Merck & Co., Inc. (NYSE:MRK)
UBS Global Healthcare Conference Call
May 20, 2013 10:30 a.m. ET
Peter N. Kellogg - Executive Vice President and Chief Financial Officer
Marc Goodman - UBS
Marc Goodman - UBS
So, good morning everybody, thanks for joining us to the conference. I am Marc Goodman, I cover large cap pharma and specialty pharma for UBS, and it's great to have Merck here. We have Peter Kellogg, who is the Executive Vice President and Chief Financial Officer, and he's been there for just between six or seven years now. And before, that you would probably remember him when he was CFO of Biogen Idec. But Peter's going to make a presentation and then we may have a little bit of time for a question or two in here, but obviously we have a breakout session right across the hall. So with that Peter, thanks very much for joining us, and I will give it to you.
Peter N. Kellogg
Thank you, Marc, and thank you everybody for joining us this morning. I hope the commute in was okay. I was wondering about coming from Connecticut, how that was going to work today with the train line issues they had last week.
I would like to start just with the standard forward-looking statement, Safe Harbor statement, that obviously I will make some statements that may be forward-looking in some cases and obviously that's all based on management's best judgment. Please read all of our SEC filings for all the profiles of the company.
I would like to begin today by highlighting really four things that all come together and have culminated in us actually making the announcement we made just recently regarding a share repurchase amount that's higher than what our run rate has been historically. We have as a company always prioritized being shareholder friendly and creating shareholder value, and we feel like we have really focused on the dividend and share repurchase activity as ways of returning cash to shareholders. And I think as we came through the Schering-Plough merger and have executed against that over last three or four years, I’d say three years, but three or four years since the announcement, we really -- it's like we have accomplished a lot, and we are now in a position to be able to take the action that we just announced.
And that's based on robust growth opportunities in our franchises. We have had great underlying growth of our existing businesses that continue on, that aren't susceptible to patent expiries in the short term. We have also done a lot with the merger of Merck and Schering-Plough as well as Organon. If you think about it, Schering-Plough had just bought Organon. So, we really had three companies coming together. And so, we have done a lot to manage costs. I'd like to highlight that as well today.
And then most importantly for a company like ours, we have actually been advancing many exciting pipeline opportunities. And so, if you will, I'd like to cover these four points in my presentation, and I think they all come together to tell the story of Merck as we stand here today.
This first chart just highlights that since the merger, which occurred at the end of 2009, we made a point of being shareholder friendly, and so we have maintained the Merck-level dividend until all the Schering shareholders came up to that level in 2010, and then we actually increased the dividend, it says about 10%, actually it was about 11% in 2012 and then 2.5% last year. So, we have been increasing the dividend. At the same time as you can see by the brown bar in this bar chart, we have actually been increasing our share repurchase activity as well, as we get past certain legal issues that were out there as well as a lot of the restructuring that drives savings, costs, and cash, because we are actually paying severance. So, once you get through that, then you can start stepping up your share repurchase activity as well.
On the first quarter earnings call, we actually announced a new $15 billion share repurchase authorization that was approved by the Board, and we highlighted that we anticipated repurchasing about 7 -- about half of that, $7.5 billion in the first 12 months, and it's funded through both cash flows of the company as well as debt, and we went to market last week on the debt, and so we had a very successful debt right offering there.
Why now? Why do we feel like it's a good time to do this? Well, first of all, over the last three years since the merger, like every company in this industry, we have been through a number of patent expiries, and we are going through one right now as well, and we have actually since the merger had $3 billion of patent expiry impact to our topline. What's important is to manage our cost structure and so forth through that, but to make sure at the same time you are investing in the opportunities you have around the world and in key growth brands, and we have been doing that. So, while we have been getting savings, we have also been investing for growth.
As you can see here, Januvia, Isentress, Gardasil, in animal health, for example, as a sampling of what's been driving our performance, all have contributed very nicely to, if you take the balance of the business, if you exclude the patent expiry products, we have actually been growing in the high-single digits very nicely. And net-net in total when you take those two impacts and balance against them, we had a 1% top-line growth rate despite having pretty significant patent expiries.
