Merck & Co., Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Unless otherwise noted, amounts are U.S. dollars. The interim statements are unaudited; Merck cautions that quarterly results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Sales | $10.264 billion | $10.671 billion |
| Income before taxes | $2.091 billion | $1.550 billion |
| Net income attributable to Merck | $1.705 billion | $1.593 billion |
| Diluted EPS | $0.57 | $0.52 |
| Gross margin | 62.0% | 62.9% |
| Operating cash flow | $2.361 billion | $2.341 billion |
| Capital expenditures | $205 million | $351 million |
| Cash and investments | $31.969 billion | $27.256 billion at Dec. 31, 2013 |
| Total debt, carrying value | $28.148 billion | $25.060 billion at Dec. 31, 2013 |
Sales declined 4% year over year; foreign exchange reduced sales by 2%. Sales included a $232 million upfront payment for U.S. Saphris marketing rights. GAAP earnings improved despite lower sales, principally reflecting reduced expenses, the Saphris payment, a $182 million Sirna divestiture gain, and a roughly $300 million tax benefit related to the Sirna transaction. Q1 2013 included approximately $140 million in Venezuelan currency-devaluation losses and a $160 million tax benefit from resolution of a tax matter.
Non-GAAP diluted EPS, which excludes specified acquisition-related, restructuring and other items, was $0.88 versus $0.85. Merck notes that these non-GAAP measures are not substitutes for GAAP results.
Business developments and changes
- Pharmaceutical segment sales were $8.451 billion versus $8.891 billion; segment profits were $5.197 billion versus $5.345 billion. Management attributed pressure chiefly to product mix and loss of exclusivity, partly offset by productivity savings.
- Product growth included Janumet ($476 million, up 16%), Remicade ($604 million, up 10%), and Simponi ($157 million, versus $108 million). Significant declines included Temodar ($83 million, down 62%), Victrelis ($59 million, down 46%), Nasonex ($312 million, down 19%), and Singulair ($271 million, down 20%).
- Marketing and administrative expense fell 8% to $2.734 billion; research and development expense fell 17% to $1.574 billion. The company cited lower promotional spending, restructuring savings, targeted reductions, and lower clinical-development spending following portfolio prioritization.
- Cash from investing activities was a use of $3.807 billion, versus $1.153 billion, largely reflecting increased purchases of securities and other investments. Financing provided $1.620 billion, compared with a $1.421 billion use in Q1 2013; short-term borrowings increased by $3.149 billion.
Outlook, management commentary, and risks
- Merck expects ongoing pricing pressure and austerity measures to weigh on revenue through the rest of 2014, including scheduled price reductions in Japan. Generic erosion and upcoming loss of exclusivity remain material sales risks.
- The 2013 restructuring program targets approximately 8,500 position reductions, with cumulative pretax costs estimated at $2.5–$3.0 billion and annual net savings of about $2.0 billion by end-2015. Together with the merger restructuring program, Merck targets $2.5 billion of annual net savings by end-2015 versus 2012 expense levels. Merck expects $1.0–$1.3 billion of restructuring costs in 2014. These are management estimates.
- In May 2014, Merck announced an agreement to sell Merck Consumer Care to Bayer for $14.2 billion, subject to closing conditions and expected to close in the second half of 2014. Expected after-tax proceeds are $8–$9 billion. Merck also agreed to pay Bayer $1 billion upfront for collaboration rights relating to soluble guanylate cyclase compounds, with potential additional milestones and shared development costs and profits.
- AstraZeneca exercised its option to acquire Merck’s interest in the AZLP arrangement. Closing was expected June 30, 2014; Merck expected a primarily non-cash pretax gain of approximately $700 million, while future AZLP equity income and supply sales would end after closing.
- Pipeline developments disclosed after quarter-end included FDA acceptance with priority review of the MK-3475 melanoma application and acceptance for review of the resubmitted suvorexant application. Conversely, the PROCEED trial’s monitoring board recommended stopping vintafolide for lack of efficacy on the specified endpoint. These development outcomes remain subject to regulatory and clinical uncertainty.
- Legal exposures include product-liability and securities litigation. Merck said it could not reasonably estimate possible losses for remaining Vioxx litigation and had established no general reserve for it beyond specified settlements and other matters. The company disclosed a proposed $100 million NuvaRing settlement subject to participation thresholds, and a Fosamax jaw-injury settlement plan subject to full participation conditions.
- Other risks include potential material impairment charges on products affected by competition or clinical evidence; patent disputes, including European anti-PD-1 patent challenges relevant to MK-3475; and possible additional Venezuelan currency losses. Merck reported approximately $500 million of Venezuelan net monetary assets using the official exchange rate and stated a change in the appropriate rate or an official devaluation could cause a significant charge.
- Liquidity considerations include slower collections in certain European and emerging markets. Receivables in Greece, Italy, Spain, and Portugal totaled approximately $940 million; Merck reported about $180 million of receivables outstanding more than one year. Approximately 80%–90% of cash and investments were held by foreign subsidiaries and could incur significant taxes if repatriated as dividends.
Most important facts for investors to verify
- Whether revenue trends and gross margin stabilize as generic competition, foreign exchange, and pricing pressure continue.
- Whether restructuring savings are realized on schedule and within the stated cost estimates.
- Closing, proceeds, tax effects, and use of proceeds from the Bayer transaction, and the effects of the AZLP exit.
- Clinical and regulatory progress for MK-3475 and other pipeline candidates, including the impact of trial setbacks and product safety findings.
- Potential financial effects of litigation, patent outcomes, product impairments, and Venezuelan currency developments.
- Debt and liquidity trends, including short-term borrowing, overseas cash accessibility, and collection of overdue receivables.