements
    (35 )
       
Special charges liability balance at December 31, 2005
  $ 4  
       
Asset impairment and other charges
      For the year ended December 31, 2005, the Company recognized asset impairment and other charges of $16 million related primarily to the consolidation of the Company’s U.S. biotechnology organizations.
      The Company recorded asset impairment and other charges of $34 million in 2004, related primarily to the shutdown of a small European research and development facility.
      Asset impairment and other charges in 2003 were $70 million and related to the closure of a manufacturing facility in the United Kingdom, the write-down of production equipment related to products that were no longer going to be produced at a manufacturing site operating under the FDA Consent Decree, and the write-down of a drug license and a sun care trade name for which expected cash flows did not support the carrying value.
Equity Income from Cholesterol Joint Venture
      Global cholesterol franchise sales, which include sales made by the Company and the cholesterol joint venture with Merck of VYTORIN and ZETIA, totaled $2.4 billion, $1.2 billion and $471 million in 2005, 2004 and 2003, respectively. The 2005 sales comparison benefited from the U.S. launch of VYTORIN in the second half of 2004. As a franchise, the two products combined have passed the 14 percent share level of new prescriptions in the U.S. cholesterol management market (based on January 2006 IMS data). VYTORIN has been launched in more than 20 countries, including the U.S. in August 2004. ZETIA has been approved in more than 70 countries and has been launched in more than 60 countries.
      The Company utilizes the equity method of accounting for the joint venture. Sharing of income from operations is based upon percentages that vary by product, sales level and country. The Company’s allocation of joint venture income is increased by milestones earned. Merck and Schering-Plough (the Partners) bear the costs of their own general sales forces and commercial overhead in marketing joint venture products around the world. In the U.S., Canada and Puerto Rico, the joint venture reimburses each Partner for a pre-defined amount of physician details that are set on an annual basis. The Company

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reports this reimbursement as part of equity income from the cholesterol joint venture. This reimbursement does not represent a reimbursement of specific, incremental and identifiable costs for the Company’s detailing of the cholesterol products in these markets. In addition, this reimbursement amount is not reflective of Schering-Plough’s sales effort related to the joint venture as Schering-Plough’s sales force and related costs associated with the joint venture are generally estimated to be higher.
      Costs of the joint venture that the Partners contractually share are a portion of manufacturing costs, specifically identified promotion costs (including direct-to-consumer advertising and direct and identifiable out-of-pocket promotion) and other agreed upon costs for specific services such as market support, market research, market expansion, a specialty sales force and physician education programs.
      Certain specified research and development expenses are generally shared equally by the Partners.
      Equity income from cholesterol joint venture totaled $873 million, $347 million and $54 million in 2005, 2004 and 2003, respectively. The 2005 equity income comparison benefited from the U.S. launch of VYTORIN in the second half of 2004.
      During 2005, 2004 and 2003, the Company recognized milestones from Merck of $20 million, $7 million and $20 million, respectively. The $20 million milestone in 2005 related to certain European approvals of VYTORIN (ezetimibe/simvastatin) in 2005. The $7 million milestone in 2004 related to the approval of ezetimibe/simvastatin in Mexico in 2004. The $20 million milestone in 2003 related to certain European approvals of ZETIA in 2003. These amounts are included in equity income.
      Under certain other conditions, as specified in the joint venture agreements with Merck, the Company could earn additional milestones totaling $105 million.
      It should be noted that the Company incurs substantial selling, general and administrative and other costs, which are not reflected in equity income from the cholesterol joint venture and instead are included in the overall cost structure of the Company.
Provision for Income Taxes
      Tax expense was $228 million, $779 million, and $46 million in 2005, 2004, and 2003, respectively. The overall income tax expense in 2005, net of the benefit described below, primarily related to foreign taxes and does not include any benefit related to U.S. Net Operating Losses (NOLs). The Company has established a valuation allowance on net U.S. deferred tax assets, including the benefit of U.S. NOLs, as management cannot conclude that it is more likely than not that the benefit of U.S. net deferred tax assets can be realized. As of December 31, 2005, the Company had U.S. NOL carryforwards totaling approximately $1.5 billion.
      The Company’s tax provision for the year ended December 31, 2005 includes a U.S. federal income tax benefit of approximately $42 million as a result of an IRS Notice issued in August 2005. The provisions of this Notice resulted in a reduction of the previously accrued tax liability attributable to the AJCA repatriation, and also reduced the 2005 U.S. NOLs carried forward to subsequent years.
      The 2005 income tax provision includes a charge of approximately $260 million related to foreign taxes, $14 million for state taxes and a benefit of $46 million for U.S. federal taxes primarily related to the 2005 IRS Notice mentioned above.
      In January 2006, the Internal Revenue Service (IRS) completed its examination of the Company’s 1993 - 1996 federal income tax returns. The Company had made a cash payment in the third quarter of 2005 in the form of a tax deposit of approximately $239 million in anticipation of the settlement of the 1993 - 1996 tax examination and to prevent additional IRS interest charges. This payment fully satisfied the liability associated with the tax examination and was consistent with the previously recorded reserves. The IRS is currently examining the Company’s 1997 - 2002 federal income tax returns.

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Net Income/(Loss) Available to Common Shareholders
      Net income available to common shareholders for 2005 includes the deduction of preferred stock dividends of $86 million related to the issuance of the 6 percent Mandatory Convertible Preferred Stock in August 2004. The 2004 net loss available to common shareholders includes the deduction of preferred stock dividends of $34 million.
LIQUIDITY AND FINANCIAL RESOURCES
Discussion of Cash Flow
                         
    For the Years Ended
    December 31,
     
    2005   2004   2003
             
    (Dollars in millions)
Cash flow from operating activities
  $ 882     $ (154 )   $ 601  
Cash flow from investing activities
    (454 )     (621 )     (790 )
Cash flow from financing activities
    (633 )     1,534       882  
      In 2005, cash flow from operating activities on a worldwide basis approximated cash payments for capital expenditures and dividends. International operations generate cash in excess of local cash needs. However, U.S. operations have cash needs well in excess of cash generated in the U.S. The U.S. operations must fund dividend payments, the majority of research and development costs and U.S. capital expenditures. In years prior to 2003, overall U.S. cash needs were funded primarily through operations.
      Cash requirements during 2005 in the U.S. including operating cash needs, capital expenditures, tax payments and dividends on common and preferred shares approximated $1.1 billion.
      In 2005, consolidated operating activities generated $882 million of cash, compared with a use of $154 million in 2004. The increase was primarily due to higher net income and timing of payments of special charges related to litigation, partially offset by an increase in accounts receivable due to sales growth, payments to tax authorities for tax liabilities related to the repatriation of foreign earnings under the AJCA of approximately $375 million and tax deposits of $239 million for the anticipated settlement of certain tax contingencies for the tax years 1993 through 1996. Tax charges related to the AJCA were expensed in 2004.
      In 2004, operating cash flow was favorably impacted by a U.S. tax refund of $404 million as a result of loss carry back. However, cash flow was unfavorably impacted by a $473 million payment to the U.S. government for a tax deficiency related to certain transactions in tax years 1991 to 1992 and the payment of $294 million under the settlement agreement with the U.S. Attorney’s office for the Eastern District of Pennsylvania.
      In 2003, operating activities provided approximately $601 million of cash. This amount includes the cash flow benefit from the reduction in accounts receivable following the end of sales of CLARITIN as a prescription product in the U.S. This amount also includes a $250 million payment under the terms of the FDA Consent Decree.
      Net cash used for investing activities during 2005 was $454 million, primarily related to $478 million of capital expenditures and the purchase of intangible assets of $51 million, partially offset by proceeds from sales of property and equipment of $43 million and the net reduction in short-term investments of $33 million. Net cash used for investing activities in 2004 was $621 million and included capital expenditures of $489 million and net purchases of investments of $264 million, partially offset by cash proceeds of $118 million from the transfer of license rights and $7 million from the dispositions of property and equipment.
      Net cash used for financing activities during 2005 was $633 million, compared to net cash provided by financing activities of $1.5 billion in 2004. Uses of cash for financing activities in 2005 include the

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payment of dividends on common and preferred shares of $410 million and the repayment of $1.2 billion of commercial paper borrowings, partially offset by proceeds of $900 million from bank debt incurred by a foreign subsidiary related to funding of a portion of the repatriations under the AJCA during 2005. The net cash provided by financing activities in 2004 reflected proceeds of $1.4 billion from the preferred stock issuance and $546 million from the increase in short-term borrowings, partially offset by the payment of dividends on common and preferred shares of $354 million.
      As the Company’s financial situation has begun to improve, the Company is moving forward with additional investments to enhance its infrastructure and business. This includes expected capital expenditures of up to $300 million over the next several years for a pharmaceutical sciences center. This center will allow the Company to streamline and integrate the Company’s drug development process, where products are moved from the drug discovery pipeline to market. There will be additional related expenditures to upgrade equipment and staffing for this center.
      In 2006, the U.S. operations will continue to generate negative cash flow. Payments regarding litigation and investigations could increase cash needs. Operating cash flows, existing cash and investments, including repatriations made during 2005 under the AJCA, are expected to provide the Company with the ability to fund cash needs, including U.S. cash needs, for the near and intermediate term. Total cash, cash equivalents and short-term investments less total debt was approximately $1.9 billion at December 31, 2005.
      In August 2004 the Company issued 6 percent mandatory convertible preferred stock (see Note 14, “Shareholders Equity,” under Item 8, Financial Statements and Supplementary Data) and received net proceeds of $1.4 billion after deducting commissions, discounts and other underwriting expenses. The proceeds were used to reduce short-term commercial paper borrowings, pay tax and litigation settlement amounts and litigation costs, and to fund operating expenses, shareholder dividends and capital expenditures. The preferred stock was issued under the Company’s $2.0 billion shelf registration. As of December 31, 2005, $563 million remains registered and unissued under the shelf registration.
Borrowings and Credit Facilities
      On November 26, 2003, the Company issued $1.25 billion aggregate principal amount of 5.3 percent senior unsecured notes due 2013 and $1.15 billion aggregate principal amount of 6.5 percent senior unsecured notes due 2033. Proceeds from this offering of $2.4 billion were used for general corporate purposes, including repaying commercial paper outstanding in the U.S. Upon issuance, the notes were rated A3 by Moody’s Investors Service (Moody’s) and A+ (on Credit Watch with negative implications) by Standard & Poor’s (S&P). The interest rates payable on the notes are subject to adjustment. If the rating assigned to the notes by either Moody’s or S&P is downgraded below A3 or A-, respectively, the interest rate payable on that series of notes would increase. See Note 12, “Short-Term Borrowings, Long-Term Debt and Other Commitments,” under Item 8, Financial Statements and Supplementary Data, in this 10-K, for additional information.
      On July 14, 2004, Moody’s lowered its rating on the notes to Baa1. Accordingly, the interest payable on each note increased 25 basis points effective December 1, 2004. Therefore, on December 1, 2004, the interest rate payable on the notes due 2013 increased from 5.3 percent to 5.55 percent, and the interest rate payable on the notes due 2033 increased from 6.5 percent to 6.75 percent. This adjustment to the interest rate payable on the notes increased the Company’s interest expense by approximately $6 million annually.
      The Company has a revolving credit facility from a syndicate of major financial institutions. During March 2005, the Company negotiated an increase in the bank commitments from $1.25 billion to $1.5 billion with no changes in the basic terms of the pre-existing credit facility. Concurrently with the increase in commitments under this facility, the Company terminated early a separate $250 million line of credit which would have matured in May 2006. There was no outstanding balance under this facility at the time it was terminated.

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      The existing $1.5 billion credit facility matures in May 2009 and requires the Company to maintain a total debt to total capital ratio of no more than 60 percent. This credit line is available for general corporate purposes and is considered as support to the Company’s commercial paper borrowings. Borrowings under this credit facility may be drawn by the U.S. parent company or by its wholly-owned international subsidiaries when accompanied by a parent guarantee. This facility does not require compensating balances, however, a nominal commitment fee is paid. As of December 31, 2005, $325 million has been drawn under this facility by a wholly-owned international subsidiary for the purposes of funding AJCA related repatriations.
      In addition to the aforementioned credit facility, the Company entered into a $575 million credit facility during the fourth quarter of 2005, all of which was drawn as of December 31, 2005. This credit facility was utilized by a wholly-owned international subsidiary to fund repatriations under the AJCA. This credit facility requires the Company to maintain a total debt to total capital ratio of no more than 60 percent. These borrowings are payable no later than November 4, 2008. Any funds borrowed under this facility which are subsequently repaid may not be re-borrowed.
      All credit facility borrowings have been classified as short-term borrowings as the Company intends to repay these amounts in the next twelve months.
      As of December 31, 2005 and 2004, short-term borrowings, including the credit facilities mentioned above, totaled $1.3 billion and $1.6 billion, respectively. Commercial paper outstanding at December 31, 2005 and 2004 was $298 million and $1.46 billion, respectively. The weighted-average interest rate for short-term borrowings at December 31, 2005 and 2004 was 4.7 percent and 2.6 percent respectively.
Credit Ratings
      The Company’s current unsecured senior credit ratings and outlook are as follows:
                         
Senior Unsecured Credit Ratings   Long-term   Short-term   Outlook
             
Moody’s Investors Service
    Baa1       P-2       Negative  
Standard and Poor’s
    A-       A-2       Negative  
Fitch Ratings
    A-       F-2       Negative  
      The commercial paper ratings discussed above have not significantly affected the Company’s ability to issue or rollover its outstanding commercial paper borrowings at this time. However, the Company believes the ability of commercial paper issuers, such as the Company, with one or more short-term credit ratings of P-2 from Moody’s, A-2 from S&P and/or F2 from Fitch to issue or rollover outstanding commercial paper can, at times, be less than that of companies with higher short-term credit ratings. In addition, the total amount of commercial paper capacity available to these issuers is typically less than that of higher-rated companies. The Company maintains sizable lines of credit with commercial banks, as well as cash and short-term investments held by U.S. and international subsidiaries, to serve as alternative sources of liquidity and to support its commercial paper program.
      The Company’s credit ratings could decline below their current levels. The impact of such decline could reduce the availability of commercial paper borrowing and would increase the interest rate on the Company’s short and long-term debt. As discussed above, the Company believes that existing cash balances and cash generated from operations will allow the Company to fund its U.S. cash needs for the near and intermediate term.

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Contractual Obligations
      Payments due by period under the Company’s known contractual obligations at December 31, 2005, are as follows:
                                           
    Payments Due by Period
     
        Less       More
        than       than
    Total   1 Year   1-3 Years   3-5 Years   5 Years
                     
    (Dollars in millions)
Short-term borrowings and current portion of long-term debt
  $ 1,278     $ 1,278     $     $     $  
Long-term debt obligations(1)
    2,399             2       1       2,396  
Operating lease obligations
    249       76       108       33       32  
Purchase obligations:
                                       
 
Advertising contracts
    107       107                    
 
Research contracts(2)
    161       140       12       7       2  
 
Capital expenditure commitments
    179       175       4              
 
Other purchase obligations(3)
    829       778       25       9       17  
Other obligations(4)
    912       269       170       25       448  
                               
Total
  $ 6,114     $ 2,823     $ 321     $ 75     $ 2,895  
                               
 
(1)  Long-term debt obligations include the $1,250 million aggregate principal amount of 5.55 percent senior, unsecured notes due 2013 and $1,150 million aggregate principal amount of 6.75 percent senior, unsecured notes due 2033 and excludes interest obligations. See Note 12, “Short-Term Borrowings, Long-Term Debt and Other Commitments,” under Item 8, Financial Statements and Supplementary Data, in this 10-K, for additional information.
 
(2)  Research contracts do not include any potential milestone payments to be made since such payments are contingent on the occurrence of certain events. The table also excludes those research contracts that are cancelable by the Company without penalty.
 
(3)  Other purchase obligations consist of both cancelable and non-cancelable inventory and expense items.
 
