Merck & Co., Inc. quarterly report, Q1 FY2015

Business Context and Reporting Period

Merck & Co., Inc. is a global pharmaceutical, vaccine and animal-health company. This unaudited Form 10-Q covers the three months ended March 31, 2015, compared with the first quarter of 2014. Results include Cubist Pharmaceuticals from its January 21, 2015 acquisition date.

Key Financial Metrics

Cash and investments totaled $28.7 billion at quarter-end; working capital was $12.5 billion. Debt carrying value was approximately $30.2 billion, comprising $4.7 billion of current debt and $25.5 billion of long-term debt. The debt-to-total-liabilities-and-equity ratio rose to 27.9% from 21.8% at December 31, 2014. Merck reported a $1.6 billion net increase in cash during the quarter, to $8.0 billion.

Material Changes Versus the Prior Period

• Sales fell 8% year over year; foreign exchange reduced sales by 5%. Merck attributed much of the decline to divestitures, the end of its AstraZeneca LP relationship, and the prior-year Saphris rights payment, as well as lower sales of several established products.
• Cubist contributed $208 million in sales after acquisition. Merck paid $7.6 billion net of acquired cash for Cubist and issued $8.0 billion of debt; total consideration was $8.3 billion, and assumed Cubist debt was redeemed.
• Net income and diluted EPS declined, reflecting the prior-year Sirna divestiture gain and related tax benefit, the Saphris payment, higher 2015 licensing costs and acquisition-related expenses. The 2014 effective tax rate also benefited from an approximately $300 million tax benefit associated with Sirna.
• Research and development expense increased 10% to $1.7 billion; marketing and administrative expense decreased 5% to $2.6 billion. Reported gross margin was broadly stable, but acquisition amortization, inventory purchase-accounting adjustments, restructuring and impairment charges reduced gross margin by 14.4 percentage points in 2015.
• Product trends were mixed: Januvia/Janumet sales grew 4% combined; Cubicin added acquired sales and Keytruda generated $83 million. Remicade sales fell 17%, PegIntron fell 50%, and newer HCV therapies continued to pressure older products.

Outlook, Commentary, Risks and Unusual Items

• Merck forecast no specific overall sales or EPS guidance in the provided filing text. Management expected pricing actions and austerity measures to continue weighing on revenue during 2015.
• For 2015, restructuring costs across the 2013 and Merger programs were expected to total $750 million to $950 million. Merck projected $2.0 billion in annual net savings from the 2013 program by year-end 2015 and $2.5 billion in combined savings versus full-year 2012 expense levels by that date. The Merger program was expected to yield $4.0 billion to $4.6 billion in annual savings upon completion.
• Pipeline and regulatory developments included planned 2015 FDA filings for Keytruda indications and grazoprevir/elbasvir. The FDA issued another complete response letter for Bridion in April 2015, requesting additional sensitivity analysis and indicating further site inspections.
• Key risks include foreign-exchange and pricing pressure, generic and biosimilar competition, product and patent litigation, and uncertainty around regulatory approvals and clinical development. Merck said it could not reasonably estimate potential losses for the remaining Vioxx litigation; an unfavorable outcome could materially affect its financial position, liquidity or results.
• Merck held approximately $870 million of net monetary assets in Venezuela measured at the official exchange rate and had approximately $650 million pending approval for settlement at that rate. A change in the appropriate rate or an official devaluation could cause a significant charge.
• Unusual and comparison-sensitive items included $225 million of Cubist-related transaction costs, a $78 million contribution of equity investments to the Merck Company Foundation, a $12 million Rebetol impairment, and a $61 million increase in contingent-consideration fair value. Merck also warned that the $315 million Zontivity intangible asset could be impaired if U.S. awareness efforts or the planned European launch are unsuccessful.
• Approximately 80%–90% of cash and investments were held by foreign subsidiaries and could incur significant tax if repatriated as dividends. The filing states the company had a $6.0 billion undrawn credit facility maturing in August 2019.

Important Facts for Investors to Verify

• How much of the sales decline reflects currency, divestitures and terminated alliances versus underlying demand, and how Cubist performs after integration.
• Whether management achieves the stated restructuring savings and whether remaining restructuring, acquisition and amortization costs continue to affect reported results.
• Debt, interest costs and capital allocation following the Cubist acquisition, including the new $10 billion share-repurchase authorization and dividend commitments.
• Progress and commercial potential for Keytruda and other pipeline assets, including regulatory decisions and the outcome of relevant patent disputes.
• Developments in Vioxx and other product litigation, Venezuelan currency settlement and valuation, and potential impairment of acquired or existing intangible assets.