Notes to Consolidated Financial Statements
1. The accompanying unaudited interim consolidated financial statements
have been prepared pursuant to the rules and regulations for reporting
on Form 10-Q. Accordingly, certain information and disclosures required
by generally accepted accounting principles for complete financial
statements are not included herein. The interim statements should be
read in conjunction with the financial statements and notes thereto
included in the Company's latest Annual Report on Form 10-K.
Interim statements are subject to possible adjustments in connection
with the annual audit of the Company's accounts for the full year 1998;
in the Company's opinion, all adjustments necessary for a fair
presentation of these interim statements have been included and are of
a normal and recurring nature.
Certain reclassifications have been made to prior year amounts to
conform with current year presentation.
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Notes to Consolidated Financial Statements (continued)
2. On July 1, 1998, the Company sold its one-half interest in The DuPont
Merck Pharmaceutical Company (DMPC), its joint venture with E.I. du
Pont de Nemours and Company (DuPont), to DuPont for $2.6 billion in
cash, resulting in a pretax gain of $2.15 billion ($1.25 billion after
tax). The joint venture was not significant to the Company's financial
position or results of operations. This gain was substantially offset
on an after-tax basis by a $1.04 billion pretax and after-tax charge
for acquired research (see Note 3) and $338.6 million of pretax other
nonrecurring charges ($193.1 million after tax) included in Other
(income) expense, net. (See Note 8.)
3. On July 1, 1998, the Company and Astra AB (Astra) completed the
restructuring of the ownership and operations of their Astra Merck Inc.
(AMI) joint venture whereby the Company acquired Astra's interest in
AMI, renamed KBI Inc. (KBI) effective August 26, 1998, for
consideration totaling $3.1 billion, including approximately $700.0
million in cash and assumption of a $2.4 billion preferred stock
obligation to Astra with a dividend rate of 5% per annum, which is
included in Minority interests in the consolidated financial
statements. KBI's net operating assets, excluding certain product
rights, were then combined with the net assets of Astra's wholly owned
subsidiary, Astra USA, Inc., to form a new U.S. limited partnership
named Astra Pharmaceuticals, L.P. in which Merck maintains a limited
partner interest. For a franchise fee payment of $230.0 million, which
is being amortized into income over 10 years on a straight-line basis,
the partnership became the exclusive distributor of the products for
which KBI retained rights. Merck earns certain partnership returns as
well as ongoing revenue based on sales of current and future KBI
products. The partnership returns include a priority return, a fixed
return and certain variable returns which, in part, are based upon
sales of certain former Astra USA, Inc. products. The fixed return
represents accretion of the carrying value of Merck's limited
partnership interest from its initial carrying value up to its
liquidating net worth, which is being recognized into income over 10
years on a straight-line basis. For a payment of $443.0 million, which
is being deferred, Astra purchased an option to buy Merck's interest in
the KBI products in 2008, 2012 or 2016, excluding Merck's interest in
the gastrointestinal medicines 'Prilosec' and perprazole.
The Company's acquisition of Astra's interest in AMI for $3.1 billion
was accounted for under the purchase method and, accordingly, 100% of
KBI's results of operations have been included with the Company's since
July 1, 1998. Pro forma information is not provided as the impact of
the transaction does not have a material effect on the Company's
reported results for 1998 and 1997. The purchase price was allocated
based upon the fair values of the portion of assets and liabilities
acquired as determined by an independent appraisal. Purchase price
allocations resulted in the recognition of goodwill and other
intangibles, principally U.S. patent rights on in-line products,
totaling $1.8 billion, to be amortized on a straight-line basis over
periods up to 20 years. The Company also recorded a $1.04 billion
charge for acquired research associated with products in development
and U.S. rights to future Astra products which have not yet entered
development for which, at the acquisition date, commercial viability
had not been established.