(4)  This caption includes obligations, based on undiscounted amounts, for estimated payments under certain of the Company’s pension and deferred compensation plans, preferred stock dividends and other contractual obligations.
REGULATORY AND COMPETITIVE ENVIRONMENT IN WHICH THE COMPANY OPERATES
      The Company is subject to the jurisdiction of various national, state and local regulatory agencies. These regulations are described in more detail in Part I, Item I, Business, of this 10-K.
      Regulatory compliance is complex, as regulatory standards (including Good Clinical Practices, Good Laboratory Practices and Good Manufacturing Practices) vary by jurisdiction and are constantly evolving.
      Regulatory compliance is costly. Regulatory compliance also impacts the timing needed to bring new drugs to market and to market drugs for new indications. Further, failure to comply with regulations can result in delays in the approval of drugs, seizure or recall of drugs, suspension or revocation of the authority necessary for the production and sale of drugs, fines and other civil or criminal sanctions.
      Regulatory compliance, and the cost of compliance failures, can have a material impact on the Company’s results of operations, its cash flows or financial condition.
      Since 2002, the Company has been working under a U.S. FDA Consent Decree to resolve issues involving the Company’s compliance with current Good Manufacturing Practices (cGMP) at certain of its

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manufacturing sites in New Jersey and Puerto Rico. See details in Note 18, “Consent Decree” under Item 8, Financial Statements and Supplementary Data, in this 10-K.
      Under the terms of the Consent Decree, the Company made payments totaling $500 million. As of the end of 2005, the Company has completed the revalidation programs for bulk active pharmaceutical ingredients and finished drug products, as well as all 212 Significant Steps of the cGMP Work Plan, in accordance with the schedules required by the Consent Decree. The Company’s completion of the cGMP Work Plan is currently pending certification by a third party expert, whose certification is in turn subject to acceptance by the FDA. Under the terms of the Decree, provided that the FDA has not notified the Company of a significant violation of FDA law, regulations, or the Decree in the five year period since the Decree’s entry, May 2002 through May 2007, the Company may petition the court to have the Decree dissolved and FDA will not oppose the Company’s petition.
      The Company is subject to pharmacovigilance reporting requirements in many countries and other jurisdictions, including the U.S., the European Union (EU) and the EU member states. The requirements differ from jurisdiction to jurisdiction, but all include requirements for reporting adverse events that occur while a patient is using a particular drug, in order to alert the manufacturer of the drug and the governmental agency to potential problems.
      During 2003, pharmacovigilance inspections by officials of the British and French medicines agencies conducted at the request of the European Agency for the Evaluation of Medicinal Products (EMEA) cited serious deficiencies in reporting processes. The Company has continued to work on its long-term action plan to rectify the deficiencies and has provided regular updates to the EMEA.
      During the fourth quarter 2005, local UK and EMEA regulatory authorities conducted a follow up inspection to assess the Company’s implementation of its action plan. The inspectors acknowledged that progress had been made since 2003, but also continued to note significant concerns with the quality systems supporting the Company’s pharmacovigilance processes. Similarly, in a follow up inspection of the Company’s clinical trial practices in the UK, inspectors identified issues with respect to the Company’s management of clinical trials and related pharmacovigilance practices.
      The Company intends to continue upgrading skills, processes and systems in clinical practices and pharmacovigilance. The Company remains committed to accomplish this work and to invest significant resources in this area. Further, in February 2006, the Company announced a 2006 initiative for building clinical excellence (in trial design, execution and tracking), which will strengthen the Company’s scientific and compliance rigor on a global basis.
      The Company does not know what action, if any, the EMEA or national authorities will take in response to the inspections. Possible actions include further inspections, demands for improvements in reporting systems, criminal sanctions against the Company and/or responsible individuals and changes in the conditions of marketing authorizations for the Company’s products.
      Recently, clinical trials and post-marketing surveillance of certain marketed drugs of competitors’ within the industry have raised safety concerns that have led to recalls, withdrawals or adverse labeling of marketed products. In addition, these situations have raised concerns among some prescribers and patients relating to the safety and efficacy of pharmaceutical products in general. Company personnel have regular, open dialogue with the FDA and other regulators and review product labels and other materials on a regular basis and as new information becomes known.
      Following this wake of recent product withdrawals of other companies and other significant safety issues, health authorities such as the FDA, the EMEA and the PMDA have increased their focus on safety, when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications and are re-reviewing select products which are already marketed, adding further to the uncertainties in the regulatory processes. There is also greater regulatory scrutiny, especially in the United States, on advertising and promotion and in particular direct-to-consumer advertising.

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      Similarly, major health authorities, including the FDA, EMEA and PMDA, have also increased collaboration amongst themselves, especially with regard to the evaluation of safety and benefit/risk information. Media attention has also increased. In the current environment, a health authority regulatory action in one market, such as a safety labeling change, may have regulatory, prescribing and marketing implications in other markets to an extent not previously seen.
      Some health authorities, such as the PMDA in Japan, have publicly acknowledged a significant backlog in workload due to resource constraints within their agency. This backlog has caused long regulatory review times for new indications and products, including the initial approval of ZETIA in Japan, and has added to the uncertainty in predicting approval timelines in these markets. While the PMDA has committed to correcting the backlog, it is expected to continue for the foreseeable future.
      In 2005, the FDA issued a Final Rule removing the essential use designation for albuterol CFC products. The removal of this designation requires that all CFC albuterol products, including the Company’s PROVENTIL CFC, be removed from the market no later than December 31, 2008. This will necessitate a transition in the marketplace from albuterol CFC (PROVENTIL) to albuterol HFA (PROVENTIL HFA) no later than the end of 2008. It is difficult to predict what impact this transition will have on the albuterol marketplace and the Company’s products.
      These and other uncertainties inherent in government regulatory approval processes, including, among other things, delays in approval of new products, formulations or indications, may also affect the Company’s operations. The effect of regulatory approval processes on operations cannot be predicted.
      The Company has nevertheless achieved a significant number of important regulatory approvals since 2004, including approvals for VYTORIN, CLARINEX D-24, CLARINEX REDITABS, CLARINEX D-12 and new indications for TEMODAR and NASONEX. Other significant approvals since 2004 include ASMANEX DPI (Dry Powder for Inhalation) in the United States, NOXAFIL in the EU, PEG-INTRON in Japan and new indications for REMICADE. The Company also has a number of significant regulatory submissions filed in major markets awaiting approval.
      As described more specifically in Note 19, “Legal, Environmental and Regulatory Matters” under Item 8, Financial Statements and Supplementary Data, in this 10-K, the pricing, sales and marketing programs and arrangements, and related business practices of the Company and other participants in the health care industry are under increasing scrutiny from federal and state regulatory, investigative, prosecutorial and administrative entities. These entities include the Department of Justice and its U.S. Attorney’s Offices, the Office of Inspector General of the Department of Health and Human Services, the FDA, the Federal Trade Commission (FTC) and various state Attorneys General offices. Many of the health care laws under which certain of these governmental entities operate, including the federal and state anti-kickback statutes and statutory and common law false claims laws, have been construed broadly by the courts and permit the government entities to exercise significant discretion. In the event that any of those governmental entities believes that wrongdoing has occurred, one or more of them could institute civil or criminal proceedings, which, if instituted and resolved unfavorably, could subject the Company to substantial fines, penalties and injunctive or administrative remedies, including exclusion from government reimbursement programs. The Company also cannot predict whether any investigations will affect its marketing practices or sales. Any such result could have a material adverse impact on the Company’s results of operations, cash flows, financial condition, or its business.
      In the U.S., many of the Company’s pharmaceutical products are subject to increasingly competitive pricing as managed care groups, institutions, government agencies and other groups seek price discounts. In the U.S. market, the Company and other pharmaceutical manufacturers are required to provide statutorily defined rebates to various government agencies in order to participate in Medicaid, the veterans’ health care program and other government-funded programs.
      In most international markets, 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 enacted across-the-board price

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cuts as methods to control costs. For example, Japan generally enacts biennial price reductions and this is expected to occur again in 2006. Pricing actions will occur in 2006 in certain major European markets.
      Since the Company is unable to predict the final form and timing of any future domestic or international governmental or other health care initiatives, including the passage of laws permitting the importation of pharmaceuticals into the U.S., their effect on operations and cash flows cannot be reasonably estimated. Similarly, the effect on operations and cash flows of decisions of government entities, managed care groups and other groups concerning formularies and pharmaceutical reimbursement policies cannot be reasonably estimated.
      The Company cannot predict what net effect the Medicare prescription drug benefit will have on markets and sales. The new Medicare Drug Benefit (Medicare Part D), which took effect January 1, 2006, offers voluntary prescription drug coverage, subsidized by Medicare, to over 40 million Medicare beneficiaries through competing private prescription drug plans (PDPs) and Medicare Advantage (MA) plans. Many of the Company’s leading drugs are already covered under Medicare Part B (e.g., TEMODAR, INTEGRILIN and INTRON A). Medicare Part B provides payment for physician services which can include prescription drugs administered along with other physician services. The manner in which drugs are reimbursed under Medicare Part B may limit the Company’s ability to offer larger price concessions or make large price increases on these drugs. Other Schering-Plough drugs have a relatively small portion of their sales to the Medicare population (e.g., CLARINEX, the hepatitis C franchise). The Company could experience expanded utilization of VYTORIN and ZETIA and new drugs in the Company’s R&D pipeline. Of greater consequence for the Company may be the legislation’s impact on pricing, rebates and discounts.
      The market for pharmaceutical products is competitive. The Company’s operations may be affected by technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, new information from clinical trials of marketed products or post-marketing surveillance and generic competition as the Company’s products mature. In addition, patent positions are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products. The effect on operations of competitive factors and patent disputes cannot be predicted.
2006 OUTLOOK
      As it relates to financial performance, the Company anticipates that sales and profits of its pivotal cholesterol franchise will continue to grow in 2006.
      The Company’s gross margin improved in 2005 as a result of, among other things, operating efficiencies in its plants and reduced spending related to the Consent Decree. The improvement in gross margin is expected to moderate in 2006 and improvements may be offset by royalty payments to partners.
      The Company anticipates that R&D expenses may grow at a faster rate than net sales in 2006, but will depend on the timing of studies and the success of Phase II trials now underway for the Thrombin Receptor Antagonist, the Hepatitis Protease Inhibitor and the HIV drug vicriviroc.
      As the Company moves forward in the Action Agenda, additional investments are anticipated to enhance the infrastructure in areas such as clinical development, pharmacovigilance and information technology.
      The risks described in Item 1A. “Risk Factors” could cause actual results to differ from the expectations provided in this section.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
      In November 2004, the FASB issued Statement of Financial Accounting Standard (SFAS) 151, “Inventory Costs.” This SFAS requires that abnormal spoilage be expensed in the period incurred (as

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opposed to inventoried and amortized to income over inventory usage) and that fixed production facility overhead costs be allocated over the normal production level of a facility. The Company implemented SFAS 151 in the fourth quarter of 2005. The implementation of this SFAS did not have a material impact on the Company’s financial statements.
      In March 2005, the FASB issued Interpretation No. 47 (FIN 47) for SFAS 143, “Accounting for Conditional Asset Retirement Obligations,” to clarify the term “conditional asset retirement obligations,” as used in SFAS 143. This term refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, a company is required to recognize liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. This interpretation is effective no later than the end of fiscal year ending after December 15, 2005. Retroactive application is not required. The Company implemented FIN 47 in the fourth quarter of 2005. The implementation of FIN 47 did not have a material impact on the Company’s financial statements.
      In December 2004, the FASB issued SFAS 123 (Revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R is effective for the Company on January 1, 2006. SFAS 123R requires companies to recognize compensation costs related to all share-based transactions as well as compensation based on the market performance of Company shares on a fair value basis. The Company will adopt SFAS 123R in the first quarter of 2006 using the modified prospective method. The modified prospective method requires the Company to recognize compensation costs on all share-based grants made on or after January 1, 2006 as well as the unrecognized cost of unvested awards at the date of adoption. Upon adoption of SFAS 123R, the Company will recognize share-based compensation costs over the service period, which is the earlier of the employees’ retirement eligibility date or the stated vesting period of the award. For grants issued to retirement eligible employees prior to the adoption of SFAS 123R, the Company will recognize compensation costs over the stated vesting period with acceleration of any unrecognized compensation costs upon the retirement of the employee. SFAS 123R also amends SFAS No. 95, “Statement of Cash Flows,” to require that excess tax benefits that had been reflected as operating cash flows be reflected as financing cash flows.
      Note 1, “Summary of Significant Accounting Policies”, under Item 8, Financial Statements and Supplementary Data, in this 10-K presents pro forma disclosures reflecting the effect on net income/(loss) as if stock based compensation had been applied under the SFAS 123, “Accounting for Stock-Based Compensation,” fair value method. As a result of the adoption of SFAS 123R, the Company’s 2006 compensation expense for stock options and deferred stock units is expected to be consistent with 2005 pro forma amounts but could be lower based on the timing and number of individual grants, the Company’s stock price and other assumptions necessary to estimate fair value.
      In addition, the Company has two compensation plans that will be accounted for under SFAS 123R as liability-based plans. The ultimate cash payout of these liability-based plans will be based on the Company’s stock price performance as compared to the stock price performance of its peer group. This change in accounting required by SFAS 123R will result in a cumulative effect of $26 million in income at January 1, 2006, in order to recognize the difference between the Company’s previously accrued liability as reported under Accounting Principles Board (APB) Opinion Number 25 and the fair value of the liability for these plans. Future operating results will be impacted by the fluctuation in the fair value of the liability under these plans, which is required to be remeasured at each reporting date.
CRITICAL ACCOUNTING POLICIES
      The following accounting policies are considered significant because changes to certain judgments and assumptions inherent in these policies could affect the Company’s financial statements:
  •  Revenue Recognition
 
  •  Rebates, Discounts and Returns
 
  •  Provision for Income Taxes

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  •  Impairment of Intangible Assets and Property
 
  •  Accounting for Pensions and Post-retirement Benefit Plans
 
  •  Accounting for Legal and Regulatory Matters
Revenue Recognition
      The Company’s pharmaceutical products are sold to direct purchasers (e.g., wholesalers, retailers and certain health maintenance organizations). Price discounts and rebates on such sales are paid to federal and state agencies as well as to indirect purchasers and other market participants (e.g., managed care organizations that indemnify beneficiaries of health plans for their pharmaceutical costs and pharmacy benefit managers).
      The Company recognizes revenue when title and risk of loss pass to the purchaser and when reliable estimates of the following can be determined:
        i. commercial discount and rebate arrangements;
 
        ii. rebate obligations under certain federal and state governmental programs and;
 
        iii. sales returns in the normal course of business.
      When recognizing revenue, the Company estimates and records the applicable commercial and governmental discounts and rebates as well as sales returns that have been or are expected to be granted or made for products sold during the period. These amounts are deducted from sales for that period. Estimates recorded in prior periods are re-evaluated as part of this process. If reliable estimates of these items cannot be made, the Company defers the recognition of revenue.
      Revenue recognition for new products is based on specific facts and circumstances including estimated acceptance rates from established products with similar marketing characteristics. Absent the ability to make reliable estimates of rebates, discounts and returns, the Company would defer revenue recognition.
      Product discounts granted are based on the terms of arrangements with wholesalers, managed-care organizations and government purchasers as well as market conditions, including prices charged by competitors. Rebates are estimated based on sales terms, historical experience, trend analysis and projected market conditions in the various markets served. The Company evaluates market conditions for products or groups of products primarily through the analysis of third party demand and market research data as well as internally generated information. Data and information provided by purchasers and obtained from third parties are subject to inherent limitations as to their accuracy and validity.
      Sales returns are generally estimated and recorded based on historical sales and returns information, analysis of recent wholesale purchase information, consideration of stocking levels at wholesalers and forecasted demand amounts. Products that exhibit unusual sales or return patterns due to dating, competition or other marketing matters are specifically investigated and analyzed as part of the formulation of return reserves.
      During 2004, the Company entered into agreements with the major U.S. pharmaceutical wholesalers. These agreements deal with a number of commercial issues, such as product returns, timing of payment, processing of chargebacks and the quantity of inventory held by these wholesalers. With respect to the quantity of inventory held by these wholesalers, these agreements provide a financial disincentive for these wholesalers to acquire quantities of product in excess of what is necessary to meet current patient demand. Through the use of this monitoring and the above noted agreements, the Company expects to avoid situations where the Company’s shipments of product are not reflective of current demand.
Rebates, Discounts and Returns
      Rebate accruals for federal and state governmental programs were $144 million at December 31, 2005 and $155 million at December 31, 2004. Commercial discounts and other rebate accruals were

