<PAGE> 1
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): August 31, 1999
PHARMACIA & UPJOHN, INC.
- -------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 1-11557 98-0155411
- ---------------------------- ------------------------ --------------------
(State or Other Jurisdiction (Commission File Number) (IRS Employer
of incorporation or Identification No.)
Organization)
100 Route 206 North
Peapack, New Jersey 07977
- ---------------------------------------- -----------------------------------
(Address of Principal Executive Offices) (Zip Code)
(888) 768-5501
- -------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
N/A
- -------------------------------------------------------------------------------
(Former Name or Former Address, if Changed Since Last Report)
===============================================================================
1
<PAGE> 2
Item 5. Other Events
As previously reported in the Registrant's Form 10-Q for the quarterly period
ended September 30, 1999, on August 31, 1999, Pharmacia & Upjohn (the "Company")
and SUGEN, Inc. ("Sugen") completed their merger (the "Merger"). Accordingly,
the Registrant's Form 10-Q filing included restated financial statements for the
applicable periods. The Company is filing herewith certain financial
information, including restated audited consolidated financial statements of the
Company as of December 31, 1998 and December 31, 1997 and for each of the years
in the three-year period ended December 31, 1998, together with the related
Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company, which are being filed as Exhibit 99.1 to this Form
8-K and are incorporated herein by reference. Also incorporated herein by
reference is the independent accountants' report filed as part of Exhibit 99.1
The consolidated financial statements give retroactive effect to the Merger,
which has been accounted for as a pooling of interests as described in Note 1 to
the consolidated financial statements. Accordingly, the Company has restated the
consolidated financial statements and all financial information to reflect the
combined operations, financial position and cash flows of both companies.
2
<PAGE> 3
Item 7. Financial Statements and Exhibits
(c) Exhibits
Exhibit No. Description of Exhibit
- ----------- ----------------------
12 Computation of Ratio of Earnings to Fixed Charges
23 Consent of Independent Accountants
27.1 Financial Data Schedule
27.2 Financial Data Schedule
27.3 Financial Data Schedule
27.4 Financial Data Schedule
27.5 Financial Data Schedule
27.6 Financial Data Schedule
27.7 Financial Data Schedule
27.8 Financial Data Schedule
27.9 Financial Data Schedule
99.1 Items 6, 7, 7A and 8 of the Form 10-K for the fiscal year ended
December 31, 1998
3
<PAGE> 4
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
PHARMACIA & UPJOHN, INC.
Date: January 24, 2000 By: /s/ Christopher J. Coughlin
---------------------------
Christopher J. Coughlin
Chief Financial Officer
4
<PAGE> 1
EX-12
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
EXHIBIT 12
PHARMACIA & UPJOHN, INC. AND SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(U.S. dollar amounts in millions)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Earnings from continuing
operations before income taxes $ 977 $ 435 $ 818 $1,124 $1,258
Less: Equity in undistributed
net income (loss) of companies
owned less than 50% 58 (32) 5 7 8
------ ----- ----- ------ ------
919 467 813 1,117 1,250
Add:
Amortization of previously
capitalized interest
12 13 11 10 7
Fixed charges included in the above:
Interest and amortization of debt
expense
50 59 83 121 139
Rental expense representative
of an interest factor 28 38 37 35 35
------ ----- ----- ------ ------
Earnings from continuing operations
before income taxes and fixed
charges $1,009 $ 577 $ 944 $1,283 $1,431
====== ===== ===== ====== ======
Interest incurred and amortization
of debt expense $ 86 $ 91 $ 116 $ 150 $ 165
Rental expense representative of an
interest factor 28 38 37 35 35
------ ----- ----- ------ ------
Total fixed charges $ 114 $ 129 $ 153 $ 185 $ 200
====== ===== ===== ====== ======
Ratio of earnings to fixed charges 8.9 4.5 6.2 6.9 7.2
====== ===== ===== ====== ======
</TABLE>
<PAGE> 2
Pharmacia & Upjohn, Inc. and subsidiaries
<TABLE>
<CAPTION>
======================================================================================================================
1998 (UNAUDITED) FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Dollar amounts in millions, except per-share data
Net sales $ 1,586 $ 1,654 $ 1,669 $1,849
Cost of products sold 486 493 516 536
Research and development 285 305 279 365
Selling, general, and administrative 568 702 599 683
Restructuring -- -- -- 92
Interest Income, net (18) (17) (15) (16)
All other, net (3) (34) (22) (3)
- ----------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 268 205 312 192
Provision for income taxes 94 74 108 70
- ----------------------------------------------------------------------------------------------------------------------
Net earnings $ 174 $ 131 $ 204 $ 122
======================================================================================================================
Net earnings per common share:
Basic $ .33 $ .25 $ .39 $ .23
Diluted $ .33 $ .24 $ .38 $ .22
- ----------------------------------------------------------------------------------------------------------------------
Dividends declared per share $ .27 $ .27 $ .27 $ .27
- ----------------------------------------------------------------------------------------------------------------------
Market Price:
High $45.875 $46.688 $51.688 $57.250
Low $33.750 $38.250 $40.438 $44.875
======================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
======================================================================================================================
1997 (UNAUDITED) FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
Dollar amounts in millions, except per-share data
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales $ 1,635 $ 1,703 $ 1,551 $1,697
Cost of products sold 502 550 476 519
Research and development 290 288 275 393
Selling, general, and administrative 601 650 620 771
Restructuring -- -- 125 191
Interest Income, net (23) (15) (20) (22)
All other, net (22) (32) (36) 70
- ----------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 287 262 111 (225)
Provision for income taxes 108 100 49 (80)
- ----------------------------------------------------------------------------------------------------------------------
Net earnings $ 179 $ 162 $ 62 $ (145)
======================================================================================================================
Net earnings per common share:
Basic $ .34 $ .31 $ .11 $ (.29)
Diluted $ .33 $ .30 $ .11 $ (.29)
- ----------------------------------------------------------------------------------------------------------------------
Dividends declared per share $ .27 $ .27 $ .27 $ .27
======================================================================================================================
</TABLE>
<PAGE> 1
Exhibit 23
Consent of Independent Accountants
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-3 (No. 333-82723) and Form S-8 (Nos. 333-03109, 333-74783,
333-74785, 333-76657, 333-76659 and 333-86893) of Pharmacia & Upjohn, Inc. of
our report dated February 10, 1999, except as to Note 1 relating to the pooling
of interests with SUGEN, Inc. which is as of August 31, 1999, which appears in
this Current Report on Form 8-K.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
January 24, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998<F3>
<CASH> 881
<SECURITIES> 0
<RECEIVABLES> 1,520
<ALLOWANCES> 103
<INVENTORY> 1,032
<CURRENT-ASSETS> 4,552
<PP&E> 5,780
<DEPRECIATION> 2,546
<TOTAL-ASSETS> 10,343
<CURRENT-LIABILITIES> 2,875
<BONDS> 295<F1>
0
277
<COMMON> 5
<OTHER-SE> 5,314
<TOTAL-LIABILITY-AND-EQUITY> 10,343
<SALES> 6,758
<TOTAL-REVENUES> 6,758
<CGS> 2,031
<TOTAL-COSTS> 2,031
<OTHER-EXPENSES> 1,234<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 26
<INCOME-PRETAX> 977
<INCOME-TAX> 346
<INCOME-CONTINUING> 631
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 631
<EPS-BASIC> 1.20
<EPS-DILUTED> 1.17
<FN>
<F1>Does not include guarantee of ESOP debt of $218.
<F2>Only includes R&D expense
<F3>Restated for 8/31/99 merger accounted for as a pooling of interests.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998<F3>
<CASH> 1,020
<SECURITIES> 0
<RECEIVABLES> 1,411
<ALLOWANCES> 99
<INVENTORY> 1,005
<CURRENT-ASSETS> 4,369
<PP&E> 6,103
<DEPRECIATION> 2,700
<TOTAL-ASSETS> 10,308
<CURRENT-LIABILITIES> 2,770
<BONDS> 347<F1>
0
278
<COMMON> 5
<OTHER-SE> 5,376
<TOTAL-LIABILITY-AND-EQUITY> 10,308
<SALES> 4,909
<TOTAL-REVENUES> 4,909
<CGS> 1,495
<TOTAL-COSTS> 1,495
<OTHER-EXPENSES> 869<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 18
<INCOME-PRETAX> 785
<INCOME-TAX> 276
<INCOME-CONTINUING> 509
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 509
<EPS-BASIC> 0.97
<EPS-DILUTED> 0.95
<FN>
<F1>Does not include guarantee of ESOP debt of $218.
<F2>Only includes R&D expense
<F3>Restated for 8/31/99 merger accounted for as a pooling of interests.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998<F3>
<CASH> 985
<SECURITIES> 0
<RECEIVABLES> 1,418
<ALLOWANCES> 89
<INVENTORY> 1,000
<CURRENT-ASSETS> 4,502
<PP&E> 5,865
<DEPRECIATION> 2,593
<TOTAL-ASSETS> 10,416
<CURRENT-LIABILITIES> 2,873
<BONDS> 393<F1>
0
279
<COMMON> 5
<OTHER-SE> 5,213
<TOTAL-LIABILITY-AND-EQUITY> 10,416
<SALES> 3,240
<TOTAL-REVENUES> 3,240
<CGS> 979
<TOTAL-COSTS> 979
<OTHER-EXPENSES> 590<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11
<INCOME-PRETAX> 473
<INCOME-TAX> 168
<INCOME-CONTINUING> 305
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 305
<EPS-BASIC> 0.58
<EPS-DILUTED> 0.57
<FN>
<F1>Does not include guarantee of ESOP debt of $218.
<F2>Only includes R&D expense
<F3>Restated for 8/31/99 merger accounted for as a pooling of interests.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998<F3>
<CASH> 831
<SECURITIES> 0
<RECEIVABLES> 1,411
<ALLOWANCES> 90
<INVENTORY> 953
<CURRENT-ASSETS> 4,455
<PP&E> 5,805
<DEPRECIATION> 2,537
<TOTAL-ASSETS> 10,385
<CURRENT-LIABILITIES> 2,798
<BONDS> 401<F1>
0
280
<COMMON> 5
<OTHER-SE> 5,212
<TOTAL-LIABILITY-AND-EQUITY> 10,385
<SALES> 1,586
<TOTAL-REVENUES> 1,586
<CGS> 486
<TOTAL-COSTS> 486
<OTHER-EXPENSES> 285<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7
<INCOME-PRETAX> 268
<INCOME-TAX> 94
<INCOME-CONTINUING> 174
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 174
<EPS-BASIC> 0.33
<EPS-DILUTED> 0.33
<FN>
<F1>Does not include guarantee of ESOP debt of $218
<F2>Only includes R&D expense.
<F3>Restated for 8/31/99 merger accounted for as a pooling of interests.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997<F3>
<CASH> 799
<SECURITIES> 0
<RECEIVABLES> 1,392
<ALLOWANCES> 89
<INVENTORY> 958
<CURRENT-ASSETS> 4,396
<PP&E> 5,831
<DEPRECIATION> 2,521
<TOTAL-ASSETS> 10,457
<CURRENT-LIABILITIES> 2,703
<BONDS> 411<F1>
0
282
<COMMON> 5
<OTHER-SE> 5,291
<TOTAL-LIABILITY-AND-EQUITY> 10,457
<SALES> 6,586
<TOTAL-REVENUES> 6,586
<CGS> 2,047
<TOTAL-COSTS> 2,047
<OTHER-EXPENSES> 1,246<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 33
<INCOME-PRETAX> 435
<INCOME-TAX> 177
<INCOME-CONTINUING> 258
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 258
<EPS-BASIC> .48
<EPS-DILUTED> .48
<FN>
<F1>Does not include guarantee of ESOP debt of $240.
<F2>Only includes R&D expense
<F3>Restated for 8/31/99 merger accounted for as a pooling of interests.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997<F3>
<CASH> 952
<SECURITIES> 0
<RECEIVABLES> 1,440
<ALLOWANCES> 94
<INVENTORY> 962
<CURRENT-ASSETS> 4,544
<PP&E> 5,891
<DEPRECIATION> 2,592
<TOTAL-ASSETS> 10,547
<CURRENT-LIABILITIES> 2,257
<BONDS> 572<F1>
0
283
<COMMON> 5
<OTHER-SE> 5,682
<TOTAL-LIABILITY-AND-EQUITY> 10,547
<SALES> 4,889
<TOTAL-REVENUES> 4,889
<CGS> 1,528
<TOTAL-COSTS> 1,528
<OTHER-EXPENSES> 853<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 25
<INCOME-PRETAX> 660
<INCOME-TAX> 257
<INCOME-CONTINUING> 403
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 403
<EPS-BASIC> .76
<EPS-DILUTED> .74
<FN>
<F1>Does not include guarantee of ESOP debt of $240.
<F2>Only includes R&D expense.
<F3>Restated for 8/31/99 merger accounted for as a pooling of interests.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997<F3>
<CASH> 989
<SECURITIES> 0
<RECEIVABLES> 1,567
<ALLOWANCES> 96
<INVENTORY> 1,016
<CURRENT-ASSETS> 4,731
<PP&E> 6,066
<DEPRECIATION> 2,607
<TOTAL-ASSETS> 10,754
<CURRENT-LIABILITIES> 2,426
<BONDS> 567<F1>
0
284
<COMMON> 5
<OTHER-SE> 5,690
<TOTAL-LIABILITY-AND-EQUITY> 10,754
<SALES> 3,338
<TOTAL-REVENUES> 3,338
<CGS> 1,052
<TOTAL-COSTS> 1,052
<OTHER-EXPENSES> 578<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 18
<INCOME-PRETAX> 549
<INCOME-TAX> 208
<INCOME-CONTINUING> 341
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 341
<EPS-BASIC> .65
<EPS-DILUTED> .63
<FN>
<F1>Does not include guarantee of ESOP debt of $240.
<F2>Only includes R&D expense.
<F3>Restated for 8/31/99 merger accounted for as a pooling of interests.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> MAR-31-1997<F3>
<CASH> 906
<SECURITIES> 0
<RECEIVABLES> 1,673
<ALLOWANCES> 96
<INVENTORY> 1,005
<CURRENT-ASSETS> 4,948
<PP&E> 6,054
<DEPRECIATION> 2,587
<TOTAL-ASSETS> 10,951
<CURRENT-LIABILITIES> 2,546
<BONDS> 568<F1>
0
286
<COMMON> 5
<OTHER-SE> 5,744
<TOTAL-LIABILITY-AND-EQUITY> 10,951
<SALES> 1,635
<TOTAL-REVENUES> 1,635
<CGS> 502
<TOTAL-COSTS> 502
<OTHER-EXPENSES> 290<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7
<INCOME-PRETAX> 287
<INCOME-TAX> 108
<INCOME-CONTINUING> 179
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 179
<EPS-BASIC> .34
<EPS-DILUTED> .33
<FN>
<F1>Does not include guarantee of ESOP debt of $240.
<F2>Only includes R&D expense.
<F3>Restated for 8/31/99 merger accounted for as a pooling of interests.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996<F3>
<CASH> 666
<SECURITIES> 0
<RECEIVABLES> 1,800
<ALLOWANCES> 95
<INVENTORY> 1,012
<CURRENT-ASSETS> 4,976
<PP&E> 6,269
<DEPRECIATION> 2,663
<TOTAL-ASSETS> 11,259
<CURRENT-LIABILITIES> 2,514
<BONDS> 567<F1>
0
287
<COMMON> 5
<OTHER-SE> 6,021
<TOTAL-LIABILITY-AND-EQUITY> 11,259
<SALES> 7,176
<TOTAL-REVENUES> 7,176
<CGS> 2,116
<TOTAL-COSTS> 2,116
<OTHER-EXPENSES> 1,283<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 56
<INCOME-PRETAX> 818
<INCOME-TAX> 268
<INCOME-CONTINUING> 550
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 550
<EPS-BASIC> 1.04
<EPS-DILUTED> 1.03
<FN>
<F1>Does not include guarantee of ESOP debt of $256.
<F2>Only includes R&D expense.
<F3>Restated for 8/31/99 merger accounted for as a pooling of interests.
</FN>
</TABLE>
<PAGE> 1
Exhibit 99.1
ANNUAL REPORT TO SHAREHOLDERS
Financial Review
-----------------------------------------
Pharmacia & Upjohn, Inc. and subsidiaries
OVERVIEW
1998 marked a turnaround year for Pharmacia & Upjohn (the company) with
significant improvement in operating performance compared to the previous year.