4. Inventories consisted of:
($ in millions)
September 30 December 31
1998 1997
---- ----
Finished goods $1,496.1 $1,230.6
Raw materials and work in process 801.4 849.7
Supplies 69.0 64.8
-------- --------
Total (approximates current cost) 2,366.5 2,145.1
Reduction to LIFO cost -- --
-------- --------
$2,366.5 $2,145.1
======== ========
5. In February 1998, the Company issued $500.0 million of 30-year senior
notes under the 1997 shelf registration, bearing a coupon of 6.4%
payable semiannually. The remaining capacity under the shelf is $1.2
billion. In July 1998, the Company issued a $1.38 billion 6.0% 40-year
term note to Astra which is subject to repayment at par upon certain
events in which Astra acquires product rights held by KBI.
(See Note 3.)
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Notes to Consolidated Financial Statements (continued)
6. The Company, along with numerous other defendants, is a party in
several antitrust actions brought by retail pharmacies and consumers,
alleging conspiracies in restraint of trade and challenging pricing
and/or purchasing practices, one of which has been certified as a
federal class action and a number of which have been certified as state
class actions. In 1996, the Company and several other defendants
finalized an agreement to settle the federal class action alleging
conspiracy, which represents the single largest group of retail
pharmacy claims, pursuant to which the Company would pay $51.8 million,
payable in four equal annual installments, the last of which will be
paid in January 1999. The Company has not engaged in any conspiracy,
and no admission of wrongdoing was made nor was included in the final
agreement, which was entered into in order to avoid the cost of
litigation and the risk of an inaccurate adverse verdict by a jury
presented with a case of this size and complexity. While it is not
feasible to predict or determine the final outcome of these
proceedings, management does not believe that they should result in a
materially adverse effect on the Company's financial position, results
of operations or liquidity.
7. Sales consisted of:
($ in millions)
Three Months Nine Months
Ended September 30 Ended September 30
1998 1997 1998 1997
---- ---- ---- ----
Elevated cholesterol $ 1,180.1 $ 1,163.6 $ 3,382.6 $ 3,397.1
Hypertension/heart failure 935.9 939.8 3,083.3 2,822.6
Anti-ulcerants 273.4 297.8 823.4 861.9
Vaccines/biologicals 251.0 236.2 654.0 570.3
Osteoporosis 192.0 139.4 539.4 368.6
Antibiotics 167.7 188.6 538.8 578.9
Human immunodeficiency virus (HIV) 156.4 133.1 491.5 397.1
Ophthalmologicals 153.0 162.1 451.5 476.1
Animal health/crop protection -- 63.5 -- 546.2
Other Merck products 615.8 214.9 1,000.7 448.3
Merck-Medco 2,913.0 2,388.7 8,402.3 6,937.7
--------- --------- --------- ---------
$ 6,838.3 $ 5,927.7 $19,367.5 $17,404.8
========= ========= ========= =========
In July 1997, the Company sold its crop protection business to
Novartis. In August 1997, the Company and Rhone-Poulenc combined their
animal health and poultry genetics businesses to form Merial Limited,
a fully integrated, stand-alone joint venture, equally owned by each
party. Other Merck products include sales of other human
pharmaceuticals, continuing sales to divested businesses and
pharmaceutical and animal health supply sales to the Company's joint
ventures and, as of July 1, 1998, increased revenues from supply sales
to Astra Pharmaceuticals, L.P. (See Note 3.)
8. Other (income) expense, net, consisted of:
($ in millions)
Three Months Nine Months
Ended September 30 Ended September 30
1998 1997 1998 1997
---- ---- ---- ----
Interest income $(100.0) $(57.5) $(225.6) $(162.8)
Interest expense 56.9 33.9 138.8 89.8
Exchange (gains) losses (9.7) 3.4 (22.4) (9.7)
Minority interests 19.6 40.6 84.8 113.2
Amortization of goodwill and other intangibles 84.3 48.5 180.8 144.6
Other, net 308.9 175.8 266.2 124.3
------- ------ ------- ------
$ 360.0 $244.7 $ 422.6 $299.4
======= ====== ======= ======
Minority interests include third parties' share of exchange gains and
losses arising from translation of the financial statements into U.S.
dollars.
