Merck & Co., Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and results
Merck is a global pharmaceutical company with pharmaceutical, animal health, consumer care and alliance operations. Worldwide sales were $11.731 billion, up 1% year over year; foreign exchange reduced sales growth by approximately 1%. Pharmaceutical segment sales were $10.082 billion, up from $9.820 billion.
Key financial metrics
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Sales | $11.731 billion | $11.580 billion |
| Income before taxes | $2.507 billion | $1.729 billion |
| Net income attributable to Merck | $1.738 billion | $1.043 billion |
| Diluted EPS | $0.56 | $0.34 |
| Non-GAAP diluted EPS | $0.99 | $0.92 |
| Gross margin | 65.6% | 64.9% |
| Operating cash flow | $2.154 billion | $1.721 billion |
Net income growth primarily reflected the absence of the prior-year $500 million arbitration charge and lower in-process R&D impairment charges, partly offset by higher restructuring costs. The effective tax rate was 29.5%, versus 38.1%. Management reported pharmaceutical segment profits of $6.596 billion, up 6%.
At March 31, cash and cash equivalents were $14.656 billion; cash and investments totaled $19.538 billion. Working capital was $17.762 billion. Debt carrying value was approximately $18.158 billion, including $2.930 billion of current borrowings and current debt and $15.228 billion of long-term debt. The company reported debt at 17.2% of total liabilities and equity, versus 16.7% at year-end. Cash increased $1.125 billion during the quarter. Investing activities used $270 million and financing activities used $725 million. Capital expenditures were $331 million.
Material changes and operating drivers
- Growth in Januvia, Janumet, Victrelis, Gardasil, Zostavax and Isentress was partly offset by lower Remicade sales following territory changes, lower AZLP-related revenue, and declines in Cozaar/Hyzaar.
- Januvia sales rose 24% to $919 million and Janumet rose 29% to $392 million. Remicade sales fell 31% to $519 million, reflecting relinquished marketing rights in certain territories; sales in retained territories rose 5%.
- Singulair sales were $1.340 billion, but U.S. exclusivity was expected to expire in August 2012. Merck expected to lose substantially all U.S. sales within a year of expiry. Cozaar/Hyzaar sales declined 21% amid generic competition.
- Gross margin improved year over year. Amortization of acquired intangible assets and restructuring charges reduced gross margin by 10.5 percentage points in Q1 2012, compared with 11.9 points in Q1 2011.
- Other expense fell to $142 million from $622 million; Q1 2011 included the $500 million J&J arbitration charge, partly offset by a $134 million facility-sale gain.
Outlook, risks and unusual items
- Merck estimated 2012 restructuring costs of $800 million to $1.1 billion. The merger restructuring program was expected to be substantially completed by the end of 2013, with certain manufacturing actions continuing through 2015. Estimated total program costs were $5.8 billion to $6.6 billion; projected annual savings were $3.5 billion to $4.0 billion by end-2013 and $4.0 billion to $4.6 billion upon completion.
- Management anticipated mid-single-digit pricing pressure across Europe for full-year 2012, as well as pressure from biennial price reductions in Japan. Estimated 2012 capital expenditures were $2.2 billion.
- Merck cited product exclusivity and generic-entry risks, manufacturing difficulties affecting certain women’s health products, and supply constraints for some varicella-zoster vaccines. A trial involving a generic Nasonex application had taken place; an unfavorable decision could materially reduce U.S. sales and cause an impairment charge.
- The FDA issued a Warning Letter regarding a required post-marketing pancreatic safety study for Januvia and Janumet. Merck said it had agreed on a study protocol and expected to initiate the study. FDA action could follow failure to meet the requirements.
- Pipeline uncertainty included FDA Complete Response Letters for investigational ezetimibe/atorvastatin and NOMAC/E2, and an FDA advisory committee vote against ridaforolimus. Vorapaxar results showed fewer cardiovascular events but increased bleeding, including intracranial hemorrhage; Merck said further impairment charges could be required.
- In April 2012, Merck paid approximately $960 million, including interest, following court approval of its Vioxx government resolution. The filing reported no reserve for other remaining Vioxx litigation and said potential losses could not be reasonably estimated; unfavorable outcomes could materially affect results, liquidity or financial position.
- Other significant litigation includes Fosamax, NuvaRing, Propecia/Proscar, Vytorin/Zetia and AWP matters. Merck said it could not reasonably estimate potential losses for the Vioxx and ENHANCE litigation. It also described approximately $1.7 billion of receivables in Greece, Italy, Spain and Portugal, including about $400 million outstanding more than one year; collection delays may pressure operating cash flow.
- AstraZeneca could exercise an option beginning April 30, 2012 to acquire Merck’s interest related to Nexium and Prilosec. Exercise would end Merck’s AZLP equity income and substantially reduce supply sales to AZLP.
- Most cash and investments were held by foreign subsidiaries and would be subject to significant tax payments if repatriated. Merck also disclosed contested Canadian tax assessments of approximately $340 million plus $400 million of interest through March 31, 2012; management did not expect resolution to materially affect financial position or liquidity.
Key investor verification points
- Check the drivers of the 2012 earnings increase, especially prior-year unusual charges, restructuring, acquired-intangible amortization and the non-GAAP adjustments.
- Monitor Singulair and other product patent expirations, generic litigation outcomes, and revenue concentration in key growth products.
- Track restructuring cash outlays, remaining costs and delivery of the stated savings, alongside the $2.2 billion capital expenditure estimate.
- Assess exposure to European public-sector receivables, cash repatriation constraints and near-term debt maturities or refinancing needs.
- Follow FDA requirements and pipeline decisions, vaccine and women’s health manufacturing recovery, and the potential financial outcomes of major litigation.