Merck & Co., Inc. — Q3 2017 Form 10-Q
Business context and period. Unaudited results cover the quarter and nine months ended September 30, 2017, compared with the same 2016 periods. Merck’s principal business is human-health pharmaceuticals and vaccines, alongside Animal Health and other businesses. 2017 vaccine sales include European markets previously served through the Sanofi Pasteur MSD joint venture, which ended in December 2016, limiting comparability.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Sales | $10.325B | $10.536B | $29.689B | $29.692B |
| Net income attributable to Merck | $(56)M | $2.184B | $3.440B | $4.515B |
| Diluted GAAP EPS | $(0.02) | $0.78 | $1.25 | $1.62 |
| Diluted non-GAAP EPS | $1.11 | $1.07 | $3.00 | $2.89 |
| Gross margin | 68.3% | 67.6% | 68.4% | 64.4% |
- Q3 sales declined 2%, including a 1% favorable foreign-exchange effect; nine-month sales were essentially flat, with a 1% unfavorable currency effect.
- The Q3 GAAP loss primarily reflects a $2.35B AstraZeneca oncology-collaboration charge in R&D, including future license-option payments; no tax benefit was recognized on that charge. Q3 GAAP income tax expense was $251M despite pretax income of $200M, producing a 125.5% effective tax rate. A $234M tax benefit from resolving federal tax matters partly offset the charge’s effect.
- Nine-month operating cash flow was $2.432B, versus $6.744B in 2016. Merck attributed the decrease mainly to a $2.8B federal tax payment, the $1.6B AstraZeneca upfront payment, and a $625M Keytruda patent-settlement payment. Investing activities provided $2.737B; financing used $4.221B. Cash and cash equivalents ended the period at $7.901B.
- At September 30, cash and investments totaled $23.401B; working capital was $8.452B. Debt was $26.995B carrying value, including $5.157B current debt, versus $24.842B total debt at year-end 2016. Debt was 29.4% of total liabilities and equity, compared with 26.0% at year-end. Merck reported a $6B undrawn five-year credit facility.
- Dividends paid totaled $3.884B for the first nine months; Merck repurchased $2.312B of stock. The declared quarterly dividend was $0.47 per share.
Changes, outlook, and significant items
- Product mix: Keytruda sales rose to $1.047B in Q3 from $356M and to $2.512B for the first nine months from $919M. Zepatier and Bridion also grew. These gains were offset by generic or biosimilar competition affecting Zetia, Vytorin, Cubicin, Remicade and Cancidas, among other declines. Januvia/Janumet sales declined year to date amid pricing pressure.
- Operational disruptions: A June cyberattack disrupted worldwide operations. Merck estimated a $135M unfavorable sales effect and $175M of manufacturing and remediation expenses for Q3 and the first nine months. It anticipated a similar revenue and expense impact in Q4 2017 and throughout 2018; insurance coverage could be disputed. Hurricane Maria’s expected 2017–2018 sales impact was assessed as immaterial, although Puerto Rico supply chains remained disrupted.
- Vaccines: Borrowing Gardasil 9 doses from the CDC stockpile reduced Q3 revenue by about $240M and created a liability; Merck expected to replenish the stockpile in the second half of 2018, when sales would be recognized and the liability reversed. The company warned that a competitor-favoring shingles-vaccine recommendation, if adopted by the CDC, could materially hurt future U.S. Zostavax sales.
- Cost and margin: Gross margin improved year over year, reflecting product mix and lower year-to-date effects from intangible amortization, impairments and restructuring, partly offset by cyberattack-related manufacturing costs. Merck expected about $250M of additional pretax restructuring costs and substantial completion of remaining program actions by year-end 2017.
- Pipeline and collaboration: Merck discontinued two investigational HCV combinations, recording a $240M IPR&D impairment, and decided not to seek approval for anacetrapib. The FDA placed full clinical holds on two Keytruda multiple-myeloma combination trials and a partial hold on another after more deaths were observed in Keytruda arms; enrolled patients discontinued investigational Keytruda treatment. A Phase 3 Keytruda head-and-neck cancer trial did not meet its primary overall-survival endpoint, although the existing indication remained unchanged. The AstraZeneca collaboration may require up to a further $6.15B in milestone payments, in addition to the $2.35B charge and scheduled $750M option payments.
- Other exposures: Merck said global pricing and healthcare-cost containment pressures were expected to continue weighing on revenue for the remainder of 2017. It disclosed significant product-liability and patent litigation; for certain matters it could not reasonably estimate a possible loss range. The filing also describes an Italian investigation involving interactions with healthcare providers. No numerical full-year sales or earnings guidance is provided in the supplied filing text.
Important facts for investors to verify
- How much of the GAAP/non-GAAP earnings gap reflects recurring acquisition, restructuring and collaboration-related costs, and how the AstraZeneca spending develops.
- Whether cyberattack-related manufacturing recovery, missed sales and insurance recoveries match management’s expectations, including the stated impact through 2018.
- Whether the CDC stockpile is replenished on schedule and the associated Gardasil 9 revenue is recognized as anticipated.
- Keytruda’s continued commercial growth and clinical/regulatory outcomes, alongside the competitive outlook for Zostavax and products facing generic or biosimilar entry.
- Debt maturities, cash availability and repatriation constraints: Merck said generally 80%–90% of cash and investments were held by foreign subsidiaries and could incur significant taxes if repatriated as dividends.
- Developments in litigation, the Italian investigation, and the potential for future intangible-asset impairments or contingent payments.