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Notes to Consolidated Financial Statements (continued)
Increased amortization of goodwill and other intangibles for the three-
and nine-month periods ended September 30, 1998 reflects amortization
of goodwill and other intangibles associated with the restructuring of
the ownership and operations of AMI. (See Note 3.)
Other, net, for the three- and nine-month periods ended September 30,
1998 includes $338.6 million of nonrecurring charges, primarily for
environmental remediation costs and asset write-offs, principally
deferred start-up costs.
Interest paid for the nine-month periods ended September 30, 1998 and
1997 was $97.0 million and $84.5 million, respectively.
9. Income taxes paid for the nine-month periods ended September 30, 1998
and 1997 were $1,639.0 million and $866.2 million, respectively.
10. The net income effect of dilutive securities was not significant to the
Company's calculation of Earnings per common share assuming dilution. A
reconciliation of weighted average common shares outstanding to
weighted average common shares outstanding assuming dilution follows:
($ in millions)
Three Months Nine Months
Ended September 30 Ended September 30
1998 1997 1998 1997
---- ---- ---- ----
Average common shares outstanding 1,188.4 1,205.8 1,192.3 1,207.2
Common shares issuable(1) 30.7 30.1 31.1 30.8
------- ------- ------- -------
Average common shares outstanding assuming dilution 1,219.1 1,235.9 1,223.4 1,238.0
======= ======= ======= =======
(1) Issuable primarily under stock option plans.
11. Effective January 1, 1998, the Company adopted the provisions of
Statement No. 130, Reporting Comprehensive Income, which modifies the
financial statement presentation of comprehensive income and its
components. Upon adoption of this Statement, the accumulated net
unrealized gain on the Company's available-for-sale investments of
$27.9 million at December 31, 1997 was reclassified from Retained
earnings to a separate component of Stockholders' equity.
Comprehensive income for the three months ended September 30, 1998 and
1997, representing all changes in Stockholders' equity during the
period other than changes resulting from the Company's stock, was
$1,371.3 million and $1,187.9 million, respectively. Comprehensive
income for the nine months ended September 30, 1998 and 1997 was
$3,850.4 million and $3,367.0 million, respectively.
12. Legal proceedings to which the Company is a party are discussed in Part
1 Item 3, Legal Proceedings, in the Annual Report on Form 10-K. Current
developments are discussed in Part II of this filing.
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MANAGEMENT'S ANALYSIS OF INTERIM FINANCIAL INFORMATION
Earnings per share for the third quarter of 1998 were $1.12, an increase of 15%
over the third quarter of 1997. Third quarter net income increased 14% to
$1,367.0 million. Sales for the quarter were $6.8 billion, up 15% from the same
period last year.
For the first nine months, earnings per share were $3.14, an increase of 15%
from the first nine months of 1997. Net income was $3,847.5 million for the
first nine months of 1998, an increase of 14% from the first nine months of
1997. Sales rose 11% to $19.4 billion.
Sales growth for the quarter and the first nine months of 1998 was affected by
the formation of the Merial joint venture and divestiture of the crop protection
business, both in the third quarter of 1997. Adjusting for these effects, sales
increased 16% for the third quarter and 14% for the first nine months of 1998
(including a 6 point and a 2 point increase attributable to the restructuring of
the ownership and operations of Astra Merck Inc. (AMI) for the third quarter and
nine months, respectively). (See Notes 3 and 7 to the consolidated financial
statements for further information.)
Sales growth for the quarter and the first nine months of 1998 was led by the
established major products and newer products, including those launched this
year, as well as growth from the Merck-Medco Managed Care business and the
effect of the AMI restructuring. Solid volume gains in both domestic and
international operations contributed to the third quarter results.
Foreign exchange reduced the third quarter sales growth by two percentage
points, the same effect as reported in the second quarter of 1998. Excluding
exchange and including the effect of the AMI restructuring, sales of Merck human
health products increased 17% for the third quarter and 12% for the nine months.
