Merck & Co. Inc.'s CEO Discusses Q3 2013 Results - Earnings Call Transcript

Oct.28.13 | About: Merck & (MRK)

Merck & Co. Inc. (NYSE:MRK)

Q3 2013 Earnings Conference Call

October 28, 2013, 8:00 a.m. ET


Joe Romanelli - Investor Relations

Ken Frazier - Chairman and Chief Executive Officer

Peter Kellogg - Chief Financial Officer

Roger Perlmutter - President, Merck Research Laboratories

Adam Schechter - President of Global Human Health


Gregg Gilbert with Bank of America Merrill Lynch

Jami Rubin - Goldman Sachs

Steve Scala - Cowen & Company

Marc Goodman - UBS

Seamus Fernandez - Leerink Swann

Tim Anderson - Sanford Bernstein

Mark Schoenebaum - ISI Group

Andrew Baum - Citi

David Risinger - Morgan Stanley

Vamil Divan - Credit Suisse

John Boris - SunTrust

Tony Butler - Barclays Capital

Christopher Schott - JPMorgan


Good day everyone and welcome to Merck’s third quarter 2013 earnings call. [Operator instructions.] At this time, I would like to turn the call over to Mr. Joseph Romanelli, vice president of investor relations. Please go ahead.

Joe Romanelli

Thank you, operator, and good morning everyone. We’d also like to say good afternoon and good evening to everyone listening outside the United States. Welcome to Merck’s third quarter 2013 conference call. Before I turn the call over to Ken, I want to point out just a couple of items.

First of all, there are number of items in the GAAP results, such as acquisition-related charges, restructuring costs, and certain other items. You should note that we have excluded those items in our non-GAAP reconciliation tables and you can see this in our press release in table two.

This will give you a better sense of the underlying performance. There are three tables in the press release. The first table provides the GAAP results. Table number two reconciles our GAAP P&L to the non-GAAP results for the third quarter and table three provide the sales performance for the company’s business units and our products, both on a reported basis and excluding exchange. During the call, we will refer to table two when we discuss the P&L and table three when we talk about revenue performance.

Finally, I would like to remind you that some of the statements we make during today’s call may be considered forward-looking statements within the meaning of the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Such statements are based upon the current beliefs of Merck’s management and are subject to significant risks and uncertainties.

If underlying assumptions prove inaccurate or uncertainties materialize, actual results may differ materially from those set forth in the forward-looking statements. The company’s SEC filings, including Item 1A in the 2012 10-K, identify certain risk factors and cautionary statements that could cause the company’s actual results to differ materially from those projected in any forward-looking statements made this morning.

Merck undertakes no obligation to publicly update any forward-looking statement. Our SEC filings can be found on the website at You can also find our earnings release and all the tables there as well.

This morning, I’m joined by Ken Frazier, our chairman and chief executive officer; Adam Schechter, president of global human health, who will update you on our product and geographic performance; Peter Kellogg, our chief financial officer, who will review our P&L and provide an update on our outlook for 2013; and Dr. Roger Perlmutter, president of Merck Research Laboratories, who will provide you with an update on some of our key programs.

With that, I would like to turn the call over to Ken Frazier. Ken?

Ken Frazier

Thank you, Joe, and good morning everyone. This morning, I’ll provide an update on our performance and highlight some key events from the quarter. I’ll start with performance. This quarter, our team’s delivered solid growth in the underlying portfolio while aggressively managing cost to deliver non-GAAP EPS of $0.92.

Our diverse core business continues to grow despite challenges in the marketplace. Excluding the impact of patent expiries, company sales grew 3% on a constant currency basis, with strong contributions to the top line from our vaccines, immunology, and HIV businesses.

At this point in 2013, I believe it’s useful to step back and look at the solid year to date performance of these and other growth drivers in our portfolio. During the first nine months of the year, excluding exchange, vaccines grew 15%. Our immunology business grew 12%. We had consistent global growth of Isentress at 7%. Our diabetes franchise grew 6%, and our hospital portfolio grew 5%.

As Adam will detail shortly, our commercial teams are focused on maintaining share and driving growth for key brands, despite competitive pressures and patent expiries. Our complementary businesses, animal health and consumer care, were flat year over year this quarter, but their fundamentals remain strong, despite some factors affecting short term performance.

Now, I’d like to briefly comment on our announcement earlier this month to sharpen our R&D and commercial focus. On this point, let me be clear, Merck is and will remain committed to investing productively in R&D, both internally, and importantly, externally, as we firmly believe it is the best pathway to sustainable competitive advantage and growth.

By investing for growth, we will strengthen our ability to drive innovation and translate cutting edge science into medically important products, the fundamental driver of long term shareholder value in this industry. As part of our global initiative, we are proactively reengineering our cost base to realize operating efficiencies while at the same time bringing greater focus and commensurate investment to those areas where we have the strongest potential for growth.

These plans enable us to reduce our cost base by $2.5 billion by the end of 2015. We are confident that this is the right plan for future growth in the current and future healthcare environment, although the steps we are taking are very difficult. However, I cannot emphasize enough that significantly reducing our cost base does not mean that we will stop investing for the future. On the contrary, we believe it is necessary to focus our resources even more precisely so that we can invest in those opportunities which best position us for a return to growth.

As part of this same process, we are evaluating strategic options for those areas that have not been prioritized. We have a research portfolio with innovative assets such as our anti-PD1 and HCV programs, both of which have been granted breakthrough therapy designation by the FDA. These require significant investment and we are committed to fully resourcing these and other critical programs like BACE for Alzheimer’s disease.

Regarding our anti-PD1 program, we are looking forward to presenting our first data in non-small cell lung cancer tomorrow. I am pleased with the speed and intensity with which our colleagues around the company are working on this important program.

Since joining us this past spring, Roger Perlmutter has been working on creating the foundation to achieve a high return on R&D capital by reducing operational complexity and introducing significant efficiencies. This ensures that our researchers are focusing their efforts on the programs most capable of delivering medicines and vaccines that provide unambiguous, promotable advantages to patients and payers. Roger will talk more about that shortly, including how our combination HCV regimen and V503 underscore this point.

As we think about our business going forward, we are focused on balancing the short term and the long term by resourcing the key internal programs to deliver our pipeline, including potential game-changers like anti-PD1, while also augmenting our pipeline with even greater emphasis on external opportunities.

