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Merck accounting murky
Drugmaker recorded $14B in revenue since '99 that it never actually collected; Medco set to price.
July 8, 2002: 2:02 PM EDT

NEW YORK (CNN/Money) - Merck & Co. shares tumbled Monday after a Securities and Exchange Commission filing by the company revealed that more than $14 billion, or 10 percent, of revenue reported since 1999 was never actually collected by the company.

The filing made Friday was for the initial public offering of Merck's Medco pharmacy benefits unit, which is scheduled to debut this week. The money involved reflects copayments on prescriptions that health plan members using Medco paid when filling prescriptions. The copayments stayed with the pharmacies, but Medco booked the money as both revenue and an expense, raising the total reported revenue for the unit as well as for Merck.

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Shares of Merck (MRK: Research, Estimates), a component of the Dow Jones industrial average, lost $1.37, or nearly 3 percent, to $47.49 in early afternoon trading, up from a near 5 percent decline earlier in the day.

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CNNfn's Amanda Lang reports on Merck which recorded more than $14 billion of revenue reported since 1999 that was never collected by the company.

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The filing prompted Merrill Lynch & Co. to downgrade the stock to "neutral" for a long-term investment outlook from its former "buy" rating on that basis, as analyst Steven Tighe questioned the outlook for the Medco IPO in light of the new revelations.

"This may reduce the likelihood that the Medco IPO gets done at this time," he wrote to clients Monday. "This deal has seen the pricing and range come down recently, but with further scrutiny from the SEC and investor concerns, it may be tough to complete."

Goldman lead on both CIT and Medco

The Medco IPO, which has been delayed twice, is scheduled to price Tuesday and trade Wednesday, people familiar with the offering told CNN/Money Monday. Medco Health is expected to sell 46.7 million shares at $20 to $22 each, down from $22 to $24, via Goldman Sachs and J.P. Morgan.

At the mid-point of its expected range, Medco could raise $980.7 million.

Merck plans to sell 20 percent of Medco through the proposed IPO, and expects to shed its remaining stake in a tax-free transaction about a year from now.

Medco's issues are similar to those raised by CIT Group Inc., the financial services unit of Tyco International Ltd., which raised $4.9 billion last week. Both Medco and CIT (CIT: Research, Estimates) face substantial accounting issues but Tyco (TYC: Research, Estimates) at least disclosed the problems, analyst Ben Holmes of said.

In June, the SEC held up the CIT offering due to accounting questions. CIT later said it would restate its second-quarter financial statements to reflect a $4.5 billion writedown in goodwill.

"The Medco deal will get done," Holmes said. "But this is one of those deals that the underwriters are working for the seller, not the buyer."

Goldman Sachs also served as co-lead on the CIT offering last week, and the Medco IPO casts a bad light on the A-list underwriter.

"Goldman's investment banking fees are down and they are out there doing deals that they shouldn't be doing," he said. "I'm telling people to avoid this deal."

But John Fitzgibbon, of IPO Desktop, said that the accounting problems make the Medco IPO questionable. "These accounting issues were known before and the details are just starting to come out," Fitzgibbon said. "The deal getting done depends on the price they put on it. The ball's in Goldman Sachs's court."

Goldman could not immediately be reached for comment.

Andersen also the auditor

The company's practice of reporting copayments as revenue was first reported in an April SEC filing, but not widely known by investors until an article two weeks ago in the Wall Street Journal. The amount of the copayments and the percentage of the company's total revenue was not known until Friday's 200-page filing, though. The June 21 article in the Journal estimated that the revenue involved could come to $4.6 billion, or less than a third of what was included in Friday's filing.

Medco's filing did not suggest there was anything improper about reporting the copayments as revenue. The company's auditor during the periods in question was embattled accounting firm Arthur Andersen. The Journal, in reporting on the filing in Monday's edition, cited questions of whether the practice is proper.

"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," the paper quoted Lynn Turner, a former chief accountant at the SEC.

"If that is what the SEC accepts, then investors are in trouble and our financial reporting indeed needs improving," added Turner, who is now an accounting professor and director of the Center for Quality Financial Reporting at Colorado State University.

The filing comes amid continuing concern about corporate accounting following the collapse of energy trader Enron Corp. late last year. Officials of telecom service provider WorldCom Corp. (WCOME: Research, Estimates) are scheduled to testify before a House panel later Monday about the company's recently disclosed accounting irregularities. President Bush will speak in New York Tuesday about corporate accountability and how he proposes to deal with recent problems.

The Journal said Merck now faces at least four shareholder lawsuits due to the booking of the copayments, and that Merck said it believes the suits are without merit.

Andersen could not be reached for comment.  Top of page