Merck & Co., Inc. — 2016 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2016; filed February 28, 2017. The filing also reports unaudited fourth-quarter results. Unless indicated otherwise, amounts are in U.S. dollars.
Business context
Merck is a global health care company focused on prescription medicines, vaccines, biologic therapies and animal health. Pharmaceutical is its only reportable segment. At year-end, Merck and Sanofi ended their European vaccine joint venture; beginning in 2017, Merck expects to record sales directly for markets previously served through that venture.
Financial results and liquidity
| Metric | 2016 | 2015 |
|---|---|---|
| Sales | $39.807 billion | $39.498 billion |
| Gross margin | 65.1% | 62.2% |
| Income before taxes | $4.659 billion | $5.401 billion |
| Net income attributable to Merck | $3.920 billion | $4.442 billion |
| Diluted GAAP EPS | $1.41 | $1.56 |
| Diluted non-GAAP EPS | $3.78 | $3.59 |
| Cash from operating activities | $10.376 billion | $12.538 billion |
| Capital expenditures | $1.614 billion | $1.283 billion |
| Cash, cash equivalents and short-term investments | $14.341 billion | $13.427 billion |
| Long-term debt | $24.274 billion | $23.829 billion |
| Working capital | $13.410 billion | $10.550 billion |
Sales increased 1% year over year, despite a 2% unfavorable foreign-exchange effect. U.S. sales rose 5% to $18.5 billion; international sales fell 3% to $21.3 billion. Operating cash flow declined year over year; 2016 included an approximately $680 million net cash payment for the Vioxx shareholder settlement. Merck returned $8.6 billion to shareholders through dividends and repurchases, including $3.4 billion of share repurchases. The quarterly dividend was raised to $0.47 per share in November 2016.
Fourth-quarter sales were $10.115 billion versus $10.215 billion a year earlier. Merck reported a fourth-quarter loss before taxes of $1.356 billion and a net loss attributable to Merck of $594 million, compared with prior-year-quarter income attributable to Merck of $976 million.
Material changes and drivers
- Growth came chiefly from Keytruda, launched HCV treatment Zepatier, vaccines and Animal Health. Keytruda sales rose to $1.402 billion from $566 million; Zepatier generated $555 million in its launch year.
- Growth was partly offset by generic and biosimilar erosion, including Remicade, Nasonex and other mature products. Remicade sales fell 29% to $1.268 billion; Nasonex fell 37% to $537 million.
- Merck recorded $3.6 billion of acquired in-process R&D impairment charges, including $2.9 billion related to uprifosbuvir, following changes to the candidate’s profile and commercial outlook. R&D expense consequently rose 51% to $10.124 billion.
- Gross margin improved, primarily because of lower amortization and acquisition-accounting impacts, impairment charges and restructuring costs, as well as lower inventory write-offs and favorable currency effects.
- In January 2017, Merck disclosed a $625 million charge recorded in 2016 to settle worldwide Keytruda patent litigation, plus royalties on worldwide Keytruda sales: 6.5% through 2023 and 2.5% for 2024–2026.
- Merck acquired Afferent and IOmet, entered a personalized cancer-vaccine collaboration with Moderna, and acquired a majority interest in StayWell. It also discontinued or deprioritized several pipeline programs.
Outlook, risks and contingencies
Merck did not provide a clear numerical 2017 sales or earnings forecast in the supplied filing text. Management expects global pricing actions and austerity measures to continue weighing on revenue in 2017. The company expects to substantially complete its remaining restructuring actions by year-end 2017 and anticipates approximately $700 million of additional pretax restructuring costs.
Key risks include loss of exclusivity and generic competition: Merck expected significant U.S. sales declines for Zetia and Vytorin in 2017; Invanz, Cancidas and Cubicin also faced upcoming or recent patent expirations. Other principal risks include pricing and reimbursement pressure, foreign-exchange and emerging-market exposure, regulatory and product-safety outcomes, manufacturing and supply continuity, and the uncertain success of clinical development. Merck discontinued odanacatib after analysis confirmed an increased stroke risk; its Phase 2/3 EPOCH verubecestat study was also recommended for termination in February 2017, while another study continued.
Merck reported $24.274 billion of long-term debt and a $6.0 billion undrawn five-year credit facility. It reported $63.1 billion of foreign earnings indefinitely reinvested abroad, for which no U.S. tax provision was recorded. The filing identifies an IRS issue concerning 2006–2008 tax years that could materially affect financial position, liquidity and results if resolved unfavorably. Merck also disclosed numerous product-liability, patent, commercial and governmental matters; several outcomes and potential losses could not be reasonably estimated. Management stated that probable and estimable environmental liabilities were accrued and did not expect them to be material.
Management and the independent auditor concluded that internal control over financial reporting was effective as of December 31, 2016; the auditor issued an unqualified opinion on the financial statements.
Investor verification priorities
- Track Keytruda growth and the economic impact of the $625 million settlement and continuing royalties.
- Assess the pace and earnings impact of generic or biosimilar erosion, particularly for Zetia/Vytorin and other products near patent expiry.
- Review the composition and persistence of the $3.6 billion R&D impairment charge and the remaining pipeline’s clinical and regulatory milestones.
- Reconcile operating cash-flow trends with shareholder distributions, capital spending, debt maturities and cash held overseas.
- Monitor 2017 pricing, foreign-exchange and Venezuela effects, along with the European vaccine sales transition and remaining restructuring costs.
- Follow material litigation and the IRS examination, noting that the filing does not provide clear loss estimates for several matters.