Merck & Co. (MRK) FY2025 Earnings Quality Report

Grade: F — Major red flags

Framework: Schilit *Financial Shenanigans* + Beneish M-Score + forensic accounting principles

Data: SEC EDGAR 10-K (Fiscal year ended December 31, 2025) + Yahoo Finance

Auditor: PricewaterhouseCoopers LLP — Unqualified opinion (1 critical audit matter: U.S. Rebate Accruals for Medicaid, Managed Care and Medicare Part D)

One-line verdict: Merck earns an F grade because two critical-severity checks fail simultaneously — cash covers only 30% of debt ($14.6B vs. $49.3B after the Verona Pharma acquisition ballooned the balance sheet) and goodwill plus intangibles now represent 92% of equity. The M-Score sits at -2.27, barely below the -2.22 manipulation threshold. The underlying operating business remains profitable (Keytruda alone is 49% of sales), but the 10-K itself confirms that Januvia/Janumet and Bridion lose U.S. market exclusivity in 2026 and Keytruda faces biosimilar competition starting as early as December 2028. The accounting is clean; the concern is the cliff.

Keytruda and Everything Else

Merck describes itself in the 10-K as "a global health care company that delivers innovative health solutions through its prescription medicines, including biologic therapies, vaccines and animal health products." Operations are reported in two segments: Pharmaceutical and Animal Health.

The product concentration is extreme. From the 10-K: "in the aggregate, in 2025, sales of Keytruda represented 49% of the Company's total sales."

The 10-K is unusually explicit about three imminent patent cliffs. From Item 1A: "Bridion will lose market exclusivity in the U.S. in July 2026 at which time the Company anticipates a significant and rapid decline in U.S. sales of Bridion. The Company expects to discontinue U.S. sales of Bridion by the end of 2026. In addition, Januvia and Janumet will lose market exclusivity in the U.S. in May 2026 and Janumet XR will lose market exclusivity in the U.S. in July 2026." And on Keytruda itself: "the Company expects that sales of Keytruda will be materially negatively impacted by biosimilar competition between 2028 and 2029... biosimilar competition could begin in December 2028 when the primary compound patent expires."

The China Gardasil collapse is disclosed in Item 1A as its own risk factor: "The Company's business in China experienced significantly lower sales of Gardasil/Gardasil 9 in 2025 and the Company expects that sales of Gardasil/Gardasil 9 in China will not materially increase in 2026."

The Verona Acquisition

The MD&A confirms that in 2025 Merck "Acquired Verona Pharma plc (Verona Pharma), a biopharmaceutical company focused on respiratory diseases, through which Merck obtained Ohtuvayre, a product approved for the maintenance treatment of chronic obstructive pulmonary disease (COPD)." This deal is the principal reason total debt climbed from $37.1B to $49.3B and goodwill + intangibles now consume 92% of equity.

(1) FY2023 net income was depressed by a $10.2B acquired IPR&D charge for the Prometheus Biosciences acquisition.

Cash Flow: Still Strong but Declining

(1) FY2023 ratio distorted by the $10.2B Prometheus IPR&D charge.

Operating cash flow of $16.5B in FY2025 dropped 23% from FY2024's $21.5B — a material decline that coincided with revenue growth of only 1%. The CFFO/NI ratio fell to 0.90, below 1.0, meaning every dollar of reported profit is backed by only 90 cents of operating cash. This is not a manipulation flag (accruals ratio is only 1.3%, which the engine marks Pass), but it is a step down from FY2024's 1.25 coverage and deserves monitoring.

Free cash flow of $12.4B still comfortably funds the $7.8B annual dividend run-rate, but after consuming $13B+ on the Verona deal, the cash cushion is much thinner.

The Balance Sheet Shifted

Cash and equivalents of $14.6B cover just 30% of the $49.3B debt load — the engine flags this as a fail (C4). The Debt/EBITDA ratio of 1.7x remains healthy in absolute terms (Pass on D2), but the trajectory is wrong: debt grew $12.2B YoY on an acquisition that added goodwill and intangibles rather than near-term cash flow. Goodwill + intangibles of $48.3B now equal 92% of equity — if Keytruda's biosimilar timeline is worse than planned, the book value of those intangibles becomes the first casualty.

The 18-Point Screening

Revenue Quality

A2: Accounts receivable grew 14.6% while revenue grew only 1.3%. The 8-day DSO increase (A1) is modest and does not trigger a fail, but combined with the 14.6% AR growth it suggests either a channel stocking pattern, a shift in collection terms, or deferred receivables from the Verona-related product additions. The MD&A does not break this out explicitly.

Expense Quality

B2: Capital expenditures grew 21.9% while revenue grew 1.3%. The MD&A describes ongoing manufacturing capacity builds for biologics and vaccines. Given that Merck is racing to build Keytruda subcutaneous (Keytruda Qlex) manufacturing ahead of the 2028 patent cliff, elevated CapEx is consistent with the strategy but does not earn its return in the current period.