Income growth for the first nine months was driven by solid sales volume gains
as well as the effects of ongoing cost controls and productivity improvements in
manufacturing, selling and general and administrative expenses.
In the third quarter of 1998, the Company recorded a pretax gain of $2.15
billion ($1.25 billion after tax) on the sale of its one-half interest in The
DuPont Merck Pharmaceutical Company (DMPC), its joint venture with E.I. du Pont
de Nemours and Company. (See Note 2 to the consolidated financial statements for
further information.) This gain was substantially offset on an after-tax basis
by a $1.04 billion pretax and after-tax charge for acquired research in
connection with the restructuring of the ownership and operations of AMI (see
Note 3 to the consolidated financial statements for further information) and
$338.6 million of pretax other nonrecurring charges ($193.1 million after tax).
These other charges, which are included in Other (income) expense, net, were
primarily for environmental remediation costs and asset write-offs, principally
deferred start-up costs which were expensed in accordance with the Company's
third quarter adoption of Statement of Position No. 98-5, "Reporting on the
Costs of Start-up Activities."
The growth in pretax income for the third quarter was affected by the gain on
sale of the Company's one-half interest in DMPC net of the nonrecurring charges.
However, the net increase in pretax growth related to these nonrecurring items
was substantially offset by an increase in the Company's effective tax rate
principally due to the nondeductibility of the charge for acquired research and
the tax impact of the DMPC-related gain.
Results for the first nine months were paced by sales volume gains of
established products, including 'Zocor' and 'Prinivil' and the newer products
'Cozaar'*, 'Hyzaar'*, 'Fosamax', 'Crixivan', and hepatitis and other viral
vaccines. Also contributing to the volume growth were 'Singulair', 'Propecia',
'Maxalt', 'Cosopt' and 'Aggrastat', all launched in 1998. Prescription volume
growth in the Merck-Medco Managed Care business also contributed to the sales
increase for the first nine months.
'Zocor' continues its strong volume growth and continues to be the most widely
used cholesterol-lowering medicine worldwide. In July, the FDA approved a new 80
mg tablet of 'Zocor', which lowered LDL ("bad") cholesterol in clinical studies
by a mean of 47 percent. In addition, the official prescribing information for
'Zocor' in the United States was changed to recommend the 20 mg tablet as the
usual starting dose. This year the FDA also approved 'Zocor' to reduce the risk
of stroke or transient ischemic attacks (mini-strokes) in patients with high
cholesterol and heart disease.
*'Cozaar' and 'Hyzaar' are registered trademarks of E.I. du Pont de Nemours and
Company, Wilmington, DE, USA.
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MANAGEMENT'S ANALYSIS OF INTERIM FINANCIAL INFORMATION (continued)
Together, 'Zocor' and 'Mevacor', Merck's other cholesterol-lowering medicine,
hold more than a 40 percent share of the statin market worldwide. The
cholesterol-lowering market continues to grow rapidly, driven primarily by
growth of about 30 percent annually in the statin category. Yet today, even in
the key U.S. market, only about one-third of potential patients are receiving
treatment.
Merck's angiotensin converting enzyme (ACE) inhibitors, 'Vasotec' and
'Prinivil', continue to be among the world's most widely prescribed branded
anti-hypertensives. Together, they hold about 30 percent of the worldwide market
for ACE inhibitors. In the United States, 'Vasotec' is the leading ACE inhibitor
and the only one indicated for high blood pressure, asymptomatic left
ventricular dysfunction and heart failure. 'Vasotec' is also the only ACE
inhibitor indicated to reduce deaths due to symptomatic heart failure,
regardless of the underlying cause. 'Prinivil', with its convenient once daily
dosing in hypertension, heart failure and acute myocardial infarction, continues
to demonstrate growth well above the overall ACE market.