In addition, we will maintain a high level of cash return to shareholders through both the dividend and stock buyback. In addition to the dividend, thus far we’ve demonstrated our shareholder friendliness with a $15 billion treasury stock authorization and the accelerated stock repurchase this year.

So, in closing, we demonstrated solid financial results again this quarter. We are taking steps to sharpen our R&D and commercial focus, which will strengthen our position for the future by increasing productivity and investing in our most promising opportunities. And finally, we are committed to increasing shareholder value in the future through value creating business development and returning a high level of our free cash flow.

So, with that, I’d like to now turn the call over to my colleague, Adam Schechter.

Adam Schechter

Thanks, Ken. Good morning everybody. This morning I’ll focus my remarks on the performance of our core products and our core markets. Let me begin with overall performance. Human health sales declined 4% in the third quarter. Our top line results continue to reflect the loss of exclusivity of a number of brands and weakness in the yen.

Our underlying business grew 4%, excluding sales from these products on a constant currency basis, and key contributors to the growth in the quarter were vaccines, Isentress, Remicade, and Simponi.

So let me provide more details, and I’ll start with the Januvia and Janumet franchise. The franchise had sales of $1.4 billion and 2% growth ex-exchange. Growth of 15% in international markets was offset by an 8% decline in the United States. The United States sales decline this quarter was driven by lower customer inventory levels of more than $60 million.

With regard to demand, in the United States we saw a decrease of about 2% in TRx volume this quarter. However, we continue to maintain our strong market leadership position, with a greater than 70% share despite three other DPP4s in the U.S. market.

The key issue in the United States is that the branded oral diabetes market is relatively flat. Regarding price, while we saw a small benefit from price this quarter, we also continue to experience rebate and pricing pressure as this is a very competitive market.

In international markets, Januvia and Janumet sales increased 15% on a constant currency basis. We drove good volume growth in each region around the world and we maintained leadership with about a 70% global market share.

Now let me touch on our outlook for the franchise. First, in the United States we continue to focus our resources on Januvia to drive demand and to take share from the sulfonylureas. With significant new competition, we must defend market share while at the same time focus on market growth. Although this has proven to be difficult, we must change the TRx trend in order to return to growth in the United States. Second, internationally we expect good growth. The diabetes market continues to grow, and we are well-positioned as the market-leading DPP4 inhibitor.

Moving to Isentress, Isentress sales were $430 million, which represents about 7% growth. In the United States, we are maintaining our patient share despite new competition, although it’s still early. Outside of the U.S., Isentress continues to have solid volume growth.

Moving to immunology, the combined immunology business, consisting of Remicade and Simponi, grew 16% in the quarter. Sales of Simponi grew 40% to $126 million this quarter. We’re seeing good growth across our markets, including the recent launch in France. We’re also pleased with last month’s European approval for an additional indication in ulcerative colitis.

Lastly, moving to our vaccine business, demand for our vaccines portfolio remains very strong, and we also benefited from about $90 million of higher U.S. public sector purchases, including about $60 million of Gardasil and about $30 million of RotaTeq sales in the quarter.

Gardasil maintained its strong performance, with 15% growth year over year. U.S. sales increased more than 30%, due to continued uptake of the male indication and higher public sector purchases.

Internationally, as expected, sales declined this quarter. The Japanese government decision in June to suspend proactive recommendation of HPV vaccines had a negative impact on the HPV market. We continue to work with the Japanese government to provide the vast amount persuasive safety and efficacy data available for Gardasil. In addition, the timing of emerging market tenders had an unfavorable impact on sales this quarter.

Moving on to Zostavax, Zostavax sales were $185 million this quarter. As expected, sales in the United States are up sequentially due to seasonality. However, the flu vaccination season is getting a late start this year, so we would expect our strongest quarter of the year to be the fourth quarter.

Internationally, we have now launched in a select set of Asian markets and the United Kingdom. We’re seeing good uptake in each of those markets. As an important reminder, our European vaccine sales are reported through equity income.

We recently received approval of our Durham manufacturing facility and we are on track to launch in additional markets beginning next year. We continue to see Zostavax as a key growth driver.

Now I’d like to touch on our regional performance. In the United States, Europe, and Canada, sales continued to be affected by the loss of exclusivity of Singulair, Maxalt, Propecia, and Clarinex, and most recently Temodar in the United States.

Excluding these products, U.S. sales increased by 7% and Europe and Canada sales increased by 3% as compared to the prior year. Japan sales declined 2% ex-exchange, due to an increase in the utilization of generic versus branded products, but also lower sales of Gardasil as I mentioned earlier. Sales in emerging markets grew by 2% ex-exchange.

Double-digit growth in key emerging markets like Brazil, Korea, Russia, and Turkey was partially offset by declines in China and Mexico this quarter. The timing of tenders also affected our performance in the emerging markets, including China this quarter. In key emerging markets, our base business is strong and diverse, and Merck’s growth continues to outpace to overall market. We expect stronger growth in the emerging markets in the fourth quarter.

Before I close, I’d just like to touch on the changes we’re making in global human health, as part of the global initiative we announced earlier this month. We are sharpening our focus on core therapeutic areas in top markets. We are prioritizing investment in those areas where we have a future platform for growth and for leadership, like diabetes and vaccines. In other areas, we are reducing investment and looking for creative ways to be successful in the marketplace and to maximize the values of these assets.

In closing, the human health business demonstrated growth of our underlying portfolio of key brands this quarter. I’m confident that the changes we are making, together with our strong portfolio, position us well for future success.

Now I’d like to turn the call over to my colleague, Peter Kellogg.

Peter Kellogg

Thank you, Adam, and good morning. As you heard from Ken and Adam, today’s results reflect the various pushes and pulls the business is facing today. First, we continue to work through the negative impact of patent expiries. Second, we saw strong growth in key areas of the base business, such as immunology and vaccines. Third, we maintained solid levels of sales and market share with products that are under considerable competitive pressures. And finally, we continue to manage costs effectively while making focused investments for future growth.

In total, we delivered a solid performance this quarter. Reflective of this quarter’s performance, we are narrowing our 2013 non-GAAP EPS guidance range to $3.48 to $3.52. Coupled with the new global initiative to strengthen Merck by sharpening our commercial and R&D focus, today’s results demonstrate that Merck is committed to delivering in the short term while preparing the organization for future growth.

