<<Merck Recorded $12.4 Billion
In Revenue It Never Collected (here's the story that those righteous saints(LOL!) have insinuated was a plant by SHORTS) online.wsj.com (a pay-site)
Drug Giant's Medco Unit Called Co-Payments
To Pharmacies Revenue, but Never Saw Funds
By BARBARA MARTINEZ
Staff Reporter of THE WALL STREET JOURNAL
Drug giant Merck & Co. recorded $12.4 billion in revenue from the company's pharmacy-benefits unit over the past three years that the subsidiary never actually collected, according to a filing with the Securities and Exchange Commission.
Merck's Medco unit, which manages pharmacy-benefit programs for employers and health insurers, included as part of its revenue the co-payments collected by pharmacies from patients, even though Medco doesn't receive those funds. Between 1999 and 2001, co-payments represented nearly 10% of Merck's overall reported revenue.
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Merck first disclosed the accounting treatment in an April SEC filing as it prepared to sell 20% of Medco in an initial public offering. But it wasn't until a subsequent SEC filing on Friday that the company said exactly how much revenue was involved.
Merck, based in Whitehouse Station, N.J., says its revenue-recognition policy conforms to generally accepted accounting principles. The company says the accounting treatment has no effect on its net income, because it subtracts the same amount as an expense. Medco is the country's second-largest pharmacy-benefits manager, with 65 million members. Medco reported revenue last year of $29.69 billion, or 59% of Merck's $50.69 billion in revenue.
"For a company such as Merck to reflect as revenues in its financial statements billions of dollars of co-payments a customer makes directly to another company, the pharmacy, which the pharmacy collects and never remits to Merck, just does not reflect the economics of what is occurring," said Lynn Turner, a former chief accountant at the SEC who is now an accounting professor and director of the Center for Quality Financial Reporting at Colorado State University in Fort Collins. "If that is what the SEC accepts, then investors are in trouble and our financial reporting indeed needs improving," he said.
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Medco's accounting practice echoes a recent case involving Edison Schools Inc., a commercial operator of public schools, which was booking as revenue funds that school districts paid directly for teacher salaries and other costs. The SEC in May found that Edison "failed to disclose that a substantial portion of its reported revenues consist of payments that never reach Edison." Although Edison's accounting practice, which didn't affect net income, conformed to generally accepted accounting principles, the SEC said that "technical compliance with GAAP" doesn't insulate a company from enforcement action if it makes filings "that mischaracterize its business or omit significant information." The SEC ordered Edison to add a director of internal audit to its management team. The agency said that Edison would exclude most of those payments from its reported revenue in the future.
There isn't any indication that regulators have an issue with Medco's or Merck's accounting. The SEC hasn't asserted that inclusion of co-payments in revenues are inappropriate or not in accordance with GAAP, according to a Merck official. SEC officials couldn't be reached to comment late Sunday.
A pharmacy-benefits manager such as Medco uses the combined buying power of millions of people in its plans to extract discounts and rebates from drug makers and pharmacies. These companies then pass on some of the savings to clients -- employers and health-insurance companies -- looking to save money on prescription drug costs.
Revenue in Question
Medco's revenue in question is the co-payment -- $10 to $15 is typical in the industry -- 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 entire amount of the co-payment.
Merck contends that it has legal liabilities for the co-payment under certain circumstances, such as if it transmits electronically to the pharmacist incorrect information about how much co-payment the pharmacist should collect. But in its SEC filing, the company said it doesn't face a "credit risk," which would force it to reimburse pharmacies if a customer skipped out on making the co-payment.
The disclosure from Merck comes amid heightened scrutiny over many companies' accounting policies after several high-profile scandals. Last week, the SEC ordered that chief executive officers and chief financial officers of more than 900 of the nation's largest companies must swear under oath in writing that the numbers in their companies' recent financial reports are correct.
Merck declined to say whether the SEC required it to disclose the amounts of the co-payments in its latest filing, its fourth amended prospectus for the planned Medco initial public offering. But Kenneth C. Frazier, Merck's general counsel, said the latest filing has been thoroughly reviewed by the agency and "reflects the discussions we had with the SEC" over the co-payments. "We are proceeding with the offering and hope to price this week. However, we can't comment further because we are in the quiet period," he said. An SEC spokesman said the commission's approval of the latest filing is still pending.
The benefits to Medco of including co-payments as revenues aren't clear cut. The accounting treatment, while making Medco's revenue look larger, actually decreases its gross-profit margins compared with some of its competitors, which is the opposite of what investors generally like to see. However, some competing pharmacy-benefit managers and customers say that large revenues and a lower gross margin are more attractive to potential clients, because they indicate that a company can handle large volumes and that it passes on more of its profits to its customers.
The largest pharmacy-benefits manager, AdvancePCS, Irving, Texas, and the third-largest, Express Scripts Inc., St. Louis, don't include the retail-pharmacy co-payments as part of their revenue, while the fourth-largest, Caremark Rx Inc., Birmingham, Ala., does. Even though Medco recognizes co-payments as revenue, and Express Scripts doesn't, the companies share the same outside auditor, PricewaterhouseCoopers. A PricewaterhouseCoopers spokesman said the firm doesn't comment on client matters.
The co-payments that Medco booked as revenue at retail pharmacies in 2001 amounted to $5.5 billion, representing 11% of Merck's 2001 overall revenue of $50.69 billion. Medco processed more than 460 million prescriptions in its retail pharmacy network last year. The co-payment revenue booked in 2000 was $4.04 billion, or 9.4% of Merck's total reported revenue. In 1999 it was $2.84 billion, or 8.1%. The company didn't disclose how much it may have booked in revenue from co-payments from 1993 to 1998. Merck acquired Medco in 1993.
Shareholder Suits
Though the revenue-recognition policy was disclosed within Merck's 200-page SEC filing in April, the policy wasn't widely known by investors or Wall Street analysts until it was reported by The Wall Street Journal two weeks ago. Merck's stock dropped 5% to a five-year low after the article was published, and at least four shareholder lawsuits have been subsequently filed against Merck alleging that the company falsely inflated its revenue by including the retail co-payments. Merck says the lawsuits are without merit and it intends to vigorously defend itself against them.
Amid weak stock markets, Merck has in the past two weeks postponed its Medco IPO twice, and its underwriters have lowered the expected price range to $20 to $22 a share from $22 to $24 a share, indicating Merck expects to raise between $934 million and $1.03 billion from the offering.
In addition to Medco's revenue-recognition policy, prospective investors have also been concerned about Medco's continuing relationship with Merck. According to the company's SEC filings, Medco will have to maintain market-share levels for Merck drugs in its plans or face paying Merck damages for its lost revenue.
Write to Barbara Martinez at barbara.martinez@wsj.com
Updated July 8, 2002 |
