Merck Falls on News About Accounting
$14 Billion Booked as Revenue Wasn't Collected
Get Quote, Company Info: MRK
Reuters

NEW YORK (July 8) - Merck & Co. Inc. reported its Medco pharmacy benefits management business booked $14 billion in revenue it never collected, but the drugmaker said on Monday it would go ahead with Medco's planned public offering as early as this week.

Merck's revelation initially rattled world currency and stock markets on investor concerns the announcement marked another accounting scandal. But the accounting treatment had no effect on net income, and the company's shares fell slightly.

Oliver Marti, portfolio manager at CCI Health Care Partners hedge fund, said the only new development was the dollar amount listed in a U.S. regulatory filing, since Merck's accounting for the money patients pay for drug costs, called co-payments in the industry, was known weeks ago.

Merck offset the $14 billion generated from co-payments made by physicians to pharmacists -- which typically range from $5 to $15 -- with matching expenses, resulting in no effect on earnings. The overall amount represented about 10 percent of Merck's overall revenue.

Despite the size of money involved, Marti said, "I wouldn't even quantify that as aggressive accounting."

Merck spokesman Christopher Loder said the company is proceeding with the initial public offering of Medco Health Solutions, which manages drug benefits for 65 million people, and plans to sell $1 billion in debt.

Several investors have been told by the underwriting banks, Goldman Sachs and J.P. Morgan, that the Medco's IPO is still slated for Tuesday.

Merrill Lynch analyst Steven Tighe cut his long-term investment rating on the stock to "neutral" from "buy" because of the proportion of revenue the company booked for patient co-payments that pharmacies received instead of Medco.

Merck shares fell $1.28, or 2.6 percent, to $47.60 in afternoon trading on the New York Stock Exchange. The shares fell earlier Monday as much as 4.6 percent to $46.60 or a nickel above its 52-week low that was reached on July 2.

IPO MAY FACE ROCKY ROAD

Merck was planning to sell 20 percent of Medco in an IPO, but the deal has been postponed twice and the price range has been cut to $20 to $22 from an original $22 to $24 per share.

"This may reduce the likelihood that the Medco IPO gets done at this time," Tighe said in a research note.

Marti, who does not own Merck shares, said Medco's accounting should not affect the value of the IPO.

However, Marti said he was uncertain that a deal could get done in the current climate.

The IPO is expected to raise between $934 million and $1.03 billion, with 46.7 million shares on offer.

David Saks, chief investment officer of the Saks MedScience Fund at Ladenburg Thalmann, said he would stay on the sidelines for a Medco IPO during the current climate, but likes the pharmacy benefits management industry longer term.

Saks, who has a short position in Merck because of his concerns about the company's drug pipeline, also said the timing of the IPO is unfortunate with the accounting issues making the news and Medco's rivals, such as Express Scripts Inc. and AdvancePCS, trading well below their highs.

Merck's disclosure comes at a time of increased scrutiny of corporate accounting in the wake of scandals involving Enron Corp., WorldCom Group and Global Crossing, among others.

Merck is confident that its accounting meets Generally Accepted Accounting Principles (GAAP) and the Securities and Exchange Commission has reviewed its registration statement for the IPO, Loder said.

Medco had used the accounting method before Merck acquired the firm in 1993 and two independent auditors had no objections with the accounting procedure, the company has said.

Co-payments included in product revenue amounted to approximately $2.8 billion in 1999, $4.04 billion in 2000, $5.5 billion in 2001, and $1.64 billion in the first quarter of 2002, according to the filing posted on Friday.

Birgit Kulhoff, an analyst at Swiss private bank Lombard Odier, said the account was specific to Merck and was not an industrywide issue because few drug firms have their own pharmacy benefits management (PBM) units.

07/08/02 13:11 ET

When the accounting firms starting offering legal and employment services it all wne tdownhill from there.
Say what you will about lawyers, but we only give legal opinions, write contracts, and sue. Accounting services started pimping out number counting (what they were supposed to do in the first place) for a piece of the lawyers pie, and now they are getting caught.

mmmmmmmmm!!! is that books i smell cooking?!?!

Methinks the executives have been sampling their own products.

This is legitimate. The income is offset by an equal expense. This is not like the Enron, Worldcom, etc. which appears to be fraud on a large scale. I would guess that this misleading report of possible accounting irregularity was systematically released and pumped to the masses after the stock was sold short. There may be fraud in that.

Goad is exactly right...

This is not illegal in any way and is, in fact, in compliance with Generally Accepted Accounting Principles.

I am not defending Merk but, they are getting the finger pointed at them as a result of a hysterical 'witch hunt' reaction to other wrongdoings and people trying to find someone else to blame for them losing their money in the markets.

I actually heard someone ask today "But, I can't go below what I put in, right?"  (no, I'm not a broker, just close to the biz)