Merck & Co., Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. The interim statements are unaudited.
Financial performance
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Sales | $10.934 billion | $11.010 billion | $21.198 billion | $21.681 billion |
| Net income attributable to Merck | $2.004 billion | $906 million | $3.709 billion | $2.499 billion |
| Diluted EPS | $0.68 | $0.30 | $1.25 | $0.82 |
| Gross margin | 55.2% | 61.1% | 58.5% | 62.0% |
| Operating cash flow | Not provided separately | Not provided separately | $4.676 billion | $4.679 billion |
- Sales declined about 1% in Q2 and 2% in the first half. Management cited lower sales of Temodar, Victrelis, Nasonex, Cozaar/Hyzaar and PegIntron, as well as divestitures. Growth in products including Remicade, Zetia, Simponi, Janumet and Isentress partly offset declines.
- GAAP earnings increased substantially, but included significant nonrecurring or unusual gains and tax benefits. Q2 included a $741 million gain related to AstraZeneca’s option exercise; first-half results also included a $168 million net Sirna divestiture gain, an approximately $300 million Sirna-related tax benefit, and a $517 million net tax benefit associated with AstraZeneca. Lower operating expenses also helped. Management’s non-GAAP diluted EPS was $0.85 versus $0.84 in Q2 and $1.72 versus $1.69 for the first half.
- Gross margin fell amid product mix, generic erosion, inventory write-offs and higher impairment and restructuring charges. Merck recorded $660 million of impairment charges for PegIntron and Victrelis, whose sales faced competition and treatment delays as new hepatitis C therapies became available.
- First-half R&D expense declined 19% to $3.238 billion, which Merck attributed mainly to restructuring savings, targeted reductions and lower clinical-development spending following portfolio prioritization. Marketing and administrative expense declined 7% to $5.707 billion.
Liquidity, debt and capital allocation
- At June 30, Merck reported $26.013 billion in cash and investments, $15.659 billion in working capital, and $23.067 billion in loans payable and debt, including current maturities. Cash and investments were down from $27.256 billion at year-end 2013; working capital declined from $17.817 billion.
- First-half operating cash flow was $4.676 billion. Investing activities used $3.856 billion and financing activities used $6.749 billion; cash and cash equivalents ended the period at $9.743 billion, down from $15.621 billion at year-end.
- Merck repurchased $3.413 billion of shares in the first half and paid $2.629 billion in dividends. The quarterly dividend was $0.44 per share. Approximately $7.0 billion remained under the authorized repurchase program at June 30.
- Approximately 80%–90% of cash and investments were held by foreign subsidiaries and could be subject to significant tax if repatriated as dividends.
Business changes, outlook and risks
- Merck agreed to sell its Consumer Care business to Bayer for $14.2 billion, with an expected pretax gain of $11.0–$11.3 billion and estimated after-tax proceeds of $8–$9 billion. Closing was expected in the second half of 2014, subject to customary conditions and regulatory approvals. The assets and liabilities were classified as held for sale at June 30.
- Merck’s worldwide collaboration with Bayer on soluble guanylate cyclase medicines, including Adempas and vericiguat, entails a $1.0 billion upfront payment and shared development costs and profits. The collaboration was conditional on closing the Consumer Care sale.
- After quarter-end, Merck completed its approximately $3.85 billion cash acquisition of Idenix, adding hepatitis C drug candidates. Merck also reported that most of the ophthalmic-products sale to Santen closed July 1, with $548 million of upfront payments received; remaining markets were expected to close by year-end.
- AstraZeneca exercised its option on June 30 to acquire Merck’s interest in AZLP. From July 1, Merck no longer records AZLP equity income or supply sales, creating a change to future revenue and earnings sources.
- Management expected pricing actions, healthcare cost-containment measures and austerity measures to continue to pressure revenue during the remainder of 2014. Merck anticipated 2014 restructuring costs of $1.2–$1.5 billion. It estimated the 2013 restructuring program would generate about $2.0 billion in annual net savings by the end of 2015; the 2013 and merger programs together were expected to produce $2.5 billion in annual net savings versus 2012 expense levels by that date.
- Product and pipeline risks include continued hepatitis C competition; expected Remicade declines following loss of exclusivity in major European markets in February 2015; generic pressure on Temodar and Nasonex; and the possibility of further intangible-asset impairments. Merck also noted that an unfavorable outcome in remaining Vioxx litigation could materially affect its financial position, liquidity and results; the possible loss range was not reasonably estimable.
- Other notable matters include a $100 million NuvaRing litigation settlement and ongoing Fosamax, Januvia/Janumet and other product-liability cases. Merck stated that it intends to defend the remaining claims. The filing also discusses patent disputes that could affect product exclusivity, including disputes concerning investigational pembrolizumab.
Most important facts for investors to verify
- Separate recurring operating trends from the AstraZeneca, Sirna and tax-related gains when assessing the reported earnings increase.
- Track sales, margins and impairment risk in hepatitis C products, and the timing and commercial impact of new therapies and pipeline launches.
- Confirm completion, proceeds, expected gain and strategic consequences of the Consumer Care sale, as well as the effects of the Bayer collaboration and post-quarter Idenix acquisition.
- Monitor the loss of AZLP-related income and supply sales, alongside cash generation, foreign-held liquidity, debt and ongoing buybacks and dividends.
- Follow restructuring spending and delivery of projected savings, plus developments in Vioxx, Fosamax, NuvaRing and significant patent litigation.