Sales growth in the U.S., restructuring of the company, and divestitures of
noncore businesses were key factors driving the 1998 turnaround.
<TABLE>
<CAPTION>
=================================================================================================
% %
CONSOLIDATED RESULTS 1998 CHANGE 1997 CHANGE 1996
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Dollars in millions, except per-share data
Sales $6,758 3 $6,586 (8) $7,176
Earnings before income taxes 977 125 435 (47) 818
Net earnings 631 145 258 (53) 550
Net earnings per common share (EPS):
--Basic $ 1.20 150 .48 (54) 1.04
--Diluted $ 1.17 144 .48 (53) 1.03
=================================================================================================
</TABLE>
The financial impact of the restructuring, divestments, and other strategic
measures described in more detail below need to be considered in the
year-to-year comparison of results. In the following discussion of consolidated
results, per-share amounts are presented on a diluted, after-tax basis.
Restructuring activity since the 1995 merger of The Upjohn Company and Pharmacia
AB reflects the ongoing transformation of the company from two unique operations
into one integrated global enterprise. Restructuring charges were $92 million
($.11 per share) in 1998; $316 million ($.38 per share) in 1997; and $518
million ($.61 per share) in 1996. Restructuring efforts in 1998 and 1997 were
associated with the global turnaround program. This program was undertaken to
achieve simplified infrastructure, improved efficiency, and a global focus on
the core pharmaceutical business. The 1996 restructuring was related primarily
to the merger and included the reduction of 4,350 positions, the elimination of
duplicate facilities, and other activities connected with the merger. In
addition, merger costs of $67 million ($.09 per share) were reported in 1996.
These costs consisted of certain organizational activities, establishing the
corporate identity for the new company, and other costs of combining the two
predecessor companies.
To concentrate resources on the faster-growing, higher-margin
pharmaceutical businesses, management has divested three noncore businesses
since 1996. In 1998, the company sold substantially all of its nutrition
business for a loss of $52 million ($.07 per share). In 1997, the company merged
Pharmacia Biotech, its biotechnology supply business, with Amersham Life Science
creating a new company, Amersham Pharmacia Biotech Ltd., of which Pharmacia &
Upjohn owns 45 percent. In connection with the merger and subsequent
restructuring of Biotech, the company recorded charges of $79 million ($.12 per
share) in 1997. In 1996, management sold 59 percent of the company's holding in
Biacore International AB through an initial public offering and recorded a gain
on the sale of Biacore stock of $55 million ($.08 per share) which was included
in All Other, Net. The ownership structure of Biotech and Biacore changed from
wholly-owned subsidiaries to equity affiliates, further affecting comparability
among years.
The company took additional strategic steps during the last three years
which affected earnings comparability. In 1998, management reached a settlement
of $103 million in a federal class-action lawsuit originally filed in 1993 on
behalf of retail pharmacies. As a consequence of the settlement, the company
increased its litigation reserves by $61 million ($0.08 per share), a charge
reported in selling, general and administrative (SG&A) expense in the second
quarter of 1998. In 1997, the company reacquired sales and marketing rights in
Japan to one of its leading products, GENOTROPIN. The reacquisition and related
inventory repurchase resulted in a charge of $115 million ($.11 per share)
recorded in sales, cost of goods sold, and SG&A expense.
1
<PAGE> 2
Also in that year, the company purchased exclusive worldwide commercialization
rights to a research compound for $35 million ($.04 per share) and terminated
certain future product plans resulting in a charge of $36 million ($.05 per
share). Both charges were reported in research and development (R&D) expense.
Management additionally recognized $70 million ($.09 per share) in
litigation-related charges in 1997 which were recorded in SG&A expense.
Significant events in 1996 included the termination of a product development
agreement with the Biopure Corporation resulting in a charge of $106 million
($.13 per share) recorded in All Other, Net; the sale of an equity interest and
related dissolution of a joint venture resulting in a gain of $46 million ($.06
per share); and the increase in certain environmental and legal reserves of $73
million ($.10 per share), the last two items being reported in SG&A expense. The
company additionally recorded $26 million ($.03 per share) for a contractual
obligation relating to a co-development agreement included in R&D expense.
NET SALES
Excluding the divested Biotech business, sales rose 6 percent in 1998 to $6.7
billion. This increase represented a 7 percent volume growth, a 2 percent net
price increase, and a 3 percent unfavorable currency exchange rate effect. On
the same basis, 1997 sales of $6.3 billion were 6 percent lower than the
previous year. The change represented a 1 percent volume growth, a 1 percent net
price decrease, and a 6 percent negative exchange effect.
As a direct outcome of the company's aggressive U.S. growth strategy,
total sales in the U.S. represented an increasingly larger percentage of
worldwide sales at 37 percent in 1998, up from 33 percent in 1997 and 1996,
excluding Biotech. Despite increasing growth in the U.S. relative to non-U.S.
markets, the company's geographic composition of sales will continue to result
in significant exposure to the fluctuations of exchange rates in both
translation of financial results and the underlying transactions that comprise
the results. The estimated effect of exchange on sales by country in the
following table is based on location of customer.
<TABLE>
<CAPTION>
===================================================================================
% % CHANGE
EXCHANGE EFFECT ON CONSOLIDATED SALES 1998 CHANGE EXCL. FX* 1997
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Dollars in millions
Non-U.S.:
Japan $ 565 (9.6) (2.4) $ 624
Italy 461 0.3 2.6 460
Germany 412 1.6 3.4 405
United Kingdom 352 17.0 16.1 300
Sweden 284 (10.1) (6.3) 317
France 275 8.3 9.8 254
Spain 168 (9.0) (6.9) 185
Rest of world 1,732 0.5 6.5 1,724
United States 2,498 20.0 20.0 2,081
- -----------------------------------------------------------------------------------
Subtotal 6,747 6.3 9.1 6,350
Biotech 11 (95.0) (95.1) 236
- -----------------------------------------------------------------------------------
Total consolidated sales $6,758 2.6 5.4 $6,586
===================================================================================
</TABLE>
* Represents percent change from the prior year excluding the approximate
effects of currency exchange rate fluctuations.
Management reports its operations within two reportable segments: prescription
pharmaceutical and consumer health care, with the remaining operations being
combined in "all other". The prescription pharmaceutical and consumer health
care segments are each comprised of a single operating unit. The "all other"
grouping includes animal health, diagnostics, nutrition, plasma, bulk drugs,
third-party manufacturing and biotechnology. Additional information regarding
segments is provided in Note 21 to the consolidated financial statements. Prior
to 1998, the company reported its operations as a single industry segment. In
the fourth quarter of 1998, the company adopted the Financial Accounting
Standards Board's Statement of Financial Accounting Standards (SFAS) No. 131
which established new standards for defining operating segments.
2
<PAGE> 3
<TABLE>
<CAPTION>
=================================================================================================
% %
SALES BY SEGMENT 1998 CHANGE 1997 CHANGE 1996
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Dollars in millions
Prescription pharmaceuticals $4,752 8.7 $ 4,370 (4.7) $ 4,586
Consumer health care 683 6.5 642 (9.6) 710
All other 1,323 (15.9) 1,574 (16.3) 1,880
- -------------------------------------------------------------------------------------------------
Total consolidated sales $ 6,758 2.6 $ 6,586 (8.2) $ 7,176
=================================================================================================
</TABLE>
The increase in prescription pharmaceutical segment sales in 1998 was due
largely to new prescription product growth in the U.S. and Europe. Although new
product growth was strong in 1997, sales that year were adversely affected by
intense generic competition and year-end 1996 trade inventory accumulations in
the U.S. and across major markets in Europe. In Japan, mandatory price decreases
in each of the last three years, negative exchange effects, and government
restrictions in health care reimbursements have adversely affected prescription
pharmaceutical segment sales.
The increase in sales of the consumer health care segment in 1998 was
driven by a particularly strong growth in sales of the NICORETTE line of
products.
The "all other" grouping accounted for approximately 20 percent of
consolidated sales in 1998, down from 24 percent in 1997 and 26 percent in 1996.
As previously mentioned, sales of Biotech effective August 1997 and Biacore
effective December 1996 are no longer reported in consolidated sales. Biotech
and Biacore transactions are further discussed in Notes 5 and 6 to the
consolidated financial statements. Nutrition sales will be significantly lower
beginning in 1999 with the sale of the majority of the nutrition business to
Fresenius AG in December 1998. To comply with antitrust regulations in Germany,
operations there could not be sold. As of December 31, 1998, the sale of the
operation in China was still pending regulatory approval.
SALES BY PRODUCT
A year-to-year consolidated net sales comparison of the company's top 20
products (including generic equivalents where applicable) is provided in the
table below.
<TABLE>
<CAPTION>
=============================================================================
% %
SALES OF TOP PRODUCTS 1998 CHANGE 1997 CHANGE 1996
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Dollars in millions
GENOTROPIN $ 395 13.1 $ 349 (12.0) $ 397
XALATAN 332 101.6 165 452.7 30
XANAX 321 14.8 279 (20.8) 353
CLEOCIN/DALACIN 314 5.1 299 7.1 279
MEDROL 264 9.4 241 (10.3) 269
DEPO-PROVERA 227 15.8 196 (5.1) 206
NICORETTE 213 26.8 168 (18.7) 207
CAMPTOSAR 193 26.0 154 162.0 59
FRAGMIN 181 9.5 165 10.4 150
PHARMORUBICIN 177 (9.3) 196 (5.8) 208
HEALON 140 (9.3) 155 (17.7) 188
ROGAINE/REGAINE 133 3.2 129 (31.8) 189
DETROL/DETRUSITOL 125 N/A 1 N/A N/A
PROVERA 100 4.9 96 (38.9) 157
AZULFIDINE/SALAZOPYRIN 97 3.2 94 (12.2) 107
NAXCEL/EXCENEL 96 13.2 85 12.9 75
MICRONASE/GLYNASE 91 8.5 84 (50.0) 168
HALCION 88 (5.8) 93 (10.5) 104
CAVERJECT 73 (17.0) 88 26.5 70
SERMION 72 (11.1) 81 (19.1) 101
- -----------------------------------------------------------------------------
Total $3,632 16.5 $3,118 (6.0) $3,317
=============================================================================
</TABLE>
Sales of new products have represented an increasing percentage of total sales
every year since the merger. In 1996 and 1997, the company's portfolio of
largely older
3
<PAGE> 4
products left it vulnerable to generic competition and consequent price erosion.
With a growing percentage of new products making up the sales base, the impact
of patent expirations on sales over the next five years will be very limited.
New product sales growth was led by XALATAN in the U.S. and Europe
during both 1998 and 1997. Introduced in 1996, XALATAN is now the leading
glaucoma treatment worldwide and is sold in 45 countries. Management expects to
launch XALATAN in Japan, the second-largest glaucoma market in the world, late
in 1999. Another successful new product for the company is DETROL (DETRUSITOL
outside the U.S.), a therapy for overactive bladder and its symptoms of urinary
urgency, frequency and urge incontinence. The product targets an underdeveloped
market which is expanding due to direct-to-consumer advertising undertaken by
Pharmacia & Upjohn. DETROL was launched in the U.S. in April 1998 and is
currently available in 22 countries in Europe, North America, and Latin America.
Sales of another promising new product, MIRAPEX, increased $29 million to $49
million in 1998. Since its U.S. launch in mid-1997, MIRAPEX has become the
leading dopamine agonist in the U.S. for the treatment of Parkinson's disease.
The strong 1998 sales performances of NICORETTE and CAMPTOSAR have
established these products as important to the company's future growth. Current
year sales of the NICORETTE line of products to treat tobacco dependency were
led by NICORETTE Gum and the NICORETTE Inhaler in the U.K. and U.S. markets. In
addition, NICORETTE Microtab was launched in Sweden. Sales levels were lower in
1997 compared to 1996 due to the initial establishment of retail inventories for
the 1996 launches of NICORETTE Gum, NICORETTE Nasal Spray, and the NICOTROL
Patch in the United States. CAMPTOSAR was granted full second-line approval by
the U.S. FDA for colorectal cancer in October 1998, two years after the product
was introduced with an accelerated approval. Sales growth of CAMPTOSAR in 1998
was positively impacted by new survival data released earlier in the year. 1997
sales levels reflected the product's initial strong market penetration in the
U.S.
FRAGMIN and GENOTROPIN also are products essential to the company's
top-line growth. New indications and improved delivery systems introduced in
selected countries over the past two years have bolstered demand for FRAGMIN, a
low molecular weight heparin for treating blood clots, deep-vein thrombosis, and
acute unstable coronary artery disease. While sales in both 1998 and 1997 fell
in Japan and France, the largest markets for FRAGMIN, the product experienced
strong growth in the U.S., Germany, and the U.K.
Pharmacia & Upjohn reacquired sales and marketing rights to GENOTROPIN
in Japan, this product's largest market, and assumed control of the product
there during 1998. The company is now able to sell the product directly to its
customers. In the last two years, sales have been adversely affected by the poor
economic climate in Japan, the weak yen, and government-imposed prescribing
restrictions and price decreases. However, continuing expansion into the U.S.
market, the introduction of the new adult indication, and the launch of
GENOTROPIN MiniQuick, a new delivery system, have resulted in strong growth in
the U.S. and Europe since 1996.
Mandatory price decreases in Japan in each of the last three years and
recent government restrictions in health care reimbursements have severely
depressed the pharmaceutical market in that country. These factors in
combination with the weak yen negatively impacted sales of several products for
which Japan is a major market. In addition to the aforementioned GENOTROPIN and
FRAGMIN, products particularly affected in both 1998 and 1997 included HEALON,
PHARMORUBICIN, SERMION, AZULFIDINE/ SALAZOPYRIN, and HALCION. HEALON is a
viscoelastic used in ophthalmic surgery. PHARMORUBICIN is an oncology product.
AZULFIDINE is a treatment for inflammatory bowel disease and rheumatoid
arthritis. SERMION is a treatment for senile dementia and HALCION is a
sleep-inducing agent.
The expansion and revitalization of the U.S. sales force benefited
certain products in 1998 for which loss of patent protection and ensuing generic
competition had led to sales declines over the past several years. These
products included XANAX, a treatment for anxiety; oral anti-diabetes agents
GLYNASE and MICRONASE; PROVERA, a progestational agent; and MEDROL steroid
products. In addition, 1997 sales levels for these products were relatively low
due to the termination of special promotions offered in the previous year and
the resulting effects of year-end 1996 trade inventory accumulations. Generic
price erosion also has affected sales of HALCION, HEALON, and PHARMORUBICIN in
Europe. Competition from generics is expected to continue to adversely affect
future sales of these products.
The U.S. market is very important to several other products including
CAVERJECT, ROGAINE, CLEOCIN, DEPO-PROVERA, and NAXCEL/EXCENEL. Since its launch
in late 1995, CAVERJECT, a treatment for erectile dysfunction, reported strong
sales growth every year until 1998 when intense U.S. competition diminished
sales there. Sales of ROGAINE, a treatment for hereditary hair loss, increased
slightly in 1998; sales levels were lower in 1997 due to the initial
establishment of retail inventories for the U.S. launch in 1996. In 1999,
ROGAINE Professional will be introduced through hair salons to
4
<PAGE> 5
improve distribution and female use of the product. The antibiotic CLEOCIN
achieved sales growth each year since 1996 led by the U.S. market. Sales growth
in 1998 of DEPO-PROVERA, the long-acting injectable contraceptive, also was led
by the U.S. market. In 1997, sales of DEPO-PROVERA fell in the U.S. due to the
termination of special promotions that were offered in the previous year and to
a temporary cutback in promotional spending. NAXCEL/ EXCENEL, an antibiotic for
animals, achieved growth across all major markets during the last three years
led by the United States.
OPERATING COSTS AND EXPENSES
Consolidated operating expenses, stated as a percentage of net sales, are
provided in the table below.
<TABLE>
<CAPTION>
===================================================================
1998 1997 1996
- -------------------------------------------------------------------
<S> <C> <C> <C>
Cost of products sold 30.1% 31.1% 29.5%
Research and development 18.3 18.9 17.9
Selling, general and
Administrative 37.7 40.1 34.2
Merger and restructuring 1.4 4.8 8.1
Interest income (1.4) (1.7) (2.2)
Interest expense 0.4 0.5 0.8
All other, net (0.9) (0.3) 0.4
Earnings before income taxes 14.4 6.6 11.4
====================================================================
</TABLE>
A favorable comparison in product mix and production costs drove cost of
products sold lower as a percentage of sales in 1998 as compared to 1997. New
products, representing an increasing percentage of sales, contributed a higher
gross profit than older products in price competition with generics.
