Merck & Co., Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018. Amounts are in U.S. dollars; financial results are unaudited.
Business context and results
Merck operates in pharmaceuticals and animal health, alongside healthcare services and alliance activities. Its growth during the period was led by oncology, particularly Keytruda, with contributions from vaccines, hospital acute care and animal health. Sales were partly offset by declines in virology, Zostavax, and products facing generic or biosimilar competition.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Sales | $10.794B | $10.325B | $31.296B | $29.689B |
| Income before taxes | $2.665B | $0.200B | $6.097B | $4.642B |
| Net income attributable to Merck | $1.950B | $(56)M | $4.393B | $3.440B |
| Diluted GAAP EPS | $0.73 | $(0.02) | $1.63 | $1.25 |
| Gross margin | 66.5% | 68.0% | 67.3% | 68.1% |
| Operating cash flow | Not presented quarterly | $7.330B | $2.432B |
Financial position and liquidity
- At September 30, cash and cash equivalents were $7.826B; cash and investments totaled $17.891B, down from $20.623B at year-end 2017.
- Working capital was $8.250B, compared with $6.152B at December 31, 2017. Total current assets were $26.836B and current liabilities $18.586B.
- Total debt, including current maturities, was $23.592B, down from $24.410B at year-end 2017. Debt was 27.7% of total liabilities and equity.
- Nine-month investing cash flow was $2.136B provided; financing cash flow was $7.594B used. Capital expenditures were $1.686B. Operating cash flow less capital expenditures was approximately $5.644B, calculated from reported figures.
- Merck has an undrawn $6.0B credit facility maturing in 2023. Cash provided by operations is identified as its primary funding source.
Material changes and significant items
- Q3 sales rose about 5% year over year, including a 1% unfavorable foreign-exchange effect. Nine-month sales also increased about 5%.
- Keytruda sales increased to $1.889B in Q3 from $1.047B and to $5.020B for nine months from $2.512B. Gardasil/Gardasil 9 sales were $1.048B in Q3, up 55%, partly reflecting comparison with doses borrowed from the CDC stockpile in 2017.
- GAAP earnings improved substantially against Q3 2017, when results included a $2.35B AstraZeneca collaboration charge. 2018 nine-month results included $1.4B of Eisai collaboration charges and a $344M Viralytics acquisition-related R&D charge.
- Q3 2018 materials and production costs included a $420M charge to terminate the Samsung Bioepis insulin glargine collaboration. The charge included a $155M termination payment, asset abandonment and inventory write-offs.
- Gross margin declined year over year, primarily due to the Samsung termination charge and, for the nine-month period, amortization of collaboration milestone-related assets.
- Merck reported non-GAAP diluted EPS of $1.19 for Q3 and $3.29 for nine months, versus GAAP diluted EPS of $0.73 and $1.63, respectively. Non-GAAP measures exclude specified acquisition, restructuring and other items and are not substitutes for GAAP results.
Outlook, management commentary and risks
- The filing gives no numerical full-year sales or earnings guidance. Management said pricing actions and austerity measures were expected to continue to weigh on revenue for the rest of 2018; it also anticipated an immaterial remaining sales impact from the 2017 cyberattack.
- Merck expected approximately $50M of additional restructuring costs in Q4 2018. It planned approximately $16B of capital investment on new projects, $4B above its prior five-year plan, focused on manufacturing capacity.
- In October 2018, the board approved a 15% quarterly dividend increase to $0.55 per share and an additional $10B share repurchase authorization. Merck entered a $5B accelerated share repurchase, funded with existing cash and investments and short-term borrowings; final settlement was expected in the first half of 2019.
- Key business risks include sustained U.S. and international pricing pressure; competition and loss of exclusivity affecting Zostavax, Zepatier, generic-exposed products and biosimilar-exposed Remicade; and continued declines in several established products. Management specifically expected competition to materially adversely affect Zostavax and Zepatier sales.
- The company continued to face Fosamax, Januvia/Janumet and other product-liability and patent litigation. Merck said it could not reasonably estimate possible losses for certain litigation; it lacks insurance for most product-liability claims. It also disclosed governmental inquiries and risks that adverse patent outcomes could shorten product exclusivity or lead to impairment charges.
- The 2017 cyberattack caused an estimated $150M of unfavorable sales impact in the first nine months of 2018, with an immaterial Q3 impact. Merck had received insurance proceeds but noted potential disputes with insurers over coverage.
- The estimated net U.S. transition tax under the Tax Cuts and Jobs Act was $5.1B; the calculation remained subject to finalization. Merck had not finalized its accounting policy election for the GILTI tax provision.
Most important facts for investors to verify
- Whether Keytruda’s rapid sales growth and newer approvals can offset pricing pressure, patent expirations and declines in older products.
- The durability and cash cost of the Eisai and AstraZeneca collaborations, including future license, regulatory and sales milestone payments not yet accrued as probable.
- How much of the reported earnings and cash-flow improvement reflects recurring operations versus unusual collaboration, acquisition, tax and working-capital items.
- The final timing, share count and funding effects of the $5B accelerated repurchase, along with the increased dividend and expanded repurchase authorization.
- Developments in major litigation, patent challenges, product competition, cyber-related insurance recovery and the final tax-transition liability.