Now, obviously we are not done yet. We had Singulair going off patent last summer in the U.S. and then in January or in the first quarter to the European market as well as Maxalt has gone off patent in the first quarter. So, we are still in the middle of some patent expiry activity, because we clear through it what is important is the right size of that chart, are the remaining -- is the remaining days of business growing nicely, so you then go into a growth period, and that's what we are focused on, and so far we have accomplished that very nicely.
At the same time since the merger, we have focused very much on our cost structure. Now this takes SG&A and R&D as a percent of sales, and so we are calling that operating expense for this discussion, and it highlights that back in 2008 and 2009 on a pro forma basis, the companies were -- I am sorry, 2008 as a Merck standalone, we had higher operating expense level as a percentage of revenue than a lot of our -- the average of our peer group. And that shouldn't be surprising because in fact we are very strong in the primary care business which is much more sales force intensive.
A lot of our peers have primary care, but they also have much more focus in specialty markets. And likewise, the pricing in specialty markets tend to be a little bit higher than the primary care space, so as a result, the cost as a percentage of revenue can be a little bit higher in our case. But what's impressive is that we have actually come down and actually caught up with the average of our peer group and actually now have an operating expense level that's below our peer group on average, and that's despite actually expanding in the emerging markets and growing our business and really making sure that we had launched products very well in Japan and so forth.
So, we feel like we have made a really nice effort on the operating expense side. We don't talk about it a lot, but it's been a steady effort throughout the first three years, and as you will recall, we highlighted that we were going after $3.5 billion of synergies when we emerge. Surely, after the merger was completed and we got into it, we actually updated that to say it's not just gross synergies, it's net synergies, which means even after the investments in the emerging markets and launching products, we are going to cover that and then get $3.5 billion of net savings. So that means that actually to get to the 3.5 that we have achieved, we actually had to earn -- deliver over $6 billion in gross synergies, which is really high stepping as a percentage of our cost base, though we really have done a nice job in that area.
I’d like to take a second just to break that out. This shows how the SG&A as a percentage of revenue and R&D as a percentage of revenue have trended over the last few years. And as you can see, a lot of the savings have come from the SG&A space. In fact SG&A today is actually below the average of our peer group, which we are quite proud of, and I think you will recall on the first quarter earnings call, we indicated that we thought that SG&A this year would also go down as opposed to -- the original guidance was that it will be flat or slightly increased, we actually now feel like it will probably come down.
On the other hand, R&D, we have taken the two pipelines and put them together. We actually feel like we have a good competitive level of R&D today, and in fact in 2012 you can see it actually came up a little bit. And so right now, our R&D spending is based on what the opportunities are in the pipeline. So, I think we feel like we have done a nice job taking advantage of the mergers and delivering a much more efficient operating structure.
And thirdly, very importantly, we have been through some patent expiries and right now in 2013 and next year 2014 as we lap some of these things, we will be high patent expiry as well as next year as the AstraZeneca joint venture is most likely to unwind. That highlights that in fact we are right in the middle of kind of our patent expiry pressure point.
If you look forward, you can see for the next three years, '14, '15, '16, and '17, actually as a percentage of revenue, our generic impact -- the generic erosion is lower and then even lower in the back end of the decade, and you can see our level of exposure is a little bit less than the average of our peer groups.
So, we actually feel like we are well positioned to actually have less as we come through '13 and '14, and we will then go into a period where we have less patent expiry exposure and actually that underlying growth I spoke about earlier, hopefully will then be able to drive the top line.
One thing is we are focused on also is making sure that we have a nice, broad, diverse portfolio of growth drivers. So Januvia and Janumet are primary care; Remicade, Simponi, Isentress, specialty markets; Gardasil, Zostavax in vaccines; Animal Health and Consumer, diversified businesses, all of which have nice businesses, and you can see the first quarter sales and all of which have very nice growth.
As you remember from the first quarter earnings call, we highlighted that Januvia and Janumet did have an impact in the U.S. as the wholesaler channel rebalanced their inventory levels. So, that actually brought down our sales rate a little bit in the U.S., and overall worldwide for Januvia and Janumet. But in general, we feel like all these areas are demonstrating nice growth.
