NEW YORK – Merck & Co. (MRK) recorded more than $12 billion in revenue over the past three years from its pharmacy benefits unit even though the subsidiary never collected the money. The news sent its stock down more than 2 percent.
The revenue in question is the co-payment paid by consumers with a prescription drug card to their retail pharmacy to cover their portion of the cost of a drug under an insurance plan. The pharmacy keeps the co-payment.
Merck, based in Whitehouse Station, N.J., said Monday its treatment was in accord with generally accepted accounting practices and had no impact on its earnings since the revenue was offset in its financial reports as an expense.
But its stock fell amid heightened investor suspicion about accounting issues. In early afternoon trading on the New York Stock Exchange, Merck stock was down $1.05 a share to close at $47.81.
Merck counted patients' co-payments to druggists as revenue generated by its Medco unit, which manages pharmacy-benefit programs for businesses and health insurance companies.
The amount was $12.4 billion from 1999 through 2001, Merck said in a filing Friday with the Securities and Exchange Commission. The Wall Street Journal reported on the filing in its Monday editions.
Medco, however, did not actually receive those co-payments.
"Merck-Medco's practice of recognizing retail co-payments as revenue has no impact on net income or earnings per share because a corresponding, equivalent amount is also included in cost of revenues," Merck spokesman Chris Loder said.
Loder said Merck's independent accountants, PricewaterhouseCoopers, concurs with this accounting treatment.
Merck plans to spin off Merck-Medco in an initial public offering later this week. He said as part of the company's registration statement for the offering, accounting practices at Merck-Medco were thoroughly reviewed by the Securities and Exchange Commission.
The accounting practice itself was reported in an April SEC filing and but the exact amount of reported but not collected revenue was reported for the first time in Friday's SEC filing.
The Medco IPO has been delayed twice and its price slashed because of market conditions, but a source close to the deal said it is still scheduled for later this week at a range of $20 to $22 a share. It has been originally slated for $22 to $24 a share.
Banc of America securities analyst Patrick Hojlo doesn't believe the disclosure about the amount of the payment should delay the deal. He notes Caremark Rx Inc., one of Merck-Medco's competitors, uses the same accounting method.
"The booking of revenues didn't affect Merck's reported earnings. They (Merck) didn't gain from this," Hojlo said.
"I think this is getting blown out of proportion given the sensitivity around accounting issue," he said.
Robert Hazlett, who follows Merck for Robertson Stephens Inc., agreed the accounting methods shouldn't affect the deal, but said he wouldn't be surprised if it's either postponed or the price drops.
"Investors need time to digest the news and in general investors are being cautious," he said.
Still, Hazlett doesn't expect the revelations about the accounting to haunt Merck, which is plagued with other problems. Like other drug companies, Merck has been hit hard by patent expirations and has been slow to develop new blockbuster treatments.
Merck has been under pressure to spin-off Merck-Medco because even though its $29.1 billion in revenues generated over half of its parent's overall sales, the unit's razor-thin profit margin of barely 1 percent hurt the drug company's bottom line.
The IPO is expected to bring $1 billion to Merck's coffers which Hazlett thinks it will use to bolster its sales force and research and development. He doesn't expect much of an improvement at Merck until 2004 when Arcoxia, its follow up drug to pain reliever Vioxx is expected to hit the market. Arcoxia's launch has been delayed because the Food and Drug Administration wants more safety data on the drug.
Merck, the world's third-largest drug maker, hurt by slumping profits and a slowdown in its drug pipeline, has been under pressure to spin off its Merck-Medco subsidiary.
With $29.1 billion in revenues last year, the unit generated over half of its parent's overall sales. But Medco's razor-thin profit margin, barely 1 percent, hurt Merck's bottom line.
Medco is the nation's second-biggest pharmacy benefit manager, handling prescriptions for 65 million Americans through retail pharmacies, a mail-order program and its Internet pharmacy.