Improvements in production efficiencies, increased production volumes, and the
favorable effect of currency exchange on costs more than offset the negative
currency impact on sales, further reducing the percentage. From 1996 to 1997,
cost of products sold increased as a percentage of sales due to declining sales
levels and rising manufacturing expenses. The unfavorable effects of selling
price erosion, product mix, and currency exchange caused sales levels to
decline. Manufacturing expense increased due to higher production start-up
expenses for new products and project expenses incurred in 1997 to achieve
long-term production efficiencies. The increase in manufacturing expenses was
partially offset by the favorable effects of exchange.
Research and development (R&D) expense decreased as a percentage of
sales from 1997 to 1998. Excluding Biotech and the previously mentioned items
recorded in 1997 (the purchase of rights to a research compound and the
cancellation of future product rights under a research agreement for a total of
$71 million), R&D spending levels increased by 7 percent in 1998. The savings
from lower infrastructure costs in 1998 due to efficiencies generated by the
1997 restructuring were reinvested into strategic licensing agreements, other
R&D collaborations to supplement the company's internal research base, and
increased clinical spending on products in development. Key activities in 1998
included the acquisition of the rights to almotriptan, an anti-migraine
compound; the in-licensing of two new compounds for the treatment of diabetes
and anxiety; and the Hepatitis C virus and pharmacogenomics collaborations.
Spending during 1998 also supported the product filings of anticancer therapies
AROMASIN (exemestane) and epirubicin as well as the development activities
related to filing a New Drug Application for EDRONAX with the U.S. FDA for
depression.
From 1996 to 1997, R&D spending grew as a percentage of sales largely
due to lower 1997 sales levels. Excluding Biotech and certain contract
terminations in both years, R&D expense declined 3 percent in 1997. The ongoing
efforts to focus R&D resources on selected projects contributed to the decline
as did the favorable effects of exchange. In addition, 1996 spending levels were
higher due to spending for 11 significant product filings.
Selling, general and administrative (SG&A) expense as reported declined
as a percentage of sales from 1997 to 1998. Included in the 1998 amount is the
previously mentioned $61 million increase in litigation reserves. In 1997, $95
million for the retrieval of marketing rights to GENOTROPIN in Japan and $70
million for litigation-related charges were expensed in this classification.
Excluding Biotech and the aforementioned specific items, 1998 spending increased
5 percent. The increase was due primarily to sales force expansions and
increased product promotion in the U.S., Europe,
5
<PAGE> 6
and Japan, particularly for the following brands: DETROL, EDRONAX, MIRAPEX,
GENOTROPIN, and XALATAN. The comparative spending increase was somewhat
mitigated by the favorable effects of exchange and a decrease in general and
administrative expense, a consequence of the 1997 restructuring.
From 1996 to 1997, SG&A expense increased as a percentage of sales.
Spending levels in 1997 were higher than 1996 due to increased advertising and
promotion expense for new products; prelaunch and launch activities throughout
the world; sales force expansions in the U.S. and certain Latin American
countries; additional marketing investments in emerging markets; and increased
information technology expenses.
In 1997, the company announced a comprehensive restructuring and
turnaround program that would result in restructuring charges of approximately
$450 million during 1997 and 1998 with anticipated annual cost savings of $250
by 2000. It is anticipated that such savings will be largely reinvested in the
company. The company has structured the turnaround program in two phases
reflecting management development and approval of plans. The turnaround program
was initiated in the third quarter of 1997 and has been scheduled to be
materially completed by December 31, 1999. The objectives of the turnaround
program were to significantly rationalize infrastructure, establish a global
headquarters in New Jersey, and eliminate duplicate resources in manufacturing,
administration, and R&D. The turnaround program mainly affects the company's
core pharmaceutical segments and corporate administration groups, with minor
restructuring of businesses included in the all other grouping. In the third and
fourth quarters of 1997, the company recorded phase one charges totaling $316
million. The second phase of the turnaround program was finalized in the fourth
quarter of 1998, resulting in an additional restructuring charge of $92 million.
Cost savings achieved from implementation of this program will allow the company
to increase investments in areas that directly impact top-line growth.
The charge of $92 million recorded in 1998 was comprised of employee
separation costs of $68 million; write-downs of fixed assets and abandoned
manufacturing projects of $8 million; and other costs of $16 million.
The 1997 restructuring charge of $316 million for the first phase of
the turnaround program primarily related to employee separation costs of $134
million; write-downs of fixed assets and abandoned manufacturing projects of
$162 million; and other costs of $20 million.
The total restructuring charges for 1998 and 1997 included involuntary
employee separation costs for 580 and 1,320 employees worldwide, respectively.
The 1998 charge included elimination of positions in marketing and
administration of $55 million, R&D of $9 million, and manufacturing of $4
million. These amounts included an adjustment of $16 million of the phase one
accruals, mainly attributable to lower employee separation costs and, to a
lesser extent, changes in plan estimates. The 1997 charge included elimination
of positions in marketing and administration of $81 million, R&D of $22 million,
and manufacturing of $31 million. As of December 31, 1998, the company had paid
$101 million in severance costs in connection with the 1998 and 1997 charges.
The remaining balance for employee separation costs related to the turnaround
program was $101 million at December 31, 1998, comprised mainly of charges
related to the phase two charge and remaining annuity separation payments for
the phase one charge. The company expects employee reductions for the 1998 and
1997 charges to be substantially completed by December 31, 1999.
The 1998 and 1997 restructuring charges included asset write-downs for
excess manufacturing, administration, and R&D facilities totaling $8 million and
$162 million, respectively. The 1998 amount included an adjustment of $15
million of the phase one accruals, mainly attributable to changes in plan
estimates, favorable outcomes on sales of facilities, and actual facility
closure costs below the original estimates. At December 31, 1998, facilities
presently being marketed had a net book value of $47 million. Fixed asset
write-downs were based on appraisals less costs to sell.
Other costs included in the 1998 and 1997 restructuring charges of $16
million and $20 million, respectively, were primarily comprised of cancelled
contractual lease obligations and, to a lesser extent, demolition and other
costs. Offsetting 1998 charges in this grouping was an adjustment of $6 million
related to all restructuring charges prior to 1997. The company expects
substantial completion of the 1997-1998 restructuring by December 31, 1999.
As a result of the turnaround restructuring, the company was able to
reinvest the savings achieved into the organization in more strategic ways.
Incremental spending on the sales force and product support was primarily funded
by the savings achieved through the turnaround restructuring. This investment in
the sales force, in conjunction with the efficiencies gained in the turnaround
restructuring, contributed to the sales growth and double-digit earnings growth
achieved by the company in 1998.
In 1996, the company recorded restructuring charges of $518 million
primarily associated with the merger. The charges reflected the elimination of
approximately 3,500
6
<PAGE> 7
positions in marketing and administration ($363 million), R&D ($59 million), and
manufacturing ($31 million); the elimination of duplicate facilities ($43
million); and other exit costs resulting from the merger ($22 million).
Implementation of the restructuring plan was completed by December 31, 1997.
Remaining reserves of $7 million consist of annuity separation payments which
will be paid by the first quarter of 2000. Additional information regarding the
restructurings is provided in Note 3 to the consolidated financial statements.
Merger costs of $67 million also were recorded in 1996. As described earlier,
these charges resulted primarily from the combination of operations.
The company also incurred $41 million in restructuring-related costs in
1998. These costs, expensed as incurred, were not included in restructuring.
These costs were associated with the turnaround program and included relocation
of administrative functions related to the establishment of a new global
headquarters in New Jersey plus registration and validation costs associated
with the company's manufacturing rationalization program in various countries.
OTHER EARNINGS STATEMENT ITEMS
The decline in both interest income and interest expense in 1998 and 1997 was
due largely to lower average interest-bearing assets and liabilities in both
years and to lower interest rates in 1997, mainly in Europe.
From 1997 to 1998, the increase in income in "All Other, Net" was
mainly related to the equity investment in Amersham Pharmacia Biotech. The
company recorded $52 million in 1998 primarily for its share of Amersham
Pharmacia Biotech's pretax earnings, while in 1997, the company recorded Biotech
merger costs of $36 million as well as its portion of the new company's
merger-related restructuring costs of $43 million. The merger costs included
transaction costs to effect the merger and charges associated with the write-off
of acquired R&D. During 1996 and for the first several months of 1997, Biotech
was part of continuing operations, and therefore was not included within All
Other, Net.
In December 1998, the company recorded a $52 million loss in connection
with the sale of the majority of the nutrition business to Fresenius AG. To
comply with regulations in Germany, operations there could not be sold. As of
December 31, 1998, the sale of the operation in China was still pending
regulatory approval.
During 1996, the company recorded a gain on the initial public offering
of stock for Biacore of $55 million in All Other, Net. Of the total gain, $8
million represented the gain on the issuance of new shares. Further information
is presented in Note 5 to the consolidated financial statements. The 1996 All
Other, Net balance also included a charge of $106 million in relation to the
dissolution of a development agreement with Biopure Corporation.
The annual effective tax rate was 35 percent, 41 percent and 33
percent for 1998, 1997 and 1996, respectively. Excluding restructuring charges
and other specifically discussed items (litigation, reacquisition of marketing
rights and Biotech divestment), the rate was 35 percent in 1998, down from 38
percent in 1997 and level with the 1996 adjusted rate of 35 percent. The lower
1998 and 1996 rates were the result of higher earnings in jurisdictions with
lower tax rates.
COMPREHENSIVE INCOME
Effective in 1998, the company adopted SFAS No. 130 which established standards
for reporting comprehensive income and its components. Comprehensive income is
defined as all nonowner changes in equity and equals net earnings plus other
comprehensive income (OCI). For Pharmacia & Upjohn, OCI consists of currency
translation adjustments, unrealized gains and losses on available-for-sale
securities, and minimum pension liability adjustments. Comprehensive income
(loss) in millions for 1998, 1997, and 1996 was $614, $(150) and $410,
respectively. Comprehensive income was less than net earnings in 1998 because
unrealized losses on available-for-sale securities, coupled with the minimum
pension liability adjustments, more than offset favorable currency translation
adjustments (CTA). Favorable CTA reflected the weaker U.S. dollar at December
31, 1998, relative to its general strength at the prior year-end. In 1997 and
1996, the stronger U.S. dollar was responsible for large CTA losses which drove
comprehensive income lower than net income in these years. Additional
information regarding OCI is provided in Note 2 to the consolidated financial
statements.
7
<PAGE> 8
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
<TABLE>
<CAPTION>
===============================================================
As of December 31, 1998 1997 1996
- ---------------------------------------------------------------
<S> <C> <C> <C>
Dollars in millions
Working capital $ 1,677 $1,693 $ 2,462
Current ratio 1.58:1 1.63:1 1.98:1
Debt to total capitalization 13.1% 15.8% 14.3%
===============================================================
</TABLE>
At year-end 1998, the company's working capital and current ratio were generally
consistent with the previous year-end. Both liquidity measures decreased from
1996 to 1997 due to declines in receivables and short-term investments. The
decrease in the percentage of debt to total capitalization from 1997 to 1998
reflects declining debt levels. Despite a modest reduction in debt in 1997, the
percentage of debt to total capitalization increased over 1996 due to a decline
in shareholders' equity. Negative currency translation adjustments recorded in
equity caused much of this decline coupled with lower 1997 earnings levels. As
indicated below, net financial assets have remained relatively constant from
1996 through 1998.
<TABLE>
<CAPTION>
=================================================================
As of December 31, 1998 1997 1996
- -----------------------------------------------------------------
<S> <C> <C> <C>
Dollars in millions
Cash, cash equivalents and
investments $1,710 $1,924 $1,905
Short-term and long-term debt 845 1,052 1,058
- -----------------------------------------------------------------
Net financial assets $ 865 $ 872 $ 847
=================================================================
</TABLE>
Net cash provided by operations is a major source of funds to finance working
capital, shareholder dividends, and capital expenditures. Cash from operations
totaled $903 million in 1998, $1,195 million in 1997, and $785 million in 1996.
The decrease in 1998 was largely attributable to increases in receivables and
inventories. The prior year increase was due to a decrease in receivables and an
increase in liabilities. The increase in liabilities resulted from certain
significant transactions previously discussed including the GENOTROPIN rights
repurchase and the litigation-related accruals. The 1996 operating cash flows
were lower due to large cash expenditures related to the merger and
restructuring and increases in receivables, inventories, and other current
assets.
In addition to net cash provided by operations, two major sources of
cash in 1998 were the proceeds on the sale of the nutrition business of $332
million and the proceeds from sales of investments net of purchases of $292
million, together accounting for a $503 million increase in sources compared to
the prior year. Cash proceeds from employee stock option exercises increased in
1998 because of higher stock market prices.
Over the three-year period from 1996 to 1998, significant uses of cash
included the company's quarterly dividend payment to shareholders and
expenditures for property, plant, and equipment (capital). Capital expenditures
in millions were $650 in 1998, $580 in 1997, and $658 in 1996. Anticipated
capital spending for 1999 of approximately $650 million includes expansion and
improvements to research and manufacturing facilities in the U.S., Belgium,
Puerto Rico, and Sweden.
In November 1998, the company announced a $1 billion stock repurchase
program. Management expects to complete the program over a two-year period. In
January 1999, the company repurchased 1.8 million shares for approximately $100
million. In connection with the pooling of interests with Sugen, the company
rescinded the repurchase program in August 1999.
The company's future cash provided by operations and borrowing capacity
are expected to cover normal operating cash flow needs, planned capital
spending, dividend payments, and stock repurchases that may be approved by the
board of directors for the foreseeable future. As of December 31, 1998, lines of
credit available for company use totaled $1,073 million, of which $500 million
are committed and $27 million were used as of year end. The company had A-1+ and
P-1 ratings for its commercial paper and AA- and A1 general bond ratings from
Standard & Poor's and Moody's, respectively, as of December 31, 1998.
8
<PAGE> 9
The company utilizes currency exchange forward and option contracts
according to established policies to mitigate the effect of currency exchange
rate fluctuations. Because currency exchange forward and option contracts used
to hedge anticipated transaction exposures are marked to market each period, but
only some of the underlying transactions have been recorded, the timing of
recognition of the related gains and losses may not match. Gains and losses from
contracts related to hedges for product shipments are recognized as "Cost of
Products Sold" and are included in the operating section of the statement of
cash flows. Gains and losses from currency exchange forward and option contracts
related to hedges on other activities are recognized as "All Other, Net," and
are included in the investment section of the statement of cash flows. Further
information is presented in Note 14 to the consolidated financial statements and
in the market risk sensitivity analysis that follows.
MARKET RISK
Market risk represents the risk of a change in the value of a financial
instrument, derivative or nonderivative, caused by fluctuations in interest
rates, currency exchange rates, and equity prices. The company handles market
risk in accordance with established policies and thereby enters into various
derivative transactions. No such transactions are entered into for trading
purposes.
Because the company's cash and investments exceed short and long-term
debt, the exposure to interest-rate risk relates primarily to the investment
portfolios. Most of the investments in the long-term portfolio are at fixed
rates. The company is actively managing the investment portfolios to increase
its return on investment, but in order to ensure liquidity, will only invest in
instruments with high credit quality where a secondary market exists. The
company holds no derivatives related to its interest-rate exposure; is in a
position to keep all investments until final maturity; and maintains long-term
debt at fixed rates.
The following sensitivity analysis presents the hypothetical change in
fair value of those financial instruments held by the company at December 31,
1998, which are sensitive to changes in interest rates. Market risk is estimated
as the potential change in fair value resulting from an immediate hypothetical
one percentage point parallel shift in the yield curve. The fair values of the
company's investments and loans are based on quoted market prices or discounted
future cash flows. As the carrying amounts on short-term loans and investments
maturing in less than 180 days approximate the fair value, these are not
included in the sensitivity analysis. The fair value of investments over 180
days is $411 million. The fair value of debt included in the analysis is $389
million and excludes Employee Stock Ownership Plan (ESOP) guaranteed debt.
Although not expected, a one percentage point change in the interest rates would
change the fair value of investments over 180 days by $6 million and debt by $3
million.
The company's management of currency exposure is primarily focused on
reducing the negative impact of currency fluctuations on consolidated cash flow
and earnings. The company uses forward contracts, cross-currency swaps, and
currency options to actively manage the net exposure in accordance with
established hedging policies. The company hedges intercompany loans and deposits
as well as a portion of both firm commitments and anticipated transactions. The
company has concentrated most of the currency exposure in facilities in Sweden,
Italy and Belgium. The largest exposures from these units are against the
Japanese yen and the U.S. dollar.