This morning, I will talk briefly about our performance in the third quarter, and I will discuss our outlook for the remainder of the year. My remarks will focus on our non-GAAP financials. Starting at the bottom line, we earned $0.92 per share this quarter.

Merck is now emerging from the most significant period of Singulair patent expiry, which began in August of last year. Also, this year has brought significant foreign exchange headwinds, so it is important for us to highlight how the underlying base business is performing outside of patent expiries in foreign exchange.

On that basis, sales increased 4% in our pharmaceutical business, as Adam outlined earlier. Also, on an ex-exchange business, animal health sales were flat year over year. Growth in companion animal and swine segments was offset by declines in the cattle segment.

In consumer care, sales were also flat on an ex-exchange basis. Strong sales of Claritin and the launch of our new Oxytrol OTC product offering were offset by the foot care and GI segments.

Moving to other revenues, we saw a 14% decline in supply sales of AstraZeneca in the third quarter. As the joint venture continues to utilize an alternative supplier and as we approach the May 2014 U.S. patent expiration for Nexium, we expect increasingly aggressive year over year declines.

At the PGM line, as discussed in prior periods, generic erosion of high gross margin products created a headwind on the gross margin this quarter. As a result, our non-GAAP gross margin declined on a year over year basis to 74%.

Turning to marketing and administrative expenses, our third quarter SG&A expenses were about $220 million lower year over year as a function of continued proactive cost management and foreign exchange. We continue to expect SG&A spending in 2013 to be lower than 2012.

Moving on to R&D, research and development expenses in the third quarter were about $260 million lower than prior year. The magnitude of this decline represents continued cost management and some impact of timing of clinical program investments.

For example, we are now initiating Phase III studies for the partnered SGLT2 program, which will bring milestone payments and clinical development costs into the fourth quarter, and we will continue to invest heavily on our anti-PD1 program. Taken together, we still expect that our full year 2013 R&D expenses will be lower than 2012.

Moving on to other line items, equity income from affiliates decreased $56 million versus the prior year, due to lower income from the AstraZeneca joint venture. We expect to see continued sharp declines as we approach the end of the partnership. We fully expect AstraZeneca to exercise its option to end the JV in June of next year and you should plan your models for supply sales and equity income accordingly.

Other income and expense was about $30 million lower year over year. Lower foreign exchange losses on the balance sheet offset higher interest expense from the $6.5 billion debt offering we completed earlier this year.

Now, moving to tax, our non-GAAP tax rate was 25.3% in the third quarter. As previously discussed, this rate is significantly higher than the first half of 2013 and it is also consistent with the range we expect to see for the business going forward in 2014. With this quarter’s results, we are maintaining our estimated full year 2013 tax rate to be in the range of 22% to 23%.

Now turning to the outlook for the rest of the year, on the bottom line, as I noted earlier, we are narrowing our 2013 non-GAAP EPS guidance to $3.48 to $3.52. On a GAAP basis, we expect to earn between $1.61 and $1.79.

Regarding capital allocation, while we remain ready to bolster the pipeline with external innovation at any time, we maintain a strong balance sheet and an efficient capital structure, which has enabled us to return cash in a shareholder friendly manner. As I noted a few weeks ago, we have returned roughly 100% of free cash flow over the last five years, through the combination of a strong dividend and a focused share repurchase program.

This year, you can see the impact of our accelerated share repurchase and our average shares outstanding. We remain on track to repurchase $7.5 billion of stock in the first 12 months of the new $15 billion repurchase authorization announced in May, inclusive of the ASR.

Beyond May 2014, you should expect ongoing share reductions that are consistent with historical patterns and continued commitment to a strong dividend. So, in conclusion, this was a strong quarter. And I’d like to clarify that I may have misspoken earlier. I said $0.93 earnings in the quarter on a non-GAAP basis. We earned $0.92 per share this quarter, and that’s what’s shown in the press release.

It was a solid quarter, where we continued to drive growth across the base of the business in the midst of generic erosion and competitive challenges. We aggressively managed costs and we will continue to do so, as outlined in the new global initiative.

We are committed to maintaining this focus while investing in innovation and driving future growth. Thank you. Now I’ll turn the call over to Roger, who will provide an update on MRL. Roger?

Roger Perlmutter

Thanks, Peter. During the third quarter, we made considerable progress in advancing the goals of Merck Research Laboratories while focusing intently on aligning investment with the best opportunities in our portfolio.

In the vaccines area, we were certainly pleased to receive the Prix Galien this year for Zostavax, our innovative shingles vaccine. We also announced last week that the V503 program, our 9-valent human papilloma virus vaccine, met its primary endpoints with respect to prevention of pathology associated with five HPV serotypes not covered by Gardasil. Detailed results will be presented at the EUROGIN conference in November, in Florence.

The distribution of cancer-associated HPV serotypes varies substantially among human populations, even in the United States. The V503 vaccine should provide protection against nearly 90% of these strains. As previously mentioned, we expect to file for FDA approval of V503 before the end of this year.

Also from a regulatory perspective we continue to make progress in developing lower dose formulations of suvorexant, our orexant antagonist for insomnia. We remain on track to complete our response to questions from the FDA during the first half of 2014.

In September, the company announced that it received a complete response letter from the U.S. FDA for the resubmission of the new drug application for sugammadex sodium injection, Merck’s investigational medicine for the reversal of neuromuscular blockade induced by rocuronium or vecuronium.

To address the complete response letter, the company intends to start a confirmatory hypersensitivity study as soon as is practicable, based on forthcoming discussions with the FDA. This will, of course, impose a delay on our FDA submission. We expect to provide more detail on the nature of this delay following additional discussion with the agency.

Separately, we’re looking forward to the advisory committee meeting for our review of oral immunization therapy for grass allergy, which has now been rescheduled for December 12. We had previously submitted a separate BLA for a ragweed allergen tablet and are working closely with our partner in this area, ALK-Abello, on a more comprehensive program for house dust mite allergy.

From a development perspective, as Ken mentioned, we will present interim data on the effect of MK3475, our antibody directed against PD1, in patients with refractory non-small cell lung cancer at the World Conference on Lung Cancer in Sydney, Australia.