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$378 million at December 31, 2005, and $382 million at December 31, 2004. These and other rebate accruals are established in the period the related revenue was recognized resulting in a reduction to sales and the establishment of liabilities, which are included in total current liabilities.
      In the case of the governmental rebate programs, the Company’s payments involve interpretations of relevant statutes and regulations. These interpretations are subject to challenges and changes in interpretive guidance by governmental authorities. The result of such a challenge or change could affect whether the estimated governmental rebate amounts are ultimately sufficient to satisfy the Company’s obligations. Additional information on governmental inquiries focused in part on the calculation of rebates is contained in Note 19, “Legal, Environmental and Regulatory Matters,” under Item 8, Financial Statements and Supplementary Data, in this 10-K. In addition, it is possible that, as a result of governmental challenges or changes in interpretive guidance, actual rebates could materially exceed amounts accrued.
      The following summarizes the activity in the accounts related to accrued rebates, sales returns and discounts:
                 
    Year Ended   Year Ended
    December 31,   December 31,
    2005   2004
         
    (Dollars in millions)
Accrued Rebates/ Returns/ Discounts, Beginning of Period
  $ 537     $ 594  
Provision for Rebates
    479       486  
Payments
    (495 )     (524 )
             
      (16 )     (38 )
             
Provision for Returns
    116       277  
Returns
    (167 )     (321 )
             
      (51 )     (44 )
             
Provision for Discounts
    459       294  
Discounts granted
    (407 )     (269 )
             
      52       25  
             
Accrued Rebates/ Returns/ Discounts, End of Period
  $ 522     $ 537  
             
      Management makes estimates and uses assumptions in recording the above accruals. Actual amounts paid in the current period were consistent with those previously estimated. Certain prior year amounts have been conformed to reflect the current year presentation.
Provision for Income Taxes
      As of December 31, 2005, taxes have not been provided on approximately $3.1 billion of undistributed earnings of international subsidiaries as the Company considers these earnings permanently reinvested in its international subsidiaries.
      The Company’s potential tax exposures result from the varying application of statutes, regulations and interpretations and include exposures on intercompany terms of cross border arrangements and utilization of cash held by foreign subsidiaries (investment in U.S. property). Although the Company’s cross border arrangements between affiliates are based upon internationally accepted standards, tax authorities in various jurisdictions may disagree with and subsequently challenge the amount of profits taxed in their country. It is reasonably possible that the ultimate resolution of any tax matters could materially affect shareholders’ equity, liquidity and/or cash flows.
      The Company believes that its accrual for tax contingencies is adequate for all open years, based on past experience, interpretations of tax law, and judgments about potential actions by taxing authorities. The Company accrues liabilities for identified tax contingencies that result from tax positions taken that could be challenged by tax authorities. While the Company believes that its tax reserves reflect the probable

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outcome of identified tax contingencies, it is reasonably possible that the ultimate resolution of any tax matters may be materially greater or less than the amount accrued.
      The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. The Company has considered ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. In the event the Company were to determine that it would be able to realize all or an additional portion of its net deferred tax assets, an adjustment to the valuation allowance would increase income in the period such determination is made. Likewise, should the Company subsequently determine that it would not be able to realize all or an additional portion of its remaining net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.
Impairment of Intangible Assets and Property
      Intangible assets representing the capitalized costs of purchased goodwill, patents, licenses and other forms of intellectual property totaled $569 million at December 31, 2005. Annual amortization expense in each of the next five years is estimated to be approximately $50 million per year based on the intangible assets recorded as of December 31, 2005. The value of these assets is subject to continuing scientific, medical and marketplace uncertainty. For example, if a marketed pharmaceutical product were to be withdrawn from the market for safety reasons or if marketing of a product could only occur with pronounced warnings, amounts capitalized for such a product may need to be reduced due to impairment. Events giving rise to impairment are an inherent risk in the pharmaceutical industry and cannot be predicted. Management regularly reviews intangible assets for possible impairment.
      Many of the Company’s manufacturing sites operate below capacity. Overall costs of operating manufacturing sites have significantly increased due to the Consent Decree and other compliance activities. The Company’s manufacturing cost base is relatively fixed. Actions on the part of management to significantly reduce the Company’s manufacturing infrastructure involve complex issues. In most cases, shifting products between manufacturing plants can take many years due to construction, revalidation and registration requirements. Management continues to review the carrying value of certain manufacturing assets for indications of impairment. Future events and decisions may lead to asset impairments and/or related costs.
Accounting for Pension and Post-retirement Benefit Plans
      Pension and other post-retirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions. The Company assesses its pension and other post-retirement benefit plan assumptions on a regular basis. In evaluating these assumptions, the Company considers many factors including evaluation of the discount rate, expected rate of return on plan assets, healthcare cost trend rate, retirement age assumption, the Company’s historical assumptions compared with actual results and analysis of current market conditions and asset allocations (see Note 6, “Retirement Plans and Other Post-retirement Benefits,” under Item 8, Financial Statements and Supplementary Data, in this 10-K, for additional information).
      Discount rates used for pension and other post-retirement benefit plan calculations are evaluated annually and modified to reflect the prevailing market rate at the measurement date of a high-quality fixed income debt instrument portfolio that would provide the future cash flows needed to pay the benefits included in the benefit obligations as they come due. In countries where debt instruments are thinly traded, estimates are based on available market rates.
      Actuarial assumptions are based upon management’s best estimates and judgment. An increase of 50 basis points in the discount rate assumption, with other assumptions held constant, would have an estimated $21 million favorable impact on net pension and post-retirement benefit cost. An increase of 50 basis points in the expected rate of return assumption, with other assumptions held constant, would have an estimated $8 million favorable impact on net pension and post-retirement benefit cost.

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      The expected rates of return for the pension and other post-retirement benefit plans represent the average rates of return to be earned on plan assets over the period during which the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company determines expected returns for each of the major asset classes, principally equities, fixed income and real estate. The return expectations for these asset classes are based on assumptions for economic growth and inflation, which are supported by long term historical data as well as the Company’s actual experience of return on plan assets. The expected portfolio performance also reflects the contribution of active management as appropriate.
      Unrecognized net loss amounts reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Expected returns are based primarily on a calculated market-related value of assets. Under this methodology, asset gains/losses resulting from actual returns that differ from the Company’s expected returns for the majority of the assets are realized in the market-related value of assets ratably over a five-year period. Total unrecognized net loss amounts in excess of certain thresholds are amortized into net pension and other post-retirement benefit cost over the average remaining service life of employees.
      The targeted investment portfolio of the Company’s U.S. pension plan is allocated 65 percent to equities, 28 percent to fixed income investments and 7 percent to real estate. The targeted investment portfolio of the Company’s U.S. other post-retirement benefit plans is allocated 70 percent to equities and 30 percent to fixed income investments. The portfolios’ equity weightings are consistent with the long-term nature of the plans’ benefit obligations. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local governmental rules and regulations.
      Substantially all investments in equities and fixed income are valued based on quoted public market values. All investments in real estate are valued based on periodic appraisals.
Accounting for Legal and Regulatory Matters
      Management judgments and estimates are required in the accounting for legal and regulatory matters on an ongoing basis including insurance coverages. The Company reviews the status of all claims, investigations and legal proceedings on an ongoing basis. From time to time, the Company may settle or otherwise resolve these matters on terms and conditions management believes are in the best interests of the Company. Resolution of any or all claims, investigations and legal proceedings, individually or in the aggregate, could have a material adverse effect on the Company’s results of operations, cash flows or financial condition.
MARKET RISK DISCLOSURE
      The Company is exposed to market risk primarily from changes in foreign currency exchange rates and, to a lesser extent, from interest rates and equity prices. The following describes the nature of these risks.
Foreign Currency Exchange Risk
      The Company has subsidiaries in more than 50 countries. In 2005, sales outside the U.S. accounted for approximately 62 percent of global sales. Virtually all these sales were denominated in currencies of the local country. As such, the Company’s reported profits and cash flows are exposed to changing exchange rates.
      To date, management has not deemed it cost effective to engage in a formula-based program of hedging the profits and cash flows of international operations using derivative financial instruments. Because the Company’s international subsidiaries purchase significant quantities of inventory payable in U.S. dollars, managing the level of inventory and related payables and the rate of inventory turnover provides a level of protection against adverse changes in exchange rates. The risk of adverse exchange rate change is also mitigated by the fact that the Company’s international operations are widespread.

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      In addition, at any point in time, the Company’s international subsidiaries hold financial assets and liabilities that are denominated in currencies other than U.S. dollars. These financial assets and liabilities consist primarily of short-term, third party and intercompany, receivables and payables. Changes in exchange rates affect the translated value of these financial assets and liabilities. Gains or losses that arise from translation do not affect net income.
      On occasion, the Company has used derivatives to hedge specific short-term risk situations involving foreign currency exposures. However, these derivative transactions have not been material.
Interest Rate and Equity Price Risk
      Financial assets exposed to changes in interest rates and/or equity prices are primarily cash equivalents, short-term investments and the debt and equity securities held in non-qualified trusts for employee benefits. These assets totaled $5.7 billion at December 31, 2005. For cash equivalents and short-term investments, a 10 percent decrease in interest rates would decrease interest income by approximately $15 million. For securities held in non-qualified trusts, due to the long-term nature of the liabilities that these trust assets will fund, the Company’s exposure to market risk is deemed to be low.
      Financial obligations exposed to variability in interest rates are primarily short-term borrowings. The Company maintains an investment portfolio in excess of the amount of borrowings. Accordingly, the Company has mitigated its exposure for changes in interest rates relating to its financial obligations.
      The Company has long-term debt outstanding, on which a 10 percent decrease in interest rates would increase the fair value of the debt by approximately $120 million. However, the Company does not expect to refund this debt.
Disclosure Notice
Cautionary Statements Under the Private Securities Litigation Reform Act of 1995
      Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this report and other written reports and oral statements made from time to time by the Company may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements do not relate strictly to historical or current facts and are based on current expectations or forecasts of future events. You can identify these forward-looking statements by their use of words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “project,” “intend,” “plan,” “potential,” “will,” and other similar words and terms. In particular, forward-looking statements include statements relating to future actions, ability to access the capital markets, prospective products or product approvals, timing and conditions of regulatory approvals, patent and other intellectual property protection, future performance or results of current and anticipated products, sales efforts, research and development programs, estimates of rebates, discounts and returns, expenses and programs to reduce expenses, the cost of and savings from reductions in work force, the outcome of contingencies such as litigation and investigations, growth strategy and financial results.
      Any or all forward-looking statements here or in other publications may turn out to be wrong. There are no guarantees about the Company’s financial and operational performance or the performance of the Company’s stock. The Company does not assume the obligation to update any forward-looking statement. Many factors could cause actual results to differ from the Company’s forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. Although it is not possible to predict or identify all such factors, we refer you to Item 1A. Risk Factors of this report, which we incorporate herein by reference, for identification of important factors with respect to these risks and uncertainties.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
      See the Market Risk Disclosures as set forth in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in this 10-K.

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Item 8. Financial Statements and Supplementary Data
Index to Financial Statements
         
    50  
    51  
    52  
    53  
    54  
    87  

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SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED OPERATIONS
                         
    For the Years Ended
    December 31,
     
    2005   2004   2003
             
    (Amounts in millions, except
    per share figures)
Net sales
  $ 9,508     $ 8,272     $ 8,334  
                   
Cost of sales
    3,346       3,070       2,833  
Selling, general and administrative
    4,374       3,811       3,474  
Research and development
    1,865       1,607       1,469  
Other expense/(income), net
    5       146       59  
Special charges
    294       153       599  
Equity income from cholesterol joint venture
    (873 )     (347 )     (54 )
                   
Income/(loss) before income taxes
    497       (168 )     (46 )
Income tax expense
    228       779       46  
                   
Net income/(loss)
  $ 269     $ (947 )   $ (92 )
                   
Preferred stock dividends
    86       34        
                   
Net income/(loss) available to common shareholders
  $ 183     $ (981 )   $ (92 )
                   
Diluted earnings/(loss) per common share
  $ 0.12     $ (0.67 )   $ (0.06 )
                   
Basic earnings/(loss) per common share
  $ 0.12     $ (0.67 )   $ (0.06 )
                   
Dividends per common share
  $ 0.22     $ 0.22     $ 0.565  
                   
The accompanying notes are an integral part of these Consolidated Financial Statements.

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SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
                           
    For the Years Ended
    December 31,
     
    2005   2004   2003
             
    (Amounts in millions)
Operating Activities:
                       
Net income/(loss)
  $ 269     $ (947 )   $ (92 )
Adjustments to reconcile net income/(loss) to net cash provided by/(used for) operating activities:
                       
 
Payments to U.S. taxing authorities
    (239 )     (473 )      
 
Tax refunds from U.S. loss carryback
    57       404        
 
Special charges
    265       (265 )     593  
 
Depreciation and amortization
    486       453       417  
Changes in assets and liabilities:
                       
 
Accounts receivable
    (209 )     (7 )     603  
 
Inventories
    (92 )     92       (152 )
 
Prepaid expenses and other assets
    168       174       (259 )
 
Accounts payable and other liabilities
    241       174       (668 )
 
Income taxes payable
    (64 )     241       159  
                   
Net cash provided by (used for) operating activities
    882       (154 )     601  
                   
Investing Activities:
                       
Capital expenditures
    (478 )     (489 )     (711 )
Dispositions of property and equipment
    43       7       10  
Proceeds from transfer of license
          118        
Purchases of investments
    (2,608 )     (2,852 )     (2,169 )
Reduction of investments
    2,641       2,588       2,063  
Other, net
    (52 )     7       17  
                   
Net cash used for investing activities
    (454 )     (621 )     (790 )
                   
Financing Activities:
                       
Cash dividends paid to common shareholders
    (324 )     (324 )     (830 )
Cash dividends paid to preferred shareholders
    (86 )     (30 )      
Proceeds from preferred stock issuance, net
          1,394        
Short-term borrowings
    900       546        
Payments of short-term borrowings
    (1,183 )           (399 )
Issuance of long-term debt
                2,369  
Reductions of long-term debt
          (18 )      
Other, net
    60       (34 )     (258 )
                   
Net cash (used for) provided by financing activities
    (633 )     1,534       882  
                   
Effect of exchange rates on cash and cash equivalents
    (12 )     7       4  
                   
Net (decrease) increase in cash and cash equivalents
    (217 )     766       697  
Cash and cash equivalents, beginning of year
    4,984       4,218       3,521  
                   
Cash and cash equivalents, end of year
  $ 4,767     $ 4,984     $ 4,218  
                   
Supplemental Disclosure:
                       
Cash paid for interest, net of amounts capitalized
  $ 159     $ 166     $ 46  
Cash paid (refunded) for income taxes (see Note 5)
    592       (144 )     196  
The accompanying notes are an integral part of these Consolidated Financial Statements.

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SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
                 
    At December 31,
     
    2005   2004
         
    (Amounts in millions,
    except per
    share figures)
ASSETS
Current Assets:
               
Cash and cash equivalents
  $ 4,767     $ 4,984  
Short-term investments
    818       851  
Accounts receivable, less allowances: 2005, $211; 2004, $173
    1,479       1,407  
Inventories
    1,605       1,580  
Deferred income taxes
    294       309  
Prepaid expenses and other current assets
    769       872  
             
Total current assets
    9,732       10,003  
Property, at cost:
               
Land
    67       79  
Buildings and improvements
    3,238       3,198  
Equipment
    3,131       2,999  
Construction in progress
    761       809  
             
Total
    7,197       7,085  
Less accumulated depreciation
    2,710       2,492  
             
Property, net
    4,487       4,593  
Goodwill
    204       209  
Other intangible assets, net
    365       371  
Other assets
    681       735  
             
Total assets
  $ 15,469     $ 15,911  
             
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
               
Accounts payable
  $ 1,078     $ 978  
Short-term borrowings and current portion of long-term debt
    1,278       1,569  
U.S., foreign and state income taxes
    213       896  
Accrued compensation
    632       443  
Other accrued liabilities
    1,458       1,280  
             
Total current liabilities
    4,659       5,166  
Long-term Liabilities:
               
Long-term debt
    2,399       2,392  
Deferred income taxes
    117       111  
Other long-term liabilities
    907       686  
             
Total long-term liabilities
    3,423       3,189  
Commitments and contingent liabilities (Note 19)
               
Shareholders’ Equity:
               
Mandatory convertible preferred shares — $1 par value; issued: 29; $50 per share face value
    1,438       1,438  
Common shares — authorized shares: 2,400, $.50 par value; issued: 2,030
    1,015       1,015  
Paid-in capital
    1,416       1,234  
Retained earnings
    9,472       9,613  
Accumulated other comprehensive income
    (516 )     (300 )
             
Total
    12,825       13,000  
Less treasury shares: 2005, 550; 2004, 555; at cost
    5,438       5,444  
             
Total shareholders’ equity
    7,387       7,556  
             
Total liabilities and shareholders’ equity
  $ 15,469     $ 15,911  
             
The accompanying notes are an integral part of these Consolidated Financial Statements.

