Merck & Co., Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Unaudited consolidated results; dollar amounts are in millions except per-share data. Merck acquired Cubist in January and cCAM in July 2015, so their results are included only from their respective acquisition dates.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Sales | $10,073 | $10,557 | $29,283 | $31,755 |
| Income before taxes | $2,397 | $1,490 | $4,585 | $5,472 |
| Net income attributable to Merck | $1,826 | $895 | $3,465 | $4,604 |
| Diluted GAAP EPS | $0.64 | $0.31 | $1.22 | $1.57 |
| Diluted non-GAAP EPS | $0.96 | $0.90 | $2.66 | $2.62 |
| Gross margin | 62.7% | 60.0% | 62.1% | 59.0% |
- Sales declined 5% in Q3 and 8% year to date; foreign exchange reduced reported sales by 7% and 6%, respectively. Excluding FX, Q3 performance included Cubist sales and growth in Keytruda, Januvia and Janumet, offset by product declines and divestitures.
- Q3 GAAP earnings increased substantially, while nine-month GAAP earnings declined. The comparison reflects significant prior-year gains and tax benefits, as well as the 2015 Venezuela currency charge. Non-GAAP EPS increased modestly year to date; Merck cautions that this non-GAAP measure excludes significant items and is not comparable across all companies.
- Gross margin improved despite acquisition-related amortization and restructuring charges; management attributed the underlying improvement mainly to lower inventory write-offs and favorable FX, with product mix also contributing year to date.
- Operating cash flow was $8,174 for the first nine months, versus $9,024 in 2014. Investing activities used $4,141 and financing activities used $2,863. Capital expenditures were $790; dividends paid were $3,854.
- At September 30, cash and investments totaled $25,169, working capital was $10,984, and total debt was approximately $26,667, compared with $21,403 at year-end 2014. Cash and investments were down from $29,234 at year-end. Merck reported that 80%–90% of cash and investments are generally held by foreign subsidiaries and could incur significant taxes if repatriated as dividends.
Material changes and notable items
- Cubist contributed $899 in sales through September 30, including $805 of Cubicin sales; Merck paid $7,598 net of cash acquired for the acquisition and assumed and subsequently redeemed Cubist debt. Merck issued $8,000 of notes in February, primarily to fund the acquisition and related corporate needs.
- Merck recorded $715 of Venezuela-related revaluation expense in Q2 and a further $138 of exchange losses in Q3. At quarter-end it reported approximately $250 of net monetary assets in Venezuelan entities, mostly cash, and warned that further losses may occur.
- Other income included a $250 gain from licensing migraine candidates to Allergan. Nine-month results also included a $370 net tax benefit from settling certain federal tax issues. Prior-year results included, among other items, a $741 AstraZeneca-related gain, a $396 ophthalmic-products divestiture gain and a $204 Sirna gain.
- Keytruda sales were $159 in Q3 and $352 year to date. Januvia and Janumet combined sales rose 10% in Q3 and 5% year to date; management said U.S. customer buying timing benefited 2015 sales by about $100 and would adversely affect a later quarter.
- Remicade sales fell 27% in Q3 and 23% year to date; Merck said biosimilar-driven declines were expected to accelerate in Q4 2015 and continue through 2016. Newer HCV therapies continued to pressure PegIntron and Victrelis.
Outlook, management commentary and risks
- Merck expected health-care pricing actions and austerity measures to continue to pressure revenue for the remainder of 2015. The filing does not provide a clear full-year sales or earnings forecast.
- Merck anticipated $900–$1,000 of restructuring costs in 2015 across its two restructuring programs. The 2013 program was expected to be substantially complete by year-end 2015; remaining manufacturing rationalization under the merger program was expected to conclude by the end of 2016. Management reported that the 2013 program’s projected $2.0 billion annual net savings had been achieved and expected $4.0–$4.6 billion annual savings upon completion of the merger program.
- Pipeline and regulatory milestones included FDA review of Keytruda melanoma applications, a December 2015 action date for Bridion and a January 2016 action date for elbasvir/grazoprevir. Merck planned to submit applications for bezlotoxumab by year-end. These are planned or pending events, not guaranteed approvals or outcomes.
- Merck recorded a $50 impairment of the acquired surotomycin program after unfavorable clinical efficacy data. It also discontinued U.S. development of corifollitropin alfa and decided not to continue bevenopran development, seeking to out-license the latter.
- Material risks include litigation and product liability claims, generic and biosimilar competition, patent challenges involving Keytruda and Cubist products, regulatory and clinical-development uncertainty, FX and Venezuela exposure, and tax examinations. Merck could not reasonably estimate a possible loss range for remaining Vioxx litigation; unfavorable outcomes could materially affect financial position, liquidity or results.
- The FDA issued a Complete Response Letter for the V419 pediatric vaccine in November 2015, after quarter-end. Merck and Sanofi Pasteur were reviewing the letter. Merck also disclosed an IRS issue relating to the 2006–2008 examination that could have a material adverse impact if resolved unfavorably.
Most important facts for investors to verify
- Whether reported sales and earnings trends persist after separating FX, acquisitions, divestitures and one-time gains, charges and tax effects.
- Whether the $250 of remaining Venezuelan net monetary assets is collected and whether further devaluation or translation losses are recorded.
- Remicade’s biosimilar-related sales trajectory, the performance of Keytruda and Cubist products, and the effect of generic competition on legacy brands.
- Progress and outcomes for key regulatory and clinical milestones, particularly Keytruda, Bridion, elbasvir/grazoprevir, bezlotoxumab and the V419 CRL response.
- Debt, cash generation, cash repatriation constraints, share repurchases and dividend commitments, alongside the pace and realized savings of restructuring.
- Developments in Vioxx, Fosamax and other litigation, Keytruda patent disputes, and the unresolved IRS examination matter.