Certain derivatives entered into in order to hedge assets, liabilities,
firm commitments, and forecasted transactions are exposed to currency
fluctuations. A ten percent decrease in the Swedish krona and Italian lira would
have a negative impact on fair value of those derivatives by $23 million and $6
million, respectively; a ten percent increase in the Japanese yen would have a
negative impact of $13 million; and a ten percent decrease in the U.S. dollar
would have a negative impact of $6 million.
The company also has investments in equity securities. All such
investments are classified as long term investments. The fair market value of
these investments is $170 million, of which 60 percent are listed on a stock
exchange or quoted in an over-the-counter market. If the market price of these
securities would decrease by ten percent, the fair value of the equities would
decrease by $10 million. Further discussion of financial instruments is provided
in Notes 9 and 15 to the consolidated financial statements.
LITIGATION AND CONTINGENT LIABILITIES
Various suits and claims arising in the ordinary course of business, primarily
for personal injury alleged to have been caused by the use of the company's
products, are pending against the company and its subsidiaries. The company also
is involved in several administrative and judicial proceedings relating to
environmental concerns, including actions brought by the U.S. Environmental
Protection Agency (EPA) and state environmental agencies for remedial clean-up
at approximately 50 sites.
9
<PAGE> 10
Based on information currently available and the company's experience
with lawsuits of the nature of those currently filed or anticipated to be filed
which have resulted from business activities to date, the amounts accrued for
product and environmental liabilities are considered adequate. Although the
company cannot predict and cannot make assurances with respect to the outcome of
individual lawsuits, the ultimate liability should not have a material effect on
its consolidated financial position. Unless there is a significant deviation
from the historical pattern of resolution of such issues, the ultimate liability
should not have a material adverse effect on the company's consolidated
financial position, its results of operations, or liquidity.
The company has been a party, along with many other U.S. drug
manufacturers and wholesalers, in numerous related federal and state civil
antitrust lawsuits brought by U.S. independent and chain retail pharmacies and
consumers. These suits claim violations of antitrust and pricing laws as a
result of the defendants providing discounts and rebates to allegedly favor
managed care customers that were not offered to the plaintiffs. Several of the
suits are class actions. The company announced in 1998 that it has reached a
settlement with plaintiffs in the federal class action cases that had been
consolidated in federal court in Chicago, Illinois. The company believes that
any potential remaining liability above amounts accrued will not have a material
adverse effect on the company's consolidated financial position, its results of
operations, or liquidity. Further discussion of current litigation matters is
provided in Note 13 to the consolidated financial statements.
The company's estimate of the ultimate cost to be incurred in
connection with environmental situations could change due to uncertainties at
many sites with respect to potential clean-up remedies, the estimated cost of
clean-up, and the company's share of a site's cost. With regard to the company's
discontinued industrial chemical facility in North Haven, Connecticut, the
company may soon be required to submit a corrective measures study report to the
EPA. As the corrective action process progresses, it may become appropriate to
reevaluate the existing reserves designated for remediation in light of changing
circumstances. It is reasonably possible that a material increase in accrued
liabilities will be required. It is not possible, however, to estimate a range
of potential losses. Accordingly, it is not possible to determine what, if any,
exposure exists at this time or when the expenditures might be made.
In 1997, the company adopted American Institute of Certified Public
Accountants' Statement of Position (SOP) 96-1, "Environmental Remediation
Liabilities." SOP 96-1 provides additional guidance for recognizing, measuring
and disclosing environmental remediation liabilities. The effect of initially
applying the provisions of SOP 96-1 was not material to the consolidated
financial statements. The company's estimated liability includes both direct and
indirect costs associated with remediation and is reduced to reflect the
anticipated participation of other potentially responsible parties where such
parties are considered solvent and it is probable that they will pay their
respective share of relevant costs. Such accruals are adjusted as further
information develops or circumstances change. Costs of future expenditures do
not reflect any claims for recoveries and are not discounted to their present
value.
YEAR 2000
DATE RECOGNITION PROBLEM
The company's global program to address the year 2000 (Y2K) date recognition
problem was launched in early 1997. The goal of the program is to ensure the
millennium event does not have a material adverse effect on the company's
business operations. The project, managed by a global team consisting of
technical, functional and business leaders, is led by a program director who
reports to the chief information officer (CIO) and an executive operations
group. Hundreds of employees worldwide are involved in this effort.
The program encompasses three distinct efforts: (1) assessment and
remediation of information technology (IT) systems; (2) assessment and
remediation of embedded systems; and (3) assessment of high-level business risks
and development of contingency plans to address those risks. Status reports of
the global program's progress have been regularly provided to the company's
board of directors since the inception of the program. Assessment, remediation,
and testing of both IT and embedded systems have been completed for most
business-critical systems and are expected to be finished by mid-1999 for
remaining systems. With all systems anticipated to be individually tested by
mid-1999, the latter half of the year is reserved for integration testing, a
more comprehensive exercise to ensure critical systems will work together. The
high-level business risk assessment is completed and development of the
resulting contingency plans are well underway, especially for those plans
involving steps to be taken during 1999.
Much of the Y2K effort is being supported by a reallocation of existing
resources. The company anticipates total spending of $150 million between 1997
and 2000 largely on replacement of applications that, for reasons other than Y2K
non-compliance,
10
<PAGE> 11
had been previously selected for replacement. Many of the replacement
applications, such as the new SAP financial systems, offer improved
functionality and commonality over predecessor systems and, at the same time,
resolve the Y2K problem. To date, the company estimates actual spending of $110
million of the total projected costs.
There are many factors beyond the company's control that could cause
the Y2K problem to seriously disrupt operations and the company can provide no
assurance that these factors will not cause it to experience business
disruptions. For example, a widespread failure in the utilities industry could
severely interrupt or even halt the company's operations. There are other risks,
however, for which the company may prepare and, in so doing, reduce its
exposure. These risks include a disruption in the supply of product with
particular emphasis on failures of raw material suppliers, third-party
manufacturers, and external distribution channels; internal infrastructure
failures such as utilities, communications, internal IT services and integrated
IT systems; non-U.S. government failures, especially as they impact import and
export activity; and major customer failures or interruptions. The scope of the
company's efforts regarding these risks is focused on key products, key markets,
critical suppliers, and major customers.
To reduce the impact of these failures were they to occur, the company
is developing contingency plans for the most critical business processes. These
plans represent a diversity of approaches and include maintaining higher
inventory levels, developing secondary sources for strategic product chain
links, and documenting back-up procedures and manual work-arounds. The ongoing
assessment of critical external partners also plays an important role in
contingency planning with appropriate actions mapped out at predetermined
decision points depending on the outcome. The company is in the process of
sending questionnaires to all major suppliers, third-party manufacturers, and
customers and auditing critical suppliers and third-party manufacturers in an
attempt to calculate, to the extent possible, where the company faces the
greatest risk of failure. In addition, management will implement a company-wide
program to strictly control and limit changes to major IT systems during the
latter half of 1999 to reduce potential additional exposures and to concentrate
IT resources on integration testing and other Y2K-related efforts. Neither this
program nor the previously mentioned reallocation of resources will have an
adverse effect on non-Y2K mission-critical projects. Barring critical failures
arising from factors beyond the company's direct control, management believes
that by meeting the objectives of its Y2K program, the date recognition problem
should not have a material adverse effect on the company's consolidated
financial position, its results of operations, or liquidity.
OTHER INFORMATION
Effective January 1, 1999, several European countries began operating with a new
common currency, the euro. The euro will completely replace these countries'
national currencies by January 1, 2002. The conversion to the euro will require
changes in the company's operations as systems and commercial arrangements are
modified to deal with the new currency. Management created a project team to
evaluate the impact of the euro conversion on the company's operations and to
develop and execute action plans, as necessary, to successfully effect the
change. The cost of this effort is not expected to be material. While
information technology systems are planned to be fully euro-compliant by the
year 2000, a minimum of euro-compliance for strategic locations will be achieved
in 1999. The conversion to the euro may have competitive implications on pricing
and marketing strategies; however, any such impact is not known at this time.
The introduction of the euro will not significantly change the currency exposure
of the company, but will reduce the number of transactions performed in the
market. At this point in its overall assessment, management believes the impact
of the euro conversion on the company will not be significant; however,
uncertainty exists as to the effects the euro currency will have on the
marketplace. As a result, there is no guarantee that all problems will be
foreseen and corrected, or that no material disruption of the company's business
will occur.
In 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
requires companies to record derivatives on the balance sheet as assets and
liabilities measured at fair value. The accounting treatment of gains and losses
resulting from changes in the value of derivatives depends on the use of the
derivative and whether it qualifies for hedge accounting. The company will adopt
SFAS No.133 as required no later than January 1, 2000, and is currently
assessing the impact of adoption on its financial position, results of
operations, and liquidity.
In 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up
Activities," which requires start-up costs and organization costs to be expensed
as incurred. The SOP is effective beginning in 1999 and will be adopted by the
company at that time. Management does not anticipate its impact to be material
to the consolidated financial statements. The AICPA also issued SOP 98-1,
"Accounting for the Costs of
11
<PAGE> 12
Computer Software Developed or Obtained for Internal Use" in 1998 which the
company adopted. The statement requires capitalization of certain costs incurred
in the development of internal-use software, including external direct material
and service costs, employee payroll and payroll-related costs, and capitalized
interest. Prior to adoption of SOP 98-1, the company expensed these costs as
incurred. The effect of initially applying the provisions of SOP 98-1 was not
material to the consolidated financial statements.
FORWARD-LOOKING INFORMATION
Many matters discussed in this annual report are forward-looking statements that
involve risks and uncertainties, including but not limited to economic,
competitive, governmental and technological factors affecting the company's
operations, markets, products, services and prices, and other factors more
specifically discussed in the company's filings with the Securities and Exchange
Commission.
SELECTED FINANCIAL DATA
In the third quarter of 1999, the company merged with SUGEN, Inc., a drug
discovery and development company. The merger was accounted for as a pooling of
interests under U.S. generally accepted accounting principles. All data prior to
this date, except dividends, have been restated to reflect the combined
operations of the two companies as if they had been merged during all prior
periods.
<TABLE>
<CAPTION>
=========================================================================================================================
YEARS ENDED DECEMBER 31 1998 1997 1996 1995(a) 1994(a)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Dollar amounts in millions, except per-share data
Net sales $ 6,758 $ 6,586 $ 7,176 $ 6,949 $ 6,704
Earnings from continuing operations 631 258 550 733 824
Total assets 10,343 10,457 11,259 11,536 10,984
Long-term debt 295 411 567 603 678
Diluted earnings per share from continuing operations $ 1.17 .48 1.03 1.39 1.57
Dividends declared per share(b) $ 1.08 $ 1.08 $ 1.08 $ .27 --
=========================================================================================================================
</TABLE>
(a) Pharmacia & Upjohn was formed through the 1995 merger of Pharmacia AB and
The Upjohn Company. The merger was accounted for as a pooling of interests
under U.S. generally accepted accounting principles. All data (except
dividends) prior to the November 1995 merger date have been combined as if
the companies had been merged during the prior periods.
(b) Information provided related to dividends declared is the historical
information for Pharmacia & Upjohn. SUGEN had no dividend history and
separate dividend information for Pharmacia AB and The Upjohn Company prior
to their merger has not been presented because the information would not be
meaningful.
12
<PAGE> 13
Report of Independent Accountants
to the Shareholders and Board of Directors, Pharmacia & Upjohn, Inc.
In our opinion, the consolidated balance sheets and the related consolidated
statements of earnings, shareholders' equity, and cash flows (pages 14 TO 37)
present fairly, in all material respects, the financial position of Pharmacia &
Upjohn, Inc. and its subsidiaries at December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of Pharmacia &
Upjohn, Inc. management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
February 10, 1999, except as to Note 1 relating to the pooling of interests with
SUGEN, Inc. which is as of August 31, 1999
13
<PAGE> 14
Consolidated Statements of Earnings
-----------------------------------------
Pharmacia & Upjohn, Inc. and subsidiaries
<TABLE>
<CAPTION>
======================================================================================================================
FOR THE YEARS ENDED DECEMBER 31 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Dollar amounts in millions, except per-share data
Net sales $6,758 $6,586 $7,176
Cost of products sold 2,031 2,047 2,116
Research and development 1,234 1,246 1,283
Selling, general and administrative 2,552 2,642 2,453
Merger and Restructuring 92 316 585
Interest Income (92) (113) (161)
Interest Expense 26 33 56
All other, net (62) (20) 26
- ----------------------------------------------------------------------------------------------------------------------
EARNINGS BEFORE INCOME TAXES 977 435 818
Provision for income taxes 346 177 268
- ----------------------------------------------------------------------------------------------------------------------
NET EARNINGS $ 631 $ 258 $ 550
- ----------------------------------------------------------------------------------------------------------------------
Earnings per common share:
Basic $1.20 $ .48 $1.04
Diluted $1.17 $ .48 $1.03
======================================================================================================================
</TABLE>
Consolidated results for all periods presented have been restated retroactively
for the effects of the August 1999 merger with SUGEN accounted for as a pooling
of interests. See Note 1.
The accompanying notes are an integral part of the consolidated financial
statements.
14
<PAGE> 15
Consolidated Balance Sheets
-----------------------------------------
Pharmacia & Upjohn, Inc. and subsidiaries
<TABLE>
<CAPTION>
======================================================================================================================
DECEMBER 31 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Dollar amounts in millions
CURRENT ASSETS:
Cash and cash equivalents $ 881 $ 799
Short-term investments 375 591
Trade accounts receivable, less allowance of $103 (1997: $89) 1,417 1,303
Inventories 1,032 958
Deferred income taxes 378 327
Other 469 418
- ----------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 4,552 4,396
Long-term investments 454 534
Properties, net 3,234 3,310
Goodwill and other intangible assets, net 1,238 1,287
Other noncurrent assets 865 930
- ----------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $10,343 $10,457
======================================================================================================================
CURRENT LIABILITIES:
Short-term debt $ 332 $ 401
Accounts payable 511 427
Compensation and compensated absences 268 188
Dividends payable 141 141
Income taxes payable 389 404
Other 1,234 1,142
- ----------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 2,875 2,703
Long-term debt 295 411
Guarantee of ESOP debt 218 240
Postretirement benefit cost 344 337
Deferred income taxes 238 362
Other noncurrent liabilities 777 826
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 4,747 4,879
======================================================================================================================
SHAREHOLDERS' EQUITY:
Preferred stock, one cent par value; authorized 100,000,000 shares, issued
Series A convertible 6,863 shares at stated value (1997: 6,996 shares) 277 282
Common stock, one cent par value; authorized 1,500,000,000 shares,
issued 518,797,031 shares (1997: 517,971,090 shares) 5 5
Capital in excess of par value 1,531 1,579
Retained earnings 5,334 5,265
ESOP-related accounts (254) (260)
Treasury stock (35) (48)
Accumulated other comprehensive income:
Currency translation adjustments (1,246) (1,298)
Unrealized investment gains, net 5 53
Minimum pension liability adjustment (21) --
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 5,596 5,578
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $10,343 $10,457
======================================================================================================================
</TABLE>
Consolidated financial position for all periods presented has been restated
retroactively for the effects of the August 1999 merger with SUGEN accounted for
as a pooling of interests. See Note 1.
The accompanying notes are an integral part of the consolidated financial
statements.