The MK3475 program is now quite broad, and it includes studies in pats with squamous cell carcinoma of the head and neck, triple-negative breast cancer, uroepithelial tumors, colorectal cancer, and hematologic malignancies, in addition to non-small cell lung cancer and of course malignant melanoma. The breadth of this program highlights the opportunity that we see for this new agent, which we hope will prove effective in a large number of malignancies.

Among novel therapeutic categories, earlier this month the FDA granted breakthrough designation to MK5172 and MK8742, our HCV protease inhibitor coupled with an inhibitor of viral assembly, which are lead elements in the broader MRL program for treatment of chronic hepatitis C virus infection.

Interim data describing virulogic responses in genotype 1 infected patients treated with these agents will be presented at the American Association for the Study of Liver Diseases meeting in Washington, DC next week.

These results should give hepatologists a sense of our enthusiasm for the new hepatitis C treatment regimens that we’re exploring, including those involving other potent direct acting antiviral agents that are at earlier stages in development.

Finally in development, we have initiated Phase III studies of ertugliflozin, an investigational oral SGLT2 inhibitor, in partnership with Pfizer. As previously discussed, this compound has very favorable pharmaceutical properties which should enable exploration in combination with sitagliptin and other anti-diabetic agents.

I wish to note that we’re making very good progress in focusing our expenditures on the most promising new programs in our portfolio. We regret that we have found it necessary to eliminate a number of positions as part of this organizational realignment.

Nevertheless, as Ken has made plain, our actions did not signal a softening in our commitment to research and development. It is my firm belief that breakthrough research provides the only sustainable competitive advantage for our company, and I intend to husband our resources with great care to ensure that the most important programs receive phase-appropriate support.


Ken Frazier

Thank you, operator, and thank you Roger. Operator, before we move into Q&A, just a reminder, so we can get through as many questions as possible, please limit yourself to just one or two questions. If you have additional questions, please feel free to rejoin the queue. So, with that, operator, we will start the Q&A session.

Question-and-Answer Session


[Operator instructions.] Your first question comes from the line of Gregg Gilbert with Bank of America Merrill Lynch.

Gregg Gilbert - Bank of America Merrill Lynch

On PD1, as the data set continues to evolve, Roger, do you have a view yet on what the duration of therapy will be in the real world? And then perhaps for Adam, on Januvia U.S., is 2014 shaping up to be a better or worse year from a rebating and discounting standpoint relative to ’13? And I believe a fourth competitor was coming into the mix as contracting was being done for ’13. Thanks.

Roger Perlmutter

We don’t know what the length of the therapeutic regimen will be. We’ve sort of taken a [swipe] at it in our studies, and we have two years of therapy in our current study protocols. But we’re not sure what the durability will be like, and we’re also not sure what it would be like to engage in retreatment in individuals who may have failed. So those are big questions that we’ll have to get at in the future. At the moment, we’re still trying to establish what the fundamental response rates are and the durability response, in a variety of different tumor settings.

Adam Schechter

And with regard to 2014, we’re not giving specific guidance at this time. And we don’t typically give discounts and rebates on individual products. But what I will say is if you look at where we are today, we have about 80% access in manage care. So we believe that we will have a similar, very strong formulary position in 2014, with greater than 80% access. And as to rebate and discounting, we’ll continue to be aggressive in the marketplace, but with that said, we’re going to maintain a very strong access position for Januvia in ’14.


Your next call comes from the line of Jami Rubin with Goldman Sachs.

Jami Rubin - Goldman Sachs

First, on the Januvia/Janumet franchise, Peter, if you can provide us a little bit more granularity on what you’re seeing in terms of volume and price. Obviously you have the largest share, over 70%, but with other DPP4s on the market and SGLT2s, can you give us a sense for where you would expect that 70% to go? And can you reconfirm whether or not you expect this franchise to still grow in the mid single digits? I think that was your guidance in the previous call.

And then secondly, on the gross margin, 74%, can you remind me what was the hit from FX and how should we think about the gross margin going forward? Is there any reason why that gets better in 2014?

Peter Kellogg

Why don’t I let Adam take the first couple of questions related to Januvia/Janumet and the franchise outlook, and then I’ll come back to the PGM. Adam?

Adam Schechter

Let me give you some context to Januvia and Janumet. I’m going to start first at a high level, and a global high level, which says, and it’s clear, that diabetes is a growing epidemic, that it is a significant concern in almost every market around the world, including the United States. And if you talk to any government, the would tell you that they’re very concerned about the growth of expenditures due to diabetic patients. So the market underlying demographics reams very strong.

If you look at the United States, we had a decline of 8% year over year, but that was almost entirely due to customer inventory levels, where we saw a greater than $60 million decrease in the inventory levels. If you focus on TRx volume in the U.S., you saw about a 2% decline in volume.

We did see a benefit from price, but with the continued pressure on rebates and discounts, we saw several percentage points that could be attributed to price. When you think about guidance in the U.S., what you’re seeing is it’s very difficult to predict the channel movements. You saw last quarter we had 9% growth. This quarter we had minus 8%. And that’s primarily due to the changes in wholesalers and channels.

So what I am focusing on are putting the right resources behind Januvia in order to change the current TRx trend. And I believe the most important thing to watch is the TRx trend. And what we need to do as we go into 2014 is to ensure that we don’t continue to see TRx volume losses.

The fact that we still have greater than a 70% market share, despite four DPP4s in the marketplace, tells you that we have a very strong position. We are losing a little bit of market share each month, but you would expect that with four competitors. The real key is that the DPP4 market in the branded oral anti-diabetic market isn’t growing.

Typically when you have four or five new branded products in the market you see growth in the market, and you see expansion in the market. We’re not seeing that right now in the United States. So we have to focus on moving patients that are currently on sulfonylureas to Januvia or make sure that Januvia is seen as the likely next step after metformin before sulfonylureas.

Outside the U.S., it’s a very different story. Outside the U.S. we still have about 70% market share. We saw 15% growth year over year, and despite losing a little bit of market share in markets here and there, the overall market is continuing to grow. So with the market growth that we’re seeing outside the U.S., that’s why we’re still able to see very strong volume growth despite losing a small amount of market share.

Peter Kellogg

Thanks, Adam. So I’ll come back on your PGM question, and in fact just to restate, in the third quarter of this year our PGM was about 74%, and that’s compared to 75.2% last year. And really most of that year over year impact is what we’ve been indicating all along, which is the generic impact of having Singulair go off patent, both in the U.S. and in Europe. And obviously Singulair was a very high PGM product, so that’s primarily the driver of that.

