Business context and reporting period
Merck & Co., Inc. filed this Form 10-K on February 27, 2015, covering the fiscal year ended December 31, 2014. The filing also reports unaudited fourth-quarter results. Merck is a global health care company focused on prescription medicines, vaccines and animal health; it divested its Consumer Care business on October 1, 2014.
Financial performance and position
| Metric | 2014 | 2013 |
|---|---|---|
| Worldwide sales | $42.237 billion | $44.033 billion |
| Income attributable to Merck | $11.920 billion | $4.404 billion |
| Diluted EPS | $4.07 | $1.47 |
| Non-GAAP diluted EPS | $3.49 | $3.49 |
| Gross margin | 60.3% | 61.5% |
| Cash from operating activities | $7.860 billion | $11.654 billion |
| Capital expenditures | $1.317 billion | $1.548 billion |
| Working capital at year-end | $14.407 billion | $17.817 billion |
| Long-term debt at year-end | $18.699 billion | $20.539 billion |
Cash, cash equivalents and investments totaled $29.2 billion at year-end, including $15.7 billion of cash, cash equivalents and short-term investments. Current assets were $33.2 billion and current liabilities $18.8 billion. Total debt, including current borrowings, was approximately $21.4 billion. The company had an undrawn $6 billion revolving credit facility.
Fourth-quarter sales were $10.482 billion versus $11.319 billion in 2013; diluted EPS was $2.54 versus $0.26. The 2014 quarter included the large Consumer Care divestiture gain, so reported earnings are not directly indicative of underlying operating performance.
Material changes versus the prior comparable period
- Annual sales declined 4%; foreign exchange reduced 2014 sales by 1%. Lower sales reflected product divestitures, the end of the AstraZeneca LP relationship, loss of exclusivity and weaker hepatitis C product sales. Growth in diabetes, immunology, acute care, vaccines and Animal Health partly offset declines.
- Reported 2014 earnings included an $11.2 billion pretax gain on the Consumer Care sale, a $741 million AstraZeneca-related gain and other divestiture gains. Operating cash flow fell partly because Merck paid approximately $5.0 billion in taxes on the Consumer Care divestiture.
- Non-GAAP EPS was unchanged at $3.49. Gross margin declined, reflecting amortization, restructuring and impairment charges, inventory write-offs and product mix.
- Cash and short-term investments decreased while long-term investments increased; total cash and investments were $29.2 billion. Merck used $15.1 billion in financing activities, including $7.7 billion for share repurchases and $5.2 billion for dividends.
- Remicade sales were expected to face increased biosimilar competition after loss of exclusivity in major European markets in February 2015. Januvia/Janumet sales grew 3% to $6.0 billion; Temodar, Singulair, Nasonex and older brands continued to experience competitive or exclusivity-related pressure.
Outlook, management commentary, risks and unusual items
Management said its restructuring and cost-reduction plan remained on track. It expected the 2013 restructuring program to be substantially complete by the end of 2015, with about $2.0 billion in annual net savings from that program; combined with remaining merger-related actions, annual net savings were projected at $2.5 billion versus 2012 expense levels. These are management expectations, not guaranteed results.
Merck highlighted pipeline and launch opportunities including Keytruda, approved in the U.S. for advanced melanoma, and Gardasil 9. The company expected to file for its HCV combination MK-5172A in the first half of 2015 and anticipated further 2015 regulatory submissions. It also expected global pricing and access pressures to continue affecting 2015 revenue. Cubist was acquired in January 2015 for approximately $9.5 billion; Merck issued $8.0 billion of debt in February 2015, using a substantial portion to repay acquisition-related commercial paper.
- Significant accounting items: 2014 included $1.1 billion of marketed-product intangible impairment charges, principally for hepatitis C products, and a $628 million loss on extinguishment of debt. The Consumer Care sale drove a large portion of GAAP earnings and cash-flow comparisons.
- Key business risks: patent expirations and generic/biosimilar competition, drug pricing and reimbursement pressures, product safety and regulatory outcomes, manufacturing reliability, currency movements and emerging-market conditions. The TECOS cardiovascular outcomes study could materially affect Januvia/Janumet demand if results raise safety concerns.
- Legal and other contingencies: Vioxx litigation continues; Merck said it could not reasonably estimate a possible loss range and had not established material reserves for most remaining Vioxx matters. Other disclosed litigation includes Fosamax, Januvia/Janumet, NuvaRing, Propecia/Proscar and M-M-R II-related proceedings. Product liability insurance is limited, and Merck self-insures substantially all product-liability risk.
- Other exposures: approximately $600 million of receivables were outstanding in Greece, Italy, Spain and Portugal. Merck reported $125 million of accrued environmental liabilities and estimated $53 million of remediation spending for 2015–2019.
Most important facts for investors to verify
- Reconcile GAAP earnings and EPS to underlying performance, including the $11.2 billion Consumer Care gain, other divestiture gains, impairment charges and debt-extinguishment loss; compare with non-GAAP EPS of $3.49.
- Assess whether operating cash flow can recover from $7.9 billion and how much was affected by divestiture taxes, working-capital movements and ongoing cash needs.
- Track the impact of Remicade biosimilar competition, patent expirations and pricing pressure, alongside growth and commercial uptake of newer products such as Keytruda and Gardasil 9.
- Monitor results and safety findings from TECOS and the progress, approval prospects and commercial potential of major pipeline candidates.
- Review the financing and integration effects of the Cubist acquisition, post-year-end $8.0 billion debt issuance, restructuring savings and remaining legal exposures, particularly Vioxx.