Speaking of Januvia and Janumet, obviously for the DPP-4 category has done quite well, and we are the leading player in that space. So, in many ways, our job in this space is to do both maintaining our position in the DPP-4 space, but to grow the pie, grow the wedge of the pie in DPP-4. As you can see in this pie chart of all oral medications for diabetes, DPP-4 still is a very small portion of the total market, so If we can grow that pie from 9% to something higher, that will actually fuel a lot of the growth.
We actually expect with the global non-insulin diabetes market growing as big as it is, it's going to be growing very nicely, as you can see on the right. We anticipate it growing from 17 billion to maybe over $30 billion by 2018. If we can just even hold our position that will be a growth segment. So we actually feel there's an opportunity to grow the DPP-IV position. And of course we are the leader in that space.
Secondly with Zostavax, which is a drug vaccine for shingles, we actually think that's a huge opportunity for us. And as you know we have been a little bit supply constrained over the last few years. We now are actually opening up that supply pretty nicely, but at this point we are still kind of coming up the growth curve. Our job here is to increase our U.S. penetration. Right now we are primarily selling it to people over 60 years old in the U.S. At this point we have about 20% penetration and as you know shingles is a pretty high unmet need, and a serious issue. So we are going to continue to drive that.
Clearly you may be seeing our advertisements where we are focusing on disease awareness and making sure people understand that's Shingles is a serious issue and there is a vaccine for it. We are also beginning to now look to new markets outside the U.S. to begin to expand. So this is just the beginning of us going outside the U.S. at this point. We will be launching in two Asian markets and eventually we will get to Latin America as well as later this year we expect to be opening up in the UK. Now the UK business I will remind you will probably come through the Schering Plough-MSD joint venture. So it will show up as a growth hopefully in equity income.
And then finally as we get more and more supply we will be able to go back and start driving again and expand utilization to people who are 50 to 59 years old at this point, that's a very low penetration rate. So we are just getting started. So Zostavax is a nice growth opportunity for us.
We also are in the middle of a lot of filings and reviews in the U.S. and Europe and this chart highlights that. We obviously are launching LIPTRUZET, which is the Zetia-atorvastatin combination. We are under review for SUVOREXANT, which I am sure many of you have seen that we have an advisory panel this week on that. That's for insomnia and that's in -- SUVOREXANT is under review in the U.S. and Japan.
Ridion, for neuromuscular blockade reversal, actually is already launched in Europe and in Japan, doing very well. And at this point it's under review for the U.S. We think that's a really good opportunity.
We have a program with allergy immunotherapy tablets, these are sublingual tablets. In fact instead of having the shots on the skin this could expand category to having people who don't want to get shot they can go -- don't get the shot, they could use these sublingual tablets. We have two of those programs under review in the U.S. right now. One is for grass and one is for Ragweed and I think this time we will highlight the unmet need. I know a lot of people are suffering from allergies right now.
And then finally in Europe we have a product called vintafolide for platinum-resistant ovarian cancer, that's under review and I think that's a very advanced approach for cancer therapy. I think you probably read about that. So that is -- we are very optimistic that could then come through very nicely and be a nice addition to our oncology business.
Now, those programs that are under review or in filing obviously very small subset of our total pipeline. You can see here the size and the number of programs we have in Phase III which are shown in the green color and then Phase II that are in the Burgundy color. And obviously it's a wide array and I don't intent to talk about all these programs. But it's really a very healthy pipeline that we have today. There's a lot of really products coming from both companies as a result of the merger.
I would like to highlight though there is a couple in this pipeline, that I think really do represent very large opportunity if they come through. And it's these four programs I'd like to just mention. First is odanacatib, which is our Cat-K Inhibitor for osteoporosis. That's in Phase III, certainly got a lot of attention in the first quarter when we actually announced that we are going to continue to study it a little longer. But the opportunity in that market is very large, 200 million women worldwide have osteoporosis. So if that drug does come through we really are optimistic that, that could be a good opportunity. We have indicated that the timing for filing will be 2014 at this point. So stay tuned.
Anacetrapib, a CETP inhibitor, is in Phase III. And I will just remind you how big that category is and if that does program come through with good data, just as an example, a 1% branded share is worth more $450 million, just 1%, to give you a sense how large that cardiovascular space is. So we will see. We will see how that CETP program comes through.