On a sequential basis, we actually had some additional product mix, as we went from the second to the third quarter, and in the second quarter we actually benefited from some productivity gains. Now, foreign exchange was really a minor impact actually in the third quarter year over year, so that’s not a big driver this time. It’s much more the impact of these patent expirations.

But I do want to mention, while we’re talking about PGM, we do have an ongoing multiyear effort to run our manufacturing network in a more and more efficient manner. We’ve made great progress so far, and you’ll recall back at the time of the merger, we had 95 plants around the world. And today we’re down to about 58 sites around the world. So great progress already, and the productivity from that continues to come through.

And so at this point, what you’re seeing on the PGM line is nice productivity gains from all that work and all those actions, but we do see, on the other hand, the impact of the expiries as well as pricing pressure that we’ve all talked about, which tightens up the PGM line as well. So it’s a bit of a balancing, and what we’ve indicated is that for this year, 2013, we expect PGM to be down at least or more than 1 point versus prior year, on a full year basis.

We haven’t given guidance yet for next year, but obviously we’re down now, at this point, where we’re out of a lot of the Singulair expiry impact. You know, Singulair went off patent, and actually the sales declined very rapidly, as you know. So as we go into 2014, we’ll see other things coming into effect, such as the AstraZeneca joint venture and others. But basically most of that LOE impact is done as far as Singulair is concerned.


Your next question comes from the line of Steve Scala with Cowen.

Steve Scala - Cowen & Company

The company reiterated that both R&D and SG&A would be below 2012, but with only one more quarter to go, I’m wondering if you could say how much below they will be. And secondly, to what do you attribute the weakness in China? Other than GlaxoSmithKline, most other companies have continued to deliver good growth in China, despite the investigations. So what can you tell us about China?

Peter Kellogg

Why don’t I take the first question, on the operating expenses. At this point, we haven’t given guidance further than that, but one thing I’d like to highlight - I’d mentioned on the call, in my comments earlier - is that in R&D we did have some timing impacts. Actually, our guidance on a full year basis hasn’t changed much. It’s just tightened the range.

And so really in that regard, the second half of the year is pretty much as our guidance was previously. It’s just that we actually got a little lighter spending in the third quarter, and we expect with the startup of some of the activity on SGLT2 as well as our growing drive against PD1 and the broadening clinical trial base that’s going on in that program, we expect to see R&D pick up some of that. So on a full year basis we’re still in the same neighborhood.

On China, I’ll turn that over to Adam.

Adam Schechter

In China, our underlying demand remains strong. And we did see some hospital inventory declines associated with the current situation there. There’s nothing specific to Merck versus the other multinational companies. There was some timing of tenders that occurred, but overall we’re seeing better performance this month than we did last month versus the prior month. So there’s nothing that you should think of different for us versus the other multinational companies and what they’ve faced in China.

The other thing affecting our emerging markets performance this quarter was wholesaler inventory levels in Mexico. We saw very strong growth in Brazil, Korea, Russia, and Turkey, and we expect you’ll see better emerging market growth in the fourth quarter of this year.


Your next question comes from the line of Mark Goodman with UBS.

Marc Goodman - UBS

Ken, you mentioned you were focused on what’s strategic, what’s non-strategic, and I was wondering if you could just remind us exactly what is strategic and what is non-strategic. And then is there any way you can help quantify for us, so I understand, how much moved into the fourth quarter for some of these emerging markets?

Ken Frazier

Let me take a step back and try to frame the strategy issues from my perspective. I’d start with what we announced on October 1, which was that we intend to drive additional efficiencies while sharpening our focus on R&D and within the commercial business to prioritize what we believe are the key programs and markets that will drive our future growth.

So we talked about the importance of vaccines going forward. We talked about the importance of diabetes going forward. We talked about the importance of our oncology portfolio, which is driven largely by the anti-PD1 opportunities that we believe we’ll be working on for the next decade, frankly. And we also talked about our hospital products area.

So those would be four that we actually cited as being the most important to our future growth. But as we go through this, I think what we’re also focusing on is we are now getting past our major loss of exclusivity period as well as the end of our JV with AstraZeneca. So as part of all of that prioritization, you should expect to see us focus more on those areas that I identified.

But at the same time, you might look to see us divest products and programs, and potentially businesses, such as our recent announcement with Aspen, which will impact 2014. Our strategic plan has multiple levers for running the business over the long term, while being mindful that there are still short term opportunities.

Let me be clear, as I said, we are evaluating all of our options to fund the right programs for the future of the company, because we know that successful R&D will be our long term competitive advantage.

As Peter Kellogg mentioned, another strategic asset we have is that we have a strong balance sheet that will afford us the opportunity to accelerate business development, which is a real and important opportunity for Merck.

We’ll also look for ways to continue to return cash to our shareholders. You’ve seen us raise our dividend over the past two years. We’re constantly evaluating if we can do more, because this is the primary way that we return cash to our shareholders. And we announced the $15 billion buyback, and the accelerated effort through the ASR.

So we’re also, finally, as I mentioned, looking at our complementary businesses of animal health and consumer care, always to determine whether these businesses are more advantageous inside or outside the company.

So I would say we have multiple levers we can pull to fund our growth over the long term while being mindful of the short term needs. But the most important ones are the areas of major focus in R&D, and the main programs that Roger has talked about, like our anti-PD1 program and our HCV portfolio.

Peter Kellogg

And with regard to tenders, we don’t break out our specific tender sales. And in fact we’re still working to win some for the fourth quarter. So you’re always working through the quarter to win as many of the tenders as you can. And then once you win them, it’s how fast you can ship, and whether you ship in the fourth quarter or the first quarter for those winning tenders.

But what I ask you to do, from a bigger picture perspective, in the first quarter we grew 8% in emerging markets. In the second quarter we grew 10% in emerging markets. I’m saying the third quarter is an anomaly at 2%, that we believe that the fourth quarter will be stronger growth than what you saw in the third quarter, which will be partially due to tenders, but there will be other reasons with the underlying dynamics of our business.


Your next question comes from the line of Seamus Fernandez from Leerink.

Seamus Fernandez - Leerink Swann

Just a couple of questions for Ken. Maybe first off, can you walk us through a little bit of the sales and the weakness in the animal health business and your thoughts there on sort of the timing issues and what the underlying trends are in that business that are specific to the Intervet business, or the Merck Animal Health business?

