Merck & Co., Inc. quarterly report, Q1 FY2013

Business context and reporting period

Merck & Co., Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2013. Results are compared with the three months ended March 31, 2012; interim results are not necessarily indicative of full-year performance. Merck’s principal business is pharmaceuticals, with additional Animal Health, Consumer Care and alliance operations.

Financial performance and liquidity

Investing activities used $1.153 billion, including $351 million of capital expenditures. Financing activities used $1.421 billion, including $580 million for treasury-stock purchases and $1.306 billion of dividends paid. Cash and cash equivalents ended the quarter at $13.024 billion, down $427 million from year-end. Merck reported a 19.6% total-debt-to-total-liabilities-and-equity ratio. Approximately 80%–90% of cash and investments were held by foreign subsidiaries and could incur significant taxes if repatriated as dividends.

Material changes versus the prior comparable period

• Sales fell 9%, primarily because of Singulair’s loss of U.S. exclusivity in 2012 and expirations in major European markets in February 2013. Foreign exchange reduced sales growth by 2%.
• Pharmaceutical segment sales fell to $8.891 billion from $10.082 billion; segment profit declined 19% to $5.345 billion. Growth in vaccines, including Gardasil and Zostavax, and in products such as Remicade, Simponi and Isentress partly offset declines.
• Profit and EPS were lower despite reduced restructuring and marketing costs. Other expense increased to $282 million from $142 million, largely due to exchange losses, including approximately $140 million from Venezuela’s February currency devaluation.
• The effective tax rate was negative 4.3%, compared with 29.5% a year earlier. Q1 2013 included a $160 million benefit from resolution of a legacy Schering-Plough tax matter, along with other discrete tax benefits.
• Operating cash flow increased, but investing cash use and financing cash use also rose year over year. Cash and cash equivalents decreased in Q1 2013, whereas they increased in Q1 2012.

Outlook, management commentary, risks and unusual items

• Management expects continued revenue pressure from healthcare cost containment and government pricing actions for the remainder of 2013. It also expects further declines from Singulair, Maxalt and Propecia exclusivity losses; generic Temodar competition is expected to significantly reduce U.S. sales in 2013.
• Management expects 2013 restructuring costs of $500 million to $700 million. The merger restructuring program is estimated at $7.2–$7.5 billion in cumulative pretax costs, with annual savings of $3.5–$4.0 billion by year-end 2013 and $4.0–$4.6 billion upon completion. These are management estimates, not guarantees.
• On May 1, 2013, after quarter-end, Merck announced a new authorization to repurchase up to $15 billion of shares and expected to repurchase approximately $7.5 billion over the next 12 months, funded with debt issuance and operating cash flow. The filing gives no formal full-year revenue or earnings guidance.
• Pipeline and regulatory developments include FDA review of investigational allergy immunotherapy tablets, an extended review of sugammadex, and Breakthrough Therapy designation for investigational lambrolizumab. These products remain subject to regulatory and clinical uncertainty. The ertugliflozin collaboration with Pfizer includes a 60%/40% sharing of potential revenue and certain costs; Merck recorded $60 million of upfront and milestone payments through Q1.
• Material legal matters include Vioxx litigation, Fosamax product-liability cases, and other product and commercial litigation. Merck says it cannot reasonably estimate potential losses for the remaining Vioxx cases; an unfavorable outcome could materially affect financial position, liquidity and results. The proposed Vytorin/Zetia securities settlements total $688 million before anticipated $195 million insurance recoveries and require court approval; the charge was reflected in 2012 results, and the company anticipated paying the settlement amount in 2013 if approved.
• Other risks include potential generic competition and impairment charges. Merck identified a $1.7 billion Nasonex intangible asset at risk if generic entry follows an adverse patent outcome, and a $525 million Saphris/Sycrest intangible asset whose value depends on commercial success. Merck also warned that future pipeline impairments could be material.
• European and emerging-market collection cycles are longer. Receivables in Greece, Italy, Spain and Portugal totaled approximately $1.2 billion; total receivables outstanding more than one year were approximately $245 million. Management did not expect related write-offs or adjustments to materially harm results, liquidity or financial position.

Most important facts for investors to verify

• Whether sales and margins stabilize as patent expirations and generic competition continue to affect key products, especially Singulair.
• Whether the $160 million tax benefit and other discrete items materially affect comparability of reported earnings, and how underlying non-GAAP results reconcile to GAAP.
• Whether the $500–$700 million restructuring-cost outlook and projected savings are achieved, including cash requirements and completion timing.
• Developments in major litigation, court approval and insurance recovery for the proposed $688 million Vytorin/Zetia settlements, and any changes in estimated legal exposure.
• Cash generation, debt funding and the implications of the announced share repurchase authorization, alongside the substantial foreign-held cash balance.
• Regulatory and clinical progress for pipeline candidates, and the patent, generic-entry and impairment risks identified for Nasonex, Saphris/Sycrest and other products.