Merck & Co., Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed February 27, 2019. The filing also reports unaudited fourth-quarter results. Unless otherwise noted, financial amounts are U.S. dollars.
Business context and reporting period
Merck is a global health care company focused on prescription medicines, vaccines, biologic therapies and animal health products. Pharmaceutical and Animal Health are its reportable segments. Worldwide sales were generated 57% internationally and 43% in the United States.
Financial performance and liquidity
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Sales | $42.294 billion | $40.122 billion |
| Income before taxes | $8.701 billion | $6.521 billion |
| Net income attributable to Merck | $6.220 billion | $2.394 billion |
| Diluted GAAP EPS | $2.32 | $0.87 |
| Diluted non-GAAP EPS | $4.34 | $3.98 |
| Gross margin | 68.1% | 67.8% |
| Cash from operating activities | $10.922 billion | $6.451 billion |
| Capital expenditures | $2.615 billion | $1.888 billion |
Sales increased 5% year over year. Net income margin was approximately 14.7%, versus 6.0% in 2017; GAAP earnings comparisons were affected by significant tax and collaboration charges in 2017 and other unusual items in both years. Management’s non-GAAP measures exclude acquisition and divestiture costs, restructuring and selected other items.
Fourth-quarter 2018 sales were $10.998 billion, compared with $10.433 billion in fourth-quarter 2017. Fourth-quarter net income attributable to Merck was $1.827 billion and diluted EPS was $0.69; the prior-year quarter reported a $1.046 billion net loss attributable to Merck and diluted loss per share of $0.39.
At year-end, cash and cash equivalents were $7.965 billion and short-term investments were $899 million. Working capital was $3.669 billion, down from $6.152 billion. Current assets were $25.875 billion versus current liabilities of $22.206 billion. Total debt, including current borrowings, was approximately $25.114 billion; long-term debt was $19.806 billion. Merck had a $6.0 billion undrawn credit facility maturing in 2023. The filing reports no off-balance-sheet financing arrangements.
Material changes versus the prior comparable period
- Keytruda sales nearly doubled to $7.171 billion from $3.809 billion, making it the largest named growth driver. Gardasil/Gardasil 9 sales rose 37% to $3.151 billion.
- Animal Health sales increased 9% to $4.212 billion; Pharmaceutical segment sales rose to $37.689 billion from $35.390 billion.
- Growth was partly offset by declines in Zepatier, Zostavax, Zetia/Vytorin and Remicade. Zepatier sales fell 73%; Zostavax fell 68% amid competition from a competing shingles vaccine.
- Operating cash flow increased to $10.922 billion from $6.451 billion, partly reflecting the prior year’s large tax-settlement and collaboration-related cash payments.
- Merck returned $14.3 billion to shareholders through dividends and repurchases, including $9.1 billion of share repurchases. The quarterly dividend was raised 15% to $0.55 per share.
- R&D expense was $9.752 billion, down 6%, but included a $1.4 billion charge related to the Eisai collaboration. Cost of sales included a $423 million charge for terminating the insulin glargine collaboration with Samsung Bioepis.
Outlook, management commentary, risks and unusual items
- Management expects pricing and market-access pressures to continue to weigh on revenue in 2019. The filing gives no consolidated numerical revenue or earnings guidance.
- Merck announced approximately $16 billion of planned capital projects for 2018–2022, primarily to expand manufacturing capacity. Capital spending reached $2.615 billion in 2018.
- Pipeline prospects include numerous Keytruda studies and collaborations involving Lynparza and Lenvima. Regulatory reviews described in the filing were pending as of the filing date; approvals and trial outcomes remain uncertain. The Phase 3 KEYNOTE-240 study of Keytruda in previously treated liver cancer did not meet its co-primary overall-survival and progression-free-survival endpoints.
- Patent expirations and generic or biosimilar competition remain material risks. The company anticipated significant sales declines for Noxafil following 2019 patent expirations; Invanz, NuvaRing and other products also faced or were expected to face generic erosion.
- Pricing, reimbursement and regulatory changes—including U.S. health reform—could pressure sales and margins. The Medicare Part D coverage-gap discount reduced 2018 revenue by $365 million and was scheduled to increase from 50% to 70% in 2019.
- The 2017 cyberattack continued to affect operations: Merck estimated approximately $150 million of unfavorable 2018 sales impact from residual order backlogs. Related 2018 costs were immaterial, but insurance-coverage disputes remained.
- Legal matters include product-liability and antitrust litigation, patent disputes and governmental inquiries. Management said it could not reasonably estimate possible losses for certain matters; it reported approximately $245 million in legal-defense reserves. Merck self-insures substantially all product-liability risk.
- Environmental liabilities accrued were $71 million; management estimated reasonably possible additional expenditures would not exceed $60 million in aggregate and did not expect a material financial effect.
Important facts for investors to verify
- How much of sales and profit growth depends on Keytruda, and whether its pipeline expansions receive approval and achieve commercial uptake.
- The trajectory of pricing, rebates and generic/biosimilar erosion, particularly for products with near-term patent expirations.
- Cash conversion and liquidity after substantial repurchases, collaboration commitments and planned capital investment; verify the composition and maturity of commercial paper and debt.
- The size, timing and accounting effects of future collaboration milestones, restructuring, impairments and tax obligations, including the remaining transition-tax liability.
- Developments in significant litigation, including whether any outcomes could exceed recorded accruals, and resolution of the cyber-insurance disputes.