And then separately, for Roger, can you give us a little bit of your thoughts on ondanacatib? I think at a recent meeting that you held with sell-side analysts, you mentioned that you were trying to push to bring a resolution to that program, whether it be a positive or a negative resolution associated with the ongoing trial for odanacatib. So just wondered if you could provide us with an update there.

Ken Frazier

I’ll start with animal health. The first thing, as I said, is the underlying fundamentals of the business remain solid, despite what we saw this quarter. As you know, we voluntarily implemented the temporary sales suspension of Zilmax in the United States and Canada to work with our industry partners to provide the data that will reaffirm confidence in Zilmax, which remains an FDA approved product.

It’s too early to speculate on when we will resume Zilmax sales in the U.S. and Canada, but again, from my perspective, we continue to believe that there are favorable macro trends that will help us drive growth in our animal health business going forward.

Roger Perlmutter

With respect to odanacatib, yes, exactly. Just keep in mind, again, as was announced some time ago, we have a data safety and monitoring committee that halted the base study early for robust efficacy and a favorable benefit risk profile. Those were the words they used. So we have to take that seriously. We know what’s underlying all of this.

The point is, though, that in order to complete the odanacatib study, we need to have a full intention to treat data set that captures all individuals who were enrolled and exposed to investigational product, and provides the basis for adjudication of all effects in those patients.

And to that end, we’ve been pursuing that. We’re making very good progress. We’ll get all of that information tidied up at that point. I think we’re prepared to say all right, we’ve got it in hand, now let’s actually look in detail at the benefit risk profile and know therefore how the drug can be used.

Our expectation is still that we should be in a position to file in 2014, as we’d indicated previously. We’re continuing along that path, and I think we’re making good progress now in getting going to last few bits of data from the many, many sites, of course that we’re involved in this 16,000 patient study.


Your next question comes from the line of Tim Anderson with Leerink.

Tim Anderson - Sanford Bernstein

A couple of questions, both for Roger. On your base inhibitor program, assuming that the safety trial, the Phase II trial, comes out clean, are you still fully committed to taking that into Phase III development?

Second question is on your PD1, still trying to understand the rationale for Merck running a 1,000 patient Phase I trial. With other companies that are doing similar dose ranging cohort expansion studies, their studies are a fraction of this size. So I’m wondering why yours would be so big, and whether you’re hoping that those cohorts could be big enough that you could potentially use this as an early to market strategy.

And the reason I ask that question is because a couple of times in the past few months you’ve sometimes alluded to the Januvia experience where you surprised the market by being first to market in the U.S. when a lot of folks thought another company was ahead of you.

Roger Perlmutter

First of all, on [base] we have a safety run in study which is then followed by the Phase III study in individuals with mild to moderate impairment. And that study is definitely going forward. And I guess I should just highlight here the magnitude of the problem is something that we’re all aware of. The genetic data supporting the importance of beta secretase, processing of amyloid precursor protein, and the production of the a-beta peptide simply couldn’t be stronger.

And the challenge is to know whether individuals who’ve already suffered some degree of neurologic damage, whether inhibition of beta secretase enhanced the reduction in a-beta production, which we have shown takes place in people, in CSF, whether that’s meaningful.

And I think we all need to know the answer to that question. It’s hugely important for all of us. And I think all of us should have our fingers crossed that it actually works, because there’s a desperate need for a new therapy in this area.

And secondly, with respect to PD1, yes, we do have an over 1,000 patient Phase I trial, which was designed to have substudies that permit exploration of dose and schedule as well as looking at other tumor types. And we have set it up in exactly that way in order to be able to acquire sufficient data to know exactly how to proceed in registration enabling studies.

And of course we have a very large number of patients, as you know, that we are now treating with our 3475, the data are coming in, and as we become persuaded that there’s something there that would really provide a benefit to people, we’ll certainly be having those discussions with the agency. Again, as you know, we have breakthrough designation, and so we are in a position to have discussions fairly frequently and are certainly doing so. But I can’t tell you what that means in terms of our ultimate filing strategy.


Your next question comes from the line of Mark Schoenebaum with ISI Group.

Mark Schoenebaum - ISI Group

I’d love to go back to some remarks that you made, Ken. I don’t have the quotes in front of me, earlier in the call, about possibly looking at divesting certain businesses like animal health and consumer. I felt like that was the strongest language you’ve used to date, and I just want your comments. Am I overreading that? And then if you were to make a decision on that, is that a decision that you think could be made in the 2014 timeframe, or should shareholders and analysts be thinking about that possibly taking a little bit of a longer time?

And then for Roger, if I might, back to the base, follow up to Time’s question, noticed that you put on a large MCI trial. I was wondering if you could talk about the rationale for putting that trial up on And I noticed also in that trial you cut the highest dose. Maybe you could just talk about what we should read into the fact that you cut the highest dose, if anything.

Ken Frazier

Let me just say that what I was trying to convey is just as we’re looking across our R&D and commercial portfolio and sharpening our focus on each of the assets there, so too with respect to animal health and the consumer care. I would say we’re currently evaluating those businesses the way we’re evaluating everything, to figure out whether those businesses produce the most value inside our portfolio or outside our portfolio. I did not mean to imply anything whatsoever with respect to timing, but I would say, again, we are currently evaluating those businesses just as we are sharpening our focus on every aspect of our business.

Roger Perlmutter

With respect to base, there has always been the concern, and we’ve discussed it in many different contexts of these calls, that though beta secretase inhibition may be enormously useful in delaying the onset of dementia, it may be necessary to go in quite early. And the question is, when do you go in? The genetic data says we believe there would be a very strong effect of beta secretase inhibition if you could start very, very early, but on the other hand, we can’t do a 20 or 30 year outcome study.

So the goal is to try and go early enough to make sure that we will see an effect, and hence we had always planned to do a prodromal study. We posted the prodromal study on, as it’s in the planning stage, and we are working to come up with exactly how that will be done. And I don’t think you should read anything more into it than that. But I think I still regard this as a hugely important program for us and for people around the world.


Your next question comes from the line of Andrew Baum with Citi.