Alzheimer's is a very big space, getting a lot of attention because it's so -- its growing prevalence and also because the cost of the healthcare systems around the world are so large. For example one in two people over 85 are diagnosed with Alzheimer's at this point. And people are living longer. So we have a base inhibitor program that had very good data. It's right now in Phase II, Phase III. This one will report after several years, it's a long term trial, but again a very high potential program.
And then finally a program that's has probably gotten the most attention in the last month or so is the anti-PD1 program. And we are obviously in Phase II for melanoma and in Phase I for non-small cell lung cancer. And advanced melanoma of course accounts for over 80% of skin cancer related death. So it's a big area. We are moving very fast. We have a special designation with the FDA and they are giving a lot of cooperation with moving very quickly on that program.
Other companies have programs in the space as well and I think there's really extraordinary opportunity here that these programs can really deliver the data we have seen so far in Phase I, this will be a very big breakthrough for both patients as well as for the treatment of a broad set of cancers. So more to come on that. I will just remind you that we will be presenting new data at ASCO and we will have a special breakout session there as well. So we will be covering the anti-PD1 program at some depth at the ASCO conference.
So with that I will wrap up and Marc I will be glad to take any questions or from the audience as well. We are excited about our future at Merck. I think that a lot has been done over the last three years. We think we are in a nice position. We have actually gotten a lot of the work of the merger behind us at this point and feel like we have got our pipeline, our cost structure in pretty good shape and we will continue to work on that. Of course we are never satisfied.
But on the other hand we actually think it's a great time to use the strength of our balance sheet to actually become even more shareholder friendly. So we did make a very significant commitment to share repurchase.
Marc Goodman - UBS
Sure, thank you very much. So we do have a few minutes in here for questions, and I will open up and just ask if the pipeline, the late stage pipeline ends up coming to fruition as you expect, can you talk about how much added expenses, how much extra sales force would you have to have or do you feel like the current infrastructure is actually pretty good to cover it?
Peter N. Kellogg
I think for the most part, the infrastructure we have today is pretty good, for the short term. I think that sometimes it depends on what the data says and just how big the opportunities are. So obviously for example in oncology, just it depends on how many indications we have and how many disease states we have, and how fast we get to market. But I think for the most part, our goal would be to try and manage the SG&A line very efficiently with the caveat though that on SG&A we do continue to grow and expand in the emerging markets.
So, we have three joint ventures in the emerging markets, in China, in India, and Brazil. And actually the one in India -- I am sorry, the one in China and Brazil just started up and is now running in the first quarter. And we actually have a majority stake in those joint ventures, very typically you will see joint ventures in this industry where the pharma company may have a minority stake and then you recognize equity income. We actually have a 51 stake in both the China and the Brazil joint ventures. So we actually have 51%, which means we will be consolidating the P&L. So you will see revenue and you will see SG&A expenses as those JVs ramp up. And so that could be one factor that could our SG&A to perhaps come up a bit, but it will be offset by our continuing focus on synergies.
Marc Goodman - UBS
So just specifically like anacetrapib and odanacatib which are your big ones, you already have the infrastructure, basically…?
Peter N. Kellogg
For the most part, that's right. And I think as we launch obviously, we have to put extra effort in, Marc, and so sometimes we may expand for a little bit of time, but then on an ongoing basis, it just depends on how many of those things come to market. There's no infinite capacity obviously in the commercial organization, but we do have a very strong primary care footprint.
Marc Goodman - UBS
So there's been a change as the head of R&D, I was wondering if you could talk about what you are kind of seeing behind the scenes on that, how is it working so far, and should we expect any major changes in strategy?
Peter N. Kellogg
Well, I think, it's too early to talk about major changes in strategy. I know there are -- we had Roger Perlmutter who's just joined us to lead the R&D organization. He's been in Merck for a long time before, so he knows the Merck organization. He then went away for a while, and now he's coming back and re-learning all the – or not relearning about the organization, but seeing what we have in the pipeline. So, I think we have to give him some time to make his assessments, but as you know Roger is going to be ambitious and he's going to have a goal of really having the pre-eminent world class R&D organization that we can have. And so as he mentioned on the first quarter earnings call, he's never satisfied with what he has in the pipeline. He will always be digging for more.
