Schering-Plough Faces Rough Road Ahead

The company meets its recently lowered earnings guidance, but posts a sharp fall in profit.
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Updated from 8:34 a.m. EDT

Schering-Plough

(SGP)

delivered some good news and some bad news Wednesday.

The good news: The company met its recently lowered earnings guidance as well as the Thomson First Call analysts' consensus of 12 cents a share. The bad news: The results were brutal. Earnings per share for the three months ended June 30 dropped 72% from 43 cents in the year-ago period, while net earnings sank 71% to $182 million from $633 million last year.

Net sales declined by 17% to $2.34 billion from $2.83 billion.

Still, the company's stock rose 4.6% Wednesday, gaining 78 cents to close at $17.75.

What could explain the higher stock price for a company that attracts some of the most diverse views on Wall Street for large pharmaceutical companies? (Schering-Plough has five buy recommendations, six sell recommendations and 16 holds, according to Thomson First Call.) The answer may lie in the plain-spoken Fred Hassan, the company's new chairman and chief executive, who came to Schering-Plough recently after having served as chairman and chief executive of Pharmacia, which has been acquired by Pfizer.

In Wednesday's earnings announcement, for example, Hassan eschewed the traditional plain-vanilla, tapioca-style press release that leads with a batch of numbers. Instead, Hassan lost no time telling investors that the company faces many internal and competitive pressures. "The company's challenges in the wake of the loss of Claritin exclusivity require sharp and decisive changes in strategies, structure and, most of all, in the business execution at Schering-Plough," Hassan said in the first paragraph of the earnings announcement.

Sales of the antihistamine Claritin, once the company's signature product, have been pounded since the drug lost its patent protection and was converted to over-the-counter status in the U.S. in December. Worldwide prescription sales of Claritin dropped 86% in the second quarter to $112 million from $792 million for the same period last year. U.S. sales for the quarter collapsed to $13 million from $677 million during the same period last year.

For the first half of 2003, worldwide Claritin prescription sales dropped 85% to $221 million from $1.45 billion. Hassan added that it was clear Schering-Plough failed to capitalize on "the huge cash flow" generated by prescription strength Claritin.

Hassan, who joined Schering-Plough on April 20, continued his no-sugar-coating approach during a telephone conference call with analysts. He noted that that he had inherited "a very tough situation," but he added, "fortunately, I like challenges."

Hassan said it was quite evident -- from his second day on the job talking to shareholders at the company's annual meeting and on his third day on the job meeting with employees -- that investors and workers were anxious about the company's future.

Some analysts suggested that Wednesday's stock gain could be attributed to Hassan's plain talk -- a not-so-veiled comparison to his predecessor, Richard Jay Kogan, who didn't hold earnings conference calls with investors and analysts.

"The increased communication from senior management certainly helps," said Robert C. Hazlett, who follows the company for SunTrust Robinson Humphrey, an Atlanta-based investment banking firm. He has an underweight rating on the stock, doesn't own Schering-Plough shares and knows of no investment banking relationship with his firm.

"

Hassan sounded encouraging, and there was no negative news," added Girish Tyagi, of the Thomas Weisel Partners investment banking firm. He has a peer perform rating; he doesn't own the stock and he said that his firm hasn't had an investment banking relationship with Schering-Plough.

Both analysts noted that changes in management and communication must be backed up by more and better products. "Time and time again, we've seen health companies come back," Tyagi said.

To Tyagi, the key growth driver is Zetia, a cholesterol-lowering drug launched in the U.S. and several other companies in November. Schering-Plough is collaborating with Merck on Zetia marketing in most countries. Total second-quarter Zetia sales were $123 million.

In the next few years, Zetia's success will be measured by the companies' ability to convince doctors that Zetia be used in conjunction with other cholesterol-lowering drugs -- known as statins -- rather than have the doctors just increase the dosages of the statins. Even more important, Tyagi added, will be Merck and Schering-Plough's efforts to develop a combination cholesterol pill -- Zetia plus Merck's Zocor. The pill is still in clinical trials.

"Zetia is a very good add-on for those who need it," added Hazlett. "As more data roll in, it can offer a substantial

financial opportunity. Clearly, the big opportunity is the Zocor-Zetia combination pill."

But Hazlett is counseling clients to hold off until the company hears from the FDA about the asthma drug Asmanex. The drug is available in several European markets. "I believe this drug can add meaningfully to operations," Hazlett said.

Aside from products, Hassan Wednesday re-emphasized the company's effort to improve its management, culture, manufacturing and relations with regulators.

He noted that he has worked on turn-around strategies at several giant drug companies, adding that the recently announced organizational changes he has instituted at Schering-Plough represent "the fastest I've ever moved at a new situation."

He said three goals -- stabilizing, repairing and turning around the company -- will take 18 to 24 months, setting the stage for the two other goals of building a strong product base and significantly expanding sales.

One major task is improving relations with the Food and Drug Administration. The company signed a consent decree with the FDA in May 2002 relating to problems with manufacturing practices at plants in New Jersey and Puerto Rico. As part of the consent decree, the company paid the federal government $500 million. The agreement "requires a massive effort to complete hundreds of milestones by December 2005," Hassan said Wednesday. "And there are negative consequences if we miss."

The company also has been making -- and will be making -- multiple changes in its executive ranks. Hassan said he will soon hire a chief compliance officer "to drive our business integrity culture, and specifically to ensure we have robust training, compliance and accountability systems worldwide."

In recent months, he has hired a new director for worldwide regulatory affairs, a new head of consumer health products, a new chief of global pharmaceuticals, a new director of global human resources and a new director of strategic communication. Most served with him at Pharmacia.