Andrew Baum - Citi

First, I think Adam, you said that the DPP4 TRx must grow Januvia, Janumet franchise must grow. I mean, it’s doing minus 5% to minus [unintelligible] year on year, right now. Given the SABRE data from one of your competitors, [unintelligible] didn’t exactly enhance the outlook for the class. And given the competitor pressures, what is there that’s going to drive that growth? Presumably it’s not marketing. You’ve obviously got the SGLT2 combination, but that’s still somewhat far off.

And then secondly, one of your competitors just took their LAG3 into the connecting combination with a PD1. When should we expect the first combination trials with MK3475, particularly if you could reference your intention to take [unintelligible] back into the clinic in combination with a PD1? Again, timing.

Adam Schechter

I’ll discuss, first, the TRx trend for Januvia. And currently, if you look at the IMS data on a weekly basis, we’re seeing about a 2% to 2.5% decline in TRxs. And I would encourage you to focus on the TRx volume, because that’s what’s most closely correlated to overall sales. And what I’m trying to say is that in order for us to grow for next year, what we have to do is see a change in that volume. If that volume continues to decline, obviously it’s going to be a problem for us to grow.

I do think there are some things that we’re doing right now in order to help us find ways to grow, and I’ll give you a few examples. Number one, we’ve spent a lot of our time defending our market share versus competition. And I think we’ve done a very good job of defending our market share. And I think you can see that by the fact that in the United States we have well over 70% share, closer to 75% share, of the DPP4 class.

What we have not been able to do is to get the class to grow by moving patients from sulfonylureas or to use DPP4s prior to sulfonylureas. I think that our sales forces have been distracted by focusing on market share. We now have representatives that are solely dedicated to focusing on market growth and trying to move share from sulfonylureas to Januvia. And I think that should help us.

In addition to that, we’ve seen the impact of the new competitors, and I think for the most part they’ve begun to level off. So I think that now we can start to focus again away from market share and more on market growth.

With regard to the outcomes trials, I think that any positive outcomes trial in the DPP4 class should be helpful to the entire class. And as you may recall, our [TICO] study will read out at the end of 2014. The other thing that we have on the horizon is MK3102, which I believe will be a very important compound, and could potentially have people start on a DPP4 even earlier than they do today. And then you also mentioned that we have an SGLT2 as well as an SGLT2 combination with Januvia.

So I believe the diabetes class is an important one for us today, and it will be important for us in the future. Today it’s about maximizing Januvia and trying to move business from sulfonylureas over to Januvia. In the future, we’ll be able to have 3102 as well as SGLT2 and an SGLT2 combination.

Ken Frazier

Let me just add that, as I said in my comments, we are very focused on strengthening Januvia in the United States, for all the reasons that Adam just stated. But it’s also important to remember that we have another set of opportunities in our portfolio, including vaccines, immunology, HIV, and others. And so even in a quarter where we actually had less than positive growth in the U.S. for Januvia, we’re still able to grow our 4% [unintelligible] portfolios.

So I just want to make sure that we are also focused as a company and ask others to remember that we have multiple things in our broad portfolio.

Adam Schechter

I think that’s an important note, Ken. And as we’ve continued to focus on Januvia, of course we will find ways to ensure that we are maximizing the potential in our vaccines business, which showed very significant growth this quarter, to maximize Remicade and Simponi and the other products in the portfolio.

So I want to assure you that although we have significant focus on Januvia, we are also focusing on our other growth drivers because I think those enable us to show things like 7% underlying growth in the U.S. when you adjust for the patent expiration, and it allows us to grow 4% on a global basis.

Roger Perlmutter

At a high level, first of all, the expectation is that having demonstrated that there is activity for 3475, that we want to look at combinations with conventional chemotherapies. And some of that’s already underway with targeted chemotherapies, more novel, targeted chemotherapies, combinations with other immunomodulators and then other novel agents that are active in relevant tumor types where we know that 3475 has some evidence of an effect.

Now, you should expect that you’re going to see a number of those combinations getting posted very soon. And in particular, as I’ve indicated before, on prior calls, we’ve had a group working in the background, before PD1 actually, on the sets of immunoregulatory molecules on the lymphocyte cell surface, that could potentially be important in responses. And a lot of that is coming to fruition and is, right now, in studies that are enabling for entry into humans.

So I would expect all of those things to be coming forward at more or less the same time early on in 2014, and that’s when you should expect to be seeing a lot of those combinations come. There’s an enormous amount of work to be done.

And more or less to the point that Ken made, we’re going to be studying this molecule, and how best to use it, for a very, very long time, because it’s responsive in a lot of tumor types. So there’s a huge amount of work to be done to find out how best to use 3475 and to bring the benefits of this therapy to patients who so desperately need it.


Your next question comes from the line of David Risinger with Morgan Stanley.

David Risinger - Morgan Stanley

I have two questions. First, on animal health, I understand that cattle was weak due to the recall of Zilmax, but is there any way that you can break out Merck’s growth in cattle excluding Zilmax? And then second, for Dr. Perlmutter, could you please provide an update on MK1293, your insulin glargine [ME2] that was moving into late stage testing recently? Are you moving that forward, or divesting it? And also, maybe you could just comment on the insulin facility at your recently completed building in Virginia and whether that will move forward or be divested.

Ken Frazier

Let me start on animal health. Zilmax was a major issue. I would also say that across the board this quarter it wasn’t the strongest quarter, but I come back to the point that I made before, which is that there are favorable macro trends for these businesses, and we continue to expect very good growth going forward.

Roger Perlmutter

With respect to our programs, we have been looking at a variety of different ways to assist in the therapy of patients with diabetes. We haven’t disclosed any information about how we might move forward in that area, so I really don’t have any comments about that. I wonder if you were thinking about our recently approved vaccine production facility. But in any case, we’ll have more information for you on advancing our diabetes franchise and therapy for diabetic patients in the future.

Ken Frazier

I should also point out on the animal health that this quarter we had plus 2% growth overall, if you adjust for exchanges.


Your next question comes from the line of Vamil Divan with Credit Suisse.

Vamil Divan - Credit Suisse

My first question is on the autoimmune franchise. It seems like you had a nice quarter there. My question is really around the future and what impact you think biosimilars will have, especially once we get into 2015. And I guess specifically on the impact of Remicade, what biosimilars might have on Remicade, but also on a related product like Simponi.

