Merck & Co., Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Unaudited results; dollar amounts are in millions unless noted.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Sales | $9,785 | $10,934 | $19,210 | $21,198 |
| Income before taxes | $807 | $1,891 | $2,188 | $3,982 |
| Net income attributable to Merck | $687 | $2,004 | $1,639 | $3,709 |
| Diluted EPS | $0.24 | $0.68 | $0.57 | $1.25 |
| Gross margin | 61.6% | 55.2% | 61.9% | 58.5% |
- Sales declined 11% in Q2 and 9% for the first half. Foreign exchange reduced sales by 7% and 5%, respectively. Management attributed much of the decline to divestitures and the end of the AstraZeneca LP relationship, partly offset by Cubist sales and growth in selected products.
- Gross margin improved year over year, reflecting lower inventory discards, favorable currency effects and, for the first half, product mix. Acquisition-related amortization, restructuring and impairment charges continued to weigh on reported margins.
- Q2 and first-half GAAP earnings were sharply lower. Key comparisons include a $715 charge for Venezuela currency revaluation in 2015 and substantial 2014 gains and tax benefits connected with AstraZeneca’s option exercise and other transactions. The 2015 first-half tax provision also included a $370 net benefit from settlement of certain federal tax issues.
- Management’s non-GAAP diluted EPS was $0.86 in Q2 and $1.70 for the first half, versus $0.85 and $1.72 in the comparable 2014 periods. These measures exclude acquisition/divestiture costs, restructuring and specified other items and are not GAAP measures.
Cash flow, debt and liquidity
- First-half operating cash flow was $4,869, compared with $4,676 in 2014. Capital expenditures were $474; cash dividends paid were $2,582.
- Investing activities used $4,080, including $7,598 net cash for the Cubist acquisition. Financing activities used $330, including $1,724 for share repurchases.
- At June 30, cash and cash equivalents were $6,922 and short-term investments were $4,448; total cash and investments, including long-term investments, were $24.7 billion. Working capital was $10.8 billion.
- Debt was approximately $26.6 billion, including $2.5 billion of current debt, versus approximately $21.4 billion at year-end 2014. Merck issued $8.0 billion of notes in February, principally to fund Cubist-related borrowing and other corporate needs. A $6.0 billion credit facility maturing in 2019 was undrawn.
- About 80%–90% of cash and investments were held by foreign subsidiaries and could incur significant tax if repatriated as dividends.
Material developments and outlook
- Merck acquired Cubist in January for $8.3 billion of consideration and assumed $1.9 billion of convertible debt, which it redeemed. Cubist contributed $329 million of Q2 sales and $537 million since acquisition; its products include Cubicin, Zerbaxa and Sivextro.
- Management expected 2015 pricing actions and austerity measures to continue to pressure revenue. Remicade sales were affected by biosimilar competition after loss of exclusivity in major European markets, and management expected the decline to accelerate in the second half. Newer HCV therapies continued to erode PegIntron and Victrelis sales.
- Restructuring costs for both programs were forecast at $850–$950 million in 2015. Management expected the 2013 program to yield about $2.0 billion in annual net savings by year-end 2015; combined programs were expected to produce $2.5 billion in annual net savings by then. The Merger Restructuring Program was expected to yield $4.0–$4.6 billion in annual savings upon completion.
- Keytruda was an emerging growth product, with Q2 sales of $110 million. The filing described regulatory reviews and clinical development milestones, including FDA priority review of its advanced lung cancer application with an October 2, 2015 action date. These are contingent developments, not assured outcomes.
- Unfavorable surotomycin trial data led to a $50 million acquired in-process R&D impairment charge. Merck also recorded a $12 million impairment for Rebetol; management warned that further impairment charges could occur.
- In July 2015, after quarter-end, Merck acquired cCAM Biotherapeutics for $95 million upfront plus up to $510 million in milestones. The filing also described other post-quarter pipeline and licensing developments.
Risks, contingencies and unusual items
- Merck revalued Venezuelan net monetary assets after concluding they were unlikely to be settled entirely at the official exchange rate, recording a $715 million Q2 charge. It reported about $280 million of remaining net monetary assets at June 30, mostly cash, and stated that additional losses were possible.
- Vioxx litigation outcomes and possible losses could not be reasonably estimated; Merck had reserves for the Canadian settlement and certain other product-liability matters, but no other Vioxx litigation liability reserve. The filing warned that unfavorable outcomes could materially affect financial position, liquidity and results.
- Other significant product litigation includes Fosamax, Januvia/Janumet, NuvaRing and Propecia/Proscar claims. Legal defense reserves were approximately $230 million. Patent challenges involving products including Cubicin and Keytruda could affect exclusivity and sales.
- Merck cited generic and biosimilar competition, foreign exchange, government pricing and reimbursement pressure, product development and regulatory uncertainty, and possible impairment charges as risks. The filing stated that ordinary-course claims were generally not expected to be material, apart from the separately discussed Vioxx matters.
Important facts for investors to verify
- Whether underlying product demand and sales stabilize after separating currency effects, divestitures, lost alliance revenue and Cubist’s contribution.
- Whether reported cash generation, working capital and debt levels remain sufficient while funding dividends, repurchases and acquisition-related commitments; also assess the accessibility and tax cost of offshore cash.
- Progress and outcomes for Keytruda, the HCV combination, Bridion, Zerbaxa and other pipeline programs, including regulatory decisions and commercial uptake.
- Whether restructuring savings materialize as expected and whether restructuring, acquisition costs or additional impairments remain significant.
- Developments in Venezuela collections, Vioxx and other litigation, and patent cases that could affect product sales or create material liabilities.