FY2006: Merck & Co Builds for the Long Term, Near-Term Profits Hit by Costs

Merck Toughens Up

Chief executive officer (CEO) Richard Clark yesterday presented the earnings results for U.S. drug giant Merck & Co that included several positive and modestly negative surprises. Most notably, annual sales unexpectedly broke through the US$6.0-billion barrier, against most analyst estimates of sales in the US$5.4-5.7 billion range. This was mainly due to a particularly strong performance in the U.S. market, where sales were up by 8% both in the quarter and the full year, despite the availability of generic simvastatin.

However, margins remain tight at the company, and its cost base also increased more than expected. In particular, final-quarter R&D spend was up fully by 55% to US$1.7 billion, or 29% of sales, and full-year investment here was up by 24% to US$4.8 billion (21% of sales). The fourth-quarter and full-year amounts include a US$466-million acquired research charge for Sirna—excluding the Sirna and restructuring charges, R&D expenses grew by 15% for the quarter and 11% for the year. Interestingly, these rates are not entirely dissimilar to its partner Schering-Plough, and indeed exceed those of R&D-intensive biotech companies. Marketing spend and cost of sales were also up significantly in the full year (17% and 14%, respectively) to accommodate new drugs. Thus, operating income was down by 71% to US$306 million on the quarter and by 37% to US$3.7 billion for the full year—operating margins stand at 5.1% and 16.2%, respectively.

Of course, the escalating cost base, which is being built up despite a concomitant, aggressive streamlining programme, is largely due to investment in new products. The year 2006 was a particularly transitory one, where Merck’s vaccines portfolio saw several new candidates enter the market, as well as the launch of Januvia (sitagliptin; diabetes) and Zolinza (vorinostat)—although sales from the latter two are not yet included in company results. Instead, sales were driven by higher-than-expected revenues from Fosamax (down 2% to US$3.1 billion against company estimates as late as December of US$2.8-2.9 billion).

Elsewhere, sales mostly hit the targets, with asthma drug Singulair (montekulast) standing strong at the top of Merck’s portfolio, with 20% growth to US$3.6 billion. Revenues from Gardasil stood at US$155 million on the quarter and US$235 million for the full year, against most analysts’ expectations of small revenues in its first few months on the market. It is as yet uncertain whether sales here are simply coming in earlier than expected or whether they represent an underestimation of the potential market value. As Global Insight noted yesterday with Schering-Plough’s results, the cholesterol joint venture (JV) grew strongly despite the entry of generic simvastatin, with sales of Vytorin (simvastatin/ezetimibe) coming in at US$2.0 billion in the full year.

Outlook and Implications

Merck & Co maintains one of the freshest portfolios and pipelines in the industry. Although risks in the latter remain high, Merck increased visibility into prospects here late last year. The company is aiming to make three filings this year, including HIV/AIDS drug MK-518 (second quarter), niacin flushing agent MK-524A (mid-2007) and insomnia drug gaboxadol (mid-2007). FDA action on the company’s COX-2 inhibitor Arcoxia (etoricoxib) will come in the second quarter, although the decisive advisory committee will be in this quarter. The metformin combination of Januvia and Janumet, will also be actioned in the second quarter. Elsewhere, the late-stage pipeline is being bolstered by several new candidates, although we do not expect to see much more insight here until November at the American Heart Association (AHA) meeting.

Perhaps most interesting, however, is what Clark re-emphasised in the earnings presentation—that the SGA spend will remain flat for some time to come. This means that Merck’s core cost base will probably remain stable until 2010, despite the likely entry of several new drugs into its portfolio, particularly in 2008. Somewhat surprisingly, the company increased its reserves to fight off litigation related to Vioxx (rofecoxib; arthritis) for the second successive quarter, by US$75 million, giving a total reserve of US$1.6 billion. Clearly, it is proving to be an expensive business to fight off these cases, but so far the company is meeting with great success.

Merck & Co’s forecasts for the year ahead remain unchanged from the December meeting: