Monday, March 1, 2010

Merck's Updated Risk Factor Labels Any Loss In Arbitration A "Material Averse Event"

This is the newly revised Merck risk factor on the Remicade-Simponi arbitration with J&J's Centocor unit, from page 30 of the just-filed SEC Form 10-K:

. . . .An arbitration proceeding commenced by Centocor against Schering-Plough may result in the Company’s loss of the rights to market Remicade and Simponi.

A subsidiary of the Company is a party to a Distribution Agreement with Centocor, now a wholly owned subsidiary of Johnson & Johnson, under which the Schering-Plough subsidiary has rights to distribute and commercialize the rheumatoid arthritis treatment Remicade and Simponi, a next-generation treatment, in certain territories.

Under Section 8.2(c) of the Distribution Agreement, “If either party is acquired by a third party or otherwise comes under Control (as defined in Section 1.4 [of the Distribution Agreement]) of a third party, it will promptly notify the other party not subject to such change of control. The party not subject to such change of control will have the right, however not later than thirty (30) days from such notification, to notify in writing the party subject to the change of Control of the termination of the Agreement taking effect immediately. As used herein ‘Change of Control’ shall mean (i) any merger, reorganization, consolidation or combination in which a party to this Agreement is not the surviving corporation; or (ii) any ‘person’ (within the meaning of Section 13(d) and Section 14(d)(2) of the Securities Exchange Act of 1934), excluding a party’s Affiliates, is or becomes the beneficial owner, directly or indirectly, of securities of the party representing more than fifty percent (50%) of either (A) the then-outstanding shares of common stock of the party or (B) the combined voting power of the party’s then-outstanding voting securities; or (iii) if individuals who as of the Effective Date [April 3, 1998] constitute the Board of Directors of the party (the ‘Incumbent Board’) cease for any reason to constitute at least a majority of the Board of Directors of the party; provided, however, that any individual becoming a director subsequent to the Effective Date whose election, or nomination for election by the party’s shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a person other than the Board; or (iv) approval by the shareholders of a party of a complete liquidation or the complete dissolution of such party.”

Section 1.4 of the Distribution Agreement defines “Control” to mean “the ability of any entity (the ‘Controlling’ entity), directly or indirectly, through ownership of securities, by agreement or by any other method, to direct the manner in which more than fifty percent (50%) of the outstanding voting rights of any other entity (the ‘Controlled’ entity), whether or not represented by securities, shall be cast, or the right to receive over fifty percent (50%) of the profits or earnings of, or to otherwise control the management decisions of, such other entity (also a ‘Controlled’ entity).”

On May 27, 2009, Centocor delivered to Schering-Plough a notice initiating an arbitration proceeding to resolve whether, as a result of the proposed Merger, Centocor is permitted to terminate the Distribution Agreement and related agreements. As part of the arbitration process, Centocor will take the position that it has the right to terminate the Distribution Agreement on the grounds that, in the Merger, Schering-Plough and the Schering-Plough subsidiary party to the Distribution Agreement were (i) “acquired by a third party or otherwise come[ing] under “Control’ (as defined in Section 1.4) of a third party” and/or (ii) undergoing a “Change of Control” (as defined in Section 8.2(c)). A hearing in the arbitration is scheduled to commence in late September 2010. Sales of Remicade and Simponi included in the Company’s results for the post-Merger period were $430.7 million and $3.9 million, respectively. Sales of Remicade recognized by Schering-Plough in 2009 prior to the Merger were $1.9 billion.

The Company is vigorously contesting Centocor’s attempt to terminate the Distribution Agreement as a result of the Merger. However, if the arbitrator were to conclude that Centocor is permitted to terminate the Distribution Agreement as a result of the Merger and Centocor in fact terminates the Distribution Agreement, the Company’s subsidiary would not be able to distribute Remicade or Simponi. In addition, in the arbitration, Centocor is claiming damages, “in an amount to be determined”, that result from Merck’s alleged non-termination of the Distribution Agreement. If Centocor were to prevail in the arbitration, Merck could be liable for the net damages, including any offsets or mitigation, that the arbitration panel finds Centocor incurred as a result of non-termination and the Company would suffer an impairment charge. An unfavorable outcome in the arbitration would have a material adverse effect on the Company’s financial position, liquidity and results of operations.

Finally, due to the uncertainty surrounding the outcome of the arbitration, the parties may choose to settle the dispute under mutually agreeable terms but any agreement reached with Centocor to resolve the dispute under the Distribution Agreement may result in the terms of the Distribution Agreement being modified in a manner that may reduce the benefits of the Distribution Agreement to the Company. . . .

This disclosure is far less rose-colored than the ones New Merck, and/or legacy Schering-Plough made in their earlier SEC filings -- the ones made to describe the bust-up transaction (and garner shareholders' approval for the same). Fascinating.

In addition, for the first time, the possibility of New Merck having to pay damages for refusal to comply with the termination provision of the Distribution Agreement are mentioned as a risk factor. Those damages could be very substantial, given the vast scale of the revenues generated under that agreement -- including both Remicade and Simponi, that could be as much as $4 billion in annual revenues by 2012 -- all now in arbitration.


Anonymous said...

Can't be good.

Since they now talk of 'payments' for damages, due to not complying to the agreement, do you think it more likely a settlement will happen before the arbitrator makes a decision?

Just more rotten fruit from Fred and his Crooks.

condor said...

I think this does show some additional weakness in its positions, finally being acknowledged, by New Merck.

So, yes, I suppose it ups the chance for a settlement -- but perhaps a far-less favorable one for New Merck, than many might be expecting.