Merck & Co., Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Amounts are in U.S. dollars; financial figures are in millions except per-share amounts.
Business context and performance
Merck’s principal reportable businesses are Pharmaceuticals and Animal Health. Healthcare Services was fully divested by March 31, 2020. The company plans to spin off its Women’s Health, legacy brands and biosimilars businesses as Organon in the first half of 2021, subject to market and other conditions.
Second-quarter sales declined amid COVID-19 disruption, while first-half sales increased modestly. Keytruda remained a major growth driver; numerous vaccines and physician-administered products faced reduced demand. First-half growth also reflected Animal Health sales, including the contribution from Antelliq.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Sales | $10,872 | $11,760 | $22,929 | $22,575 |
| Income before taxes | $3,519 | $3,259 | $7,357 | $6,326 |
| Net income attributable to Merck | $3,002 | $2,670 | $6,221 | $5,585 |
| Diluted GAAP EPS | $1.18 | $1.03 | $2.45 | $2.15 |
| Diluted non-GAAP EPS | $1.37 | $1.30 | $2.87 | $2.52 |
| Gross margin | 70.9% | 71.1% | 71.8% | 71.4% |
Q2 sales fell 8% year over year; first-half sales rose 2% (4% excluding foreign exchange). Q2 Pharmaceutical segment profits decreased 8%, while first-half Pharmaceutical profits increased 3%. Animal Health segment profits increased 1% in Q2 and 8% in the first half.
Q2 other income, net, included substantial investment gains: income from equity securities was $551 million, mainly from unrealized gains on investments including Moderna and NGM Biopharmaceuticals. Merck estimated approximately $300 million of additional gains from investment funds would be recognized in Q3. This volatility is an important factor when assessing reported earnings.
Operating cash flow was $4,074 for the first half, versus $4,420 in 2019. Investing activities used $2,510 and financing activities used $353. Capital expenditures were $1,654; dividends paid were $3,128. At June 30, cash and cash equivalents were $11,103, and cash and investments totaled $12,354. Working capital was $7,165.
Debt at June 30 comprised $4,718 of loans payable and current debt plus $26,156 of long-term debt, compared with total debt of $26,346 at year-end 2019. Merck issued $4.5 billion of long-term notes in June. Total debt to total liabilities and equity was 34.1%, versus 31.2% at December 31, 2019.
Material changes and drivers
- Keytruda sales grew 29% in Q2 and 36% in the first half. Alliance revenue from Lynparza and Lenvima also increased substantially.
- Q2 vaccine sales were pressured by fewer visits and delayed care: Gardasil/Gardasil 9 fell 26%, ProQuad 35%, and M-M-R II 64%. Bridion sales fell 19%, reflecting fewer elective surgeries.
- Ongoing generic competition weighed on products including NuvaRing, Noxafil, Emend, Zetia/Vytorin and Cubicin. Januvia/Janumet sales declined 7% in Q2 amid U.S. pricing pressure and lower demand in some markets.
- First-half GAAP earnings benefited from improved other income, including investment gains. First-half 2019 earnings had included a $360 million net tax benefit from resolution of federal tax matters.
- Merck acquired ArQule for approximately $2.7 billion in January and Themis for $366 million in cash in June. The Themis deal includes up to $740 million of potential contingent payments.
Outlook, commentary and risks
- Management estimated COVID-19 reduced Q2 sales by $1.6 billion and expects an approximately $1.95 billion unfavorable full-year sales impact, excluding foreign exchange. It assumed gradual recovery through Q3 and a return to normal operating levels in Q4; management cautioned actual results could differ materially.
- COVID-19 reduced access to healthcare providers and veterinary services, affecting vaccines, Keytruda, women’s health products, hospital medicines and Animal Health. Management estimated operating expenses benefited by $425 million in the first half and expects an approximately $400 million net favorable full-year expense impact, including planned COVID-19 research spending.
- The global restructuring program is expected to cost approximately $2.5 billion pretax, with about $800 million of charges expected in 2020, and is anticipated to generate approximately $900 million in annual net cost savings by the end of 2023.
- Pricing pressure, generic and biosimilar competition, product patent expirations, clinical-trial outcomes, regulatory decisions and the uncertain course of the pandemic may affect results. Merck disclosed a July 2020 FDA Complete Response Letter for Keytruda plus Lenvima in first-line unresectable liver cancer; the companies plan to discuss next steps with the FDA.
- Litigation and investigations include Fosamax and Januvia/Janumet product-liability matters, Zetia antitrust litigation, and a DOJ investigation concerning temperature excursions at a third-party storage facility. Merck said it could not reasonably estimate possible losses for certain litigation.
Investor verification points
- Track actual COVID-19 sales effects and recovery against management’s full-year assumptions, particularly for physician-administered products and vaccines.
- Assess how much reported earnings growth reflects recurring operations versus equity-investment gains and other non-operating items.
- Monitor operating cash flow, working capital, debt levels, and funding needs following the June debt issuance and major acquisitions.
- Evaluate Keytruda, Keytruda-combination and other pipeline trial results, regulatory reviews, and the impact of patent expirations and generic competition.
- Confirm Organon spin-off timing and scope, restructuring costs and savings progress, and developments in material litigation and government inquiries.