15
<PAGE> 16
Consolidated Statements of Shareholders' Equity
-----------------------------------------
Pharmacia & Upjohn, Inc. and subsidiaries
<TABLE>
<CAPTION>
======================================================================================================================
FOR THE YEARS ENDED DECEMBER 31 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Dollar amounts in millions
PREFERRED STOCK:
Balance at beginning of year $ 282 $ 287 $ 291
Redemptions and conversions (5) (5) (4)
- ----------------------------------------------------------------------------------------------------------------------
Balance at end of year 277 282 287
- ----------------------------------------------------------------------------------------------------------------------
COMMON STOCK:
Balance at end of year 5 5 5
- ----------------------------------------------------------------------------------------------------------------------
CAPITAL IN EXCESS OF PAR VALUE:
Balance at beginning of year 1,579 1,563 1,539
Stock option, incentive and dividend reinvestment plans (56) (20) 12
Offering to the public, net of issuance costs of $2 and $2, respectively -- 30 23
Debt converted to equity with conversions of senior custom convertible notes 10 -- --
Retirements, conversions and other (2) 6 (11)
- ----------------------------------------------------------------------------------------------------------------------
Balance at end of year 1,531 1,579 1,563
- ----------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS:
Balance at beginning of year 5,265 5,569 5,581
Net earnings 631 258 550
Dividends declared (549) (549) (549)
Dividends on preferred stock (net of tax) (13) (13) (13)
- ----------------------------------------------------------------------------------------------------------------------
Balance at end of year 5,334 5,265 5,569
- ----------------------------------------------------------------------------------------------------------------------
ESOP-RELATED ACCOUNTS:
Balance at beginning of year (260) (266) (272)
Third-party debt repayment 16 11 8
ESOP expense exceeding cash contributed (2) 5 --
Additional loan (5) (7) --
Rollover of interest on ESOP note receivable (3) (3) (2)
- ----------------------------------------------------------------------------------------------------------------------
Balance at end of year (254) (260) (266)
- ----------------------------------------------------------------------------------------------------------------------
TREASURY STOCK:
Balance at beginning of year (48) (8) (18)
Stock options and incentive plans 130 54 103
Purchases of treasury stock (117) (94) (93)
- ----------------------------------------------------------------------------------------------------------------------
Balance at end of year (35) (48) (8)
- ----------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME:
Balance at beginning of year (1,245) (837) (697)
Other comprehensive loss (17) (408) (140)
- ----------------------------------------------------------------------------------------------------------------------
Balance at end of year (1,262) (1,245) (837)
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY $ 5,596 $ 5,578 $6,313
======================================================================================================================
COMPREHENSIVE INCOME (NET OF TAX):
Currency translation adjustments $ 52 $ (443) $ (127)
Unrealized investment gains (losses) (48) 35 (13)
Minimum pension liability adjustments (21) -- --
- ----------------------------------------------------------------------------------------------------------------------
Other comprehensive loss (17) (408) (140)
Net earnings 631 258 550
- ----------------------------------------------------------------------------------------------------------------------
TOTAL COMPREHENSIVE INCOME (LOSS) $ 614 $ (150) $ 410
======================================================================================================================
</TABLE>
Consolidated results for all periods presented have been restated retroactively
for the effects of the August 1999 merger with SUGEN accounted for as a pooling
of interests. See Note 1.
The accompanying notes are an integral part of the consolidated financial
statements.
16
<PAGE> 17
Consolidated Statements of Cash Flows
-----------------------------------------
Pharmacia & Upjohn, Inc. and subsidiaries
<TABLE>
<CAPTION>
======================================================================================================================
FOR THE YEARS ENDED DECEMBER 31 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Dollar amounts in millions
CASH FLOWS FROM OPERATIONS:
Net earnings $ 631 $ 258 $ 550
Adjustments to net earnings:
Depreciation 321 327 345
Amortization of intangibles 112 116 130
Restructuring 92 316 518
Cash expended on restructurings (140) (132) (344)
Loss on sale of nutrition 52 -- --
Net gains on sales of noncurrent assets 20 (35) (79)
Write-downs of investments, properties and intangibles 9 43 106
Deferred income taxes (153) (254) (102)
Net (earnings) loss from equity investments (57) 68 (5)
Other 11 17 (4)
Changes in:
Accounts receivable (net) (65) 196 (218)
Inventories (91) (127) (69)
Accounts payable 69 33 (25)
Income taxes payable (16) 107 52
Other current and noncurrent assets and liabilities 108 262 (70)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by operations 903 1,195 785
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS (REQUIRED) PROVIDED BY INVESTMENT ACTIVITIES:
Additions of properties (650) (580) (658)
Proceeds from sales of properties 37 70 50
Proceeds from sale of nutrition 332 -- --
Purchases of investments (691) (1,034) (1,578)
Proceeds from sales of investments 983 1,155 2,146
Other (3) (48) (6)
- ----------------------------------------------------------------------------------------------------------------------
Net cash required by investment activities 8 (437) (46)
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS (REQUIRED) PROVIDED BY FINANCING ACTIVITIES:
Proceeds from issuance of debt 60 58 38
Repayment of debt and ESOP guaranteed loan (243) (72) (410)
Net increase (decrease) in debt with initial maturity of 90 days or less (3) 26 33
Dividend payments (566) (567) (567)
Purchases of treasury stock (117) (95) (95)
Proceeds from stock options exercises 80 18 83
Proceeds from issuance of common stock, net 4 31 27
Other 3 2 (4)
- ----------------------------------------------------------------------------------------------------------------------
Net cash required by financing activities (782) (599) (895)
- ----------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash (47) (26) (27)
- ----------------------------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents 82 133 (183)
Cash and cash equivalents, beginning of year 799 666 849
- ----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 881 $ 799 $ 666
======================================================================================================================
Cash paid during the year for:
Interest (net of amounts capitalized) $ 22 $ 30 $ 61
Income taxes $ 398 $ 281 $ 287
Noncash investing activity:
Assets disposed of in exchange for equity securities $ 54 $ -- $ --
======================================================================================================================
</TABLE>
Consolidated results for all periods presented have been restated retroactively
for the effects of the August 1999 merger with SUGEN accounted for as a pooling
of interests. See Note 1.
The accompanying notes are an integral part of the consolidated financial
statements.
17
<PAGE> 18
Notes to Consolidated Financial Statements
Dollar amounts in millions, except per-share data
1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements are presented on the basis of accounting
principles that are generally accepted in the United States. All professional
accounting standards that are effective as of December 31, 1998, have been taken
into consideration in preparing the financial statements. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make certain estimates and assumptions which affect the
reported earnings, financial position and various disclosures. Actual results
could differ from those estimates.
On August 31, 1999, the company completed its merger with SUGEN, Inc.
(Sugen) by exchanging approximately 10 million shares of its common stock for
all of the common stock of Sugen. Each share of Sugen common stock was exchanged
for .6091 of one share of Pharmacia & Upjohn (P&U) common stock. In addition,
terms on outstanding Sugen stock options, stock warrants, convertible debt, and
warrants on convertible debt were changed to convert Sugen shares to P&U shares
using the same exchange ratio.
The merger, a tax-free reorganization, was accounted for as a pooling
of interests under APB Opinion No. 16. As a result, all prior period
consolidated financial statements presented have been restated to include the
combined results of operations, financial position, and cash flows of both
companies as if Sugen had always been a part of P&U. There were no transactions
between P&U and Sugen prior to the combination. Immaterial reclassifications
were recorded to conform Sugen's financial statements to P&U's presentation.
The combined net sales of the company for the years ended 1998, 1997
and 1996 totaled $6,758, $6,586 and $7,176, respectively. These amounts
represent P&U's sales for the respective periods as Sugen did not have any sales
for these periods. The combined net income for the same periods equaled $631,
$258 and $550, respectively. These amounts represent P&U's net income of $691,
$323 and $562 for the respective periods combined with Sugen's net losses of
$40, $33 and $20. An adjustment was made in each year to reflect the tax benefit
of Sugen's net operating loss as if the companies had been combined for all
periods presented.
Principles of Consolidation
The consolidated financial statements include the accounts of the company and
all majority-owned subsidiaries. All material intercompany transactions and
balances have been eliminated in consolidation. Investments in affiliates which
are not majority owned are reported using the equity method and are recorded in
other noncurrent assets. Gains and losses resulting from the issuance of
subsidiaries' stock are recognized in consolidated earnings.
Currency Translation
The results of operations for non-U.S. subsidiaries, other than those located in
highly inflationary countries, are translated into U.S. dollars using the
average exchange rates during the year, while assets and liabilities are
translated using period-end rates. Resulting translation adjustments are
recorded as currency translation adjustments in shareholders' equity. For
subsidiaries in highly inflationary countries, currency gains and losses
resulting from translation and transactions are determined using a combination
of current and historical rates and are reported directly in the consolidated
statements of earnings.
Cash Equivalents
The company considers all highly liquid debt instruments with an original
maturity of 91 days or less to be cash equivalents.
Investments
In addition to cash equivalents, the company has investments in debt securities
that are classified in the consolidated balance sheet as short-term (restricted
bank deposits and securities that mature in more than 91 days but not more than
one year and securities with maturities beyond one year which management intends
to sell within one year) or long-term (maturities beyond one year). The company
also has investments in equity securities, all of which are classified as
long-term investments.
Investments are further categorized as being available for sale or
expected to be held to maturity. Investments categorized as available-for-sale
are marked to market based on fluctuations in the market values of the
securities, with the resulting
18
<PAGE> 19
adjustments, net of deferred taxes, reported as a component of other
comprehensive income in shareholder's equity until realized (see Note 2).
Investments categorized as held-to-maturity are carried at amortized cost,
without recognition of gains or losses that are deemed to be temporary, because
the company has both the intent and the ability to hold these investments until
they mature.
Inventories
Inventories are valued at the lower of cost or market. Cost is determined by the
last-in, first-out (LIFO) method for substantially all U.S. inventories and the
first-in, first-out (FIFO) method for substantially all non-U.S.
inventories.
Properties
Property, plant and equipment are recorded at acquisition cost. Depreciation is
computed principally on the straight-line method for financial reporting
purposes, while accelerated methods are used for income tax purposes where
permitted. Maintenance and repair costs are charged to earnings as incurred
including repair costs associated with the year 2000 date recognition problem.
Costs of renewals and improvements are capitalized. Upon retirement or other
disposition of property, any gain or loss is included in earnings.
Consistent with prior years, purchased computer software is capitalized
and amortized over the software's useful life. Effective in 1998,
internally-developed software is also capitalized and amortized over its useful
life with the adoption of the American Institute of Certified Public
Accountants' (AICPA) Statement of Position (SOP) 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." Prior to adoption,
the company expensed these costs as incurred. The effect of initially applying
the provisions of SOP 98-1 was not material to the consolidated financial
statements.
Goodwill and Other Intangibles
Goodwill represents the excess of the purchase cost over the fair value of net
assets acquired in a business or product acquisition and is presented net of
accumulated amortization. Amortization of goodwill is recorded on a
straight-line basis over periods ranging primarily from 5 to 20 years. The
company assesses the recoverability of goodwill when events or changes in
circumstances indicate that the carrying amount may be impaired. If an
impairment indicator exists, an estimate of future cash flows is developed and
compared to the carrying amount of the goodwill. If the expected undiscounted
cash flows are less than the carrying amount of the goodwill, an impairment loss
is recognized for the difference between the carrying amount of the goodwill and
discounted cash flows.
Rights acquired under patent are reported at acquisition cost.
Amortization is calculated on a straight-line basis over the remaining legal
lives of the patents. Other intangible assets are amortized over the useful
lives of those assets.
Product Liability
The company is self-insured for product liability exposures up to reasonable
risk retention levels where excess coverages have been obtained. Liability
calculations take into account such factors as specific claim amounts, past
experience with such claims, number of claims reported and estimates of claims
incurred but not yet reported. In addition to this base level of reserves,
individually significant contingent losses are accrued for in compliance with
applicable guidance. Product liability accruals are not reduced for expected
insurance recoveries.
Income Taxes
The company applies an asset and liability approach to accounting for income
taxes. Deferred tax liabilities and assets are recognized for the expected
future tax consequences of temporary differences between the financial statement
and tax bases of assets and liabilities using enacted tax rates in effect for
the years in which the differences are expected to reverse. The company records
deferred income taxes on subsidiaries' earnings that are not considered to be
permanently invested in those subsidiaries.
Currency Exchange Contracts
Forward currency exchange contracts, cross-currency interest-rate swaps, and
currency options (hereafter referred to as contracts) are held for purposes
other than trading. Contracts held to hedge anticipated transactions are marked
to market at each balance sheet date with resulting gains and losses recognized
in earnings. Contracts that hedge recorded assets and liabilities are valued at
the month-end exchange rate with resulting exchange gains and losses recognized
in earnings, offsetting the respective losses and
19
<PAGE> 20
gains recognized on the underlying recorded exposure. Any premium or discount is
amortized over the life of the contract. The carrying values of all contracts
are generally reported with other current assets or other current liabilities.
Gains or losses from currency transactions that are designated as hedges of
currency net investments are classified as currency translation adjustments in
shareholders' equity.
In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires companies to record
derivatives on the balance sheet as assets and liabilities measured at fair
value. The accounting treatment of gains and losses resulting from changes in
the value of derivatives depends on the use of the derivative and whether it
qualifies for hedge accounting. The company will adopt SFAS No. 133 as required
no later than January 1, 2000, and is currently assessing the impact of adoption
on its consolidated financial statements.
Environmental Remediation Liabilities
In 1997, the company adopted SOP 96-1, "Environmental Remediation Liabilities,"
which provides additional guidance for recognizing, measuring and disclosing
environmental remediation liabilities. The effect of initially applying the
provisions of SOP 96-1 was not material to the consolidated financial
statements. The company accrues for these losses when they are probable and
reasonably estimable based on current law and existing technologies. The
estimated liability is reduced to reflect the anticipated participation of other
potentially responsible parties where such parties are considered solvent and it
is probable that they will pay their respective share of relevant costs. The
accruals are adjusted as further information develops or circumstances change.
Costs of future expenditures do not reflect any claims for recoveries and are
not discounted to their present value. Accruals for environmental liabilities
are classified in the consolidated balance sheets primarily as other noncurrent
liabilities.
Stock Based Compensation
Employee stock options are accounted for pursuant to Accounting Principles Board
Opinion (APB) No. 25, "Accounting for Stock Issued to Employees."
Reclassifications
Certain reclassifications have been made to conform prior periods' data to the
current presentation.
2 OTHER COMPREHENSIVE INCOME
Effective January 1, 1998, the company adopted SFAS No. 130, "Reporting
Comprehensive Income." The statement establishes standards for reporting
comprehensive income and its components. Comprehensive income is defined as all
nonowner changes in equity and is equal to net earnings plus other comprehensive
income (OCI). OCI for the company includes three components: changes in currency
translation adjustments, unrealized gains and losses on available-for-sale
securities, and minimum pension liability adjustments. The following table shows
the changes in each OCI component. Reclassification adjustments represent items
that are included in net earnings in the current period but previously were
reported in OCI. To avoid double counting these items in comprehensive income,
gains are subtracted from OCI, while losses are added.
<TABLE>
<CAPTION>
===================================================================
TAX
FOR THE YEAR ENDED BEFORE EXPENSE NET OF
DECEMBER 31, 1998 TAX OR (BENEFIT) TAX
- -------------------------------------------------------------------
<S> <C> <C> <C>
Currency translation adjustments $ 51 $ (1) $ 52
- -------------------------------------------------------------------
Unrealized investment (losses) (52) (20) (32)
Less: reclassification adjustments
for gains realized in net earnings 24 8 16
- -------------------------------------------------------------------
Net unrealized investment (losses) (76) (28) (48)
- -------------------------------------------------------------------
Minimum pension
liability adjustments (33) (12) (21)
- -------------------------------------------------------------------
Other comprehensive (loss) $ (58) $ (41) $ (17)
===================================================================
</TABLE>
20
<PAGE> 21
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31, 1997
- -------------------------------------------------------------------
<S> <C> <C> <C>
Currency translation adjustments $(446) $ -- $(446)
Less: reclassification adjustments
for (losses) realized in net earnings
from the sales of subsidiaries (3) -- (3)
- -------------------------------------------------------------------
Net currency translation
adjustments (443) -- (443)
- -------------------------------------------------------------------
Unrealized investment gains 85 40 45
Less: reclassification adjustments
for gains realized in net earnings 23 13 10
- -------------------------------------------------------------------
Net unrealized investment gains 62 27 35
- -------------------------------------------------------------------
Other comprehensive
(loss) income $(381) $ 27 $(408)
===================================================================
FOR THE YEAR ENDED
DECEMBER 31, 1996
- -------------------------------------------------------------------
Currency translation adjustments $(128) $ (1) $(127)
- -------------------------------------------------------------------
Unrealized investment gains 31 6 25
Less: reclassification adjustments
for gains realized in net earnings 52 14 38
- -------------------------------------------------------------------
Net unrealized investment (losses) (21) (8) (13)
- -------------------------------------------------------------------
Other comprehensive (loss) $(149) $ (9) $(140)
===================================================================
</TABLE>
3 RESTRUCTURING
In 1997, the company announced a comprehensive restructuring and turnaround
program that would result in restructuring charges of approximately $450 during
1997 and 1998. The company has structured the turnaround program in two phases
reflecting management development and approval of plans. The turnaround program
was initiated in the third quarter 1997 and has been scheduled to be materially
completed by December 31, 1999. The objectives of the turnaround program were to
significantly rationalize infrastructure, establish a global headquarters in New
Jersey, and eliminate duplicate resources in manufacturing, administration, and
research and development (R&D). The turnaround program mainly affects the
company's core pharmaceutical segments and corporate administration groups, with
minor restructuring of businesses included in the all other grouping (see Note
21). In the third and fourth quarters of 1997, the company recorded phase one
charges totaling $316. The second phase of the turnaround program was finalized
in the fourth quarter of 1998, resulting in an additional restructuring charge
of $92.
