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http://www.nytimes.com/2002/07/09/business/09PLAC.html

Merck's Accounting Raises Questions About a Stock Offering

By MILT FREUDENHEIM

espite a series of surprising disclosures about the way it accounts for billions of dollars in revenue from its Medco managed care unit, Merck & Company plans to proceed today with the pricing and initial offering of Medco shares.

Medco Health Solutions provides services to health plans, including discounted prices and rebates on drugs, making sure that patients pay the correct share, or co-payment, for prescriptions.

Pressed by officials of the Securities and Exchange Commission to make clear how much of Merck's reported revenues were, in fact, co-payments that did not go to Medco or Merck, Merck said in an S.E.C. filing on Sunday that the co-payments produced $14.05 billion in the months from Jan. 1, 1999, to March 30, 2002.

The disclosure, which was reported by The Wall Street Journal, rattled some investors who drove Merck shares down as much as 4.6 percent yesterday. Merck rebounded to close at $47.81, losing 2.2 percent on a down day for stocks. In all, Merck is down a third from its 12-month high of $71.50 in August 2001.

In a separate report, S.E.C. documents obtained through Freedom of Information requests showed that it began questioning Merck's method of accounting for Medco's revenue as long as three years ago.

There was apparently no enforcement action by the S.E.C. and no change in the accounting, which Merck asserted was not material because the revenues in question "were less than 5 percent of Merck's consolidated sales" at the time, according to SEC Insight, a research firm that obtained the documents.

"It is clear that the S.E.C. had concerns about Merck's revenue-recognition policies as far back as 1999," said John Gavin, president of SEC Insight. "We now think it's legitimate to openly question whether Merck is adequately disclosing all the information that investors need."

Merck said yesterday that the Medco filings were "thoroughly reviewed by the S.E.C., including the recognition of retail co-payments as revenue." A Merck spokesman, Chris Loder, said it was confident that its filings were "in accordance with generally accepted accounting practices." The co-payment revenue was taken out as expenses and had "no impact on Merck's income per share," he said.

Standard & Poor's affirmed Merck's top-rank AAA credit rating yesterday. This revenue was "a nonissue," said Arthur Wong, an S.& P. credit analyst. "Merck is generating more than enough cash for its immediate needs."

Rita M. Freedman, a health care analyst at PNC Advisors in Philadelphia, said, "But the question now is: Are there any more skeletons in the closet?" PNC manages accounts for individuals — including, she said, "a lot of Merck." Ms. Freedman noted that Merck recently dismissed its accountant, Arthur Andersen, after it became known that the accounting firm had destroyed records relating to Enron.

Martin Bukoll, an analyst with Northern Trust in Chicago, also said Merck's accounting was appropriate and consistent. "It doesn't bother us at all," he said.

But Mr. Bukoll questioned Merck's timing: Why try to spin off 20 percent of Medco at an inhospitable time for initial public offerings? Noting that Merck has said it will have flat earnings this year, he said he wondered if the company was "desperate" for the $1 billion-plus that the Medco shares might bring.

At last count, Merck's advisers, Goldman, Sachs and J. P. Morgan Chase, were planning to price Medco at $20 to $22, a retreat from their original hopes for $22 to $24. The offering would value Medco at more than $5 billion.

Mr. Bukoll also noted Medco's commitments to promote Merck drugs, even after becoming independent one day. "Are these unholy agreements in the best interest of some of Medco's clients?" he asked.

In fact, Merck has been defending its influence on its Medco unit in a long-running battle with plaintiffs' lawyers who are seeking class-action status. Adding to the legal tangle, it now faces several shareholder lawsuits that seek to link the Merck stock slide to the Medco accounting disclosures.

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