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SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED SHAREHOLDERS’ EQUITY
                                                         
                        Accumulated    
    Mandatory                   Other   Total
    Convertible                   Compre-   Share-
    Preferred   Common   Paid-in   Retained   Treasury   hensive   holders’
    Shares   Shares   Capital   Earnings   Shares   Income   Equity
                             
    (Amounts in millions)
Balance January 1, 2003
        $ 1,015     $ 1,203     $ 11,840     $ (5,439 )   $ (477 )   $ 8,142  
                                           
Comprehensive income:
                                                       
Net loss
                            (92 )                     (92 )
Foreign currency translation
                                            218       218  
Minimum pension liability, net of tax
                                            (178 )     (178 )
Unrealized gain on investments available for sale, net of tax
                                            13       13  
Other
                                            (2 )     (2 )
                                           
Total comprehensive (loss)
                                                    (41 )
                                           
Cash dividends on common shares
                            (830 )                     (830 )
Stock incentive plans and other
                69             (3 )           66  
                                           
Balance December 31, 2003
          1,015       1,272       10,918       (5,442 )     (426 )     7,337  
                                           
Comprehensive income:
                                                       
Net loss
                            (947 )                     (947 )
Foreign currency translation
                                            107       107  
Minimum pension liability, net of tax
                                            14       14  
Unrealized gain on investments available for sale, net of tax
                                            5       5  
                                           
Total comprehensive (loss)
                                                    (821 )
                                           
Issuance of preferred stock
    1,438               (44 )                             1,394  
Cash dividends on common shares
                            (324 )                     (324 )
Dividends on preferred shares
                            (34 )                     (34 )
Stock incentive plans and other
                6             (2 )           4  
                                           
Balance December 31, 2004
  $ 1,438     $ 1,015     $ 1,234     $ 9,613     $ (5,444 )   $ (300 )   $ 7,556  
                                           
Comprehensive income:
                                                       
Net income
                            269                       269  
Foreign currency translation
                                            (160 )     (160 )
Minimum pension liability, net of tax
                                            (56 )     (56 )
                                           
Total comprehensive income
                                                    53  
                                           
Cash dividends on common shares
                            (324 )                     (324 )
Dividends on preferred shares
                            (86 )                     (86 )
Stock incentive plans and other
                182             6             188  
                                           
Balance December 31, 2005
  $ 1,438     $ 1,015     $ 1,416     $ 9,472     $ (5,438 )   $ (516 )   $ 7,387  
                                           
The accompanying notes are an integral part of these Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Overview
      Schering-Plough (the Company) discovers, develops, manufactures and markets medical therapies and treatments to enhance human health. The Company also markets leading consumer brands in the over-the-counter (OTC), foot care and sun care markets and operates a global animal health business.
Principles of Consolidation
      The consolidated financial statements include Schering-Plough Corporation and its subsidiaries (the Company). Intercompany balances and transactions are eliminated. Certain prior year amounts have been reclassified to conform to the current year presentation.
Use of Estimates
      The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and use assumptions that affect certain reported amounts and disclosures. Actual amounts may differ.
Equity Method of Accounting
      The Company accounts for its share of activity from the Merck/ Schering-Plough cholesterol joint venture (the Partnership or the joint venture) with Merck & Co., Inc. (Merck) using the equity method of accounting as the Company has significant influence over the joint venture’s operating and financial policies. Accordingly, the Company’s share of earnings in the joint venture is included in consolidated net income/(loss). Revenue from the sales of VYTORIN and ZETIA are recognized by the joint venture when title and risk of loss has passed to the customer. Equity income from the joint venture excludes any profit arising from transactions between the Company and the joint venture until such time as there is an underlying profit realized by the joint venture in a transaction with a party other than the Company or Merck. See Note 3, “Equity Income From Cholesterol Joint Venture” for information regarding this joint venture.
Cash and Cash Equivalents
      Cash and cash equivalents include operating cash and highly liquid investments with original maturities of three months or less.
Short-term Investments
      Short-term investments are carried at their fair value and are classified as available for sale. These investments consist of time deposits, certificates of deposit and commercial paper with maturities of less than a year.
Inventories
      Inventories are valued at the lower of cost or market. Cost is determined by using the last-in, first-out (LIFO) method for a substantial portion of inventories located in the U.S. The cost of all other inventories is determined by the first-in, first-out method (FIFO).
Depreciation of Property and Equipment
      Depreciation is provided over the estimated useful lives of the properties, generally by use of the straight-line method.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
      Useful lives of property are generally as follows:
         
Asset Category   Years
     
Buildings
    50  
Building Improvements
    25  
Equipment
    3 - 15  
      The Company reviews the carrying value of property and equipment for indications of impairment in accordance with Statement of Financial Accounting Standard (SFAS) 144, “Accounting for the Impairment and Disposal of Long-Lived Assets.”
      Depreciation expense was $362 million, $340 million and $304 million in 2005, 2004 and 2003, respectively.
Foreign Currency Translation
      The net assets of most of the Company’s international subsidiaries are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in other comprehensive income. For the remaining international subsidiaries, non-monetary assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in income.
      Exchange gains and losses arising from translating intercompany balances of a long-term investment nature are recorded in the foreign currency translation account. Transactional exchange gains and losses are included in income.
Revenue Recognition
      The Company’s pharmaceutical products are sold to direct purchasers (e.g., wholesalers, retailers and certain health maintenance organizations). Price discounts and rebates on such sales are paid to federal and state agencies as well as to indirect purchasers and other market participants (e.g., managed care organizations that indemnify beneficiaries of health plans for their pharmaceutical costs and pharmacy benefit managers).
      The Company recognizes revenue when title and risk of loss pass to the purchaser and when reliable estimates of the following can be determined:
        i. commercial discount and rebate arrangements;
 
        ii. rebate obligations under certain federal and state governmental programs; and
 
        iii. sales returns in the normal course of business.
      When recognizing revenue the Company estimates and records the applicable commercial and governmental discounts and rebates as well as sales returns that have been or are expected to be granted or made for products sold during the period. These amounts are deducted from sales for that period. Estimates recorded in prior periods are reevaluated as part of this process. If reliable estimates of these items cannot be made, the Company defers the recognition of revenue.
Earnings Per Common Share
      In 2005, diluted earnings per common share is computed by dividing income available to common shareholders by the sum of the weighted average number of common shares outstanding plus the dilutive effect of shares issuable through deferred stock units and the exercise of stock options. The impact of the

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conversion of mandatory convertible preferred shares has been excluded from this calculation since including these securities in the earnings per share calculation would be antidilutive.
      In 2004, diluted loss per common share excludes the effect of shares issuable through deferred stock units, the exercise of stock options and the impact of the conversion of mandatory convertible preferred shares because including these securities in the earnings per share calculation would be antidilutive as it would result in a lower loss per share.
      In 2003, diluted loss per common share excludes the effect of shares issuable through deferred stock units and through the exercise of stock options because including these securities would be antidilutive.
      For all periods presented, basic earnings/(loss) per common share is computed by dividing income/(loss) available to common shareholders by the weighted average number of common shares outstanding.
Goodwill and Other Intangible Assets
      SFAS 142, “Goodwill and Other Intangible Assets,” requires that intangible assets acquired either individually or with a group of other assets be initially recognized and measured based on fair value. An intangible with a finite life is amortized over its useful life, while an intangible with an indefinite life, including goodwill, is not amortized.
      The Company evaluates goodwill for impairment using a fair-value-based test. If goodwill is determined to be impaired, it is written down to its estimated fair value. The Company’s goodwill is primarily related to the Animal Health business.
Income Taxes
      Deferred income taxes are recognized for the future tax effects of temporary differences between the financial and income tax reporting basis of the Company’s assets and liabilities based on enacted tax laws and rates.
Accounting for Stock-Based Compensation
      Through December 31, 2005, the Company accounted for its stock-based compensation arrangements using the intrinsic value method. No stock-based employee compensation cost is reflected in net income/(loss), other than for the Company’s deferred stock units and performance plans, as stock options granted under all other plans had an exercise price equal to the market value of the underlying common stock on the date of grant.
      In December 2004, the FASB issued SFAS 123 (Revised 2004) “Share-Based Payment” (SFAS 123R). SFAS 123R is effective for the Company on January 1, 2006. SFAS 123R requires companies to recognize compensation costs related to all share-based transactions and compensation based on the market performance of the Company’s shares determined on a fair value basis. The Company will adopt SFAS 123R in the first quarter of 2006 using the modified prospective method. The modified prospective method requires the Company to recognize compensation costs on all share-based grants made on or after January 1, 2006 as well as the unrecognized cost of unvested awards at the date of adoption. Upon adoption of SFAS 123R, the Company will recognize share-based compensation costs over the service period, which is the earlier of the employees retirement eligibility date or the stated vesting period of the award. For grants issued to retirement eligible employees prior to the adoption of SFAS 123R, the Company will recognize compensation costs over the stated vesting period with acceleration of any unrecognized compensation costs upon the retirement of the employee. SFAS 123R also amends SFAS No. 95, “Statement of Cash Flows,” to require that excess tax benefits that had been reflected as operating cash flows be reflected as financing cash flows.

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      In addition, the Company has two compensation plans that will be accounted for under SFAS 123R as liability-based plans. The ultimate cash payout of these liability-based plans will be based on the Company’s stock price performance as compared to the stock price performance of its peer group. This change in accounting required by SFAS 123R will result in a cumulative effect of $26 million in income at January 1, 2006, in order to recognize the difference between the Company’s previously accrued liability as reported under Accounting Principles Board (APB) Opinion number 25, “Accounting for Stock Issued to Employees”, and the fair value of the liability for these plans. Future operating results will be impacted by the fluctuation in the fair value of the liability under these plans, which is required to be remeasured at each reporting date.
      The following table reconciles net income/(loss) available to common shareholders and basic/diluted earnings/(loss) per common share, as reported, to pro forma net income/(loss) available to common shareholders and basic/diluted earnings/(loss) per common share, as if the Company had expensed the grant-date fair value of both stock options and deferred stock units as permitted by SFAS 123, “Accounting for Stock-Based Compensation.”
                           
    2005   2004   2003
             
    (Dollars in millions,
    except per share data)
Net income/(loss) available to common shareholders, as reported
  $ 183     $ (981 )   $ (92 )
Add back: Expense included in reported net income for deferred stock units, net of tax in 2003
    89       59       66  
Deduct: Pro forma expense as if both stock options and deferred stock units were charged against net income/(loss) available to common shareholders in accordance with SFAS 123, net of
tax in 2003
    (177 )     (160 )     (143 )
                   
Pro forma net income/(loss) available to common shareholders using the fair value method
  $ 95     $ (1,082 )   $ (169 )
                   
Diluted earnings/(loss) per common share:
                       
 
Diluted earnings/(loss) per common share, as reported
  $ 0.12     $ (0.67 )   $ (0.06 )
 
Pro forma diluted earnings/(loss) per common share using the fair value method
    0.06       (0.74 )     (0.12 )
Basic earnings/(loss) per common share:
                       
 
Basic earnings/(loss) per common share, as reported
  $ 0.12     $ (0.67 )   $ (0.06 )
 
Pro forma basic earnings/(loss) per common share using the fair value method
    0.06       (0.74 )     (0.12 )
      The weighted-average fair value of options granted in 2005, 2004 and 2003 was $7.04, $6.15 and $5.29, respectively. These fair values were estimated using the Black-Scholes option-pricing model, based on the following assumptions:
                         
    2005   2004   2003
             
Dividend yield
    1.7 %     1.7 %     1.4 %
Volatility
    32 %     33 %     34 %
Risk-free interest rate
    4.1 %     3.9 %     2.9 %
Expected term of options (in years)
    7       7       5  
Impact of Other Recently Issued Accounting Pronouncements
      In November 2004, the FASB issued SFAS 151, “Inventory Costs.” This SFAS requires that abnormal spoilage be expensed in the period incurred (as opposed to inventoried and amortized to income

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over inventory usage) and that fixed production facility overhead costs be allocated over the normal production level of a facility. The Company implemented SFAS 151 in the fourth quarter of 2005. The implementation of this SFAS did not have a material impact on the Company’s financial statements.
      In March 2005, the FASB issued Interpretation No. 47 (FIN 47) for SFAS 143, “Accounting for Conditional Asset Retirement Obligations,” to clarify the term “conditional asset retirement obligations,” as used in SFAS 143. This term refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, a company is required to recognize liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. This interpretation is effective no later than the end of fiscal year ending after December 15, 2005. Retroactive application is not required. The Company implemented FIN 47 in the fourth quarter of 2005. The implementation of FIN 47 did not have a material impact on the Company’s financial statements.
2. SPECIAL CHARGES
      The components of special charges for the year ended December 31 are as follows:
                         
    2005   2004   2003
             
    (Dollars in millions)
Litigation charges
  $ 250     $     $ 350  
Employee termination costs
    28       119       179  
Asset impairment and related charges
    16       34       70  
                   
    $ 294     $ 153     $ 599  
                   
Litigation Charges
      During 2005, litigation reserves were increased by $250 million resulting in a total reserve of $500 million for the Massachusetts investigation as well as the investigations disclosed under “AWP Investigations” and the state litigation disclosed under “AWP Litigation” in Note 19, “Legal, Environmental and Regulatory Matters.”
      In 2003, litigation reserves were increased by $350 million primarily as a result of the investigations into the Company’s sales and marketing practices (see Note 19, “Legal, Environmental and Regulatory Matters,” for additional information).
Employee Termination Costs
      In August 2003, the Company announced a global workforce reduction initiative. The first phase of this initiative was a Voluntary Early Retirement Program (VERP) in the U.S. Under this program, eligible employees in the U.S. had until December 15, 2003 to elect early retirement and receive an enhanced retirement benefit. Approximately 900 employees elected to retire under the program, all of which have retired by December 31, 2005. The total cost of this program was approximately $191 million, comprised of increased pension costs of $108 million, increased post-retirement health care costs of $57 million, vacation payments of $4 million and costs related to accelerated vesting of stock grants of $22 million. Amounts recognized relating to this program during the years ended December 31, 2005, 2004 and 2003 were $7 million, $20 million and $164 million, respectively.
      Employee termination costs not associated with the VERP totaled $21 million, $99 million and $15 million in 2005, 2004 and 2003, respectively.

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      The following summarizes the activity in the accounts related to employee termination costs:
         
    Employee
    Termination
    Costs
     
    (Dollars
    in millions)
Special charges incurred during 2003
  $ 179  
Credit to retirement benefit plan liability
    (144 )
Disbursements
    (6 )
       
Special charges liability balance at December 31, 2003
  $ 29  
       
Special charges incurred during 2004
  $ 119  
Credit to retirement benefit plan liability
    (20 )
Disbursements
    (110 )
       
Special charges liability balance at December 31, 2004
  $ 18  
       
Special charges incurred during 2005
  $ 28  
Credit to retirement benefit plan liability
    (7 )
Disbursements
    (35 )
       
Special charges liability balance at December 31, 2005
  $ 4  
       
Asset Impairment and Other Charges
      Asset impairment charges have been recognized in accordance with SFAS 142, “Goodwill and Other Intangible Assets” and SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
      For the year ended December 31, 2005, the Company recognized asset impairment and other charges of $16 million related primarily to the consolidation of the Company’s U.S. biotechnology organizations.
      For the year ended December 31, 2004, the Company recognized asset impairment charges of $27 million based on discounted cash flows, and other charges of $7 million related primarily to the shutdown of a small European research and development facility.
      For the year ended December 31, 2003, the Company recognized asset impairment charges related to the following:
  •  Asset impairment charges totaling $26 million were recognized based on discounted cash flow analysis related to the facilities and equipment at two of the Company’s manufacturing sites.
 
  •  An asset impairment charge of $27 million based on discounted cash flows was recognized related to the intangible asset for a licensed cancer therapy drug that was sold in countries outside the U.S.
 