So we have always said and this will certainly be true going forward that we anticipate continuing to do business development deals, to bring in the best technologies. We just announced collaboration with Pfizer for SGLT2 program, and we will continue to drive against next generation technologies in all the therapeutic areas that we are interested in. So I think that while we do have very robust pipeline as I showed, I think we will also be on the BD front looking for other opportunities. I know Roger's going to be very involved in that.
In terms of the organization I think let Roger have some time to kind of look at how he wants to run things. I think he's only been on board for a little bit, but I know we are all focused in the company on having an excellent return on investment and R&D. And I think when you accomplish, when you're really getting returns on the dollar spent then you are very comfortable with the R&D budget you have.
Marc Goodman - UBS
And just to follow-up on that. So primary care is going to focus for Merck is it going to remain a focus with the kind of…
Peter N. Kellogg
Yeah, I would say you look at some of those pipeline assets, yeah, primary care will continue to be a focus for us. Now that doesn't mean that we won't be very strong in specialty care areas, or the vaccine which is (even decent), what I highlighted today is some of those are going to be specialty care or oncology areas and so forth. But we also have a commitment and we will probably be very strong in the primary care space?
Marc Goodman - UBS
You mentioned a few of the emerging markets that you have taken some joint venture activity into to kind of get there, what are you thinking some of the other markets that you are not in, where you do not play right now, that you want to get bigger in?
Peter N. Kellogg
Well certainly the two markets that where we have done joint ventures that are broad-based, both commercial and manufacturing, China with Simcere and Brazil with Supera are -- those are joint ventures are just getting started. So those will ramp up and I think those are both areas where we have an opportunity to grow. So I wouldn't want to present them as if they were in great shape and all set there. We really have a great growth opportunity to expand and drive our products well in those markets.
I think around the world obviously we are very interested in a lot of the emerging markets and we would see, if we have the right opportunities we would see definitely a priority that we would want to invest to drive those businesses forward. That said we are very focused on making sure we are creating value. And so for example a couple of years ago, I think there were a number of opportunities to buy companies in the emerging markets and we studied those very carefully.
At this point we are very happy that we did the joint ventures. We think we have got great joint venture partners. We have retained their management in place. We actually get the benefit of their local presence in the market as well and their expertise. And finally we actually get access to their low cost manufacturing and their running of their manufacturing plant. So it's sort of a nice win-win and actually doesn't have a huge upfront commitment of capital in terms of an acquisition nor does it have a timeline delay of having to build out a sales force or build out a low cost manufacturing base.
So at this point we really think the approach we have taken is quite good. We will be open doing other joint ventures Marc in the future in other markets. We have done some that are kind of low profile but I think in general we see kind of the emerging markets and quite frankly Japan, all as high growth markets opportunities for us. So we are really prioritizing those.
Marc Goodman - UBS
And then the AstraZeneca deal kind of unwinds is there any change in the expenses for that, how does that work?
Peter N. Kellogg
For the most part that joint venture comes through our equity income line. There are some revenue items that would go away because we have some supply agreements relative to supporting the joint venture but for the most, bigger thing, economic impact would be at the equity income line. There are no other expenses per se that's related to the joint venture.
And as you know both companies have said after we renegotiate the timeline and the terms of our joint venture there is option June 30 of 2014 for AstraZeneca to execute an option. Both companies have said I think pretty firmly that it will be our expectation that they probably would execute their options.
Marc Goodman - UBS
So last question before we move into the breakout which is when you look at Merck and you listen to the questions you get from investors, what do you believe is the most underappreciated aspect of Merck right now?
Peter N. Kellogg
Well, I think for Merck and I think it is true for the industry in general but certainly is true for Merck. I think that there is a lot of question about the pipeline, in general, in terms of will it come through, will it have great -- will the $8 billion that we spend each year have a great return. And I think that clearly as you see stocks move and investor interest move it's usually related to the pipeline.
I think our operations are pretty well understood. I think we performed very well and people appreciate that, but I think that the pipeline is where the really breakout value could lay, and I think at this point for the most part, investors generally are focused on a lot of the programs I showed today and some of the other ones in the pipeline and they are trying to size up appropriately what the potential is and whether our science is leading and whether we have great data to support approval and commercialization. So I think really most of the questions I get is about the pipeline.
Marc Goodman - UBS
Thank you. So we stop there and we will move across the hall for the breakout. Thank you.
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