Merck's oral angiotensin II antagonist, 'Cozaar', the first in this new class of
antihypertensive drugs, is now approved in 78 countries. Recent approvals
include Japan, where the medicine was launched in August as the first
angiotension II antagonist in that important market. Physicians continue to
adopt 'Cozaar' faster than any new antihypertensive launched in this decade
because of its excellent tolerability profile and proven efficacy in treating
high blood pressure. 'Cozaar' along with its companion agent, 'Hyzaar' ('Cozaar'
in combination with a low dose of the diuretic hydrochlorothiazide), have been
prescribed for more than 7 million patients worldwide. 'Cozaar' has also been
approved for the treatment of heart failure in 11 countries to date, including
Germany and Spain, and applications for this indication are pending in other
countries outside the United States. 'Cozaar' is the only product in its class
cleared for use in the treatment of heart failure in any market.
'Fosamax', Merck's medicine to treat and prevent postmenopausal osteoporosis and
reduce the risk of fractures due to osteoporosis, is now the leading nonhormonal
treatment for osteoporosis worldwide. A recent study showed that adding
'Fosamax' to the treatment regimen when a woman is taking hormone therapy was
effective in building bone and was generally well tolerated in treating
postmenopausal osteoporosis.
'Crixivan', Merck's protease inhibitor for the treatment of HIV infection, is
sold in more than 80 countries. Results from Merck's study, published in the
July issue of the Journal of the American Medical Association, showed sustained
anti-HIV effects of 'Crixivan' in triple combination with AZT and 3TC in nearly
80 percent of patients at 100 weeks of treatment. The Merck study is the longest
reported combination study with a protease inhibitor to date.
'Singulair', Merck's new once-a-day tablet to treat chronic asthma in adults and
children aged six and older, has been launched in 29 countries, including the
United States, the United Kingdom, Spain, Germany, Sweden and Denmark. In
clinical studies, 'Singulair' has improved asthma control in many patients by
significantly decreasing asthma attacks, helping to prevent day- and night-time
asthma symptoms, and reducing reliance on bronchodilators. It also has allowed
many patients to gradually reduce their use of inhaled steroids.
'Propecia', the first and only oral tablet to treat male pattern hair loss, had
its first major launch in January in the United States. It also has been
launched in 11 other countries and launches are pending in 11 more. In clinical
studies, 83 percent of men maintained their current hair count and 66 percent
grew visible new hair.
'Maxalt', Merck's new acute treatment for migraine headache, has been launched
in the United States, the United Kingdom, Sweden, Denmark, Germany, the
Netherlands and Mexico. 'Maxalt' provides fast and effective relief of the
debilitating headache pain and other symptoms such as nausea and sensitivity to
light and noise that often accompany a migraine attack. 'Maxalt' is the first
and only migraine medicine available in both conventional tablets and
convenient, rapidly dissolving oral tablets, which disintegrate within seconds
on the tongue without liquids.
In April, the FDA cleared Merck's combination product 'Cosopt' for the reduction
of elevated intraocular pressure in patients with open-angle glaucoma or ocular
hypertension who do not respond adequately to beta-blockers alone. 'Cosopt' is a
combination of 'Timoptic' and 'Trusopt'; both Merck medicines are leading
therapies in their product categories.
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MANAGEMENT'S ANALYSIS OF INTERIM FINANCIAL INFORMATION (continued)
Merck's "platelet blocker" 'Aggrastat' was launched in the United States in May.
It is the first drug in its class approved for the treatment of acute coronary
syndrome, including patients presenting with unstable angina/non-Q-wave
myocardial infarction who are managed medically and those undergoing angioplasty
or atherectomy. 'Aggrastat' also has been launched in Switzerland, Germany and
Mexico.
Working capital at September 30, 1998 was affected by the proceeds from the sale
of the Company's one-half interest in DMPC and proceeds from the issuance of a
$1.38 billion 40-year note to Astra AB. (See Note 5 to the consolidated
financial statements for further information.) These proceeds were used, in
part, to fund a portion of the Company's stock repurchase program and for other
general corporate purposes. During the first nine months of 1998, the Company
purchased 22.1 million of its shares at a total cost of $2.8 billion, of which
15.7 million shares at a total cost of $2.0 billion were purchased during the
third quarter.
