Merck & Co., Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods. Merck is a global pharmaceutical and health-products company, with Pharmaceutical as its largest operating segment. The 2009 Merck–Schering-Plough merger is accounted for as an acquisition, with associated purchase-accounting amortization and restructuring still affecting reported results.
Financial performance and liquidity
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Sales | $12.022B | $11.125B | $35.753B | $33.893B |
| Net income attributable to Merck | $1.692B | $342M | $4.760B | $1.393B |
| Diluted EPS | $0.55 | $0.11 | $1.53 | $0.44 |
| Gross margin | 63.8% | 62.3% | 64.5% | 58.8% |
| Operating cash flow | — | $9.150B | $7.283B |
Sales increased 8% in the quarter and 5% year to date; favorable foreign exchange contributed 5 and 3 percentage points, respectively. Reported earnings rose sharply, but comparisons are affected by unusual items and purchase-accounting charges. Management attributed the improvement principally to lower inventory step-up amortization, legal reserves and restructuring costs; year-to-date results also benefited from a $700M tax provision benefit. The 2011 year-to-date result included a $500M charge for the J&J arbitration settlement.
Cash and investments totaled $18.0B at September 30, 2011, versus $14.4B at year-end 2010; working capital was $17.5B versus $13.4B. Cash and cash equivalents were $14.253B. Debt carrying value was approximately $18.1B, comprising $2.455B current and $15.692B long-term debt. Merck reported total debt at 17.0% of total liabilities and equity. Most cash and investments were held by foreign subsidiaries and could incur significant taxes if repatriated.
Nine-month investing cash outflow was $1.206B, including $1.120B capital expenditures; financing cash outflow was $4.673B, including $3.526B of dividends and $1.359B of treasury-stock purchases. The quarterly dividend remained $0.38 per share. Full-year 2011 capital expenditures were estimated at $1.8B.
Material changes and operating trends
- Pharmaceutical segment sales rose 9% in Q3 and 6% year to date. Growth in Januvia, Janumet, Singulair, Gardasil, Isentress and other products was partly offset by declines in established brands and lost or relinquished marketing rights.
- Januvia sales increased 41% in Q3 and 38% year to date; Janumet rose 42% and 47%. Cozaar/Hyzaar sales fell 27% year to date following patent expirations. Singulair sales grew 10% year to date, but Merck expected substantial U.S. declines after its August 2012 patent expiry.
- Q3 Remicade sales declined 15%, reflecting the July 2011 relinquishment of marketing rights in certain territories. Under amended terms, Merck retained Europe, Russia and Turkey, with profits there shared equally with J&J; Merck paid J&J $500M.
- EU austerity and drug-pricing measures weighed on revenue; Merck expected this pressure to continue into 2012. Manufacturing constraints affected certain vaccines and women’s-health products, including ProQuad and Zostavax supply.
- Gross margin improved, reflecting product mix and manufacturing efficiencies, though merger-related amortization, restructuring and impairment charges remained substantial. R&D expense declined 8% year to date; marketing and administrative expense rose 5%.
Outlook, risks, contingencies and unusual items
- The Merger Restructuring Program is expected to cost $5.8B–$6.6B pretax cumulatively, with most actions substantially complete by end-2013 and certain manufacturing actions by 2015. Estimated annual savings are $3.5B–$4.0B by end-2013 and $4.0B–$4.6B upon completion. Combined 2011 restructuring costs were forecast at $1.3B–$1.5B.
- No consolidated full-year sales or EPS guidance is stated in the supplied filing text. Pipeline and regulatory uncertainty includes FDA Complete Response letters for Janumet XR, Zoely/NOMAC-E2 and tafluprost; further discussions with the FDA were planned. Merck also discontinued development of MK-0431C.
- Merck recorded $343M of year-to-date in-process R&D impairment charges and $118M of marketed-product intangible impairment. The company warned additional non-cash impairment charges could be material.
- Vioxx litigation and the related DOJ investigation remain significant uncertainties. A $950M Vioxx liability reserve had been established in 2010; the company said it could not estimate possible losses for remaining Vioxx claims. The Vioxx legal-defense reserve was approximately $64M at September 30, 2011. Unfavorable outcomes could materially affect financial position, liquidity and results.
- Other litigation includes Fosamax, NuvaRing and Vytorin/Zetia matters; Merck generally said it could not reasonably estimate possible losses in the specified major cases. A proposed $49.5M Vioxx ERISA settlement awaited final court approval. A Massachusetts AWP verdict called for approximately $13.8M plus interest and fees, and Merck planned to appeal.
- European sovereign-debt conditions affected collections: receivables in Greece, Italy, Spain and Portugal were approximately $1.6B, with about $370M outstanding over one year; approximately 90% of the latter balance related to those countries. Management did not expect material receivable write-offs, but collection timing had lengthened.
- Canadian tax assessments could add approximately $330M in tax and $370M in interest through September 30, 2011; Merck contested them and said resolution was not expected to materially affect its financial position or liquidity. In contrast, the IRS settlement generated a $700M tax benefit despite approximately $465M of net cash payments.
Important facts for investors to verify
- How much of earnings and EPS growth reflects recurring operations versus tax benefits, merger accounting, restructuring and other unusual items.
- Progress against restructuring cost, completion and savings targets, including the additional workforce reduction announced in 2011.
- Product exposure to patent expirations—especially Singulair—and the commercial impact of territory changes for Remicade and Simponi.
- Developments in Vioxx, Fosamax, NuvaRing, Vytorin/Zetia and government investigations, including reserves, insurance recoveries and potential cash exposure.
- Collection trends for Southern European public-sector receivables and the tax and liquidity implications of cash held overseas.
- Vaccine and women’s-health manufacturing recovery, and the timing and prospects of key pipeline and regulatory decisions.