Merck & Co., Inc. — Q3 2012 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and nine months ended September 30, 2012, compared with the corresponding 2011 periods. Merck’s operations are primarily pharmaceuticals, with animal health, consumer care and alliance businesses. Dollar figures are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Sales | $11,488 | $12,022 | $35,530 | $35,753 |
| Income before taxes | $2,218 | $2,352 | $7,405 | $5,753 |
| Net income attributable to Merck | $1,729 | $1,692 | $5,261 | $4,760 |
| Diluted EPS | $0.56 | $0.55 | $1.71 | $1.53 |
| Gross margin | 64.0% | 63.8% | 65.4% | 64.5% |
| Effective tax rate | 20.5% | 26.7% | 27.8% | 15.7% |
- Sales declined 4% for the quarter and 1% year to date. Foreign exchange reduced reported sales by 4% and 3%, respectively.
- Operating cash flow was $8,213 for the first nine months, down from $9,150; the filing attributes pressure in part to changes in assets and liabilities and a $960 million Vioxx-related payment, including interest.
- Capital expenditures were $1,176. Investing cash use was $2,407 and financing cash use was $2,049. Cash and cash equivalents ended at $17,360, up from $13,531 at year-end 2011.
- At September 30, cash and investments were $23,677; working capital was $20,646. Current liabilities were $15,583. Debt carrying value, including current maturities, was approximately $19,600, versus $17,515 at December 31, 2011. Total debt was 18.4% of total liabilities and equity, compared with 16.7%.
- Merck issued $2.5 billion of senior notes in September. Its $4.0 billion five-year credit facility was undrawn. Approximately 80%–90% of cash and investments were held by foreign subsidiaries and could incur significant tax if repatriated as dividends.
- Dividends paid were $3,836; treasury-stock purchases were $1,439. Dividends declared were $0.42 per share in Q3, compared with $0.38 a year earlier.
Material changes versus prior periods
- Patent-related sales pressure: Singulair U.S. exclusivity expired in August 2012. Q3 Singulair sales fell 55% globally and 72% in the United States. Merck expects significant further declines, including in major European markets after anticipated February 2013 expiries.
- Growth brands partly offset declines: Nine-month Januvia sales rose 25%, Janumet 24%, Gardasil 27%, Isentress 17% and Zostavax 68%. Declines in Singulair, Remicade, Cozaar/Hyzaar, Clarinex and other products, along with lower AZLP revenue, offset growth.
- Marketing and administrative expense fell 6% year to date; restructuring costs fell to $473 from $773. Pharmaceutical segment profit increased 4% year to date, while Q3 pharmaceutical segment profit declined 1%.
- Net income and diluted EPS rose year to date, while sales were nearly flat. The comparison benefited from lower restructuring and impairment charges and the absence of the $500 million 2011 arbitration charge; tax settlements and prior-year divestiture gains also affected comparisons.
- Gross margin improved as reported, but excluding amortization, impairment and restructuring effects, management said margin declined, principally reflecting Singulair’s loss of exclusivity, partly offset by product mix and manufacturing efficiencies.
Outlook, commentary and risks
- Merck forecast 2012 restructuring costs of $800 million–$1.1 billion. The Merger Restructuring Program’s cumulative pretax cost estimate was raised to $7.2 billion–$7.5 billion; completion is expected mainly by end-2013, with certain manufacturing actions extending to 2016. Expected annual savings are $3.5 billion–$4.0 billion by end-2013 and $4.0 billion–$4.6 billion upon completion. These are estimates, not guaranteed results.
- Management expected mid-single-digit pricing pressure across Europe for full-year 2012 and further pressure from Japanese biennial price reductions. No overall full-year sales or EPS guidance is stated in the provided filing text.
- Other exposure to product exclusivity includes Clarinex, Fosamax, Cozaar/Hyzaar and upcoming expiries for Maxalt, Temodar and certain other products. Generic competition or adverse patent rulings could reduce sales and lead to intangible-asset impairments.
- Manufacturing difficulties affected certain women’s health products; supply constraints had affected ProQuad, Varivax and Zostavax. Merck said it was working to resolve manufacturing issues.
- Regulatory and pipeline uncertainty includes an FDA Warning Letter concerning a required Januvia/Janumet rodent pancreatic-safety study; the company said it agreed a protocol and was proceeding. Suvorexant was accepted for standard FDA review; other candidates received Complete Response Letters, and certain development programs were discontinued or returned to partners.
- Litigation remains a material uncertainty. Merck could not reasonably estimate possible losses for remaining Vioxx or ENHANCE matters; adverse outcomes could materially affect results, liquidity or financial position. The filing also describes Fosamax, NuvaRing, Propecia, antitrust and other proceedings. The Missouri Vioxx class-action settlement carried a $39 million reserve, subject to court approval.
- European sovereign-debt conditions affected collections: receivables in Greece, Italy, Spain and Portugal totaled about $1.0 billion, including roughly $300 million outstanding more than one year. Merck said it did not expect related write-offs to materially harm its financial position, liquidity or results.
Most important facts for investors to verify
- How quickly Singulair sales decline after U.S. and European patent expiries, and whether growth products can offset the lost revenue.
- Whether operating cash flow recovers from working-capital pressure and whether pension contributions, dividends and buybacks remain supportable.
- Progress and realized savings from restructuring against the revised cost and completion estimates.
- Developments in Vioxx, ENHANCE and other litigation, including any changes to reserves, insurance recoveries or loss estimates.
- Regulatory, clinical and manufacturing developments affecting key products and pipeline candidates, as well as European receivables collection and foreign-cash repatriation considerations.