  •  An impairment charge of $17 million related to the trade name of the Company’s high-end sun care brand was recognized based on discounted cash flows.
3. EQUITY INCOME FROM CHOLESTEROL JOINT VENTURE
      In May 2000, the Company and Merck & Co., Inc. (Merck) entered into two separate sets of agreements to jointly develop and market certain products in the U.S. including (1) two cholesterol-lowering drugs and (2) an allergy/asthma drug. In December 2001, the cholesterol agreements were expanded to include all countries of the world except Japan. In general, the companies agreed that the collaborative activities under these agreements would operate in a virtual joint venture to the maximum degree possible by relying on the respective infrastructures of the two companies. These agreements

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generally provide for equal sharing of development costs and for co-promotion of approved products by each company.
      The cholesterol agreements provide for the Company and Merck to jointly develop ezetimibe (marketed as ZETIA in the U.S. and Asia and EZETROL in Europe):
        i. as a once-daily monotherapy;
 
        ii. in co-administration with any statin drug, and;
 
        iii. as a once-daily fixed-combination tablet of ezetimibe and simvastatin (Zocor), Merck’s cholesterol-modifying medicine. This combination medication (ezetimibe/simvastatin) is marketed as VYTORIN in the U.S. and as INEGY in many international countries.
      ZETIA/ EZETROL (ezetimibe) and VYTORIN/ INEGY (the combination of ezetimibe/simvastatin) are approved for use in the U.S. and have been launched in several international markets.
      The Company utilizes the equity method of accounting in recording its share of activity from the Merck/ Schering-Plough cholesterol joint venture. As such, the Company’s net sales do not include the sales of the joint venture. The cholesterol joint venture agreements provide for the sharing of operating income generated by the joint venture based upon percentages that vary by product, sales level and country. In the U.S. market, the Company receives a greater share of profits on the first $300 million of annual ZETIA sales. Above $300 million of annual ZETIA sales, Merck and Schering-Plough (the Partners) generally share profits equally. Schering-Plough’s allocation of the joint venture income is increased by milestones recognized. Further, either Partner’s share of the joint venture’s income from operations is subject to a reduction if the Partner fails to perform a specified minimum number of physician details in a particular country. The Partners agree annually to the minimum number of physician details by country.
      The Partners bear the costs of their own general sales forces and commercial overhead in marketing joint venture products around the world. In the U.S., Canada, and Puerto Rico, the cholesterol agreements provide for a reimbursement to each Partner for physician details that are set on an annual basis. This reimbursed amount is equal to each Partner’s physician details multiplied by a contractual fixed fee. Schering-Plough reports this reimbursement as part of equity income from the cholesterol joint venture. This amount does not represent a reimbursement of specific, incremental and identifiable costs for the Company’s detailing of the cholesterol products in these markets. In addition, this reimbursement amount is not reflective of the Company’s sales effort related to the joint venture as the Company’s sales force and related costs associated with the joint venture are generally estimated to be higher.
      For the year ended December 31, 2005, the Company recognized milestones of $20 million. These milestones related to certain European approvals of VYTORIN (ezetimibe/simvastatin) in 2005. During 2004, the Company recognized a milestone of $7 million related to the approval of ezetimibe/simvastatin in Mexico during 2004. During 2003, the Company recognized milestones of $20 million related to certain European approvals of ZETIA in 2003.
      Under certain other conditions, as specified in the joint venture agreements with Merck, the Company could earn additional milestones totaling $105 million.
      Costs of the joint venture that the Partners contractually share are a portion of manufacturing costs, specifically identified promotion costs (including direct-to-consumer advertising and direct and identifiable out-of-pocket promotion) and other agreed upon costs for specific services such as market support, market research, market expansion, a specialty sales force and physician education programs.
      Certain specified research and development expenses are generally shared equally by the Partners.

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      The following information provides a summary of the components of the Company’s equity income from the cholesterol joint venture for the year ended December 31:
                           
    2005   2004   2003
             
    (Dollars in millions)
Schering-Plough’s share of net income/(loss) (including milestones of $20, $7 and $20 in 2005, 2004 and 2003, respectively)
  $ 689     $ 244     $ (11 )
Reimbursement to Schering-Plough for physician details
    194       121       68  
Elimination of intercompany profit and other, net
    (10 )     (18 )     (3 )
                   
 
Total equity income from cholesterol joint venture
  $ 873     $ 347     $ 54  
                   
      Equity income from the joint venture excludes any profit arising from transactions between the Company and the joint venture until such time as there is an underlying profit realized by the joint venture in a transaction with a party other than the Company or Merck.
      Due to the virtual nature of the cholesterol joint venture, the Company incurs substantial costs, such as selling, general and administrative costs, that are not reflected in equity income and are borne by the overall cost structure of the Company. These costs are reported on their respective line items in the Statements of Consolidated Operations. The cholesterol agreements do not provide for any jointly owned facilities and, as such, products resulting from the joint venture are manufactured in facilities owned by either the Company or Merck.
      The allergy/asthma agreements provide for the joint development and marketing by the Partners of a once-daily, fixed-combination tablet containing CLARITIN and Singulair. Singulair is Merck’s once-daily leukotriene receptor antagonist for the treatment of asthma and seasonal allergic rhinitis. In January 2002, the Merck/ Schering-Plough respiratory joint venture reported on results of Phase III clinical trials of a fixed-combination tablet containing CLARITIN and Singulair. This Phase III study did not demonstrate sufficient added benefits in the treatment of seasonal allergic rhinitis. The CLARITIN and Singulair combination tablet does not have approval in any country and remains in clinical development with new Phase III clinical trials planned.
4. OTHER EXPENSE/(INCOME), NET
      The components of other expense/(income), net are as follows:
                         
    2005   2004   2003
             
    (Dollars in millions)
Interest cost incurred
  $ 177     $ 188     $ 92  
Less: amount capitalized on construction
    (14 )     (20 )     (11 )
                   
Interest expense
    163       168       81  
Interest income
    (176 )     (80 )     (57 )
Foreign exchange losses
    8       5       1  
Other, net
    10       53       34  
                   
Total other expense/(income), net
  $ 5     $ 146     $ 59  
                   

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5. INCOME TAXES
      The components of consolidated income/(loss) before income taxes for the years ended December 31 are as follows:
                         
    2005   2004   2003
             
    (Dollars in millions)
United States
  $ (1,436 )   $ (1,548 )   $ (1,169 )
Foreign
    1,933       1,380       1,123  
                   
Total income/(loss) before income taxes
  $ 497     $ (168 )   $ (46 )
                   
      Income from the cholesterol joint venture is included in the above table based on the jurisdiction in which the income is earned.
      The components of income tax expense for the years ended December 31 are as follows:
                                 
    Federal   State   Foreign   Total
                 
    (Dollars in millions)
2005
                               
Current
  $ (46 )   $ 23     $ 227     $ 204  
Deferred
          (9 )     33       24  
                         
Total
  $ (46 )   $ 14     $ 260     $ 228  
                         
2004
                               
Current
  $ 365     $ 24     $ 182     $ 571  
Deferred
    240       (14 )     (18 )     208  
                         
Total
  $ 605     $ 10     $ 164     $ 779  
                         
2003
                               
Current
  $ (299 )   $ 21     $ 187     $ (91 )
Deferred
    126             11       137  
                         
Total
  $ (173 )   $ 21     $ 198     $ 46  
                         
      The Company’s tax provision for the year ended December 31, 2005 includes a U.S. federal income tax benefit of approximately $42 million as a result of an IRS Notice issued in August 2005. The provisions of this Notice resulted in a reduction of the previously accrued tax liability attributable to the American Jobs Creation Act (AJCA) repatriation, and also reduced the 2005 U.S. Net Operating Loss (NOL) carried forward to subsequent years.
      In the fourth quarter of 2004, the Company made the decision to repatriate approximately $9.4 billion under the provisions of the AJCA, which was the maximum amount of foreign earnings that qualified for the reduced tax rate of 5.25 percent. The intended repatriation of earnings resulted in a U.S. federal tax liability of approximately $417 million and a state income tax liability of approximately $6 million, which was recorded in the 2004 income tax expense. During 2005, the Company repatriated approximately $9.4 billion in accordance with its planned repatriation under the AJCA. The Company will continue to use the repatriated funds for qualified spending.
      Prior to the AJCA, the Company’s intent was to permanently reinvest all unremitted earnings of its international subsidiaries, and except for the amounts repatriated under the AJCA, the Company maintains its intent to permanently reinvest earnings of its international subsidiaries. The Company has not provided deferred taxes on approximately $3.1 billion of undistributed foreign earnings as of December 31, 2005. Determining the tax liability that would arise if these earnings were remitted is not practicable. That

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liability would depend on a number of factors, including the amount of the earnings distributed and whether the U.S. operations were generating taxable profits or losses.
      In the fourth quarter of 2004, due to changes in tax planning strategies triggered by the Company’s intent to repatriate earnings under the AJCA, management was no longer able to conclude that it was more likely than not that it would realize the benefit of its net U.S. deferred tax assets, including any benefit related to its U.S. NOLs. Therefore, in general, the Company established a valuation allowance on its net U.S. deferred tax asset at December 31, 2004. The Company continues to maintain a valuation allowance for its net U.S. deferred tax asset at December 31, 2005.
      Deferred income taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities. The Company’s deferred tax assets result principally from the recording of certain items that currently are not deductible for tax purposes and net operating loss and other tax credit carryforwards. The Company’s deferred tax liabilities principally result from the use of accelerated depreciation for tax purposes.
      The components of the Company’s deferred tax assets and liabilities at December 31, are as follows:
                   
    2005   2004
         
    (Dollars in millions)
Deferred tax assets:
               
 
Net operating losses (NOLs) and other tax credit carryforwards
  $ 865     $ 324  
 
Postretirement and other employee benefits
    275       281  
 
Inventory related
    170       190  
 
Sales return reserves
    149       153  
 
Litigation accruals
    126       103  
 
Other
    223       145  
             
Total deferred tax assets:
  $ 1,808     $ 1,196  
             
Deferred tax liabilities:
               
 
Depreciation
  $ (310 )   $ (333 )
 
Inventory valuation
    (26 )     (63 )
 
Other
    (89 )     (166 )
             
Total deferred tax liabilities:
  $ (425 )   $ (562 )
             
Deferred tax valuation allowance
  $ (1,143 )   $ (406 )
             
Net deferred tax assets
  $ 240     $ 228  
             
      The change in the valuation allowance from 2004 to 2005 is primarily due to the increase in the U.S. NOL.
      Deferred taxes for net operating losses and other carryforwards principally relate to U.S. NOLs, Research and Development (R&D) tax credits, U.S. foreign tax credits and Federal Alternative Minimum Tax (AMT) credit carryforwards. At December 31, 2005, the Company had approximately $1.5 billion of U.S. NOLs for income tax purposes that are available to offset future U.S. taxable income. These U.S. NOLs will expire in varying amounts in 2024 and 2025, if unused. At December 31, 2005, the Company had approximately $66 million of R&D tax credits carryforwards that will expire between 2022 and 2025; $155 million of foreign tax credit carryforwards that will expire between 2011 and 2015; and $44 million of AMT tax credit carryforwards that have an indefinite life. Approximately $300 million and $1.5 billion of the U.S. NOLs generated in 2004 and 2003, respectively, were eligible for carryback benefits under a provision of the U.S. tax law. In accordance with this provision, the Company was able to

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recoup previous U.S. taxes paid, which resulted in income tax benefits of $52 million and $452 million for 2004 and 2003, respectively.
      The difference between income taxes based on the U.S. statutory tax rate and the Company’s income tax expense for the years ending December 31 was due to the following:
                           
    2005   2004   2003
             
    (Dollars in millions)
Income tax expense/(benefit) at U.S. statutory rate
  $ 174     $ (59 )   $ (16 )
Increase/(decrease) in taxes resulting from:
                       
 
Lower rates in other jurisdictions, net
    (417 )     (319 )     (308 )
 
Federal (benefit) tax on repatriated foreign earnings under the Act, net of credits
    (42 )     417        
 
U.S. NOLs for which no tax benefit was recorded
    437       384        
 
Provision for valuation allowance of net U.S. deferred tax assets
          240        
 
Non-deductible litigation reserves
                123  
 
Reserves for tax litigation
                200  
 
Research tax credit
                (13 )
 
State income tax
    14       10       13  
 
Permanent differences
    66       98       28  
 
All other, net
    (4 )     8       19  
                   
Income tax at effective tax rate
  $ 228     $ 779     $ 46  
                   
      The lower tax rates in other jurisdictions in 2005, 2004 and 2003, net, are primarily attributable to the Company’s manufacturing subsidiaries in Puerto Rico, Singapore and Ireland, which operate under various incentive tax grants that begin to expire in 2011. Overall income tax expense primarily relates to foreign taxes and does not include any benefit related to U.S. NOLs.
      Net consolidated income tax payments/(refunds), exclusive of payments related to the tax examinations and litigation discussed below, during 2005, 2004 and 2003 were $592 million, $(144) million and $196 million, respectively.
      In January 2006, the Internal Revenue Service (IRS) completed its examination of the Company’s 1993-1996 federal income tax returns. The Company had made a cash payment in the third quarter of 2005 in the form of a tax deposit of approximately $239 million in anticipation of the settlement of the 1993-1996 tax examination and to prevent additional IRS interest charges. This payment fully satisfied the liability associated with the tax examination and was consistent with the previously recorded reserves. The IRS is currently examining the Company’s 1997-2002 federal income tax returns.
      The Company’s potential tax exposures result from the varying application of statutes, regulations and interpretations and include exposures on intercompany terms of cross border arrangements and utilization of cash held by foreign subsidiaries (investment in U.S. property). Although the Company’s cross border arrangements between affiliates are based upon internationally accepted standards, tax authorities in various jurisdictions may disagree with and subsequently challenge the amount of profits taxed in their country. It is reasonably possible that the ultimate resolution of any tax matters could materially affect shareholders’ equity, liquidity and/or cash flows.
      The Company believes that its accrual for tax contingencies is adequate for all open years, based on past experience, interpretations of tax law, and judgments about potential actions by taxing authorities. The Company accrues liabilities for identified tax contingencies that result from tax positions taken that could be challenged by tax authorities. While the Company believes that its tax reserves reflect the

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probable outcome of identified tax contingencies, it is reasonably possible that the ultimate resolution of any tax matters may be materially greater or less than the amount accrued.
      In October 2001, IRS auditors asserted that two interest rate swaps that the Company entered into with an unrelated party should be recharacterized as loans from affiliated companies, resulting in additional tax liability for the 1991 and 1992 tax years. In September 2004, the Company made payments to the IRS in the amount of $194 million for income tax and $279 million for interest. The Company filed refund claims for the tax and interest with the IRS in December 2004. Following the IRS’s denial of the Company’s claims for a refund, the Company filed suit in May 2005 in the U.S. District Court for the District of New Jersey for refund of the full amount of the tax and interest. This refund litigation is currently in the discovery phase. The Company’s tax reserves were adequate to cover the above mentioned payments.
6. RETIREMENT PLANS AND OTHER POST-RETIREMENT BENEFITS
Plan Descriptions
      The Company has defined benefit pension plans covering eligible employees in the U.S. and certain foreign countries. For the U.S. plan, benefits for normal retirement are primarily based upon the participant’s average final earnings, years of service and Social Security income, and are modified for early retirement. Death and disability benefits are also available under the plan. Benefits become fully vested after five years of service. The plan provides for the continued accrual of credited service for employees who opt to postpone retirement and remain employed with the Company after reaching the normal retirement age. Non-U.S. pension plans offer benefits that are competitive with local market conditions.
      In addition, the Company provides post-retirement medical and life insurance benefits to its eligible U.S. retirees and their dependents through its post-retirement benefit plans.
      The measurement date for the majority of the plans’ liabilities is December 31. The net pension and other post-retirement benefit costs totaled $165 million in 2005 as compared to $155 million in 2004 and $181 million in 2003.
Actuarial Assumptions
      The consolidated weighted average assumptions used to determine benefit obligations at December 31 were:
                                 
        Other Post-
    Retirement   retirement
    Plans   Benefits
         
    2005   2004   2005   2004
                 
Discount rate
    5.3%       5.6%       5.7%       6.0%  
Rate of increase in future compensation
    3.8%       3.9%       N/A       N/A  
      The assumptions above are used to develop the benefit obligations at year-end.
      The consolidated weighted average assumptions used to determine net benefit costs for the years ended December 31 were:
                                                 
        Other Post-retirement
    Retirement Plans   Benefits
         
    2005   2004   2003   2005   2004   2003
                         
Discount rate
    5.6%       5.7%       6.3%       6.0%       6.0%       6.7%  
Long-term expected rate of return on plan assets
    7.5%       7.6%       8.5%       7.5%       7.5%       8.0%  
Rate of increase in future compensation
    3.9%       3.9%       3.9%       N/A       N/A       N/A  

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      The assumptions used to determine net periodic benefit costs for each year are established at the end of each previous year while the assumptions used to determine benefit obligations are established at each year-end. The net periodic benefit costs and the actuarial present value of the benefit obligations are based on actuarial assumptions that are determined annually based on an evaluation of long-term trends, as well as market conditions, that may have an impact on the cost of providing retirement benefits.
      The long-term expected rates of return on plan assets are derived from return assumptions determined for each of the major asset classes: equities, fixed income and real estate, on a proportional basis. The return expectations for each of these asset classes are based largely on assumptions about economic growth and inflation, which are supported by long-term historical data.
      The weighted average assumed healthcare cost trend rate used for post-retirement measurement purposes is 9.1 percent for 2006, trending down to 4.8 percent by 2013. A one percent increase in the assumed healthcare cost trend rate would increase combined post-retirement service and interest cost by $8 million and the post-retirement benefit obligation by $65 million. A one percent decrease in the assumed health care cost trend rate would decrease combined post-retirement service and interest cost by $6 million and the post-retirement benefit obligation by $51 million.
      Average retirement age is assumed based on the annual rates of retirement experienced by the Company.
Components of Net Periodic Benefit Costs
      The components of net pension and other post-retirement benefits expense were as follows:
                                                 
        Other Post-retirement
    Retirement Plans   Benefits
         
    2005   2004   2003   2005   2004   2003
                         
    (Dollars in millions)
Service cost
  $ 102     $ 91     $ 71     $ 15     $ 13     $ 9  
Interest cost
    106       102       85       24       22       18  
Expected return on plan assets
    (112 )     (115 )     (118 )     (15 )     (16 )     (18 )
Amortization, net
    31       27       (1 )     2       2        
Termination benefits(1)
    7       18       70       1       2       9  
Curtailment(1)
                8                   46  
Settlement(1)
    4       9       2                    
                                     
Net pension and other post-retirement benefits expense
  $ 138     $ 132     $ 117     $ 27     $ 23     $ 64  
                                     
 
(1)  Termination benefits, curtailment and settlement costs primarily relate to the matters discussed in Note 2, “Special Charges.”

