Merck & Co., Inc. — Form 10-Q Summary
Reporting period: Third quarter and nine months ended September 30, 2014. Unless otherwise indicated, figures are in U.S. dollars; financial results are unaudited.
Business context and reporting period
Merck is a global pharmaceutical and animal-health company. Its principal reportable business is Pharmaceuticals; other activities include Animal Health, Consumer Care and alliances. After quarter-end, on October 1, 2014, Merck completed the sale of its Consumer Care business to Bayer. The business and related assets and liabilities were classified as held for sale at September 30.
Financial results and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Sales | $10.557 billion | $11.032 billion | $31.755 billion | $32.713 billion |
| Net income attributable to Merck | $895 million | $1.124 billion | $4.604 billion | $3.623 billion |
| Diluted EPS | $0.31 | $0.38 | $1.57 | $1.20 |
| Gross margin | 60.0% | 62.8% | 59.0% | 62.3% |
| Operating cash flow | Not separately stated | Not separately stated | $9.024 billion | $8.628 billion |
Q3 income before taxes was $1.490 billion versus $1.525 billion; the effective tax rate was 43.5% versus 24.6%. Nine-month income before taxes was $5.472 billion versus $4.320 billion, and the effective tax rate was 15.8% versus 14.3%. Nine-month results include significant transaction gains and tax benefits, so reported earnings are not solely indicative of underlying operating trends.
For the first nine months, investing activities used $7.578 billion, including the $3.7 billion net cash outflow for Idenix; financing activities used $5.470 billion. Capital expenditures were $827 million, treasury-stock purchases were $6.083 billion and dividends paid were $3.911 billion. Cash and cash equivalents declined to $11.370 billion from $15.621 billion at year-end 2013.
At September 30, cash and investments totaled $27.839 billion; working capital was $8.796 billion, down from $17.817 billion at December 31, 2013. Debt carrying value, including current maturities, was approximately $27.8 billion versus $25.1 billion at year-end. Total debt to total liabilities and equity was 27.3%, compared with 23.7%. Merck reported a new undrawn $6 billion five-year credit facility. Approximately 80%–90% of cash and investments were held by foreign subsidiaries and could incur significant tax if repatriated as dividends.
Material changes versus the prior comparable period
- Worldwide sales fell 4% in Q3 and 3% for the first nine months. Q3 foreign exchange provided a 1% benefit; nine-month foreign exchange reduced sales by 1%.
- Q3 attributable net income and diluted EPS declined, reflecting lower sales, higher intangible-asset impairments and an additional health-care reform fee expense, partly offset by divestiture gains and lower restructuring and operating costs.
- Nine-month attributable net income and diluted EPS increased, driven in part by AstraZeneca-related gains, divestiture gains, tax benefits, lower operating expenses and $232 million of revenue from the Saphris U.S. rights sale.
- Pharmaceutical segment sales were $9.134 billion in Q3, down from $9.475 billion; nine-month sales were $26.672 billion, down from $27.677 billion. Januvia/Janumet, Remicade, Simponi and animal health helped offset declines in products including Victrelis, Temodar, Gardasil and older brands.
- Q3 gross margin decreased 2.8 percentage points. Merck attributed the year-to-date decline, excluding amortization, restructuring and impairment items, chiefly to product mix, generic erosion and inventory write-offs.
Outlook, management commentary, risks and unusual items
- Sales and pricing: Management said pricing actions, including Japan’s biennial price reductions, and austerity measures were expected to continue weighing on revenue through the remainder of 2014. The filing provides no clear full-year sales or EPS guidance.
- Restructuring: Merck estimated 2014 costs for its 2013 and merger restructuring programs at $1.5–$1.7 billion. The 2013 program targets approximately $2.0 billion in annual net savings by the end of 2015; combined programs were expected to yield $2.5 billion in annual savings by then. The merger program’s estimated cumulative pretax cost is $7.9–$8.2 billion.
- Portfolio and transactions: The October 1 Consumer Care sale was for $14.2 billion, subject to adjustments and contingent holdbacks; Merck expected an approximately $11.0 billion pretax gain and said it would use after-tax proceeds, net of the Idenix acquisition cash use, to return capital to shareholders. Merck also entered an sGC-modulator collaboration with Bayer, paying $1.0 billion upfront. The Idenix acquisition cost approximately $3.9 billion in cash and included $3.2 billion of acquired in-process R&D.
- Product and development risks: New HCV therapies caused significant market-share losses for PegIntron, Victrelis and Rebetol; Merck recorded $1.1 billion of nine-month marketed-product impairment charges, primarily related to these products. Remicade faced expected substantial competition after loss of exclusivity in major European markets in February 2015. Keytruda received U.S. approval for certain advanced melanoma patients in September 2014; patent disputes involving Ono and Bristol-Myers Squibb remain unresolved.
- Other unusual items: Nine-month other income included a $741 million AstraZeneca option-exercise gain and a $396 million ophthalmic-products divestiture gain; the quarter also included a $93 million Supera goodwill impairment. The Q3 effective tax rate was elevated partly because of the additional health-care reform fee expense.
- Contingencies and exposures: Merck said it could not reasonably estimate possible loss ranges for remaining Vioxx litigation; unfavorable outcomes could materially affect results, liquidity or financial position. It reported approximately 5,555 Fosamax cases and approximately 700 Januvia/Janumet product-user claims pending at September 30. Merck also cited European public-sector receivables and longer collection periods in emerging markets. It had approximately $600 million of net monetary assets in Venezuela measured at the official exchange rate and warned that a rate change could result in a significant charge.
- Debt actions after quarter-end: October debt tenders and planned redemptions were expected to result in an approximately $650 million pretax loss in Q4. These transactions and the October note maturity occurred after the reporting date.
Most important facts for investors to verify
- Whether core product sales and margins stabilize after considering the continuing HCV and generic-competition declines and the loss of Consumer Care and AZLP revenue.
- How much of reported nine-month earnings reflects transaction gains and discrete tax benefits, and how the business performs on a comparable operating basis.
- Whether the Consumer Care sale proceeds, expected gain and stated shareholder-return plans are realized as described, including any closing adjustments or holdbacks.
- Whether restructuring costs, completion timing and targeted savings track management’s estimates.
- Developments in Keytruda’s commercial uptake and patent disputes, major product litigation, European receivable collections and Venezuela currency exposure.