Merck & Co., Inc. MRK reported second-quarter 2018 adjusted earnings of $1.06 per share, which beat the Zacks Consensus Estimate of $1.03 by 2.9%. Earnings rose 5% year over year.

Including acquisition/divestiture related costs, restructuring expenses and certain other items, second-quarter 2018 earnings per share were 63 cents, down 11% year over year.

Revenues for the quarter rose 5% year over year to $10.47 billion. Sales also surpassed the Zacks Consensus Estimate of $10.32 billion. Currency movement positively impacted revenues by 1%. Excluding currency impact, sales rose 4% year over year.

Strength in Keytruda, Bridion, Gardasil and Animal Health offset headwinds from loss of exclusivity (LOE) for some products and competitive pressure for Zostavax and Zepatier.

Quarter in Detail

The Pharmaceutical segment generated revenues of $9.28 billion, up 6% (up 3% excluding Fx impact) year over year as higher sales in oncology, vaccines and hospital acute care areas were offset by lower sales in virology. As in the previous quarters, loss of market exclusivity for several drugs hurt the top line.

Keytruda, the largest product in Merck’s portfolio, brought in sales of $1.67 billion in second-quarter 2018, up 13.8% sequentially and 89% year over year. Sales were driven by the launch of new indications globally. Keytruda sales are gaining particularly from strong momentum in the first-line lung cancer indication as it is the only anti-PD-1 approved in first-line setting.

Keytruda is already approved for many types of cancers and treatment settings including lung cancer, melanoma, head and neck cancer, classical Hodgkin’s lymphoma and bladder cancer.

In June, Keytruda gained FDA approval for two new indications. These include third-line treatment of adult as well as pediatric patients with primary mediastinal B-cell lymphoma (PMBCL), a type of non-Hodgkin lymphoma and second-line treatment of recurrent or metastatic cervical cancer. These label expansion approvals should drive sales of Keytruda in the future quarters.

Alliance revenues from Lynparza and Lenvima also boosted oncology sales in the quarter.

Lynparza alliance revenues were $44 million in the second quarter compared with $33 million in the first quarter. Lenvima alliance revenues were $35 million.

Merck has a deal with Swiss pharma giant AstraZeneca AZN to co-develop and commercialize PARP inhibitor Lynparza and a similar one with Japan’s Eisai for tyrosine kinase inhibitor Lenvima.

In the hospital specialty portfolio, Bridion (sugammadex) Injection generated sales of $240 million in the quarter, up 48% year over year, driven by strong demand.

Januvia/Janumet (diabetes) franchise sales rose 2% to $1.54 billion.

In vaccines, Gardasil/Gardasil 9 sales rose 30% to $608 million as lower sales in the United States were offset by commercial launch in China and strong growth in Europe. Continued transition to two-dose regimens impacted volumes unfavorably in the United States.

Proquad, M-M-R II and Varivax vaccines recorded combined sales of $426 million, up 7% year over year.

Meanwhile, pharmaceutical sales were hurt by biosimilar competition for blockbuster drug, Remicade in Europe and loss of U.S. market exclusivity for Zetia and Vytorin. Sales of Zepatier and Zostavax also declined in the quarter.

Remicade sales declined 31% to $157 million in the quarter. The Zetia/Vytorin franchise recorded sales of $381 million, down 31% due to loss of exclusivity for both Zetia and Vytorin.

Zepatier brought in sales of $113 million, significantly down from $517 million in the year-ago quarter on reduction in patient volume due to increasing competition. Management expects the negative trend to continue in 2018 as most markets outside the United States will come under pressure in 2018.

Zostavax sales declined 72.5% to $44 million in the quarter as it faced strong competition from Glaxo’s GSK newly approved shingles vaccines, Shingrix. Zostavax sales are expected to be hurt by these competitive pressures, going forward.

Merck’s Animal Health segment generated revenues of $1.09 billion, up 14% (up 12% excluding Fx impact) from the year-ago quarter, driven by higher sales of its companion animal products as well as livestock products, particularly ruminant, swine and poultry products. Excluding the impact of exchange, livestock sales grew 7%. Companion animal sales grew 19% in the quarter.

Gross Margins Decline & R&D Costs Increase                   

Adjusted gross margin came in at 74.4%, down 290 basis points (bps) from the year-ago quarter.

Marketing and administrative (M&A) expenses were $2.5 billion in the reported quarter, flat year over year as lower promotion and direct selling costs were offset by higher administrative costs and currency headwinds. Research and development (R&D) spend rose 9% to $1.9 billion in the quarter due to increased clinical development spending and investment in oncology collaborations and early drug development.

2018 Outlook

Merck raised its earnings guidance but tightened sales expectations.

Merck tightened its outlook for 2018 revenues to a range of $42.0 billion – $42.8 billion from $41.8 billion – $43.0 billion. The revenue guidance includes a slightly positive impact from currency fluctuation compared with a positive impact of approximately 2% expected previously.

Merck raised its adjusted earnings guidance to a range of $4.22–$4.30 from the previous guidance of $4.16–$4.28, despite more onerous currency headwinds.

The adjusted earnings guidance includes approximately 1% negative impact from currency fluctuation versus a similar positive impact expected previously.

Adjusted operating expenses are still expected to increase year over year at a low- to mid-single digit rate due to higher R&D costs.

Adjusted tax rate is expected to be between 18.5% and 19.5% compared with 19% and 20% expected previously.

Our Take

Merck’s second-quarter results were impressive as the company beat estimates for both earnings as well as sales. Though it tightened it sales guidance for 2018, it was only due to less favorable currency impact owing to a strengthening dollar. Meanwhile, despite currency headwind expectations, it raised its expectations for earnings for the full year.

Shares were up around 1% in pre-market trading. So far this year, Merck’s shares have outperformed the industry. Merck’s shares have risen 13.7% in the period compared with a 0.9% increase for the industry.

All eyes were on the performance of Keytruda, which is being touted as a key long-term growth driver for Merck. The drug continued its robust performance on strong demand trends.

In 2018, Merck expects growth from key products like Keytruda, Lynparza, Gardasil, Bridion and Animal Health to make up for headwinds from LOEs, softness in the diabetes franchise, and competitive pressure on Zepatier and Zostavax.

Zacks Rank & Key Picks

Merck currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Merck & Co., Inc. Price, Consensus and EPS Surprise

Merck & Co., Inc. Price, Consensus and EPS Surprise | Merck & Co., Inc. Quote

A better-ranked large drug stock is Eli Lilly & Company LLY, with a Zacks Rank #2 (Buy).

Lilly’s earnings estimates for 2018 and 2019 have risen 3.3% and 0.9%, respectively over the past seven days. Its stock has gained 12.7% this year so far.