The charge of $92 recorded in 1998 was comprised of employee separation
costs of $68; write-downs of fixed assets and abandoned manufacturing projects
of $8; and other costs of $16.
The 1997 restructuring charge of $316 for the first phase of the
turnaround program primarily related to employee separation costs of $134;
write-downs of fixed assets and abandoned manufacturing projects of $162; and
other costs of $20.
The total restructuring charges for 1998 and 1997 included involuntary
employee separation costs for 580 and 1,320 employees worldwide, respectively.
The 1998 charge included elimination of positions in marketing and
administration of $55, R&D of $9, and manufacturing of $4. These amounts
included an adjustment of $16 of the phase one accruals, mainly attributable to
lower employee separation costs and, to a lesser extent, changes in plan
estimates. The 1997 charge included elimination of positions in marketing and
administration of $81, R&D of $22, and manufacturing of $31. As of December 31,
1998, the company had paid $101 in severance costs in connection with the 1998
and 1997 charges. The remaining balance for employee separation costs related to
the turnaround program was $101 at December 31, 1998 comprised mainly of charges
related to the phase two charge and remaining annuity separation payments for
the phase one
21
<PAGE> 22
charge. The company expects employee reductions for the 1998 and 1997 charges to
be substantially completed by December 31, 1999.
The 1998 and 1997 restructuring charges included asset write-downs for
excess manufacturing, administration, and R&D facilities totaling $8 and $162,
respectively. The 1998 amount included an adjustment of $15 of the phase one
accruals, mainly attributable to changes in plan estimates, favorable outcomes
on sales of facilities, and actual facility closure costs below the original
estimates. At December 31, 1998, facilities presently being marketed had a net
book value of $47. Fixed asset write-downs were based on appraisals less costs
to sell.
Other costs included in the 1998 and 1997 restructuring charges of $16
and $20, respectively, were primarily comprised of cancelled contractual lease
obligations and, to a lesser extent, demolition and other costs. Offsetting 1998
charges in this grouping was an adjustment of $6 related to all restructuring
charges prior to 1997. The company expects substantial completion of the
1997-1998 restructuring by December 31, 1999.
In 1996, the company recorded restructuring charges of $518 primarily
associated with the merger. The charges reflected the elimination of
approximately 3,500 positions in marketing and administration ($363), R&D ($59),
and manufacturing ($31); the elimination of duplicate facilities ($43); and
other exit costs resulting from the merger ($22). Implementation of the
restructuring plan was completed by December 31, 1997. Remaining reserves of $7
consist of annuity separation payments which will be paid by the first quarter
of 2000.
The following table displays a roll-forward of the liabilities for
business restructurings from December 31, 1996 to December 31, 1998:
<TABLE>
<CAPTION>
==============================================================
EMPLOYEE
SEPARATION
COSTS OTHER TOTAL
- --------------------------------------------------------------
<S> <C> <C> <C>
Balance December 31, 1996 $ 201 $ 25 $ 226
Additions 134 20 154
Deductions (182) (25) (207)
- --------------------------------------------------------------
Balance December 31, 1997 153 20 $ 173
Additions 68 16 84
Deductions (113) (12) (125)
- --------------------------------------------------------------
Balance December 31, 1998 $ 108 $ 24 $ 132
- --------------------------------------------------------------
</TABLE>
4 INCOME TAXES
The provision for income taxes included in the consolidated statements of
earnings consisted of:
<TABLE>
<CAPTION>
=========================================================
YEARS ENDED DECEMBER 31 1998 1997 1996
- ---------------------------------------------------------
<S> <C> <C> <C>
CURRENTLY PAYABLE:
U.S. $ 68 $ 34 $ 171
Non-U.S. 432 429 214
- ---------------------------------------------------------
Total currently payable 500 463 385
- ---------------------------------------------------------
DEFERRED:
U.S. (46) (14) (108)
Non-U.S. (108) (272) (9)
- ---------------------------------------------------------
Total deferred (154) (286) (117)
- ---------------------------------------------------------
Provision for income taxes $ 346 $ 177 $ 268
=========================================================
</TABLE>
22
<PAGE> 23
Differences between the company's effective tax rate and the U.S. statutory tax
rate were as follows:
<TABLE>
<CAPTION>
================================================================
PERCENT OF PRETAX INCOME 1998 1997 1996
- ----------------------------------------------------------------
<S> <C> <C> <C>
Statutory tax rate 35.0% 35.0% 35.0%
Lower rates in other
jurisdictions, net (4.6) (11.7) (4.0)
Goodwill amortization and other
non-deductible expenses 3.1 7.2 4.3
Valuation allowances associated
with Sugen merger 3.1 10.6 0
All other, net (1.2) (0.4) (2.5)
- ----------------------------------------------------------------
Effective tax rate 35.4 40.7 32.8
================================================================
</TABLE>
The lower rates in other jurisdictions are principally attributable to
manufacturing operations in jurisdictions subject to more favorable tax rates.
Excluding restructuring and other specifically discussed items (litigation,
reacquisition of marketing rights and Biotech divestment), the annual effective
tax rate was 35 percent, 38 percent and 35 percent for 1998, 1997 and 1996,
respectively.
Deferred income taxes are in the consolidated balance sheets as follows:
<TABLE>
<CAPTION>
================================================================================
1998 1998 1997 1997
DECEMBER 31 ASSETS LIABILITIES ASSETS LIABILITIES
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Current $ 378 $ 49 $ 327 $ 3
Noncurrent $ 408 $238 $ 382 $362
- --------------------------------------------------------------------------------
Components of deferred taxes were:
Property, plant and
equipment $ -- $210 $ -- $277
Inventory 172 -- 185 --
Compensation and
benefit plans 194 60 174 60
Swedish tax deferrals -- 31 -- 62
Tax loss and tax credit
carryforwards 307 -- 201 --
Environmental and product
liabilities 59 -- 107 --
Restructuring and
discontinued operations 111 -- 107 --
Tax on unremitted earnings -- 108 -- 121
All other 277 95 297 124
- --------------------------------------------------------------------------------
Subtotal 1,120 504 1,071 644
Valuation allowances (117) -- (83) --
- --------------------------------------------------------------------------------
Total deferred taxes $ 1,003 $504 $ 988 $644
- --------------------------------------------------------------------------------
Net deferred tax assets $ 499 $ 344
================================================================================
</TABLE>
Valuation allowances have been provided for certain deferred tax assets that are
not likely to be realized. The changes in the valuation allowance were increases
of $34 and $13 for the years ended December 31, 1998 and 1997, respectively, and
a decrease of $84 for the year ended December 31, 1996. The increases in the
allowance during 1997 and 1998 were primarily due to certain tax credit
carryforwards which were not likely to be realized as a result of the Sugen
merger. During 1996, the valuation allowances decreased due to merger activities
in various countries which improved the likelihood of realizing the benefit of
the deferred tax assets.
Tax loss carryforwards of $220 have various expiration dates through
2018. At December 31, 1998, undistributed earnings of subsidiaries considered
permanently invested, for which deferred income taxes have not been provided,
were approximately $3,000.
23
<PAGE> 24
5 GAIN ON SALE OF MAJORITY INTEREST IN SUBSIDIARY
In December 1996, the company completed the sale of a portion of its holdings in
its wholly-owned subsidiary, Biacore International AB, through an initial public
offering, reducing the company's ownership to 41 percent. The investment in
Biacore, previously consolidated, is now accounted for using the equity method.
Biacore develops, manufactures, and markets advanced scientific instruments
employing affinity-based biosensor technology.
The global offering included 5.75 million total shares (or American
Depository Shares) at $16 per share. Of the total shares, 1.5 million were newly
issued and 4.25 million were sold by the company. The sale generated net
proceeds to the company of $57 and a gain of $55 recorded in 1996. The gain is
composed of an $8 gain on the issuance of new shares and a $47 gain on the sale
of existing shares.
6 BIOTECH AND NUTRITION DIVESTITURES
In August 1997, the company merged its biotechnology supply business, Pharmacia
Biotech, with Amersham Life Science, a division of Amersham International plc,
in a noncash transaction that did not result in the recognition of a gain or
loss. The merger created a new company, Amersham Pharmacia Biotech Ltd., of
which Pharmacia & Upjohn owns 45 percent and accounts for using the equity
method. In 1998, Pharmacia & Upjohn recorded a credit of $52 primarily
representing the company's share of Amersham Pharmacia Biotech's pretax
earnings. In 1997, the company recorded $79 in charges related to the Biotech
merger and subsequent restructuring of the new company. Of this total, $36
consisted of transaction costs to effect the merger and a write-off of certain
acquired research and development costs. The Biotech line item on the
consolidated statement of earnings includes these charges as well as the
company's share of Amersham Pharmacia Biotech's pretax earnings.
In December 1998, the company sold substantially all of its nutrition
business to Fresenius AG for a loss of $52. To comply with antitrust regulations
in Germany, operations there could not be sold. As of December 31, 1998, the
sale of the operations in China was still pending regulatory approval.
7 EARNINGS PER COMMON SHARE
Basic earnings per share is computed by dividing net earnings available to
holders of common stock by the weighted average number of shares of common stock
outstanding. Diluted earnings per share is computed assuming the exercise of
stock options and warrants, conversion of preferred stock and debt, and the
issuance of stock as incentive compensation to certain employees. Under these
assumptions, the weighted-average number of common shares outstanding is
increased accordingly, and net earnings is adjusted by the after-tax interest
effects of convertible debt and reduced by an incremental contribution to the
Employee Stock Ownership Plan (ESOP). This contribution is the after-tax
difference between (1) the income the ESOP would have received in preferred
stock dividends and (2) the dividend on the common shares assumed to have been
outstanding.
The following table reconciles the numerators and denominators of the basic and
diluted earnings per share computations:
<TABLE>
<CAPTION>
========================================================================================================================
1998 1998 1997 1997 1996 1996
YEARS ENDED DECEMBER 31 BASIC DILUTED BASIC DILUTED BASIC DILUTED
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
EPS numerator:
Net earnings $ 631 $ 631 $ 258 $258 $550 $ 550
Less: Preferred stock dividends, net of tax (13) -- (13) -- (13) --
Less: Interest effects on convertible instruments, -- 1 -- -- -- --
net of tax
Less: ESOP contribution, net of tax -- (5) -- (5) -- (5)
- ------------------------------------------------------------------------------------------------------------------------
Income available to common shareholders $ 618 $ 627 $245 $253 $537 $ 545
- ------------------------------------------------------------------------------------------------------------------------
EPS denominator:
Average common shares outstanding 518 518 516 516 515 515
Effect of dilutive securities:
Stock options and stock warrants -- 5 -- 3 -- 4
Convertible instruments and incentive compensation -- 11 -- 11 -- 11
- ------------------------------------------------------------------------------------------------------------------------
Total shares 518 534 516 530 515 530
- ------------------------------------------------------------------------------------------------------------------------
Earnings per share $1.20 $1.17 $ .48 $.48 $1.04 $1.03
========================================================================================================================
</TABLE>
24
<PAGE> 25
8 ACCOUNTS RECEIVABLE AND INVENTORIES
The following table displays a roll-forward of allowances for doubtful trade
accounts receivable from December 31, 1995 to December 31, 1998:
<TABLE>
<S> <C>
Balance December 31, 1995 $ 93
Additions - charged to expense 17
Deductions (15)
----
Balance December 31, 1996 95
Additions - charged to expense 11
Deductions (17)
----
Balance December 31, 1997 89
Additions - charged to expense 43
Deductions (29)
----
Balance December 31, 1998 $103
====
</TABLE>
Inventories valued on the LIFO method had an estimated replacement cost (FIFO
basis) of $521 at December 31, 1998, and $416 at December 31, 1997.
<TABLE>
<CAPTION>
===================================================================
DECEMBER 31 1998 1997
- -------------------------------------------------------------------
<S> <C> <C>
Estimated replacement cost (FIFO basis):
Pharmaceutical and other finished products $ 558 $ 500
Raw materials, supplies and work in process 628 618
- -------------------------------------------------------------------
Inventories (FIFO basis) 1,186 1,118
Less reduction to LIFO cost (154) (160)
- -------------------------------------------------------------------
Inventories $1,032 $ 958
===================================================================
</TABLE>
9 INVESTMENTS
<TABLE>
<CAPTION>
===================================================================
DECEMBER 31 1998 1997
- -------------------------------------------------------------------
<S> <C> <C>
SHORT-TERM INVESTMENTS:
Available-for-sale:
Kingdom of Sweden debt instruments $242 $267
Government of Italy debt instruments -- 30
Government of Belgium debt instruments -- 10
Government of Norway debt instruments -- 48
U.S. Treasury securities and
other U.S. Government obligations 6 12
Certificates of deposit 5 65
Corporate notes 15 36
Corporate commercial paper 17 31
Other 9 81
- -------------------------------------------------------------------
Total available-for-sale 294 580
Held-to-maturity 81 11
- -------------------------------------------------------------------
Total short-term investments $375 $591
===================================================================
</TABLE>
Amortized cost of short-term investments classified as available-for-sale
approximates fair market value. Short-term investments classified as
held-to-maturity consist primarily of bank certificates of deposit with
amortized cost approximating fair market value.
25
<PAGE> 26
<TABLE>
<CAPTION>
======================================================================
UNREALIZED
--------------- CARRYING
LONG-TERM INVESTMENTS COST GAINS (LOSSES) VALUE
- ----------------------------------------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1998:
Available-for-sale:
Equity securities $164 $ 29 $(23) $170
Mortgage-backed securities--
guaranteed by the
U.S. Government 144 4 -- 148
- ----------------------------------------------------------------------
Total available-for-sale $308 $ 33 $(23) 318
Held-to-maturity 136
- ----------------------------------------------------------------------
Total long-term investments $454
- ----------------------------------------------------------------------
December 31, 1997:
Available-for-sale:
Equity securities $ 55 $77 $ -- $132
Mortgage-backed securities--
guaranteed by the
U.S. Government 179 4 -- 183
- ----------------------------------------------------------------------
Total available-for-sale $234 $81 $ -- 315
Held-to-maturity 219
- ----------------------------------------------------------------------
Total long-term investments $534
======================================================================
</TABLE>
The total of unrealized gains (net of deferred taxes) included in shareholders'
equity amounted to $5 at December 31, 1998, compared to $53 and $18 at December
31, 1997 and 1996, respectively.
During 1997 and 1996 the company sold debt securities in the
held-to-maturity category for the amortized cost of $25 and $70, respectively.
Because these sales were initiated through the call option of the issuer, which
effectively accelerates the maturity date of the security, no gain or loss was
realized. No sales of held-to-maturity securities occurred in 1998.
The proceeds realized from the sale of available-for-sale debt
securities were $254, $942 and $1,132 for 1998, 1997 and 1996, respectively.
Profits realized on these sales are recorded as interest income. During 1998,
1997 and 1996, the proceeds realized from the sale of available-for-sale equity
securities amounted to $53, $4 and $123. Profits realized on these sales are
recorded in other nonoperating income. Based on original cost, gains of $24, $23
and $52 were realized on all sales of available-for-sale securities in 1998,
1997 and 1996, respectively.
Long-term investments held to maturity are summarized as follows:
<TABLE>
<CAPTION>
=============================================================
1998 1998 1997 1997
FAIR AMORTIZED FAIR AMORTIZED
DECEMBER 31 VALUE COST VALUE COST
- -------------------------------------------------------------
<S> <C> <C> <C> <C>
Guaranteed by the
U.S. Government $ 71 $ 71 $ 92 $ 83
Commonwealth of
Puerto Rico debt
instruments 35 35 73 71
Bank obligations:
Certificates of
deposit 10 10 15 15
Other 20 20 51 50
- -------------------------------------------------------------
Long-term
investments held
to maturity $136 $136 $231 $219
=============================================================
</TABLE>
26
<PAGE> 27
At December 31, 1998, long-term mortgage-backed securities available for sale
had scheduled maturities ranging from 2001 to 2024. Scheduled maturities of
long-term securities to be held to maturity were from 2000 to 2022.
