Saturday, April 30, 2011

Will Merck Use "Fuzzy" R & D Expense Rates -- To Improve EPS In 2011 and 2012?

I said yesterday that it was possible that some of New Merck's "beat" on Q1 2011 earnings was not a pure fundamental sales and gross margin improvement. That seems true, given these comments on the call, courtesy of SeekingAlpha:

. . . .Q: Tim Anderson -- Sanford C. Bernstein & Co., Inc.

My guess is you're going to resist answering this, but I'm hoping you can share your thoughts. On R&D spending, if you could potentially keep it flat or slightly down in 2011, is it possible that R&D spend might contract further beyond 2011? Just looking for a directional answer on this. . . .

A: Kenneth Frazier -- CEO, Merck & Co., Inc.

Yes. On the R&D question, I would say that as I've tried to say all along, the R&D spending that you see at this time in Merck is a function of the assets that we have at various stages of development in the pipeline. I don't think you should consider it to be a number going forward. I think it will all depend on what we have. We're pleased to have the assets that we have in late-stage development inside our company. And going forward, we are going to be looking for ways to produce efficiencies in our R&D, including prioritization decisions. We've been reducing the number of R&D sites. So we are committed to ensuring that whatever we spend on R&D going forward is about quality, not about quantity. So we have no dogma about an $8 billion spend in R&D. It's really about making sure that we maximize the assets because we're committed to growth long term, and we believe that R&D is the predominant driver of long-term growth in this industry. . . .

So, if R&D spending will be moved back and forth, quarter by quarter, there is a real probability that any earnings "beats" will come from below the sales and gross margin lines (by staging the indirect expenses, like R&D, that do not come out at the "cost of sales" line).

So, were I you, given that the R&D spending goal for 2011 just dropped from $8.5 billion to something south of $8 billion (said another way, adding about 16 cents a share, at the EPS line -- on the 3.08 billion shares outstanding -- and more like 18 cents a share, if Merck quickly repurchases all of the $6.4 billion of stock it is suddenly authorized to repurchase). . . I'd take Merck's generally good news of yesterday with some significant salt. It is not going to be primarily a fundamental improvement in gross margins. It is going to be R&D expense savings, in part -- and thus not clearly sustainable, longer term.


Anonymous said...

funny to see confirmed what was becoming apparent from recent developments in R&D, the budget is used to support EPS rather than R&'s all about the patient.

Anonymous said...

Funny how R&D is used to please shareholders by playing with the R&D-budget. Normally R&D is a long term business. So it's a mystery to me how Frazier adapts the R&D-budget each quarter, dependent of the results of sales. The first cuts are made in Quarter 2 in Oss, when the MRL is closed Julky 1 and will be replaced by what Merck calls Plan B.
In Production the first layoffs are a fact, without the new organization in Production in place.

Anonymous said...

If you review the 'growth' breakout, it was 11% overall and only 1% came from top line sales. The other 10% was representative of cost cutting measures which are surely not going to be sustainable in the long term - through R&D or any other area of the company's operations.