Business context and reporting period
Merck & Co., Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2010. The November 2009 merger with Schering-Plough makes reported year-over-year comparisons uneven: under acquisition accounting, 2010 includes Schering-Plough, while 2009 reported results generally reflect legacy Merck only. The merger was treated as an acquisition with legacy Merck as the accounting acquirer.
Key financial results
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Sales | $11.35B | $5.90B | $22.77B | $11.29B |
| Income before taxes | $1.24B | $1.97B | $1.86B | $3.75B |
| Net income attributable to Merck | $752M | $1.56B | $1.05B | $2.98B |
| Diluted EPS | $0.24 | $0.74 | $0.33 | $1.41 |
| Gross margin | 59.9% | 77.1% | 57.1% | 76.2% |
Sales growth largely reflects the inclusion of Schering-Plough products and consolidation of Zetia and Vytorin sales previously reported through the equity-method partnership—not comparable organic growth. Reported earnings and margins fell amid merger-related purchase-accounting amortization, inventory step-up, restructuring charges, lower affiliate income and health-care reform effects. Merck reported non-GAAP diluted EPS of $0.86 for Q2 and $1.69 for the six months, excluding specified items; these non-GAAP measures are not substitutes for GAAP results.
For the six months, operating cash flow was $4.69B, versus $1.46B in 2009; capital expenditures were $680M, implying operating cash flow less capex of about $4.01B. Investing activities used $2.68B and financing activities used $2.52B. Cash and equivalents declined $646M to $8.67B. Cash and investments totaled $11.99B at June 30; working capital was $10.83B.
Total debt was approximately $18.0B at June 30, compared with $17.5B at December 31, 2009; its estimated fair value was $19.0B. Total debt to total liabilities and equity was 16.9%, versus 15.5%. Merck had $4.15B of loans payable and current debt and $13.84B of long-term debt. It reported $2.0B each on a new 364-day credit facility and an existing facility maturing in 2012, both undrawn.
Material changes and business trends
- Product mix included substantial newly consolidated sales, including Remicade, Nasonex and Temodar. Januvia, Janumet and Isentress grew; Cozaar/Hyzaar fell 46% in Q2 as patent protection expired in the U.S. and major European markets. Gardasil and Fosamax sales also declined.
- Merck recognized a $443M gain from AstraZeneca’s exercise of an asset option and received $647M in cash. The gain boosted reported earnings and should be distinguished from recurring operations.
- Reported equity income from affiliates fell to $43M in Q2 from $587M, partly because the Merck/Schering-Plough partnership became wholly owned and Merial had been sold.
- Merck repurchased $1.30B of stock in the first half; approximately $1.7B remained under its authorization. Cash dividends paid were $2.38B; the declared common dividend remained $0.38 per share quarterly.
Outlook, management commentary and risks
- The first two phases of merger restructuring are expected to be substantially complete by end-2012, with cumulative pretax costs of $3.5B–$4.3B and anticipated annual savings of $2.7B–$3.1B in 2012. Merck expects total 2010 restructuring costs of $1.7B–$2.0B. Its separate 2008 program is expected to cost $1.6B–$2.0B and be substantially complete by end-2011.
- Management expects European austerity measures and price reductions to weigh on revenue in the second half of 2010 and into 2011. It also anticipates substantial U.S. Singulair sales declines after U.S. patent expiry in August 2012. 2010 capital expenditures were estimated at $1.9B; expected pension contributions were approximately $1.45B.
- Health-care reform reduced revenue by about $44M in Q2 and $76M in the first half; a $147M tax charge was recorded in Q1. Further impacts include a Medicare Part D coverage-gap discount beginning in 2011 and an annual industry fee.
- Key contingencies include the Remicade/Simponi distribution-rights arbitration; Merck warns an adverse result could materially affect results, liquidity and financial position. Vioxx claims and investigations remain ongoing; no reserve was established for potential liability outside the settlement program, although $92M was reserved for future defense costs. Fosamax, NuvaRing, AWP, Vytorin/Zetia, patent and other litigation also remain risks.
- Other exposures include approximately $1.3B of receivables in Greece, Italy, Spain and Portugal, which Merck expects to collect, and contested Canadian tax assessments of approximately $322M plus $344M interest. Merck cited foreign-exchange exposure, including an $80M first-half loss associated with Venezuela’s currency devaluation.
- Pipeline and regulatory developments included U.S. approval of Dulera and positive EU committee opinions for Brinavess and Sycrest. Merck said it expected to complete boceprevir regulatory submissions in 2010 and anticipated 2011 filings for ridaforolimus and vorapaxar. Development programs for vicriviroc and, subsequently, acadesine were terminated.
Important facts for investors to verify
- Use merger-adjusted comparisons where possible: the filing’s reported 2009 results are not a like-for-like base. The filing provides pro forma 2009 sales of $11.53B for Q2 and $22.22B for the first half, but cautions that pro forma results are not indicative of actual or future results.
- Separate recurring operating performance from acquisition-related amortization, restructuring, inventory step-up and the $443M AstraZeneca gain; review the assumptions behind Merck’s non-GAAP adjustments.
- Track execution, cash costs and savings from restructuring, along with potential supply transfers and facility closures.
- Monitor patent erosion and product-level trends, especially Cozaar/Hyzaar, Singulair, Fosamax and Gardasil, and the timing and outcome of the Remicade/Simponi arbitration.
- Assess litigation and tax contingencies, collection of European public-sector receivables, and the company’s debt, liquidity and capital-allocation plans.