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Benefit Obligations and Funded Status
      The components of the changes in the benefit obligations were as follows:
                                   
            Other
        Post-retirement
    Retirement Plans   Benefits
         
    2005   2004   2005   2004
                 
    (Dollars in millions)
Benefit obligations at beginning of year
  $ 1,995     $ 1,822     $ 409     $ 431  
 
Service cost
    102       91       15       13  
 
Interest cost
    106       102       24       22  
 
Participant contributions
    4       6       1       1  
 
Effects of exchange rate changes
    (59 )     41              
 
Benefits paid
    (91 )     (119 )     (23 )     (21 )
 
Acquisitions/ plan transfers
    5             6        
 
Actuarial losses/(gains) (including assumption change)
    91       39       38       (4 )
 
Plan amendments
          8       (19 )     (33 )
 
Termination benefits(1)
    2       6              
 
Curtailment(1)
          (1 )            
                         
Benefit obligations at end of year
  $ 2,155     $ 1,995     $ 451     $ 409  
                         
Benefit obligations of over-funded plans
  $ 84     $ 16     $     $  
Benefit obligations of under-funded plans
    2,071       1,979       451       409  
 
(1)  Termination benefits and Curtailment costs primarily relate to the matters discussed in Note 2, “Special Charges.”
      The components of the changes in plan assets were as follows:
                                   
            Other Post-
        retirement
    Retirement Plans   Benefits
         
    2005   2004   2005   2004
                 
    (Dollars in millions)
Fair value of plan assets, primarily stocks and bonds, at beginning of year
  $ 1,429     $ 1,319     $ 197     $ 200  
 
Actual gain (loss) on plan assets
    122       113       9       17  
 
Contributions
    27       82       2       1  
 
Acquisitions/ plan transfers
    1                    
 
Effects of exchange rate changes
    (47 )     34              
 
Benefits paid
    (91 )     (119 )     (23 )     (21 )
                         
Fair value of plan assets at end of year
  $ 1,441     $ 1,429     $ 185     $ 197  
                         
Plan assets of over-funded plans
  $ 96     $ 18     $     $  
Plan assets of under-funded plans
    1,345       1,411       185       197  
      In addition to the plan assets indicated above, at December 31, 2005 and 2004, securities investments of $70 million and $71 million, respectively, were held in a non-qualified trust designated to provide pension benefits for certain under-funded plans.
      At December 31, 2005 and 2004, the accumulated benefit obligations (ABO) for the retirement plans were $1,844 million and $1,672 million, respectively. The aggregated accumulated benefit obligations and

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fair values of plan assets for retirement plans with accumulated benefit obligations in excess of plan assets were $1,671 million and $1,232 million, respectively, at December 31, 2005, and $1,331 million and $1,029 million, respectively, at December 31, 2004.
      In accordance with FASB Staff Position 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Medicare Act), the Company began accounting for the effect of the federal subsidy under the Medicare Act in the third quarter of 2004. As a result, the Company’s accumulated other post-retirement benefit obligation was reduced by $48 million, and the Company’s net other post-retirement benefits expense was reduced by $7 million during 2004. The reduction in the other post-retirement benefits expense consists of reductions in service cost, interest cost and net amortization of $2 million, $3 million and $2 million, respectively.
      The following is a reconciliation of the funded status of the plans to the net asset/(liability):
                                 
            Other
        Post-retirement
    Retirement Plans   Benefits
         
    2005   2004   2005   2004
                 
    (Dollars in millions)
Benefit obligations in excess of plan assets
  $ (714 )   $ (566 )   $ (266 )   $ (212 )
Post measurement date contributions
    4                    
Unrecognized prior service costs
    69       78       (48 )     (2 )
Unrecognized net actuarial loss
    669       636       203       133  
                         
Net asset/(liability) at end of year
  $ 28     $ 148     $ (111 )   $ (81 )
                         
      The unrecognized actuarial gains or losses primarily represent the cumulative difference between the actuarial assumptions and the actual returns from plan assets, changes in discount rates and plans’ experience. At December 31, 2005, the Company has an unrecognized net actuarial loss of $669 million for the retirement plans and $203 million for the post-retirement benefit plans. Total unrecognized net loss amounts in excess of certain thresholds are amortized into net pension and other post-retirement benefit cost over the average remaining service life of employees.
      The components of the net asset/(liability) were recorded in the consolidated balance sheet as follows:
                                 
            Other
        Post-retirement
    Retirement Plans   Benefits
         
    2005   2004   2005   2004
                 
    (Dollars in millions)
Prepaid benefit cost
  $ 51     $ 124     $     $  
Accrued benefit cost
    (439 )     (312 )     (111 )     (81 )
Intangible assets
    61       49              
Accumulated other comprehensive income
    355       287              
                         
Net asset/(liability) at end of year
  $ 28     $ 148     $ (111 )   $ (81 )
                         
      As of December 31, 2005 and 2004, the Company’s additional minimum pension liability was $416 million and $335 million, respectively, primarily related to domestic retirement plans. This resulted in an adjustment to accumulated other comprehensive income/(loss), net of tax, of $56 million and $(14) million in 2005 and 2004, respectively.

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Plan Assets at Fair Value
      The asset allocation for the consolidated retirement plans at December 31, 2005 and 2004, and the target allocation for 2006 are as follows:
                           
        Percentage of
        Plan Assets at
    Target   December 31,
    Allocation    
Asset Category   2006   2005   2004
             
Equity Securities
    59%       62%       60%  
Debt Securities
    36       32       33  
Real Estate
    5       6       7  
                   
 
Total
    100%       100%       100%  
                   
      The asset allocation for the post-retirement benefit trusts at December 31, 2005 and 2004, and the target allocation for 2006 are as follows:
                           
        Percentage of
        Plan Assets at
    Target   December 31,
    Allocation    
Asset Category   2006   2005   2004
             
Equity Securities
    70%       72%       74%  
Debt Securities
    30       28       26  
                   
 
Total
    100%       100%       100%  
                   
      The Company’s investments related to these plans are broadly diversified, consisting primarily of equities and fixed income securities, with an objective of generating long-term investment returns that are consistent with an acceptable level of overall portfolio market value risk. The assets are periodically rebalanced back to the target allocations.
Estimated Future Benefit Payments
      The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
                 
        Other
    Retirement   Post-retirement
    Plans   Benefits(1)
         
    (Dollars in millions)
2006
  $ 96     $ 23  
2007
    88       24  
2008
    89       26  
2009
    95       27  
2010
    99       28  
Years 2011-2015
    630       158  
 
(1)  Expected benefit payments have not been reduced for expected subsidy payments under the Medicare Act of $2 million, $3 million, $3 million, $3 million, $3 million, and $21 million in 2006, 2007, 2008, 2009, 2010, and 2011-2015, respectively.
      The Company’s practice is to fund qualified pension plans at least at sufficient amounts to meet the minimum requirements set forth in applicable laws.

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      The Company expects to contribute approximately $100 million to its retirement plans during 2006, including about $50 million to its U.S. Retirement Plan. The contribution in the U.S. may change based on the outcome of pending funding reform legislation.
Defined Contribution Plans
      In 2003, the Company had a defined contribution profit-sharing plan covering substantially all of its full-time domestic employees who have completed one year of service. The annual contribution was determined by a formula based on the Company’s income, shareholders’ equity and participants’ compensation.. There was no profit sharing contribution in 2003 as determined by the formula described above. The Company no longer makes contributions to this plan.
      Beginning in 2004, the Company makes contributions to an existing defined contribution savings plan equal to three percent of eligible employee earnings, plus a matching of up to two percent of eligible employee earnings based on employee contributions to this plan. The total Company contributions to this plan in 2005 and 2004 were $58 million and $48 million, respectively.
7. EARNINGS PER COMMON SHARE
      The following table reconciles the components of the basic and diluted earnings/(loss) per share computations:
                         
    2005   2004   2003
             
    (Dollars and shares in millions)
EPS Numerator:
                       
Net income/(loss)
  $ 269     $ (947 )   $ (92 )
Less: Preferred stock dividends
    86       34        
                   
Net income/(loss) available to common shareholders
  $ 183     $ (981 )   $ (92 )
                   
EPS Denominator:
                       
Average shares outstanding for basic EPS
    1,476       1,472       1,469  
Dilutive effect of options and deferred stock units
    8              
                   
Average shares outstanding for diluted EPS
    1,484       1,472       1,469  
                   
      The equivalent common shares issuable under the Company’s stock incentive plans which were excluded from the computation of diluted EPS because their effect would have been antidilutive were 39 million, 89 million and 77 million, respectively, for the years ended December 31, 2005, 2004 and 2003, respectively. Also, for the years ended December 31, 2005 and 2004, 69 million and 27 million common shares, respectively, obtainable upon conversion of the Company’s 6 percent Mandatory Convertible Preferred Stock were excluded from the computation of diluted earnings per share because their effect would have been antidilutive.
8. COMPREHENSIVE INCOME/(LOSS)
      The components of accumulated other comprehensive income/(loss) at December 31 were:
                 
    2005   2004
         
    (Dollars in millions)
Foreign currency translation adjustment
  $ (291 )   $ (131 )
Minimum pension liability, net of tax
    (238 )     (182 )
Unrealized gain on investments available for sale, net of tax
    13       13  
             
Total
  $ (516 )   $ (300 )
             

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      Gross unrealized pre-tax gains on investments in 2005 and 2004 were $0 and $5 million, respectively; unrealized losses were immaterial.
9. INVENTORIES
      Inventories consisted of the following at December 31:
                   
    2005   2004
         
    (Dollars in millions)
Finished products
  $ 665     $ 630  
Goods in process
    614       651  
Raw materials and supplies
    326       299  
             
 
Total inventories
  $ 1,605     $ 1,580  
             
      Inventories valued on a last-in, first-out basis comprised approximately 19 percent of total inventories at December 31, 2005 and 2004. The estimated replacement cost of total inventories at December 31, 2005 and 2004 was $1,652 million and $1,624 million, respectively.
10. OTHER INTANGIBLE ASSETS
      The components of other intangible assets, net are as follows at December 31:
                                                 
    2005   2004
         
    Gross       Gross    
    Carrying   Accumulated       Carrying   Accumulated    
    Amount   Amortization   Net   Amount   Amortization   Net
                         
    (Dollars in millions)
Patents and licenses
  $ 579     $ 329     $ 250     $ 558     $ 287     $ 271  
Trademarks and other
    166       51       115       144       44       100  
                                     
Total other intangible assets
  $ 745     $ 380     $ 365     $ 702     $ 331     $ 371  
                                     
      Included in other are pension assets of $61 million and $49 million for 2005 and 2004, respectively.
      Patents, licenses and trademarks are amortized on the straight-line method over their respective useful lives. The residual value of intangible assets is estimated to be zero.
      During 2005, the Company recorded $11 million in base technology intangibles related to the acquisition of NeoGenesis’ assets. This amount is being amortized over five years.
      During 2005, the Company restructured its INTEGRILIN co-promotion agreement with Millennium Pharmaceuticals, Inc. (Millennium). As a result, $36 million has been included in intangible assets and is being amortized over approximately nine years.
      Included in intangible assets is approximately $120 million related to the license and co-promotion agreements with Bayer. These amounts are being amortized over the effective useful lives of the agreements ranging from seven to 14 years.
      See Note 11, “Product Licenses and Acquisitions,” for additional information on the above transactions.
      During 2004, the net carrying amount of patents and licenses was reduced by approximately $118 million as a result of Bristol-Myers Squibb’s reacquisition of co-promotion rights of TEQUIN in the U.S.
      Amortization expense related to other intangible assets in 2005, 2004 and 2003 was $49 million, $42 million, and $55 million, respectively. All intangible assets are reviewed to determine their

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recoverability by comparing their carrying values to their expected undiscounted future cash flows when events or circumstances warrant such a review.
11. PRODUCT LICENSES & ACQUISITIONS
      On February 14, 2005, the Company acquired most of the assets of NeoGenesis Pharmaceuticals for approximately $18 million, of which $11 million was recorded as an intangible asset related to base technology. NeoGenesis applies novel screening and chemistry technologies to discover new drug candidates.
      In August 2005, the Company announced that it exercised its right to develop and commercialize with Centocor, Inc. (Centocor), golimumab, a fully human monoclonal antibody being developed as a therapy for the treatment of rheumatoid arthritis and other immune-mediated inflammatory diseases. Pursuant to the exercise, the Company receives exclusive worldwide marketing rights to golimumab, excluding the U.S., Japan, China (including Hong Kong), Taiwan, and Indonesia. In exchange for its rights under this agreement, the Company made an upfront payment in the amount of $124 million to Centocor before a tax benefit of $6 million. This payment has been expensed and reported in Research and development for the year ended December 31, 2005, in the Statements of Consolidated Operations. The Company is sharing development costs with Centocor.
      Effective September 1, 2005, the Company restructured its INTEGRILIN co-promotion agreement with Millennium. Under the terms of the restructured agreement, the Company acquired exclusive U.S. development and commercialization rights to INTEGRILIN in exchange for an upfront payment of $36 million and royalties on INTEGRILIN sales. The Company has agreed to pay minimum royalties of $85 million per year to Millennium for 2006 and 2007. The Company also purchased existing INTEGRILIN inventory from Millennium. The $36 million upfront payment has been capitalized and included in other intangible assets.
      During 2004, the Company entered into a collaboration and license agreement with Toyama Chemical Co. Ltd (Toyama). Under the terms of the agreement, the Company has acquired the exclusive worldwide rights, excluding Japan, Korea and China, to develop, use and sell garenoxacin for all human and veterinary uses (excluding topical ophthalmic applications). Garenoxacin is Toyama’s quinolone antibacterial agent currently under regulatory review in the U.S. In connection with the execution of the agreement, the Company incurred a charge in the second quarter of 2004 for an up-front fee of $80 million to Toyama. This amount has been expensed and reported in Research and development for the year ended December 31, 2004, in the Statements of Consolidated Operations.
      During 2004, the Company entered into a strategic agreement with Bayer intended to enhance the Company’s pharmaceutical resources. Under the terms of this agreement, the Company has exclusive rights in the U.S. and Puerto Rico to market, sell and distribute the AVELOX and CIPRO antibiotics for all uses (excluding certain topical formulations for administration to the eye or ear). The Company pays Bayer royalties generally in excess of 50 percent of these products based on sales.
      Under the agreement, the Company also undertook Bayer’s U.S. commercialization activities for the erectile dysfunction medicine LEVITRA under Bayer’s co-promotion agreement with GlaxoSmithKline PLC. In the Japanese market, Bayer will co-market the Company’s cholesterol-absorption inhibitor ZETIA, when it is approved. The Company has received and recorded deferred revenue of $120 million related to the sale of ZETIA co-promotion rights to Bayer. This deferred revenue will begin to be recognized upon regulatory approval in Japan. ZETIA is currently under regulatory review in Japan. Under certain circumstances, if ZETIA does not receive regulatory/marketing approval in Japan by a certain date, this amount will be required to be repaid to Bayer.
      The agreement with Bayer potentially restricts the Company from marketing products in the U.S. that would compete with any of the products under the agreement. As a result, the Company expects that it