10 PROPERTIES, NET
<TABLE>
<CAPTION>
=========================================================
DECEMBER 31 1998 1997
- ---------------------------------------------------------
<S> <C> <C>
Land $ 100 $ 92
Buildings and improvements 1,872 1,901
Equipment 3,078 3,044
Construction in process 730 794
Less allowance for depreciation (2,546) (2,521)
- ---------------------------------------------------------
Properties, net $ 3,234 $ 3,310
=========================================================
</TABLE>
11 LINES OF CREDIT AND LONG-TERM DEBT
The company has a borrowing facility amounting to $500 which was unused as of
December 31, 1998. The facility is available through 2004 largely to support
commercial paper borrowings in the U.S. and Europe. While the facility does not
require compensating balances, it is subject to various fees. The company also
has uncommitted lines of credit amounting to $573 available with various
international banks, of which $546 were unused at December 31, 1998.
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
=========================================================
DECEMBER 31 1998 1997
- ---------------------------------------------------------
<S> <C> <C>
5.875% Notes due 2000 $200 $200
6.182-6.843% Medium-Term Notes due 1999 80 238
0.818-11.85% Italian Government Loans
due 1999-2004 46 54
7.5% Industrial Revenue Bonds due 2023 40 40
3.78% Industrial Revenue Bonds due 2008 -- 6
5.0% Senior Custom Convertible Notes
due 2000 5 18
Other 23 28
Current maturities (99) (173)
- ---------------------------------------------------------
Total long-term debt $295 $411
=========================================================
</TABLE>
Current maturities of long-term debt are included with short-term debt in the
consolidated balance sheets. Annual aggregate maturities of long-term debt
during the next five years are: 2000--$221; 2001--$11; 2002--$7; 2003--$5 and
2004--$51. The company has guaranteed $275 original principal amount of ESOP
9.79% notes due in 2004. At December 31, 1998, the balance of the guarantee was
$240 of which $22 was classified as current. Principal payments that began in
1995 cause the recognition of compensation expense (see Note 18). Annual
aggregate maturities of guaranteed debt during the five years subsequent to 1999
are: 2000--$28; 2001--$35; 2002--$44; 2003--$53 and 2004--$59. In September
1997, Sugen completed the sale of $18 principal amount of 5% Senior Custom
Convertible Notes due 2000 (the "1997 Notes"). The 1997 Notes are convertible
into shares of common stock. In connection with the issuance of the 1997 Notes,
Sugen issued warrants to purchase up to 202,525 equivalent shares of common
stock at an exercise price of $27.48 per equivalent share. Upon the occurrence
of certain events, at the election of the holders of the 1997 Notes, the company
may be required to redeem in cash all or a portion of the 1997 Notes at
redemption prices, which are at a premium to the face value of the 1997 Notes.
27
<PAGE> 28
Information regarding interest expense and weighted average interest
rates follows:
<TABLE>
<CAPTION>
=====================================================================
YEARS ENDED DECEMBER 31 1998 1997 1996
- ---------------------------------------------------------------------
<S> <C> <C> <C>
Interest cost incurred $ 62 $ 64 $ 89
Less: Capitalized on construction (36) (31) (33)
- ---------------------------------------------------------------------
Interest expense $ 26 $ 33 $ 56
- ---------------------------------------------------------------------
Weighted average interest rate on
short-term borrowings at end
of period 6.36% 7.27% 5.99%
- ---------------------------------------------------------------------
</TABLE>
12 COMMITMENTS AND OTHER CONTINGENT LIABILITIES
Future minimum payments under noncancellable operating leases at December 31,
1998, approximately 80 percent real estate and 20 percent equipment, are as
follows: 1999--$82; 2000--$62; 2001--$42; 2002--$33; 2003--$33 and later
years--$103. Capital asset spending committed for construction and equipment but
unexpended at December 31, 1998, was approximately $480.
The consolidated balance sheets include accruals for estimated product
litigation and environmental liabilities. The latter includes exposures related
to discontinued operations, including the industrial chemical facility and
several sites which, under the Comprehensive Environmental Response,
Compensation, and Liability Act, are commonly known as Superfund sites (see Note
13). The company's ultimate liability in connection with Superfund sites depends
on many factors, including the number of other responsible parties, their
financial viability, and the remediation methods and technology to be used.
Actual costs incurred may vary from the estimates given the inherent
uncertainties in evaluating environmental exposures.
With regard to its discontinued industrial chemical facility in North
Haven, Connecticut, the company may soon be required to submit a corrective
measures study report to the U.S. Environmental Protection Agency (EPA). As the
corrective action process progresses, it may become appropriate to reevaluate
the existing reserves designated for remediation in light of changing
circumstances. It is reasonably possible that a material increase in accrued
liabilities will be required. It is not possible, however, to estimate a range
of potential losses. Accordingly, it is not possible to determine what, if any,
exposure exists at this time.
13 LITIGATION
The company is involved in a number of legal and environmental proceedings.
These include a substantial number of product liability suits claiming damages
as a result of the use of the company's products and administrative and judicial
proceedings at approximately 50 "Superfund" sites.
While it is not possible to predict or determine the outcome of legal
actions brought against the company, or the ultimate cost of environmental
matters, the company continues to believe that any potentially unaccrued costs
and liabilities associated with such matters will not have a material adverse
effect on the company's consolidated financial position. Unless there is a
significant deviation from the historical pattern of resolution of these issues,
there should not be a material adverse effect on the company's consolidated
financial position, its results of operations or liquidity.
The company has been a party along with a number of other defendants
(both manufacturers and wholesalers) in several federal civil antitrust
lawsuits, some of which were consolidated and transferred to the Federal
District Court for the Northern District of Illinois. These suits, brought by
independent pharmacies and chains, generally allege unlawful conspiracy, price
discrimination and price fixing and, in some cases, unfair competition, and
specifically allege that the company and the other named defendants violated the
following: (1) the Robinson-Patman Act by giving substantial discounts to
hospitals, nursing homes, mail-order pharmacies and health maintenance
organizations ("HMOs") without offering the same discounts to retail drugstores,
and (2) Section I of the Sherman Antitrust Act by entering into illegal vertical
combination with other manufacturers and wholesalers to restrict certain
discounts and rebates so they benefited only favored customers. The Federal
28
<PAGE> 29
District Court for the Northern District of Illinois certified a national class
of retail pharmacies in November 1994. Similar actions by proposed retailer
classes have been filed in the state courts of Alabama, California, Minnesota,
Mississippi, and Wisconsin. Eighteen class action lawsuits seeking damages based
on the same alleged conduct have been filed in 14 states and the District of
Columbia. The plaintiffs claim to represent consumers who purchased prescription
drugs in those jurisdictions and four other states. Two of the lawsuits have
been dismissed. The company announced in 1998 that it reached a settlement with
the plaintiffs in the federal class action cases for $103. The company believes
that any potential remaining liability above amounts accrued will not have a
material adverse effect on the company's consolidated financial position, its
results of operations, or liquidity
14 CURRENCY RISK MANAGEMENT
The company is exposed to currency exchange rate fluctuations related to certain
intercompany and third-party transactions, primarily intercompany sales from
Sweden and Italy to other European countries, the U.S. and Japan. The exposures
and related hedging program are managed centrally using forward currency
contracts, cross-currency swaps and currency options to hedge a portion of both
net recorded currency transaction exposures on the balance sheet as well as net
anticipated currency transactions. The company also has hedged part of its net
investment in Japan. Financial instruments for trading purposes are neither held
nor issued by the company.
The company's program to hedge net anticipated currency transaction
exposures is designed to protect cash flows from potentially adverse effects of
exchange rate fluctuations. At December 31, 1998, the contract amount of the
company's outstanding contracts used to hedge net transaction exposure was $690.
The aggregate net transaction gain /(loss) included in net income for the years
ended December 31, 1998, 1997 and 1996 related to foreign currency transaction
hedges was $15, $18, and $43, respectively. Of these contracts, 20 percent were
denominated in Japanese yen, 11 percent were denominated in U.S. dollars, 8
percent were denominated in German marks, and 17 percent were denominated in
mainly other European currencies all against Swedish kronor; 10 percent were
denominated in various currencies, mainly Japanese yen and U.S. dollars, against
Italian lira; and 34 percent in various currencies, mainly European currencies
and Japanese yen, against U.S. dollars.
Gains and losses on hedges of intercompany loans and deposits offset
the currency exchange gains and losses of the underlying loans and deposits. At
December 31, 1998, the contract amount of forward exchange contracts held for
balance sheet financial exposure hedging program was $756. Of these contracts,
59 percent were denominated in U.S. dollars against European currencies; 17
percent were denominated in U.S. dollars against Japanese yen; 4 percent were
denominated in Swedish kronor against various European currencies; and 20
percent were denominated in various other currencies mainly against the Swedish
krona and the U.S. dollar.
Because the contract amounts are stated as notional amounts, the amount
of contracts disclosed above is not a direct measure of the exposure of the
company through its use of derivatives. These contracts generally have
maturities that do not exceed twelve months and require the company to exchange
currencies at agreed-upon rates at maturity. The counterparties to the contracts
consist of a limited number of major international financial institutions. The
company does not expect any losses from credit exposure.
29
<PAGE> 30
15 FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair values of the company's financial
instruments were as follows:
<TABLE>
<CAPTION>
==================================================================
1998 1998 1997 1997
CARRYING FAIR CARRYING FAIR
DECEMBER 31 AMOUNT VALUE AMOUNT VALUE
- ------------------------------------------------------------------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Short-term investments $375 $375 $591 $591
Long-term investments 454 454 534 546
Forward currency
exchange contracts
Hedges of loans and deposits (7) (7) (14) (14)
Hedges of anticipated
transactions (13) (13) (10) (10)
FINANCIAL LIABILITIES:
Short-term debt 332 332 401 401
Long-term debt 295 305 411 409
Guaranteed ESOP debt 218 241 240 280
==================================================================
</TABLE>
Because maturities are short-term, fair value approximates carrying amount for
cash and cash equivalents, short-term investments, accounts receivable,
short-term debt, and accounts payable. Fair values of forward currency exchange
contracts, long-term investments, long-term debt, and guaranteed ESOP debt were
estimated based on quoted market prices for the same or similar instruments or
on discounted cash flows.
16 CONCENTRATIONS OF CREDIT RISK
The company invests excess cash in deposits with major banks throughout the
world and in high quality short-term liquid debt instruments. Such investments
are made only in instruments issued or enhanced by high quality institutions.
Financial instruments which potentially subject the company to concentrations of
credit risk consist principally of short-term investments in instruments issued
by the Kingdom of Sweden; otherwise, amounts invested in a single institution
are limited to minimize risk. The company has not incurred losses related to
these investments.
The company sells a broad range of pharmaceutical products to a diverse
group of customers operating throughout the world. In the U.S. and Japan, the
company makes substantial sales to relatively few large wholesale customers.
Credit limits, ongoing credit evaluation, and account monitoring procedures are
utilized to minimize the risk of loss. Collateral is generally not required.
17 SHAREHOLDERS' EQUITY
Preferred Stock
The Series A Convertible Perpetual Preferred Stock is held by the Employee Stock
Ownership Trust (ESOP Trust). The per-share stated value is $40,300.00 and the
preferred stock ranks senior to the company's common stock as to dividends and
liquidation rights. Each share is convertible, at the holder's option, into
1,450 shares of the company's common stock and has voting rights equal to 1,450
shares of common stock. The company may redeem the preferred stock at any time
after July 20, 1999, or upon termination of the ESOP at a minimum price of
$40,300.00 per share. Dividends, at the rate of 6.25 percent, are cumulative,
paid quarterly, and charged against retained earnings.
Common Stock
The number of common shares outstanding at December 31, 1998, 1997 and 1996 was
518,119,813; 516,558,279; and 516,197,570, respectively. On a per-share basis,
dividends were declared on common stock at a rate of $1.08 in 1998 and 1997. In
November 1997, Sugen completed a follow-on public offering of 1,218,200 shares
of common stock at a price of $26.27 per share. The net proceeds to the company
were approximately $30. Common stock dividends payable were $137 at December 31,
1998 and 1997.
30
<PAGE> 31
Capital in Excess of Par Value
Amounts of paid-in capital that exceed the par value ($.01 per share) of the
company's common stock are recorded in this account. This method was also
followed for all prior periods, including those preceding the November 1995
merger of Pharmacia AB and The Upjohn Company and the August 1999 merger between
Pharmacia & Upjohn, Inc. and Sugen, Inc., because the common stock was assumed
to have been outstanding for all years. The tax benefit related to the exercise
of certain stock options reduces income taxes payable and is reflected as
capital in excess of par. Offsetting this is the difference between the cost of
treasury shares and cash received for them, if any, when used to satisfy stock
option exercises and other employee stock awards.
ESOP-related Accounts
The company holds a note receivable from the ESOP Trust that matures on February
1, 2005; bears interest at 6.25 percent; and may be added to or repaid, in whole
or in part, at any time. Accrued interest at the end of any calendar year is
added to the note principal. At December 31, 1998, the note principal balance
was $56. Also, upon recognition of the company's guarantee of the debt of the
ESOP Trust, an offsetting amount was recorded in shareholders' equity. As
guaranteed debt is repaid, this amount diminishes correspondingly (see Notes 11
and 18). Also, to the extent the company recognizes expense more rapidly than
the corresponding cash contributions are made to the Trust, this account is
reduced. The balance in this account at December 31, 1998, was $198.
Treasury Stock
The balance at December 31, 1998, and 1997 was $35 and $48, respectively,
carried at cost. The number of treasury shares used in 1998 for stock options
and employee benefit plans, net of shares acquired, was 730,593.
Accumulated Other Comprehensive Income
Accumulated other comprehensive income reflects the cumulative balance of (1)
currency translation adjustments, the adjustments of translating the financial
statements of non-U.S. subsidiaries from local currencies into U.S. dollars (see
Note 1); (2) unrealized gains and losses on investments categorized as
available-for-sale, net of deferred taxes and reclassifications (see Note 2);
and (3) minimum pension liability adjustments, net of deferred tax (see Notes 2
and 20).
Warrants
Certain warrants to purchase shares of common stock were issued by Sugen in
connection with the Senior Custom Convertible Notes, certain collaboration
agreements, and various license, facility and equipment lease financing
arrangements. Warrants to purchase 432,549 shares were outstanding at December
31, 1998 with exercise prices and expirations ranging between $6.16 and $27.48
and October 1999 and March 2003, respectively.
Shareholder Protection Rights Plan
In February 1997, the Board of Directors approved a shareholder protection
rights plan, declaring a dividend of one right for each share of the company's
common stock outstanding on or after March 7, 1997. Exercisable 10 days after
any person or group acquires 15 percent or more or commences a tender offer for
15 percent or more of the company's common stock, the rights entitle holders to
effectively purchase a specified amount of the company's common stock at an
exercise price equal to half of its market value. The rights are redeemable for
$.01 per right and have a life of 10 years, unless redeemed earlier by the
company. In lieu of cash payment, the company has the option to exchange stock
for rights unless the acquiring person acquires more than 50 percent of the
company's common stock.
18 EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)
The ESOP, created in 1989, is a funding vehicle for the Employee Savings Plan
covering essentially all active U.S. employees. As the ESOP Trust makes debt
principal and interest payments, a proportionate amount of preferred stock is
released for allocation to plan participants. The preferred shares are allocated
to participants' accounts based upon their respective savings plan contributions
and the dividends earned on their previously allocated preferred shares. As of
December 31, 1998, 1,878 preferred shares had been released and allocated; 352
shares were released but unallocated; and 4,633 shares remained unreleased, of
which 37 shares are committed to be released. Shares released during 1998, 1997
and 1996 were 391, 346 and 390, respectively.
31
<PAGE> 32
Under the agreement whereby the company guaranteed third-party debt of
the ESOP Trust, the company is obligated to provide sufficient cash annually to
the Trust to enable it to make required principal and interest payments. The
company satisfies this annual cash flow requirement through payment of dividends
on all preferred shares outstanding, loans and cash contributions. The company
has fully and unconditionally guaranteed the ESOP Trust's payment obligations
whether at maturity, upon redemption, upon declaration of acceleration, or
otherwise. The holders of the debt securities have no recourse against the
assets of the ESOP Trust except in the event that the Trust defaults on payments
due and the company also fails to make such payments. In that event, the holders
may have recourse against unallocated funds held by the Trust. At December 31,
1998, assets of the ESOP trust consisted primarily of $277 of Pharmacia &
Upjohn, Inc., Series A Convertible Perpetual Preferred Stock.
