Merck & Co., Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context and results
Merck is a pharmaceutical and vaccine company, with additional Animal Health, Healthcare Services and alliance businesses. Q2 sales were $9.844 billion, up 1% year over year; first-half sales were $19.156 billion, down slightly from $19.210 billion. Foreign exchange reduced sales growth by 2% in Q2 and 3% in the first half. Reduced Venezuelan operations lowered sales by approximately $210 million and $450 million, respectively.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Sales | $9.844B | $9.785B | $19.156B | $19.210B |
| Net income attributable to Merck | $1.205B | $687M | $2.330B | $1.639B |
| Diluted GAAP EPS | $0.43 | $0.24 | $0.83 | $0.57 |
| Gross margin | 63.7% | 61.6% | 62.7% | 61.9% |
| Operating cash flow | Not separately reported for the quarter | $3.773B | $4.981B |
Financial position and cash flows
- At June 30, cash and cash equivalents were $6.608B; short-term investments were $5.226B and long-term investments $11.879B. Merck reported total cash and investments of $23.713B, down from $26.466B at year-end 2015.
- Debt carrying value was approximately $24.3B, including $644M of current debt and $23.642B of long-term debt. Working capital was $13.008B; total debt was 25.2% of total liabilities and equity.
- First-half investing activities provided $243M, versus using $4.080B in the prior-year period, which included the Cubist acquisition. Financing activities used $6.232B, including $2.351B of debt repayments, $1.573B of share repurchases and $2.579B of dividends. Cash decreased $1.916B.
- Capital expenditures were $654M in the first half. Merck paid approximately $680M net of insurance proceeds for the Vioxx securities settlement; this affected operating cash flow.
Changes and notable items
- GAAP net income and diluted EPS increased substantially, while revenue was essentially flat. The comparison benefited from the prior-year $715M Venezuela currency devaluation charge and lower 2016 acquisition-related costs; 2016 also included product impairments and higher R&D expense.
- Q2 R&D expense increased 29% to $2.151B; first-half expense rose 12% to $3.810B, reflecting higher licensing and clinical-development spending and impairments. Merck recorded $567M of intangible-asset impairment charges in the first half, including charges related to Zontivity and discontinued or returned development programs.
- Gross margin improved year over year. Amortization, restructuring and impairment items reduced reported gross margin by 12.0 percentage points in Q2 2016 and 13.6 points in the first half.
- Merck reported non-GAAP diluted EPS of $0.93 for Q2 and $1.82 for the first half, versus GAAP EPS of $0.43 and $0.83. Non-GAAP measures exclude significant acquisition/divestiture, restructuring and other items and are not GAAP measures.
- Product performance was mixed: Keytruda sales rose to $314M in Q2 and $563M in the first half; Zepatier launched in the U.S. in 2016. Remicade, Nasonex and Isentress declined. U.S. Cubicin sales face generic competition following expiration of its composition patent in June 2016.
Outlook, risks and contingencies
- Merck anticipated continuing pricing and market-access pressure, including Japanese price reductions and austerity measures, to weigh on revenue during the remainder of 2016. Management expected Remicade declines to accelerate and a significant decline in U.S. Cubicin sales.
- The company expected approximately $900M of restructuring-program costs in 2016 and approximately $1.0B of additional pretax costs to complete remaining actions, substantially by the end of 2017. No overall full-year sales or earnings guidance is provided in the filing text.
- Merck and Sanofi planned to end their European vaccine joint venture, SPMSD, by the end of 2016, subject to approvals and local requirements. Merck intended to integrate its European vaccine business into its own operations.
- Subsequent to quarter-end, Merck acquired Afferent for $500M plus up to $750M in contingent milestones, acquired a majority interest in StayWell for $150M, and agreed to acquire approximately 93% of Brazil’s Vallée for an estimated $400M. Merck also accrued a $200M Moderna collaboration payment as Q2 R&D expense; the cash payment occurred in July.
- Litigation includes product-liability claims, patent disputes and challenges to Keytruda patents. The company states that adverse patent outcomes could affect product exclusivity, sales or cause impairment charges. Merck paid the Vioxx securities settlement into escrow; its net cash cost was approximately $680M, and additional insurance recovery is disputed.
- Merck disclosed an IRS issue relating to the 2006–2008 examination that could materially affect financial position, liquidity and results if resolved unfavorably. It also warned that further product or pipeline impairments could be material. Zepatier’s European review identified quality-system and record-keeping issues at a third-party manufacturer; Merck said it did not expect a U.S. supply impact.
- Approximately 80%–90% of cash and investments were held by foreign subsidiaries and could incur significant tax if repatriated as dividends. Merck had not drawn on its new $6B five-year credit facility.
Key facts for investors to verify
- Whether growth in Keytruda, Zepatier and other newer products can offset generic competition, biosimilar erosion and expected declines in established products.
- How much of reported earnings improvement reflects underlying operations versus prior-year Venezuela losses, acquisition accounting, impairments, litigation gains and other excluded items.
- The pace and cash cost of restructuring, and whether planned savings offset ongoing R&D and commercial investment.
- Developments in Keytruda patent litigation, product-liability matters and the disputed IRS tax issue, including any changes to reserves or potential exposure.
- Whether foreign-held liquidity is practically available for U.S. needs, and the effect of dividends, repurchases and debt repayments on cash balances.