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will sublicense rights to garenoxacin, the quinolone antibacterial agent that the Company licensed from Toyama in 2004.
12. SHORT-TERM BORROWINGS, LONG-TERM DEBT AND OTHER COMMITMENTS
Short and Long-Term Borrowings
      In general, short-term borrowings consist of bank loans and commercial paper issued in the U.S. Short-term borrowings at December 31, 2005 and 2004 totaled $1.3 billion and $1.6 billion, respectively. Included in short-term borrowings is commercial paper outstanding at December 31, 2005 and 2004 of $298 million and $1.5 billion, respectively. The weighted average interest rate for short-term borrowings at December 31, 2005 and 2004 was 4.7 percent and 2.6 percent respectively.
      On November 26, 2003, the Company issued $1.25 billion aggregate principal amount of 5.3 percent senior unsecured notes due 2013 and $1.15 billion aggregate principal amount of 6.5 percent senior unsecured notes due 2033. Interest is payable semi-annually. The net proceeds from this offering were $2.37 billion. Upon issuance, the notes were rated A3 by Moody’s Investors Service, Inc. (Moody’s), and A+ by Standard & Poor’s Rating Services (S&P). The interest rates payable on the notes are subject to adjustment as follows: if the rating assigned to a particular series of notes by either Moody’s or S&P changes to a rating set forth below, the interest rate payable on that series of notes will be the initial interest rate (5.3 percent for the notes due 2013 and 6.5 percent for the notes due 2033) plus the additional interest rate set forth below by Moody’s and S&P:
                 
Additional Interest Rate   Moody’s Rating   S&P Rating
         
0.25%
    Baa1       BBB+  
0.50%
    Baa2       BBB  
0.75%
    Baa3       BBB-  
1.00%
    Ba1 or below       BB+ or below  
      In no event will the interest rate for any of the notes increase by more than 2 percent above the initial coupon rates of 5.3 percent and 6.5 percent, respectively. If either Moody’s or S&P subsequently upgrades its ratings, the interest rates will be correspondingly reduced, but not below 5.3 percent or 6.5 percent, respectively. Furthermore, the interest rate payable on a particular series of notes will return to 5.3 percent and 6.5 percent, respectively, and the rate adjustment provisions will permanently cease to apply if, following a downgrade by either Moody’s or S&P below A3 or A-, respectively, the notes are subsequently rated above Baa1 by Moody’s and BBB+ by S&P.
      On July 14, 2004, Moody’s lowered its rating of the notes to Baa1 and, accordingly, the interest payable on each note increased by 25 basis points, effective December 1, 2004. Therefore, effective on December 1, 2004, the interest rate payable on the notes due 2013 increased from 5.3 percent to 5.55 percent, and the interest rate payable on the notes due 2033 increased from 6.5 percent to 6.75 percent. At December 31, 2005, the notes were rated Baa1 by Moody’s and A- by S&P.
      The notes are redeemable in whole or in part, at the Company’s option at any time, at a redemption price equal to the greater of (1) 100 percent of the principal amount of such notes and (2) the sum of the present values of the remaining scheduled payments of principal and interest discounted using the rate of Treasury Notes with comparable remaining terms plus 25 basis points for the 2013 notes or 35 basis points for the 2033 notes.
Credit Facilities
      The Company has a revolving credit facility from a syndicate of major financial institutions. During March 2005, the Company negotiated an increase in the commitment under this facility from $1.25 billion to $1.5 billion with no changes in the basic terms of the pre-existing credit facility. Concurrently with the

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increase in commitments under this facility, the Company terminated early a separate $250 million line of credit which would have matured in May 2006. There was no outstanding balance under this facility at the time it was terminated. The existing $1.5 billion credit facility matures in May 2009 and requires the Company to maintain a total debt to capital ratio of no more than 60 percent. This credit line is available for general corporate purposes and management considers this facility as support to the Company’s commercial paper borrowings. Borrowings under the credit facility may be drawn by the U.S. parent company or by its wholly-owned international subsidiaries when accompanied by a parent guarantee. This facility does not require compensating balances, however, a nominal commitment fee is paid. As of December 31, 2005, $325 million has been drawn down under this facility by a wholly-owned international subsidiary to fund AJCA repatriations.
      In addition to the aforementioned credit facility, the Company entered into a $575 million credit facility during the fourth quarter of 2005, all of which was drawn as of December 31, 2005. This credit facility was utilized by a wholly-owned international subsidiary to fund repatriations under the AJCA. This credit facility requires the Company to maintain a total debt to total capital ratio of no more than 60 percent. These borrowings are payable no later than November 4, 2008. Any funds borrowed under this facility which are subsequently repaid may not be re-borrowed.
      All credit facility borrowings have been classified as short-term borrowings as the Company intends to repay these amounts in the next twelve months.
      In addition, the Company’s international subsidiaries had approximately $173 million available in unused lines of credit from various financial institutions at December 31, 2005.
Other Commitments
      Total rent expense amounted to $110 million in 2005, $100 million in 2004, and $91 million in 2003. Future annual minimum rental commitments on non-cancelable operating leases as of December 31, 2005, are as follows: 2006, $76 million; 2007, $63 million; 2008, $45 million; 2009, $21 million; 2010, $12 million; with aggregate minimum lease obligations of $32 million due thereafter.
      As of December 31, 2005, capital lease obligations of $1 million and $6 million are included in current portion of long-term debt and long-term debt, respectively.
      As of December 31, 2005, the Company has commitments totaling $175 million related to capital expenditures to be made in 2006.
13. FINANCIAL INSTRUMENTS
      SFAS 133, “Derivative Instruments and Financial Hedging Activities,” as amended, requires all derivatives to be recorded on the balance sheet at fair value. This accounting standard also provides that the effective portion of qualifying cash flow hedges be recognized in income when the hedged item affects income; that changes in the fair value of derivatives that qualify as fair value hedges, along with the change in the fair value of the hedged risk, be recognized as they occur; and that changes in the fair value of derivatives that do not qualify for hedge treatment, as well as the ineffective portion of qualifying hedges, be recognized in income as they occur.
Risks, Policy and Objectives
      The Company is exposed to market risk, primarily from changes in foreign currency exchange rates and, to a lesser extent, from interest rate and equity price changes. From time to time, the Company will hedge selective foreign currency risks with derivatives. Currently, management has not deemed it cost effective to engage in a formula-based program of hedging the profits and cash flows of international operations using derivative financial instruments. Because the Company’s international subsidiaries purchase significant quantities of inventory payable in U.S. dollars, managing the level of inventory and

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related payables and the rate of inventory turnover can provide a natural level of protection against adverse changes in exchange rates. Furthermore, the risk of adverse exchange rate change is somewhat mitigated by the fact that the Company’s international operations are widespread. On a limited basis, the Company will hedge selective foreign currency contract exposures to mitigate exchange rate risks.
      The Company mitigates credit risk on derivative instruments by dealing only with counterparties considered to be financially sound. Accordingly, the Company does not anticipate loss for non-performance. The Company does not enter into derivative instruments to generate trading profits.
      The table below presents the carrying values and estimated fair values for certain of the Company’s financial instruments at December 31. Estimated fair values were determined based on market prices, where available, or dealer quotes. The carrying values of all other financial instruments, including cash and cash equivalents, approximated their estimated fair values at December 31, 2005 and 2004.
                                 
    2005   2004
         
    Carrying   Estimated   Carrying   Estimated
    Value   Fair Value   Value   Fair Value
                 
    (Dollars in millions)
ASSETS:
                               
Short-term investments
  $ 818     $ 818     $ 851     $ 851  
Long-term investments
    144       147       153       157  
 
LIABILITIES:
Short-term borrowings and current portion of long-term debt
  $ 1,278     $ 1,278     $ 1,569     $ 1,569  
Long-term debt
    2,399       2,583       2,392       2,600  
Long-term Investments
      Long-term investments, which are included in other non-current assets, primarily consist of debt and equity securities held in non-qualified trusts to fund long-term employee benefit obligations, which are included as liabilities in the Consolidated Balance Sheets. These assets can only be used to fund the related liabilities.
Interest Rate Swap Contract
      Prior to March 2005, the Company had an interest rate swap arrangement in effect with a counterparty bank. The arrangement utilized two long-term interest rate swap contracts, one between a foreign-based subsidiary of the Company and a bank and the other between a U.S. subsidiary of the Company and the same bank. The two contracts had equal and offsetting terms and were covered by a master netting arrangement. The contract involving the foreign-based subsidiary permitted the subsidiary to prepay a portion of its future obligation to the bank, and the contract involving the U.S. subsidiary permitted the bank to prepay a portion of its future obligation to the U.S. subsidiary. Prepayments totaling $1.9 billion were made under both contracts as of December 31, 2004.
      The terms of the swap contracts, as amended, called for a phased termination of the swaps based on an agreed repayment schedule that was to begin no later than March 31, 2005. Termination would require the Company and the counterparty each to repay all prepayments pursuant to the agreed repayment schedule. The Company, at its option, was allowed to accelerate the termination of the arrangement and associated scheduled repayments for a nominal fee.
      On February 28, 2005, the Company’s foreign-based subsidiary and U.S. subsidiary each gave notice to the counterparty of their intent to terminate the arrangement. On March 21, 2005, the Company terminated these swap agreements and all associated repayments were made by the respective obligors.

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The termination of this arrangement did not have a material impact on the Company’s Statement of Consolidated Operations.
14. SHAREHOLDERS’ EQUITY
      The Company has authorized 50,000,000 shares of preferred stock that consists of: 12,000,000 preferred shares designated as Series A Junior Participating Preferred Stock, 28,750,000 preferred shares designated as 6 percent Mandatory Convertible Preferred Stock, and 9,250,000 preferred shares whose designations have not yet been determined.
     6  percent Mandatory Convertible Preferred Stock and Shelf Registration
      On August 10, 2004, the Company issued 28,750,000 shares of 6 percent Mandatory Convertible Preferred Stock (the Preferred Stock) with a face value of $1.44 billion. Net proceeds to the Company were $1.4 billion after deducting commissions, discounts and other underwriting expenses. The Preferred Stock will automatically convert into between 2.2451 and 2.7840 common shares of the Company depending on the average closing price of the Company’s common shares over a period immediately preceding the mandatory conversion date of September 14, 2007, as defined in the prospectus. The preferred shareholders may elect to convert at any time prior to September 14, 2007, at the minimum conversion ratio of 2.2451 common shares per share of the Preferred Stock. Additionally, if at any time prior to the mandatory conversion date, the closing price of the Company’s common shares exceeds $33.41 (for at least 20 trading days within a period of 30 consecutive trading days), the Company may elect to cause the conversion of all, but not less than all, of the Preferred Stock then outstanding at the same minimum conversion ratio of 2.2451 common shares for each preferred share.
      The Preferred Stock accrues dividends at an annual rate of 6 percent on shares outstanding. The dividends are cumulative from the date of issuance and, to the extent the Company is legally permitted to pay dividends and the Board of Directors declares a dividend payable, the Company will pay dividends on each dividend payment date. The dividend payment dates are March 15, June 15, September 15 and December 15, with the first dividend having been paid on December 15, 2004.
      As of December 31, 2005, the Company has the ability to issue $563 million (principal amount) of securities under a currently effective Securities and Exchange Commission (SEC) shelf registration.
Treasury Stock
      A summary of treasury share transactions for the years ended December 31 is as follows:
                         
    2005   2004   2003
             
    (Shares in millions)
Share balance at January 1
    555       559       562  
Shares issued under stock incentive plans
    (5 )     (4 )     (3 )
                   
Share balance at December 31
    550       555       559  
                   
Preferred Share Purchase Rights
      The Company has Preferred Share Purchase Rights outstanding that are attached to and presently only trade with the Company’s common shares and are not exercisable. The rights will become exercisable only if a person or group acquires 20 percent or more of the Company’s common stock or announces a tender offer that, if completed, would result in ownership by a person or group of 20 percent or more of the Company’s common stock. Should a person or group acquire 20 percent or more of the Company’s outstanding common stock through a merger or other business combination transaction, each right will

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entitle its holder (other than such acquirer) to purchase common shares of Schering-Plough having a market value of twice the exercise price of the right. The exercise price of the rights is $100.
      Following the acquisition by a person or group of beneficial ownership of 20 percent or more but less than 50 percent of the Company’s common stock, the Board of Directors may call for the exchange of the rights (other than rights owned by such acquirer), in whole or in part, at an exchange ratio of one common share or one two-hundredth of a share of Series A Junior Participating Preferred Stock per right. Also, prior to the acquisition by a person or group of beneficial ownership of 20 percent or more of the Company’s common stock, the rights are redeemable for $.005 per right at the option of the Board of Directors. The rights will expire on July 10, 2007, unless earlier redeemed or exchanged. The Board of Directors is also authorized to reduce the 20 percent thresholds referred to above to not less than the greater of (i) the sum of .001 percent and the largest percentage of the outstanding shares of common stock then known to the Company to be beneficially owned by any person or group of affiliated or associated persons and (ii) 10 percent, except that, following the acquisition by a person or group of beneficial ownership of 20 percent or more of the Company’s common stock, no such reduction may adversely affect the interests of the holders of the rights.
15. STOCK INCENTIVE PLANS
      Under the terms of the Company’s 2002 Stock Incentive Plan, which was approved by the Company’s shareholders, 72 million of the Company’s common shares may be granted as stock options or awarded as deferred stock units to officers and certain employees of the Company through December 2007. As of December 31, 2005, 11 million options and deferred stock units remain available for future year grants under the 2002 Stock Incentive Plan. Option exercise prices equal the market price of the common shares at their grant dates. Options expire no later than 10 years after the date of grant. Options granted in 2005 and 2004 generally had a three-year vesting term, while those granted in 2003 and prior generally had a one-year vesting term. Other option grants vest over longer periods ranging from three to nine years. Deferred stock units are payable in an equivalent number of common shares; the shares are distributable in a single installment or in three or five equal annual installments generally commencing three years from the date of the award.
      The following table summarizes stock option activity over the past three years under the current and prior plans. These incentive plans are approved by the Company’s shareholders.
                                                   
    2005   2004   2003
             
        Weighted-       Weighted-       Weighted-
    Number   Average   Number   Average   Number   Average
    of   Exercise   of   Exercise   of   Exercise
    Options   Price   Options   Price   Options   Price
                         
    (Number of options in millions)
Outstanding at January 1
    79     $ 27.43       71     $ 30.15       54     $ 35.40  
 
Granted
    12       19.58       19       18.12       23       17.57  
 
Exercised
    (4 )     14.58       (2 )     12.12       (1 )     9.40  
 
Canceled or expired
    (5 )     29.45       (9 )     32.37       (5 )     33.19  
                                     
Outstanding at December 31
    82     $ 27.00       79     $ 27.43       71     $ 30.15  
                                     
Exercisable at December 31
    54     $ 31.03       50     $ 32.07       43     $ 34.94  
                                     

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      Summarized information about stock options outstanding and exercisable at December 31, 2005 is as follows:
                                         
        Outstanding            
        Weighted-            
        Average   Weighted-       Weighted-
    Number   Remaining   Average   Exercisable   Average
    of   Term in   Exercise   Number of   Exercise
Exercise Price Range   Options   Years   Price   Options   Price
                     
    (Number of options in millions)
Under $20
    41       6.9     $ 17.81       24     $ 17.74  
$20 to $30
    10       9.2       20.83             23.70  
$30 to $40
    16       4.2       36.57       15       36.59  
Over $40
    15       4.3       46.37       15       46.33  
                               