On July 28, 1998, the Board of Directors approved a new $5 billion stock
repurchase program to begin upon the completion of the 1997 program.
The continued efficient operation of the Company's business will be dependent
upon the ability of its systems to process date sensitive information in the
Year 2000. As a result, the Company implemented a program in 1996 to inventory
all critical systems, assess the impact of Year 2000 noncompliance, develop
plans to remediate or replace non-compliant systems and assess the readiness of
key third parties. The inventory and assessment phases are complete for internal
information technology (IT) systems and the Company expects to complete
remediation or replacement of 80% of non-compliant systems by December 31, 1998.
The evaluation and remediation phases for non-IT systems (e.g. building, process
and factory control systems) are currently underway. Although the Company has
designed these programs to properly prepare its systems for the Year 2000, there
can be no assurances that the Company will not experience business disruptions
or incur material costs caused by the failure to detect and remediate all
instances of Year 2000 noncompliance in its systems. Failure to complete these
programs as planned could result in the corruption of data, hardware or
equipment failures or the inability to manufacture products or conduct other
business activities, all of which could have a material impact on the Company's
business, results of operations or financial position. Contingency plans
(including the substitution of systems, use of manual methods and other means to
prevent the failure of critical systems from having a material effect on the
Company) are currently being developed.
In addition to risks associated with internal systems, the Company has
relationships with, and is to varying degrees dependent upon, third parties that
provide us with information, goods and services. These include financial
institutions, suppliers, vendors, research partners and governmental entities,
as well as customers and distributors. If significant numbers of these third
parties experience failures in their systems due to Year 2000 noncompliance, it
could affect the Company's ability to process transactions, manufacture
products, or engage in other business activities. While some of these risks are
outside of our control, the Company has instituted programs, including internal
records review and the use of external questionnaires, to identify key third
parties, assess their level of Year 2000 compliance, update contracts and
address any noncompliance issues.
All aspects of the Company's Year 2000 program are expected to be completed by
the end of the third quarter 1999. Total costs to resolve the Year 2000 issue
are not expected to be material to the Company's financial position, results of
operations or cash flows.
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities, which requires
adoption by fiscal 2000. The Statement establishes accounting and reporting
standards requiring that every derivative instrument be recorded in the balance
sheet as either an asset or liability measured at fair value and that changes in
fair value be recognized currently in earnings, unless specific hedge accounting
criteria are met. The timing of adoption and effect on the Company's financial
position or results of operations have not yet been determined.
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CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
This report and other written reports and oral statements made from time to time
by the Company may contain so-called "forward-looking statements," all of which
are subject to risks and uncertainties. One can identify these forward-looking
statements by their use of words such as "expects," "plans," "will,"
"estimates," "forecasts," "projects," and other words of similar meaning. One
can also identify them by the fact that they do not relate strictly to
historical or current facts. These statements are likely to address the
Company's growth strategy, financial results, product approvals and development
programs. One must carefully consider any such statement and should understand
that many factors could cause actual results to differ from the Company's
forward-looking statements. These factors include inaccurate assumptions and a
broad variety of other risks and uncertainties, including some that are known
and some that are not. No forward-looking statement can be guaranteed and actual
future results may vary materially.
The Company does not assume the obligation to update any forward-looking
statement. One should carefully evaluate such statements in light of factors
described in the Company's filings with the Securities and Exchange Commission,
especially on Forms 10-K, 10-Q and 8-K (if any). In Item 1 of the Company's
Annual Report on Form 10-K for the year ended December 31, 1997, as filed on
March 25, 1998, the Company discusses in more detail various important factors
that could cause actual results to differ from expected or historic results. The
Company notes these factors for investors as permitted by the Private Securities
Litigation Reform Act of 1995. One should understand that it is not possible to
predict or identify all such factors. Consequently, the reader should not
consider any such list to be a complete statement of all potential risks or
uncertainties.
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