Merck & Co., Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Amounts are in U.S. dollars; financial statements are unaudited.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Sales | $11.032B | $11.488B | $32.713B | $35.530B |
| Income before taxes | $1.525B | $2.218B | $4.320B | $7.405B |
| Net income attributable to Merck | $1.124B | $1.729B | $3.623B | $5.261B |
| Diluted GAAP EPS | $0.38 | $0.56 | $1.20 | $1.71 |
| Gross margin | 62.8% | 64.0% | 62.3% | 65.4% |
| Operating cash flow | Not presented separately for the quarter | $8.628B | $8.213B |
For the nine-month period, cash used in investing activities was $4.325B and cash used in financing activities was $3.366B. Capital expenditures were $1.119B. Cash and cash equivalents ended September at $14.090B, versus $13.451B at year-end 2012.
At September 30, cash and investments totaled $27.367B and working capital was $19.550B. Total debt, calculated from current and long-term debt, was $26.623B, up from $20.569B at December 31, 2012. The reported debt-to-total-liabilities-and-equity ratio rose to 25.0% from 19.4%. The company issued $6.5B of notes in May, with a substantial portion used for share repurchases. Most cash and investments were held by foreign subsidiaries and could incur significant taxes if repatriated as dividends.
Reported non-GAAP diluted EPS was $0.92 for Q3 and $2.61 for the first nine months, compared with $0.95 and $2.99, respectively, in 2012. Merck excludes acquisition-related costs, restructuring costs and certain other items from this measure; it should be considered alongside, not instead of, GAAP results.
Material changes and business drivers
- Worldwide sales declined 4% in Q3 and 8% year to date. Foreign exchange reduced sales by 2% in both periods. Management attributed the decline principally to Singulair’s loss of exclusivity, with further pressure from Maxalt, Temodar, Propecia and other products facing generic competition.
- Singulair sales fell 53% in Q3 and 73% year to date. Growth in Gardasil, Remicade, Simponi, RotaTeq and certain other products partly offset declines. Pharmaceutical segment profits fell 5% in Q3 and 14% year to date.
- Gross margin fell 1.2 percentage points in Q3 and 3.1 points year to date. Merck cited lost exclusivity and generic competition, partly offset by manufacturing efficiencies. Amortization, restructuring and impairment charges reduced gross margin by 11.2 points in Q3 and 12.4 points year to date.
- Restructuring costs were $870M in Q3 and $1.144B year to date, compared with $110M and $473M in the respective 2012 periods. Intangible-asset impairment charges included $330M for Saphris/Sycrest and $181M related to discontinued preladenant development.
- Year-to-date net income and diluted EPS declined substantially, reflecting lower sales, higher restructuring costs, higher impairment charges and exchange losses, partly offset by tax benefits, lower operating expenses and fewer average shares following repurchases.
Outlook, commentary and risks
- A newly announced restructuring program targets approximately 8,500 position reductions. Merck estimates $2.5B–$3.0B of cumulative pretax costs, about two-thirds expected to be cash costs, and approximately $2.0B of annual net savings by the end of 2015. Combined with remaining merger restructuring actions, management expects $2.5B of annual net savings by that date versus 2012 expense levels. Total 2013 restructuring costs were forecast at $1.6B–$1.9B.
- Management expected global pricing and access pressures to continue weighing on revenue for the remainder of 2013, and gross margin to remain pressured by loss of exclusivity. The filing gives no overall sales or earnings guidance.
- Pipeline developments included FDA review of corifollitropin alfa and vorapaxar, review of two allergy immunotherapy candidates, and Breakthrough Therapy designations for investigational cancer and hepatitis C treatments. Suvorexant and sugammadex received FDA Complete Response Letters; Merck planned further work and anticipated a suvorexant resubmission in the first half of 2014. Preladenant development was discontinued.
- On October 1, 2013, Merck sold its Netherlands API manufacturing business; certain branded products were to transfer at year-end. The divested businesses represented approximately $200M and $230M of annual sales, respectively. On October 31, the company received an additional 5.5M shares in settlement of its $5B accelerated share repurchase.
- Key exposures include product and securities litigation, patent challenges and potential generic entry, regulatory and clinical-development outcomes, foreign exchange and Venezuelan currency risk, and collection delays in certain European and emerging markets. Receivables in Greece, Italy, Spain and Portugal totaled approximately $1.2B; the company could not reasonably estimate possible losses for remaining Vioxx litigation. Management stated that unfavorable Vioxx outcomes could materially affect results, liquidity or financial position.
Investor verification priorities
- Track sales and margins as Singulair, Maxalt, Temodar and other products lose exclusivity, and assess the contribution from growing products and vaccines.
- Monitor restructuring execution, cash outlays, workforce reductions and whether projected savings materialize without impairing commercial or research capabilities.
- Review debt growth, future buybacks and dividends, and the availability and tax implications of overseas cash.
- Follow pipeline and regulatory milestones, including FDA decisions and required follow-up studies, plus potential pipeline impairment charges.
- Assess developments in major litigation, patent cases and the collection of overdue or public-sector receivables.