Merck & Co., Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Figures are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context and results
Merck is a global pharmaceutical and animal-health company. Worldwide sales rose 1% to $9.434 billion; foreign exchange reduced reported sales growth by 2%. The end of the Sanofi Pasteur MSD vaccine joint venture at year-end 2016 shifted European vaccine sales into Merck’s reported sales beginning in 2017, limiting direct comparability with the prior-year quarter.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Sales | $9.434 billion | $9.312 billion |
| Gross margin | 68.0% | 61.6% |
| Income before taxes | $2.003 billion | $1.624 billion |
| Net income attributable to Merck | $1.551 billion | $1.125 billion |
| Diluted GAAP EPS | $0.56 | $0.40 |
| Diluted non-GAAP EPS | $0.88 | $0.89 |
| Operating cash flow | $286 million | $2.173 billion |
| Capital expenditures | $339 million | $279 million |
Gross-margin improvement primarily reflected lower amortization of acquired intangibles and lower impairment and restructuring impacts. The effective tax rate fell to 22.3% from 30.4%. Operating cash flow less capital expenditures was negative $53 million, derived from the reported figures.
At March 31, cash and cash equivalents were $11.708 billion and short-term investments were $3.541 billion. Total cash and investments, including long-term investments, were $27.145 billion. Working capital was $11.707 billion, down from $13.410 billion at year-end. Loans payable and current debt were $5.037 billion; long-term debt was $23.437 billion. Total debt to total liabilities and equity increased to 29.5% from 26.0%.
Material changes and drivers
- Keytruda sales grew to $584 million from $249 million, and Zepatier sales rose to $378 million from $50 million. Vaccine sales also benefited from the SPMSD transition; Merck estimated the transition added approximately $65 million to Q1 2017 vaccine sales.
- Declines included Zetia ($334 million versus $612 million), Cubicin ($96 million versus $292 million), and Remicade ($229 million versus $349 million), reflecting generic or biosimilar competition. Januvia and Janumet combined sales declined 5%.
- GAAP earnings increased while non-GAAP diluted EPS was nearly flat. Merck’s non-GAAP reconciliation excluded acquisition and divestiture-related costs, restructuring costs, and other items; these exclusions were substantial.
- Operating cash flow fell sharply, reflecting a $625 million payment in Q1 2017 connected with the Keytruda patent settlement, a $2.535 billion net cash use from changes in assets and liabilities, and comparison with prior-year tax-refund and insurance receipts.
Outlook, commentary, risks, and unusual items
- Merck expected pricing actions and austerity measures in global markets to continue pressuring revenue through the remainder of 2017. The filing does not provide a clear company-wide full-year earnings or revenue guidance figure.
- The company expected to substantially complete its restructuring programs by year-end 2017 and incur about $500 million of additional pretax costs. Q1 program costs were $215 million, including costs recorded outside the separate restructuring-cost line.
- Management cited continued growth opportunities for Keytruda, with multiple supplemental applications under FDA review and a broad clinical-trial program. Regulatory decisions and trial outcomes remain uncertain.
- Keytruda carries royalties of 6.5% of worldwide net sales through 2023 and 2.5% from 2024 through 2026 under a patent settlement. The $625 million settlement payment was made in Q1 2017 but recorded as expense in 2016.
- Legal exposures include Fosamax femur-fracture litigation; a March 2017 appellate ruling reversed a preemption decision affecting hundreds of cases. Merck also disclosed an approximately $80 million contribution toward a K-DUR antitrust settlement, subject to court approval of the class settlement.
- Merck said an unresolved IRS matter concerning the 2006–2008 examination could materially adversely affect financial position, liquidity, and results if resolved unfavorably. The company stated its tax reserves were adequate and believed its position should be sustained.
- Most cash and investments—generally 80%–90%—were held by foreign subsidiaries and could incur significant tax if repatriated as dividends. Merck had not drawn on its $6 billion credit facility.
- Merck acquired 93.5% of Brazilian animal-health company Vallée for $358 million, with $176 million placed in escrow pending contingent items. The filing also warns that future intangible-asset impairment charges could be material.
Most important facts for investors to verify
- How much reported sales growth reflects underlying demand versus the SPMSD transition, currency, pricing, and rebate adjustments.
- Whether Keytruda growth and pending approvals can offset continuing product erosion from generic and biosimilar competition, and the impact of related royalties.
- Whether operating cash flow recovers from the Q1 working-capital outflow and how cash generation supports dividends, repurchases, and debt obligations.
- The timing and cash cost of remaining restructuring actions, and whether additional impairment charges arise.
- Developments in major litigation, including Fosamax, and the outcome of the IRS matter.