Merck & Co., Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Unless otherwise stated, amounts are U.S. dollars.
Business context and financial performance
Merck operates primarily in Pharmaceuticals and Animal Health. It plans to spin off its women’s health, biosimilars and established brands businesses as Organon in Q2 2021, subject to market and other conditions.
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Sales | $12.551B | $12.397B | $35.479B | $34.972B |
| Net income attributable to Merck | $2.941B | $1.901B | $9.161B | $7.487B |
| Diluted EPS | $1.16 | $0.74 | $3.61 | $2.89 |
| Gross margin | 72.3% | 67.8% | 71.9% | 70.1% |
Sales grew 1% in both periods year over year (2% and 3%, respectively, excluding foreign exchange). Keytruda was the largest growth driver, with sales up 21% in Q3 and 30% for the nine months. Alliance revenue from Lynparza and Lenvima also increased. Growth was partly offset by COVID-19 effects, generic competition and weaker demand for several vaccines and other products. Pharmaceutical segment sales were $11.320B in Q3; Animal Health sales were $1.220B.
Net income and EPS increased substantially versus 2019, when results included a $612M Q3 impairment charge for Sivextro and a $982M Peloton acquisition charge. 2020 results included significant investment and other items: R&D expense rose 6% in Q3, including $832M of Seagen-related collaboration and investment costs. Other income included substantial investment gains, primarily from Moderna: $360M in Q3 and $964M for the nine months. Non-GAAP diluted EPS was $1.74 for Q3 and $4.62 for the nine months, compared with GAAP diluted EPS of $1.16 and $3.61.
Cash flow, debt and liquidity
- Nine-month operating cash flow: $6.247B, down from $8.646B. Merck cited $2.1B of collaboration payments, versus $505M in the prior-year period, and unfavorable net changes in assets and liabilities.
- Investing cash flow: $4.665B used, including $3.170B of capital expenditures and $2.545B for the ArQule acquisition.
- Financing cash flow: $4.204B used; dividends paid were $4.673B and treasury-stock purchases were $1.281B. Share repurchases were suspended in March 2020.
- Cash and investments: $8.728B at September 30, versus $11.919B at December 31, 2019. Working capital was $6.172B, versus $5.263B.
- Debt: Balance-sheet loans payable/current debt and long-term debt totaled $28.741B, versus $26.346B at year-end 2019. Debt was 32.0% of total liabilities and equity, versus 31.2%. Merck issued $4.5B of long-term notes in June and repaid maturing debt.
Outlook, risks and notable items
- COVID-19: Management estimated a $475M Q3 sales headwind and a $2.0B headwind for the first nine months. It forecast a full-year 2020 sales impact of about $2.35B, excluding foreign exchange, including residual Q4 impacts, particularly in Europe and emerging markets. Gardasil 9 recovery was slower than expected. COVID-related lower spending was expected to benefit full-year operating expenses by about $625M net of pandemic-related R&D investment.
- Restructuring: The program is expected to cost about $2.5B pretax cumulatively and be substantially completed by the end of 2023. Merck expected about $800M of charges in 2020 and approximately $900M of annual net savings by the end of 2023.
- Pipeline and transactions: Merck expanded oncology and COVID-19 development efforts, including the Seagen collaboration, molnupiravir and vaccine programs. A proposed $2.75B VelosBio acquisition was announced after quarter-end. The filing reports a July Phase 3 Keytruda combination trial in bladder cancer did not meet its prespecified endpoints; the FDA also issued a Complete Response Letter for the Keytruda-Lenvima application in first-line liver cancer.
- Other material risks: Pricing pressure, generic and biosimilar competition, patent challenges, clinical and regulatory outcomes, and pandemic-related disruption may affect results. Merck warned that further deterioration in Zerbaxa sales could lead to a potentially material impairment; its carrying value was $2.2B. The filing describes ongoing product-liability, antitrust and patent litigation; for certain matters, Merck said a possible loss or range could not be reasonably estimated.
Key facts for investors to verify
- Whether COVID-19 sales effects and the slower Gardasil 9 recovery track management’s full-year assumptions.
- How much reported earnings growth reflects underlying operating performance versus investment gains and excluded non-GAAP items, particularly the Seagen charges.
- Whether operating cash flow recovers after collaboration payments, and how acquisition, capital-spending and dividend commitments affect liquidity and debt.
- Progress and execution of the Organon spin-off, restructuring savings, and the announced or completed business-development transactions.
- Keytruda and other pipeline trial and regulatory outcomes; generic competition, patent litigation and potential Zerbaxa impairment.