Merck & Co., Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and results
Merck is a global pharmaceutical and animal-health company. It reported Q1 sales of $12.057 billion, up 11% year over year (13% excluding foreign exchange). Growth was led by Keytruda, vaccines, alliance revenue from Lynparza and Lenvima, and Animal Health. Healthcare Services businesses were fully divested by March 31, 2020.
- Revenue: $12.057 billion, versus $10.816 billion.
- Net income attributable to Merck: $3.219 billion, versus $2.915 billion. Diluted EPS was $1.26, versus $1.12.
- Non-GAAP results: Non-GAAP net income was $3.822 billion and diluted EPS $1.50, compared with $3.175 billion and $1.22. These company-defined measures exclude specified acquisition/divestiture, restructuring and other items.
- Margins and costs: Gross margin was 72.5%, up from 71.8%. Cost of sales increased 9%, SG&A 5%, and R&D 14%; restructuring costs were $72 million, down from $153 million.
- Cash flow: Operating cash flow was $707 million, versus $1.336 billion. Capital expenditures were $986 million, versus $595 million. The company cited $750 million of collaboration payments and working-capital movements as factors affecting operating cash flow.
- Liquidity: Cash and investments were $7.987 billion, versus $11.919 billion at year-end; working capital was $2.691 billion, versus $5.263 billion. Current assets were $26.174 billion and current liabilities $23.483 billion.
- Debt: Current and long-term debt totaled approximately $28.0 billion, versus $26.3 billion at December 31, 2019. The company had an undrawn $6.0 billion credit facility maturing in 2024.
Material changes and notable items
- Keytruda sales increased 45% to $3.284 billion; Gardasil/Gardasil 9 increased 31% to $1.097 billion. Lynparza alliance revenue rose 84% to $145 million and Lenvima alliance revenue rose 72% to $128 million.
- Several established products faced generic or biosimilar competition: NuvaRing sales fell 71%, Emend 63%, Noxafil 50%, and Januvia/Janumet combined 6%.
- Merck acquired ArQule in January for $2.7 billion, adding oncology research assets, including investigational candidate MK-1026.
- The effective tax rate was 16.1%, versus 6.7%. The 2019 rate benefited from a $360 million tax benefit related to settlement of federal tax matters.
- Merck repurchased $1.3 billion of shares during the quarter, then temporarily suspended its repurchase program in response to the operating environment. Dividends paid were $1.6 billion.
Outlook, management commentary, and risks
- Merck estimated COVID-19 would reduce 2020 revenue by approximately $2.1 billion, excluding foreign exchange: about $1.7 billion in Pharmaceutical and $400 million in Animal Health. It expected approximately $400 million of favorable operating-expense impact for the year. These estimates assumed most revenue pressure would occur in Q2, with recovery through Q3 and a return to normal operations in Q4; the company cautioned that actual results could differ materially.
- Management said Q1 COVID-19 revenue impact was immaterial overall. Reduced provider access, fewer visits and delayed elective procedures were pressuring physician-administered products. Animal Health benefited by approximately $60 million from customer advance purchases, but management expected later pressure from fewer veterinary visits and lower food-service-related demand.
- Merck reported no material pandemic-related supply disruption to date and expected normal supply levels, while noting that prolonged disruption could adversely affect operations. It also warned that trial enrollment or study-start delays could postpone development and regulatory milestones.
- A global restructuring program is expected to cost approximately $2.5 billion pretax, with about $800 million of charges expected in 2020, and is projected to generate approximately $900 million in annual net savings by the end of 2023.
- Merck planned to spin off its women’s health, legacy brands and biosimilars businesses as Organon & Co. in the first half of 2021, subject to market and other conditions. The planned transaction excludes Merck’s existing research pipeline programs.
- Risks include pricing and market-access pressure, generic and biosimilar competition, patent challenges, uncertain litigation outcomes, and COVID-19 impacts. Merck said it could not reasonably estimate possible losses for certain litigation matters; its legal defense reserves were approximately $255 million.
Most important facts for investors to verify
- Whether COVID-19 revenue and expense assumptions—and the anticipated timing of recovery—were borne out in subsequent reporting periods.
- Cash conversion and working-capital trends, given operating cash flow fell year over year while capital spending increased.
- Debt, liquidity and capital-return developments after the share repurchase suspension.
- Progress, costs, savings and completion conditions for the Organon spin-off and restructuring program.
- Key product growth, especially Keytruda and vaccines, against ongoing pricing pressure and generic, biosimilar and patent-related risks.
- Developments in significant litigation and patent disputes, for which ultimate outcomes and potential losses were uncertain.