Merck & Co., Inc. — Q2 2012 Form 10-Q
Business context and reporting period. Unaudited results cover the three and six months ended June 30, 2012, compared with the corresponding 2011 periods. Merck’s operations include pharmaceuticals, vaccines, animal health, consumer care and alliances.
Financial results and liquidity
| Metric ($ millions, except per-share data) | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Sales | 12,311 | 12,151 | 24,041 | 23,732 |
| Income before taxes | 2,680 | 1,672 | 5,186 | 3,401 |
| Net income attributable to Merck | 1,793 | 2,024 | 3,531 | 3,067 |
| Diluted EPS | $0.58 | $0.65 | $1.15 | $0.98 |
| Gross margin | 66.6% | 64.7% | 66.1% | 64.8% |
- Sales increased 1% in both Q2 and the first half. Foreign exchange reduced reported sales growth by 4% in Q2 and 2% for the six months.
- Operating cash flow was $5.074 billion for the first half, versus $4.573 billion in 2011. Investing activities used $568 million and financing activities used $1.311 billion. Cash and cash equivalents ended the period at $16.752 billion.
- At June 30, cash and investments totaled $21.535 billion and working capital was $18.727 billion. Loans payable and current debt were $3.922 billion; long-term debt was $15.057 billion. Total debt was approximately $18.979 billion at carrying value; debt was 18.0% of total liabilities and equity.
- Capital expenditures were $762 million in the first half; full-year 2012 spending was estimated at $2.2 billion. Dividends paid in the first half were $2.559 billion. The declared quarterly dividend for Q3 and Q4 was $0.42 per share.
Material changes versus the prior period
- Pharmaceutical sales rose to $10.560 billion in Q2 from $10.360 billion; first-half sales were $20.642 billion versus $20.179 billion. Growth in Januvia, Janumet, vaccines, Isentress and other products was partly offset by lower Remicade and AZLP-related revenue and declines in several older brands.
- Januvia sales rose 36% in Q2 and 30% year to date; Janumet rose 28% in both periods. Remicade sales fell 38% in Q2 and 35% year to date, largely reflecting Merck’s relinquishment of marketing rights in certain territories. Singulair sales increased in the reported periods, but U.S. exclusivity expired in August 2012.
- Gross margin improved year over year, which management attributed, excluding amortization, impairment and restructuring effects, to product mix and manufacturing efficiencies. Marketing and administrative expense declined 8% in Q2 and 5% year to date; R&D expense rose 12% in Q2 and declined 2% year to date.
- First-half income attributable to Merck and diluted EPS increased, while Q2 income and EPS declined. Comparisons were affected by significant 2011 tax benefits: the 2011 Q2 effective tax rate was negative 22.8%, including a $700 million benefit from settlement of a federal tax audit and favorable tax-rate changes. The 2012 effective tax rates were 32.1% for Q2 and 30.8% for the first half.
Outlook, management commentary, risks and unusual items
- Pricing and patent exposure: Management expected high mid-single-digit pricing pressure across Europe for 2012 and further pricing reductions in Japan. It anticipated significant sales declines following Singulair patent expiries in the U.S. and major European markets. A generic Clarinex launched in the U.S. in July 2012; generic competition and other patent expiries also threaten products including Nasonex, Maxalt and older brands.
- Restructuring: Merger-related restructuring charges were $568 million in the first half. The program had incurred approximately $5.7 billion cumulatively; Merck expected total costs near the upper end of its $5.8–$6.6 billion estimate. Substantial completion was expected by the end of 2013, except certain manufacturing actions expected by 2015. Management projected annual savings of $3.5–$4.0 billion by the end of 2013 and $4.0–$4.6 billion upon completion. Total 2012 restructuring costs were forecast at $800 million–$1.1 billion across the programs.
- Pipeline and development: Merck reported that the odanacatib Phase III trial would close early following a favorable interim efficacy recommendation, while monitoring of identified safety areas would continue; regulatory filings were anticipated in the U.S. and EU in the first half of 2013. The company planned to file an NDA for suvorexant in 2012. The FDA issued Complete Response Letters for ridaforolimus and Atozet; Merck was evaluating next steps or preparing additional information. The MK-0524B program was placed on hold for business reasons. Merck paid Endocyte $120 million upfront for vintafolide rights and may owe up to $880 million in milestones, in addition to potential profit sharing and royalties.
- Unusual charges and cash items: First-half operating cash flow included a $960 million payment, including interest, related to the Vioxx resolution. Merck recorded a $120 million Endocyte upfront R&D expense and $136 million of first-half in-process R&D impairment charges. The Vioxx federal and state resolution was accepted by the court in April 2012; remaining Vioxx litigation continues.
- Other risks and contingencies: Merck disclosed substantial ongoing product-liability and commercial litigation, including Fosamax, NuvaRing and Vioxx matters, as well as the K-DUR antitrust case, which was remanded for further proceedings. The company said it could not reasonably estimate possible losses for certain major litigation. European sovereign-debt conditions affected receivable collection: receivables in Greece, Italy, Spain and Portugal totaled about $1.0 billion, including approximately $200 million more than one year outstanding. Management reported collecting about $500 million in Spain during Q2. Merck also cited manufacturing difficulties affecting certain women’s-health products and prior supply constraints for varicella-containing vaccines.
- Approximately 80%–90% of cash and investments were held by foreign subsidiaries and could be subject to significant taxes if repatriated as dividends. Merck had a new undrawn $4.0 billion five-year credit facility maturing in May 2017.
Important facts for investors to verify
- How much of the sales and earnings trend reflects underlying volume and product mix versus foreign exchange, tax items, restructuring and other exclusions.
- The pace and financial impact of generic entry and patent expiries, particularly for Singulair and Clarinex, and the outcome of the Nasonex patent appeal.
- Progress against restructuring cost, completion and savings estimates, including cash outlays and any additional restructuring actions.
- Developments in key pipeline programs, FDA responses, clinical safety monitoring and potential future impairment charges.
- Collections of European public-sector receivables and the potential financial exposure from unresolved litigation and tax disputes.