Cash Flow Quality

C4 (critical fail): This is the first of two fails. The Verona acquisition transformed Merck's balance sheet — cash is $14.6B, debt is $49.3B, so cash covers 30%. Because C4 is in the critical-codes set, any fail here drives the grade toward F.

Balance Sheet

D1 (fail): Goodwill plus intangibles of $48.3B represent 92% of the $52.6B stockholders' equity. This is the direct mathematical consequence of building pharmaceutical brand value through acquisitions rather than organic R&D. The Prometheus, Verona, and Harpoon deals over the last three years all added intangibles at the top of the pricing cycle. A Keytruda biosimilar shock in 2028-2029 would put these carrying values under direct impairment pressure.

M&A Risk

E2 is Pass but the +27% growth is notable and connects to D1 above.

Beneish M-Score

The M-Score of -2.27 is only 0.05 below the -2.22 cutoff. It technically passes but sits at the edge — the DSRI ratio is elevated (AR growing faster than sales), which is the main contributor pulling the score toward grey territory.

Critical Audit Matter: U.S. Rebate Accruals

PwC identified U.S. rebate accruals for Medicaid, Managed Care and Medicare Part D as the sole critical audit matter. From the audit report: "The accrued balance relative to the provision for rebates included in accrued and other current liabilities was $1.5 billion as of December 31, 2025, of which the majority relates to U.S. rebate accruals Medicaid, Managed Care and Medicare Part D."

PwC explained the judgment: "The principal considerations for our determination that performing procedures relating to U.S. rebate accruals - Medicaid, Managed Care and Medicare Part D is a critical audit matter are the significant judgment by management due to the significant measurement uncertainty involved in developing the rebate accruals, as the accruals are based on assumptions developed using pricing information and historical customer segment utilization mix, and a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating evidence related to these assumptions."

The procedures PwC performed included "developing an independent estimate of the rebate accruals by utilizing third party data on historical customer segment utilization mix in the U.S., pricing information, the terms of the specific rebate programs, and the historical trend of actual rebate claims paid." PwC has served as Merck's auditor since 2002.

Key Risks from Item 1A

1. Keytruda concentration and imminent biosimilar competition. From the 10-K: "in the aggregate, in 2025, sales of Keytruda represented 49% of the Company's total sales... the Company expects that sales of Keytruda will be materially negatively impacted by biosimilar competition between 2028 and 2029." The Company's primary compound patent expires December 2028.

2. 2026 patent cliff on Januvia/Janumet/Bridion. From Item 1A: "Bridion will lose market exclusivity in the U.S. in July 2026... Januvia and Janumet will lose market exclusivity in the U.S. in May 2026... The Company expects a significant decline in sales of Januvia in the first half of 2026."

3. China Gardasil collapse. From Item 1A: "The Company's business in China experienced significantly lower sales of Gardasil/Gardasil 9 in 2025 and the Company expects that sales of Gardasil/Gardasil 9 in China will not materially increase in 2026." Gardasil total sales dropped from $8.6B to $5.2B YoY — a $3.4B hit.

4. IRA price setting. The risk factor on pricing pressure explicitly names the Inflation Reduction Act: "selection for IRA price setting" is listed as an event that could adversely affect key product sales.

5. Manufacturing complexity. From Item 1A: "The Company may experience difficulties and delays in manufacturing certain of its products, including vaccines" — which matters especially for the Keytruda Qlex subcutaneous ramp and the new biologics launches.

Altman Z-Score and F-Score

The Z-Score of 4.23 comfortably clears distress thresholds — working capital, retained earnings, and EBIT margin all remain strong. The F-Score of 1.22 is slightly elevated vs. a typical low-risk profile (the accruals component contributes), but it is not at a level that signals manipulation, consistent with the M-Score sitting just below its own threshold.

Summary

Grade: F. Two critical checks fail.

Merck's accounting does not show signs of manipulation. Accruals are clean, M-Score passes (barely), auditor opinion is unqualified, the only critical audit matter is routine rebate estimation. Gross margins hold at 74.8% and CFFO of $16.5B is real.

The F grade reflects that both C4 (cash vs. debt) and D1 (goodwill + intangibles) are in the critical-failure set and the combination drives the rules-based grade downward. Both fails are the direct result of the Verona Pharma acquisition: debt ballooned to $49.3B, intangibles now sit at 92% of equity. Neither fail indicates accounting fraud; both indicate a balance sheet that has little margin for error if Keytruda's 2028 biosimilar timeline proves to be the downside case rather than the base case.

The investment story on MRK has shifted from "clean mega-cap pharma" to "bet on the Keytruda franchise lasting longer than the 10-K itself says it will." The 10-K is explicit about the cliff. The numbers are the numbers.

**Disclaimer**: This report is based on Merck's FY2025 10-K (SEC EDGAR) and public financial data. This is NOT investment advice.

Data: SEC EDGAR 10-K (Fiscal year ended December 31, 2025) + Yahoo Finance

Auditor: PricewaterhouseCoopers LLP (Unqualified opinion, 1 critical audit matter: U.S. Rebate Accruals)