      82                       54          
                               
      In 2005, 2004 and 2003, the Company awarded deferred stock units totaling 7.3 million units, 3.4 million units, and 3.2 million units, respectively. The weighted average fair values of the deferred stock units granted in 2005, 2004 and 2003 were $20.65, $18.11 and $17.59, respectively.
16. INSURANCE COVERAGE
      The Company maintains insurance coverage with such deductibles and self-insurance as management believes adequate for its needs under current circumstances. Such coverage reflects market conditions (including cost and availability) existing at the time it is written, and the relationship of insurance coverage to self-insurance varies accordingly. As a result of recent external events, the availability of insurance has become more restrictive. Management considers the impact of these changes as it continually assesses the best way to provide for its insurance needs in the future. The Company self-insures a substantial proportion of risk as it relates to products’ liability.
17. SEGMENT INFORMATION
      The Company has three reportable segments: Prescription Pharmaceuticals, Consumer Health Care and Animal Health. The segment sales and profit data that follow are consistent with the Company’s current management reporting structure. The Prescription Pharmaceuticals segment discovers, develops, manufactures and markets human pharmaceutical products. The Consumer Health Care segment develops, manufactures and markets over-the-counter, foot care and sun care products, primarily in the U.S. The Animal Health segment discovers, develops, manufactures and markets animal health products.
Net sales by segment:
                         
    Year Ended December 31,
     
    2005   2004   2003
             
    (Dollars in millions)
Prescription Pharmaceuticals
  $ 7,564     $ 6,417     $ 6,611  
Consumer Health Care
    1,093       1,085       1,026  
Animal Health
    851       770       697  
                   
Consolidated net sales
  $ 9,508     $ 8,272     $ 8,334  
                   

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Profit by segment:
                         
    Year Ended December 31,
     
    2005   2004   2003
             
    (Dollars in millions)
Prescription Pharmaceuticals
  $ 733     $ 13     $ 513  
Consumer Health Care
    235       234       199  
Animal Health
    120       88       86  
Corporate and other
    (591 )     (503 )     (844 )
                   
Consolidated profit/(loss) before tax
  $ 497     $ (168 )   $ (46 )
                   
      “Corporate and other” includes interest income and expense, foreign exchange gains and losses, headquarters expenses, special charges and other miscellaneous items. The accounting policies used for segment reporting are the same as those described in Note 1, “Summary of Significant Accounting Policies.”
      In 2005, “Corporate and other” includes special charges of $294 million, including $28 million of employee termination costs, $16 million of asset impairment and other charges, and an increase in litigation reserves by $250 million resulting in a total reserve of $500 million representing the Company’s current estimate to resolve the Massachusetts investigation as well as the investigations disclosed under “AWP Investigations” and the state litigation disclosed under “AWP Litigation” in Note 19, “Legal, Environmental and Regulatory Matters.” It is estimated that the charges relate to the reportable segments as follows: Prescription Pharmaceuticals — $289 million, Consumer Health Care — $2 million, Animal Health — $1 million and Corporate and other — $2 million.
      In 2004, “Corporate and other” includes special charges of $153 million, including $119 million of employee termination costs, as well as $27 million of asset impairment charges and $7 million of closure costs primarily related to the exit from a small European research and development facility. It is estimated the charges relate to the reportable segments as follows: Prescription Pharmaceuticals — $135 million, Consumer Health Care — $3 million, Animal Health — $2 million and Corporate and other — $13 million.
      In 2003, “Corporate and other” includes special charges of $599 million, including $179 million of employee termination costs, a $350 million provision to increase litigation reserves, and $70 million of asset impairment charges. It is estimated that the charges relate to the reportable segments as follows: Prescription Pharmaceuticals — $515 million, Consumer Health Care — $25 million, Animal Health — $4 million and Corporate and other — $55 million.

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     Net Sales by Major Product:
                           
    2005   2004   2003
             
    (Dollars in millions)
PRESCRIPTION PHARMACEUTICALS
  $ 7,564     $ 6,417     $ 6,611  
 
REMICADE
    942       746       540  
 
PEG-INTRON
    751       563       802  
 
NASONEX
    737       594       500  
 
CLARINEX/ AERIUS
    646       692       694  
 
TEMODAR
    588       459       324  
 
CLARITIN Rx
    371       321       328  
 
REBETOL
    331       287       639  
 
INTEGRILIN
    315       325       306  
 
INTRON A
    287       318       409  
 
AVELOX
    228       44        
 
SUBUTEX
    197       185       144  
 
CAELYX
    181       150       111  
 
CIPRO
    146       43        
 
ELOCON
    144       168       154  
 
Other Pharmaceutical
    1,700       1,522       1,660  
CONSUMER HEALTH CARE
    1,093       1,085       1,026  
 
OTC (includes OTC CLARITIN sales in 2005, 2004, and 2003 of $394, $419, and $432, respectively)
    556       578       588  
 
Foot Care
    333       331       292  
 
Sun Care
    204       176       146  
ANIMAL HEALTH
    851       770       697  
                   
CONSOLIDATED NET SALES
  $ 9,508     $ 8,272     $ 8,334  
                   
     Net Sales by Geographic Area:
                         
    2005   2004   2003
             
    (Dollars in millions)
United States
  $ 3,589     $ 3,219     $ 3,559  
Europe and Canada
    4,040       3,595       3,410  
Pacific Area and Asia
    995       676       649  
Latin America
    884       782       716  
                   
Consolidated net sales
  $ 9,508     $ 8,272     $ 8,334  
                   
      The Company has subsidiaries in more than 50 countries outside the U.S. No single foreign country, except for France, Italy and Japan, accounted for 5 percent or more of consolidated net sales during the

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past three years. Net sales are presented in the geographic area in which the Company’s customers are located.
                                                 
    2005   2004   2003
             
        % of       % of       % of
        Consolidated       Consolidated       Consolidated
    Net Sales   Net Sales   Net Sales   Net Sales   Net Sales   Net Sales
                         
    (Dollars in millions)
Total International net sales
  $ 5,919       62 %   $ 5,053       61 %   $ 4,775       57 %
                                     
France
    771       8 %     729       9 %     691       8 %
Japan
    687       7 %     385       5 %     414       5 %
Italy
    457       5 %     443       5 %     436       5 %
Net sales by customer
                                                 
    2005   2004   2003
             
        % of       % of       % of
        Consolidated       Consolidated       Consolidated
    Net Sales   Net Sales   Net Sales   Net Sales   Net Sales   Net Sales
                         
    (Dollars in millions)
McKesson Corporation
  $ 1,073       11 %   $ 868       10 %   $ 667       8 %
      No single customer, except for McKesson Corporation, a major pharmaceutical and health care products distributor, accounted for 10 percent or more of consolidated net sales during the past three years.
Long-lived Assets by Geographic Location:
                         
    2005   2004   2003
             
    (Dollars in millions)
United States
  $ 2,538     $ 2,447     $ 2,507  
Singapore
    840       884       828  
Ireland
    486       449       444  
Puerto Rico
    307       298       317  
Other
    602       768       726  
                   
Total
  $ 4,773     $ 4,846     $ 4,822  
                   
      Long-lived assets shown by geographic location are primarily property.
Supplemental sales information:
      Sales of products comprising 10 percent or more of the Company’s U.S. or international sales for the year ended December 31, 2005, were as follows:
                 
    Amount   Percentage
         
    (Dollars in millions)
U.S.
               
NASONEX
  $ 447       12%  
OTC CLARITIN
    375       10%  
International
               
REMICADE
  $ 942       16%  
PEG-INTRON
    567       10%  

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      Schering-Plough’s net sales do not include sales of VYTORIN and ZETIA that are marketed in partnership with Merck, as the Company accounts for this joint venture under the equity method of accounting. See Note 3, “Equity Income From Cholesterol Joint Venture.”
      The Company does not disaggregate assets on a segment basis for internal management reporting and, therefore, such information is not presented.
18. CONSENT DECREE
      In May 2002, the Company agreed with the FDA to the entry of a Consent Decree to resolve issues related to compliance with current Good Manufacturing Practices (cGMP) at certain of the Company’s facilities in New Jersey and Puerto Rico (the “Consent Decree” or the “Decree”).
      In summary, the Decree required the Company to make payments totaling $500 million in two equal installments of $250 million, which were paid in 2002 and 2003. In addition, the Decree required the Company to complete revalidation programs for manufacturing processes used to produce bulk active pharmaceutical ingredients and finished drug products at the covered facilities, as well as to implement a comprehensive cGMP Work Plan for each such facility. The Decree required the foregoing to be completed in accordance with strict schedules, and provided for possible imposition of additional payments in the event the Company did not adhere to the approved schedules. Final completion of the work was made subject to certification by independent experts, whose certifications were in turn made subject to FDA acceptance.
      As of September 30, 2005, the Company had completed the revalidation and third party certification of the bulk active pharmaceutical ingredients. As of December 31, 2005, the Company had completed the revalidation and third party certification of the finished drug products. The Company also completed all 212 Significant Steps of the cGMP Work Plan by December 31, 2005. All of these requirements were completed in accordance with the schedules required by the Decree.
      Under the terms of the Decree, provided that the FDA has not notified the Company of a significant violation of FDA law, regulations, or the Decree in the five year period since the Decree’s entry, May 2002 through May 2007, the Company may petition the court to have the Decree dissolved and the FDA will not oppose the Company’s petition.
      Although the Company has reported to the FDA that it has completed both the revalidation programs and the cGMP Work Plan, third party certification of the Work Plan is still pending. It is possible that the third party expert may not certify the completion of a Work Plan Significant Step or that the FDA may disagree with the expert’s certification. In such an event, it is possible that FDA may assess additional payments as permitted under the Decree, and as described in more detail below.
      In general, the cGMP Work Plan contained 212 Significant Steps whose timely and satisfactory completion are subject to payments of $15 thousand per business day for each deadline missed. These payments may not exceed $25 million for 2002, and $50 million for each of the years 2003, 2004 and 2005. These payments are subject to an overall cap of $175 million. The Company would expense any such additional payments assessed under the Decree if and when incurred.
19. LEGAL, ENVIRONMENTAL AND REGULATORY MATTERS
Background
      The Company is involved in various claims, investigations and legal proceedings.
      The Company records a liability for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. The Company adjusts its liabilities for contingencies to reflect the current best estimate of probable loss or minimum liability as the case may be. Where no best estimate is determinable the company records the minimum amount within the most probable range

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of its liability. Expected insurance recoveries have not been considered in determining the amounts of recorded liabilities for environmental-related matters.
      If the Company believes that a loss contingency is reasonably possible, rather than probable, or the amount of loss cannot be estimated, no liability is recorded. However, where a liability is reasonably possible, disclosure of the loss contingency is made.
      The Company reviews the status of all claims, investigations and legal proceedings on an ongoing basis, including related insurance coverages. From time to time, the Company may settle or otherwise resolve these matters on terms and conditions management believes are in the best interests of the Company. Resolution of any or all claims, investigations and legal proceedings, individually or in the aggregate, could have a material adverse effect on the Company’s results of operations, cash flows or financial condition.
      Resolution (including settlements) of matters of the types set forth in the remainder of this Note, and in particular under Investigations, frequently involve fines and penalties of an amount that would be material to its results of operations, cash flows or financial condition. Resolution of such matters may also involve injunctive or administrative remedies that would adversely impact the business such as exclusion from government reimbursement programs, which in turn would have a material adverse impact on the business, future financial condition, cash flows or the results of operations. There are no assurances that the Company will prevail in any of the matters discussed in the remainder of this Note, that settlements can be reached on acceptable terms (including the scope of the release provided and the absence of injunctive or administrative remedies that would adversely impact the business such as exclusion from government reimbursement programs) or in amounts that do not exceed the amounts reserved. Even if an acceptable settlement were to be reached, there can be no assurance that further investigations or litigations will not be commenced raising similar issues, potentially exposing the Company to additional material liabilities. The outcome of the matters discussed below under Investigations could include the commencement of civil and/or criminal proceedings involving the imposition of substantial fines, penalties and injunctive or administrative remedies, including exclusion from government reimbursement programs. Total liabilities reserved reflect an estimate (and in the case of the Investigations, a current estimate of the liability), and any final settlement or adjudication of any of these matters could possibly be less than, or could materially exceed the liabilities recorded in the financial statements and could have a material adverse impact on the Company’s financial condition, cash flows or operations. Further, the Company cannot predict the timing of the resolution of these matters or their outcomes.
      Except for the matters discussed in the remainder of this Note, the recorded liabilities for contingencies at December 31, 2005, and the related expenses incurred during the year ended December 31, 2005, were not material. In the opinion of management, based on the advice of legal counsel, the ultimate outcome of these matters, except matters discussed in the remainder of this Note, will not have a material impact on the Company’s results of operations, cash flows or financial condition.
Patent Matters
      DR. SCHOLL’S FREEZE AWAY Patent. On July 26, 2004, OraSure Technologies filed an action in the U.S. District Court for the Eastern District of Pennsylvania alleging patent infringement by Schering-Plough HealthCare Products by its sale of DR. SCHOLL’S FREEZE AWAY wart removal product. The complaint seeks a permanent injunction and unspecified damages, including treble damages.
Investigations
      Massachusetts Investigation. The U.S. Attorney’s Office for the District of Massachusetts is investigating a broad range of the Company’s sales, marketing and clinical trial practices and programs along with those of Warrick Pharmaceuticals (Warrick), the Company’s generic subsidiary. The investigation is focused on the following alleged practices: providing remuneration to managed care

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organizations, physicians and others to induce the purchase of Schering pharmaceutical products; off-label marketing of drugs; and submitting false pharmaceutical pricing information to the government for purposes of calculating rebates required to be paid to the Medicaid program. The Company is cooperating with this investigation.
      The outcome of this investigation could include the commencement of civil and/or criminal proceedings involving the imposition of substantial fines, penalties and injunctive or administrative remedies, including exclusion from government reimbursement programs. The Company has recorded a liability of $500 million related to this investigation as well as the investigations described below under “AWP Investigations” and the state litigation described below under “AWP Litigation.” If the Company is not able to reach a settlement at the current estimate, the resolution of this matter could have a material adverse impact on the Company’s results of operations (beyond what has been reflected to date if the Company is not able to reach a settlement at the current estimate), cash flows, financial condition and/or its business.
      AWP Investigations. The Company continues to respond to existing and new investigations by the Department of Health and Human Services, the Department of Justice and several states into industry and Company practices regarding average wholesale price (AWP). These investigations relate to whether the AWP used by pharmaceutical companies for certain drugs improperly exceeds the average prices paid by providers and, as a consequence, results in unlawful inflation of certain government drug reimbursements that are based on AWP. The Company is cooperating with these investigations. The outcome of these investigations could include the imposition of substantial fines, penalties and injunctive or administrative remedies.
      NITRO-DUR Investigation. In August 2003, the Company received a civil investigative subpoena issued by the Office of Inspector General of the U.S. Department of Health and Human Services, seeking documents concerning the Company’s classification of NITRO-DUR for Medicaid rebate purposes, and the Company’s use of nominal pricing and bundling of product sales. The Company is cooperating with the investigation. It appears that the subpoena is one of a number addressed to pharmaceutical companies concerning an inquiry into issues relating to the payment of government rebates.
Pricing Matters
      AWP Litigation. The Company continues to respond to existing and new litigation by certain states and private payors into industry and Company practices regarding average wholesale price (AWP). These litigations relate to whether the AWP used by pharmaceutical companies for certain drugs improperly exceeds the average prices paid by providers and, as a consequence, results in unlawful inflation of certain reimbursements for drugs by state programs and private payors that are based on AWP. The complaints allege violations of federal and state law, including fraud, Medicaid fraud and consumer protection violations, among other claims. In the majority of cases, the plaintiffs are seeking class certifications. In some cases, classes have been certified. The outcome of these litigations could include substantial damages, the imposition of substantial fines, penalties and injunctive or administrative remedies.
Securities and Class Action Litigation
      Federal Securities Litigation. Following the Company’s announcement that the FDA had been conducting inspections of the Company’s manufacturing facilities in New Jersey and Puerto Rico and had issued reports citing deficiencies concerning compliance with current Good Manufacturing Practices, several lawsuits were filed against the Company and certain named officers. These lawsuits allege that the defendants violated the federal securities law by allegedly failing to disclose material information and making material misstatements. Specifically, they allege that the Company failed to disclose an alleged serious risk that a new drug application for CLARINEX would be delayed as a result of these manufacturing issues, and they allege that the Company failed to disclose the alleged depth and severity of

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its manufacturing issues. These complaints were consolidated into one action in the U.S. District Court for the District of New Jersey, and a consolidated amended complaint was filed on October 11, 2001, purporting to represent a class of shareholders who purchased shares of Company stock from May 9, 2000 through February 15, 2001. The complaint seeks comp