ESOP expense is determined by a formula that apportions debt service to
each year of the plan based on shares allocated to participants and deducts
dividends paid on all preferred stock held by the trust. ESOP expense represents
a fringe benefit and, as such, it attaches to payroll costs that comprise a
portion of all functional expense captions in the earnings statement.
Key measures of the ESOP are presented in the table that follows.
<TABLE>
<CAPTION>
===============================================================
YEARS ENDED DECEMBER 31
DOLLARS IN MILLIONS 1998 1997 1996
- ---------------------------------------------------------------
<S> <C> <C> <C>
Interest expense of ESOP Trust $27 $28 $28
Dividend income of ESOP Trust 17 18 18
Company contribution to
ESOP Trust 18 12 16
Company ESOP expense (net) 13 14 14
===============================================================
</TABLE>
19 STOCK COMPENSATION
Under the Pharmacia & Upjohn plans incentive and nonqualified stock options are
granted to certain employees. Options granted in 1998 have a ten-year term and
vest at the end of three years or vest pro rata over three years. All options
have an exercise price equal to the market value of the underlying stock at date
of grant. Since the company has elected the disclosure-only alternative under
SFAS No. 123 and continues to account for stock options per the terms of APB No.
25, no compensation expense is recognized in earnings.
Upon a stock-for-stock exercise of an option, an active employee will
receive a new, nonqualified "reloaded" option at the then-current market price
for the number of shares surrendered to exercise the option. The "reloaded"
option will have an exercise term equal to the remaining term of the original
exercised option.
Sugen's plans include incentive and nonqualified stock options, which
are granted to certain employees, directors, and consultants. Vesting is graded
and based on plan provisions and has expiration periods of not more than ten
years. Exercise prices are specified according to the plans and may be equal to
or less than the market value at the date of grant. Compensation expense is
measured under the provisions of APB No. 25, where applicable. At the
consummation of the merger, Sugen's plans are merged into Pharmacia & Upjohn's.
32
<PAGE> 33
The number of shares authorized for grants each year is governed by the
related plan documents. Information concerning option activity and balances
follows:
<TABLE>
<CAPTION>
====================================================================
WEIGHTED
AVERAGE NUMBER
EXERCISE PRICE OF SHARES
PER SHARE (000)
- --------------------------------------------------------------------
<S> <C> <C>
Balance outstanding, January 1, 1996 $23.23 13,659
Granted 36.42 3,982
Exercised 23.76 (4,332)
Canceled 20.67 (220)
- --------------------------------------------------------------------
Balance outstanding, December 31, 1996 27.22 13,089
Granted 35.66 4,879
Exercised 22.63 (1,681)
Canceled 33.45 (236)
- --------------------------------------------------------------------
Balance outstanding, December 31, 1997 30.18 16,051
Granted 39.51 10,285
Exercised 28.44 (4,313)
Canceled 38.02 (683)
- --------------------------------------------------------------------
Balance outstanding, December 31, 1998 $34.78 21,340
====================================================================
</TABLE>
<TABLE>
<CAPTION>
===========================================================================
COMPOSITION OF THE WEIGHTED WEIGHTED
DECEMBER 31, 1998 BALANCE: AVERAGE AVERAGE NUMBER
OPTIONS HAVING A REMAINING EXERCISE PRICE OF SHARES
PER-SHARE EXERCISE PRICE OF: LIFE PER SHARE (000)
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
$ .62--19.49 5.80 years $15.15 1,008
$19.50--29.99 5.04 years 23.90 4,545
$30.00--39.99 7.82 years 37.22 7,947
$40.00--49.99 8.67 years 40.71 7,580
$50.00--56.34 7.77 years 53.30 260
- ---------------------------------------------------------------------------
</TABLE>
As of December 31, 1998, 1997, and 1996, the company had exercisable options of
11,813,000, 11,392,000, and 9,232,000, respectively with weighted average
exercise prices of $36.65, $28.39, and $24.08, respectively.
Had the company elected to measure stock compensation using the fair value of
the awards at grant date under the provisions of SFAS No. 123, the company's net
income and earnings per share would have been reduced by approximately $47 or
$.10 per share for 1998, $42 or $.08 per share for 1997, and $40 or $.07 per
share for 1996. The fair value of each option grant was estimated on the date of
grant using the Black-Scholes option-pricing model with the following
assumptions for 1998, 1997 and 1996, respectively: dividend yield of 2.7, 2.83,
and 2.8 percent; volatility of 24, 21, and 21 percent; risk-free interest rate
of 4.72, 5.45, and 5.4 percent; and an expected life of 5.1, 5.3, and 5.5 years.
33
<PAGE> 34
20 RETIREMENT BENEFITS
The company has various pension plans covering substantially all employees.
Benefits provided under the defined benefit pension plans are primarily based on
years of service and the employee's compensation. The company also provides
nonpension benefits to eligible retirees and their dependents, primarily in the
form of medical and dental benefits. The following tables summarize the changes
in benefit obligations and plan assets during 1997 and 1998.
<TABLE>
<CAPTION>
====================================================================
OTHER RETIREMENT
PENSION BENEFITS BENEFITS
CHANGE IN BENEFIT OBLIGATION: 1998 1997 1998 1997
- --------------------------------------------------------------------
<S> <C> <C> <C> <C>
Benefit obligation at
beginning of year $1,394 $1,266 $ 393 $ 366
Service cost 56 52 10 9
Interest cost 91 90 27 26
Benefits paid (133) (105) (19) (18)
Actuarial (gain) loss 53 114 (10) 7
Plan amendment and other
adjustments (14) 27 5 3
Currency exchange effects 8 (50) -- --
- --------------------------------------------------------------------
Benefit obligation at
end of year $1,455 $1,394 $ 406 $ 393
====================================================================
</TABLE>
<TABLE>
<CAPTION>
====================================================================
CHANGE IN PLAN ASSETS: 1998 1997 1998 1997
- --------------------------------------------------------------------
<S> <C> <C> <C> <C>
Fair value of plan assets
at beginning of year $1,387 $1,247 $ 170 $ 144
Actual return on plan assets 184 215 40 27
Employer contribution 38 26 18 16
Benefits paid (133) (105) (19) (18)
Other adjustments (5) 21 2 1
Currency exchange effects 6 (17) -- --
- --------------------------------------------------------------------
Fair value of plan assets at
end of year $1,477 $1,387 $ 211 $ 170
====================================================================
</TABLE>
<TABLE>
<CAPTION>
====================================================================
AT DECEMBER 31, 1998 1997 1998 1997
- --------------------------------------------------------------------
<S> <C> <C> <C> <C>
Funded status $ 22 $ (7) $(195) $(223)
Unrecognized net actuarial
(gains) losses (11) (4) (115) (74)
Amortized net transition asset (45) (56) -- --
Unrecognized prior service cost 41 33 (34) (40)
- --------------------------------------------------------------------
Prepaid (accrued) benefit cost $ 7 $ (34) $(344) $(337)
====================================================================
</TABLE>
The projected benefit obligation, accumulated benefit obligation, and fair value
of plan assets for the pension plans with accumulated benefit obligations in
excess of plan assets were $346, $291, and $90 as of December 31, 1998, and
$361, $302, and $78 as of December 31, 1997, respectively. The benefit
obligation and fair value of plan assets for benefit plans with obligations in
excess of plan assets were $752 and $301, as of December 31, 1998, and $810 and
$290 as of December 31, 1997, respectively.
34
<PAGE> 35
<TABLE>
<CAPTION>
====================================================================
AT DECEMBER 31, 1998 1997 1998 1997
- --------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total accrual balances $(221) $(221) $(344) $(337)
Total prepaid balances 190 187 -- --
Minimum pension liability
offsets:
Intangible assets 5 -- -- --
Shareholders' equity
(pretax) 33 -- -- --
- --------------------------------------------------------------------
Prepaid (accrued) benefit cost $ 7 $ (34) $(344) $(337)
====================================================================
</TABLE>
<TABLE>
<CAPTION>
====================================================================
WEIGHTED-AVERAGE ASSUMPTIONS
AS OF DECEMBER 31, 1998 1997
- --------------------------------------------------------------------
<S> <C> <C>
Discount rate 6.66% 6.95%
Salary growth rate 3.68 4.20
Return on plan assets 9.21 9.27
Health care cost rate--initially 5.83 6.33
trending down to 5.00 5.00
====================================================================
</TABLE>
The consolidated net expense amounts in the following table are exclusive of
curtailments, settlements, and termination benefit costs associated with
restructurings. Net amounts of $4, $5 and $25 before tax were recorded in 1998,
1997 and 1996, respectively, within restructuring charges. During 1996, the
company recognized administrative credits of $24 related to curtailments of its
postretirement life insurance plans. The curtailments resulted principally from
elimination of the company's obligation to provide future postretirement life
insurance benefits for those retirees electing to switch to the new plan.
<TABLE>
<CAPTION>
=============================================================================================================
PENSION BENEFITS OTHER RETIREMENT BENEFITS
COMPONENTS OF NET PERIODIC BENEFIT COST: 1998 1997 1996 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Service cost $ 56 $ 52 $ 55 $ 10 $ 9 $ 10
Interest cost 91 90 88 27 26 26
Expected return on plan assets (109) (102) (100) (15) (12) (10)
Amortization of transition amount (9) (9) (9) -- -- --
Amortization of prior service cost 5 4 4 (3) (4) (4)
Recognized actuarial loss (gain) 3 4 3 (2) (1) (1)
- -------------------------------------------------------------------------------------------------------------
Net periodic benefit cost 37 39 41 17 18 21
Curtailment gain (3) -- -- -- -- (24)
- -------------------------------------------------------------------------------------------------------------
Net benefit cost $ 34 $ 39 $ 41 $ 17 $ 18 $ (3)
=============================================================================================================
</TABLE>
The assumption concerning health care cost trend rate has a significant effect
on the amounts reported. Increasing the rate by one percentage point in each
year would increase the postretirement benefit obligation as of December 31,
1998, by $52 and the total of service and interest cost components of net
postretirement benefit cost for the year by $6. Conversely, decreasing the rate
by one percentage point in each year would decrease the postretirement benefit
obligation as of December 31, 1998, by $46 and the total of service and interest
cost components of net postretirement benefit cost for the year by $5.
The company recorded an additional minimum liability of $38 for
underfunded plans at December 31, 1998. This liability represents the amount by
which the accumulated benefit obligation exceeds the sum of the fair market
value of plan assets and accrued amounts previously recorded. The additional
liability is offset by an intangible asset ($5) to the extent of previously
unrecognized prior service cost. The remaining amount ($33) is recorded, net of
tax benefits, as a reduction to shareholders' equity within accumulated other
comprehensive income.
35
<PAGE> 36
21 SEGMENT INFORMATION
Effective January 1, 1998, the company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which requires reporting
certain financial information according to the "management approach." This
approach is based on how management organizes the segments for operating
decisions. The statement requires enterprises to report certain information
about segments including information about products, geographic areas, and major
customers.
The company's core business is the development, manufacture and sale of
pharmaceutical products. This business is organized in two segments,
prescription pharmaceutical and consumer health care. The prescription
pharmaceutical segment includes general therapeutics, ophthalmology and hospital
products including oncology, and diversified therapeutics. The consumer health
care segment consists of self-medication products that are available to
consumers over the counter without a prescription. This segment includes product
line extensions of key prescription drugs, plus products to treat tobacco
dependency.
The remaining operating units include animal health, diagnostics,
nutrition, plasma, pharmaceutical commercial services and biotechnology. Due to
the size of these operating segments, they have been included in an "all other"
grouping. Animal health produces and markets both pharmaceuticals and feed
additives for livestock and pets. Diagnostics provides services to identify
specific allergies in people. Nutrition sells food replacement products,
primarily to hospitals. Plasma is a therapeutic area that prepares and markets
products derived from blood plasma. Pharmaceutical commercial services develops,
manufactures and markets certain bulk pharmaceutical chemicals and selected
high-technology and specialty chemicals. Biotechnology primarily represents
minority equity positions in biotechnology joint ventures that manufacture and
market reagents, chemicals, and systems for biotechnology companies and academic
research laboratories.
The following table shows revenues and expenses for the company's
operating segments and reconciling items necessary to total to amounts reported
in the consolidated financial statements. Information about segment assets,
interest income and expense, and income taxes is not provided on a segment level
as the segments are reviewed based on operating income. Corporate support
functions and restructuring charges also are not allocated to segments. There
are no inter-segment revenues. Depreciation is not available on a segmental
basis.
Segments for year ended December 31, 1998
<TABLE>
<CAPTION>
==================================================================================================================
PRESCRIPTION CONSUMER ALL RECONCILING
PHARMACEUTICAL HEALTH CARE OTHER ITEMS TOTAL
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net sales $ 4,752 $ 683 $ 1,323 $ -- $6,758
- ------------------------------------------------------------------------------------------------------------------
Earnings from equity affiliates $ 1 $ -- $ 56 $ -- $ 57
- ------------------------------------------------------------------------------------------------------------------
Amortization expense $ 15 $ 6 $ 11 $ 80 $ 112
- ------------------------------------------------------------------------------------------------------------------
Operating income (loss) before corporate $ 984 $ 111 $ 324 $ (171) $1,248
Corporate and all other (271)
- ------------------------------------------------------------------------------------------------------------------
Earnings before taxes $ 977
==================================================================================================================
</TABLE>
Segments for year ended December 31, 1997
<TABLE>
<CAPTION>
==================================================================================================================
PRESCRIPTION CONSUMER ALL RECONCILING
PHARMACEUTICAL HEALTH CARE OTHER ITEMS TOTAL
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net sales $ 4,370 $ 642 $ 1,574 $ -- $6,586
- ------------------------------------------------------------------------------------------------------------------
Earnings (loss) from equity investments $ 5 $ -- $ (73) $ -- $ (68)
- ------------------------------------------------------------------------------------------------------------------
Amortization expense $ 13 $ 5 $ 11 $ 87 $ 116
- ------------------------------------------------------------------------------------------------------------------
Operating income (loss) before corporate $ 765 $ 119 $ 192 $ (125) $ 951
Corporate and all other (516)
- ------------------------------------------------------------------------------------------------------------------
Earnings before taxes $ 435
==================================================================================================================
</TABLE>
36
<PAGE> 37
As part of the global turnaround program, the structure of the company has
changed significantly from 1996 to 1998. It is therefore not practicable to
display segmental earnings information for the year ended December 31, 1996, on
a basis comparable to that presented above. Net sales of the prescription
pharmaceutical segment in 1996 totaled $4,586 while consumer health care sales
were $710 and "all other" sales totaled $1,880. The reconciling item for
amortization expense represents goodwill amortization resulting from
acquisitions by Pharmacia AB prior to the 1995 merger with The Upjohn Company.
In addition to amortization, unallocated noncorporate general and administrative
expenses are included in the other reconciling item. Corporate and all other
amounts represent general and administrative expenses of corporate support
functions, corporate items such as restructuring charges and litigation
accruals, and net nonoperating income.
The company's products are sold throughout the world to a wide range of
customers including pharmacies, hospitals, chain warehouses, governments,
physicians, wholesalers, and other distributors. No single customer accounts for
10 percent or more of the company's consolidated sales.
The top selling 20 products in 1998 represent approximately 54 percent
of total sales with no one product constituting more than 6 percent of total
sales. A more comprehensive analysis of product sales performance is provided in
the Financial Review. The following table shows the company's sales
geographically. U.S. exports to third-party customers are less than 10 percent
of U.S. sales.
<TABLE>
<CAPTION>
====================================================================
GEOGRAPHIC SALES FOR YEARS ENDED DECEMBER 31 1998 1997
- --------------------------------------------------------------------
<S> <C> <C>
Sales to customers in:
United States $2,498 $2,081
Japan 565 624
Italy 461 460
Germany 412 405
United Kingdom 352 300
Sweden 284 317
France 275 254
Spain 168 185
Rest of the world 1,743 1,960
- --------------------------------------------------------------------
Total sales $6,758 $6,586
====================================================================
</TABLE>
Long-lived assets include property, plant and equipment, goodwill and
other intangibles, all net of depreciation or amortization.
<TABLE>
<CAPTION>
====================================================================
Long-lived assets, December 31 1998 1997
- --------------------------------------------------------------------
<S> <C> <C>
United States $1,840 $1,805
Sweden 995 1,322
Italy 443 416
Japan 186 188
United Kingdom 133 147
Ireland 123 81
Rest of the world 752 638
- --------------------------------------------------------------------
Total long-lived assets $4,472 $4,597
====================================================================
</TABLE>
37
