Merck & Co., Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Financial statements are unaudited; amounts are in U.S. dollars.
Business context
Merck operates principally in pharmaceuticals and animal health. Growth was led by oncology—especially Keytruda—and vaccines. Antelliq, an animal-health technology company, was acquired in April; Immune Design was also acquired in April. Merck acquired Peloton Therapeutics in July, after quarter-end.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Sales | $11.76B | $10.47B | $22.58B | $20.50B |
| Net income attributable to Merck | $2.67B | $1.71B | $5.59B | $2.44B |
| Diluted GAAP EPS | $1.03 | $0.63 | $2.15 | $0.90 |
| Diluted non-GAAP EPS | $1.30 | $1.06 | $2.52 | $2.11 |
| Gross margin | 71.1% | 67.3% | 71.4% | 67.8% |
| Operating cash flow | Not separately reported quarterly | $4.42B | $4.54B |
Worldwide sales increased 12% in Q2 and 10% year to date; foreign exchange reduced growth by 3% in both periods. Keytruda sales rose 58% in Q2 to $2.63B and 57% year to date to $4.90B. Higher vaccine sales and alliance revenue from Lynparza and Lenvima also contributed. U.S. pricing pressure, generic competition and biosimilar competition weighed on several established products.
For the first six months, capital expenditures were $1.38B, dividends paid were $2.90B, and share repurchases were $2.33B. Cash and investments totaled $10.88B at June 30, down from $15.10B at year-end; working capital was $4.21B. Current and long-term debt totaled approximately $26.59B, compared with $25.11B at December 31, 2018. The company issued $5.0B of senior notes in March. Total debt as a share of liabilities and equity was 31.7%, versus 30.4% at year-end.
Material changes versus prior period
- GAAP earnings improved substantially, while reported sales grew at a slower rate than earnings. Year-to-date R&D expense fell 25%, chiefly because 2018 included a $1.4B Eisai collaboration charge and a $344M Viralytics charge.
- Gross margin increased, reflecting product mix and lower acquisition-related intangible amortization and restructuring impacts.
- Operating cash flow declined modestly to $4.42B. Investing activities used $2.06B, including the Antelliq acquisition; financing activities used $3.70B.
- Pharmaceutical segment profits rose 19% in Q2 and 15% year to date. Animal Health segment profits fell 10% in Q2 and 5% year to date.
Outlook, commentary, risks and unusual items
- Merck expects its 2019 restructuring program to cost approximately $800M–$1.2B pretax through expected completion by the end of 2023, including about $500M of charges in 2019. Management anticipates approximately $500M in annual net cost savings by the end of 2023.
- Management expects pricing and cost-containment measures to continue to pressure revenue for the remainder of 2019. It also anticipates significant declines in certain products following patent expiries or generic competition, including Emend, Noxafil and Invanz.
- The first-half effective tax rate was 13.0%, including a $360M net tax benefit from settlement of federal tax matters. Results also included goodwill impairment charges of $162M in the first half, restructuring costs, and acquisition-related costs. Merck cautions that additional intangible-asset impairments could be material.
- Keytruda development remains a major growth opportunity, but trial outcomes are mixed: a Phase 3 gastric-cancer combination trial did not meet specified superiority endpoints, and a metastatic triple-negative breast cancer trial missed its primary endpoint. Other trials and regulatory reviews remain ongoing; no quantified company-wide revenue or EPS guidance is provided in the supplied filing text.
- Legal matters include Fosamax and Januvia/Janumet product-liability litigation, Zetia antitrust litigation, patent disputes and government investigations. Merck says it cannot reasonably estimate possible losses for certain litigation; it states that other matters are unlikely to be material. Legal defense reserves were approximately $260M.
- The Peloton acquisition occurred after quarter-end: $1.05B upfront cash consideration, with up to $1.15B in contingent milestone payments.
Important facts for investors to verify
- How much of sales and earnings growth is sustained by Keytruda, vaccines and alliance products, versus acquisition effects and one-time tax benefits?
- Whether generic competition, biosimilars, pricing pressure and foreign exchange further affect established-product sales and margins.
- Cash generation, debt levels and capital returns, including the funding impact of acquisitions, dividends and share repurchases.
- Execution, timing and cash costs of the restructuring program, and whether projected savings are achieved.
- Developments in major litigation and investigations, and any resulting financial exposure or effects on product exclusivity.
- Clinical-trial results and regulatory decisions for Keytruda and other pipeline assets; the filing provides no quantified company-wide revenue or EPS outlook.