And then the second one is on hepatitis C. obviously positive news you’ve gotten there from the FDA, and the data does look good. Just wondering if there’s other answers you’re going to need - we have to wait, obviously, for the data, but just in terms of other answers you might need from Phase II, or is this something that might be moving to Phase III quickly? Is 2017 a reasonable timeframe to assume that this might be something that could get to the market? Any color there would be helpful.

Adam Schechter

I’ll go ahead and take that Remicade and Simponi question. If you look at Remicade and Simponi, we had a combined growth of about 16% ex foreign exchange this quarter, where Remicade was 12% and Simponi was about 405.

If you look at the Remicade growth, there was some benefit to the timing and tenders. If you exclude that, our growth rate was in the mid-single digits. And I also believe that Simponi will represent the strongest growth opportunity, particularly with the UC approval that we had last month, and we’re continuing to prepare for launch.

If you look at the biosimilars, we anticipate biosimilars in smaller markets next year, and if you look at those markets, they represent less than 20% of our current Remicade business. So we believe that we’ll continue to be successful overall with Remicade in the market, in the largest markets, where there won’t be biosimilars. And we don’t believe that having a biosimilar Remicade should necessarily impact the sales as we move forward with Simponi.

Roger Perlmutter

And with respect to the HCV program, I can’t provide explicit timing for you. I would just say as I mentioned we have a portfolio of molecules. We have breakthrough designation of course as we’ve indicated, for the combination of 5172 and 8742. But there are other molecules as well, and I think the key is getting to an all-oral pangenotypic ribavirin-free regimen that is useful in patients irrespective of comorbidities.

And that’s an important thing to keep in mind, right? Because these patients, who have chronic HCV infection, are in general elderly patients who have other things going on. So it would be important that whatever drug cocktails are used in these patients, in order to cure them of HCV, that these be things that are tolerable and can be used, even with the comorbid situation.

So we’re focusing on all of that. Very excited about where we are in the program, and we’re going to move it forward just as quickly as we can.

Ken Frazier

Can I make a correction? On the response to Dave Risinger’s question, I think I said that the animal health sales was 2% ex-exchange. It’s ex-exchange, and it’s also excluding Zilmax.


Your next question comes from the line of John Boris with SunTrust.

John Boris - SunTrust

First question, for Ken, as you look back and reflect on your 2013 plan, and the pushes and pulls there, what are some of the things that you really like that materialized? And then what are some of those things that you saw in the ’13 plan that could have been done better for the ’14 planning process?

And then a question for Roger Perlmutter. If you look at Merck’s regulatory track record, historically the company’s had an impeccable regulatory track record, but if you look at the last seven programs that you put into registration, you received three complete response letters, including a request for additional data. Very uncharacteristic of the company. What are you doing going forward to help improve that, to basically your standard, which was an impeccable track record, especially in light of the new products that you’re putting into clinical development?

Ken Frazier

Why don’t I start with the 2013 plan issues. I would start by saying that I guess the things that were the most negative things versus assumptions, obviously Januvia U.S. growth we had hoped would be stronger. Also, the impact of our hepatitis C category in terms of Victrelis growth and Pegintron’s growth, given warehousing of patients, were things that we wish had gone better.

On the other hand, I think in a year of patent expiries, being able to continue to drive underlying growth in vaccines, immunology, HIV, are all important. Geographically, continuing to be in the emerging markets and doing well in the emerging markets year to date, I think is also a very positive thing.

The biggest thing that makes me excited, though, is I have to look past any particular quarter. And when you see things like the breakthrough designations for our anti-PD1, and for our HCV program, those are things that I think are the most important to the company going forward. And those are the areas where we want to continue to be focused, where we can drive the greatest amount of growth going forward.

Peter Kellogg

If I can add to that, Ken, the one thing I would add also is that in 2013 we just saw an exceptionally strong impact from the Japanese yen forex, and we just probably didn’t see that coming quite as much, and that, combined with the devaluation in Venezuela, caused us to change our guidance earlier this year. But again, I think against that, and some of the comments pointed to that, we’ve had a very proactive cost management response.

So basically I think that’s something that we’re now set up for as we go into 2014. We seem to manage well in this environment, and the foreign exchange rates have stabilized. The euro’s come back a little bit, so we’ll have to kind of watch that. Obviously, Venezuela continues to be a topic that we’ll all have to watch as we go forward in all years going forward, but in general I think we shouldn’t miss how big the impact was from the yen and the Venezuelan devaluation this year.

Roger Perlmutter

I have to say that I think that it is the case that I’m not happy with where we stand in terms of how our organization has been able to deliver documents that meet regulatory guidelines. I just am really not happy with that. And as a result, I have been leaning into this process very, very heavily.

There is no single explanation for what has gone on over the last few years. First of all, of course there are issues with respect to study design, and complexity in study design always makes it challenging to deliver data sets that are interpretable on first pass. There are also issues related to study execution. There are complexities associated with this.

And then there is the fact that there have been many studies that have been large outcome studies and those have their own challenges associated with them. Suffice it to say that there are a number of issues that I’ve identified and that we’re working to correct.

We’re doing a lot to improve the management of our safety data and our good clinical practice approach. I’m very pleased that we have a new head of global safety who will be joining us next month, and we also are bringing in some additional people to shore this up. I’m confident that we can get to a point where we and the FDA can work together in a way that brings files forward that pass muster right from the beginning, and that’s my goal.


Your next question is from the line of Tony Butler with Barclays Capital.

Tony Butler - Barclays Capital

Roger, just on 3475, tomorrow there will be some data presented in Sydney, and I’m just curious, what should we be mindful of looking at, given it is a Phase I trial? Second, the SMR conference is in November, and again, would you mind making some statements about what we should be mindful of that Merck will present at that point? And then finally, will there be other data readouts between now and ASCO, where Merck may present top line data?

Roger Perlmutter

With respect to the 3475 lung cancer data, again, it’s a small data set, but I think that what we’re learning, as is plain from the abstract, and as you’ll see, that there clearly is evidence of a response. And looking at the nuances of those responses and in particular whether or not there are characteristics of patients that have predictive value, with respect to response, I think that could prove to be very important. And so I would look at that.

We’re going to have more data that will be coming out at all the major scientific meetings, including SMR. AACR is going on, I believe, in February, and there will be more data presented there, before ASCO. So we have a lot of studies going on, and we will have the opportunity to make sure that in the appropriate scientific forums we present data that places 3475 therapy in the context of what can be done for patients with a widely disseminated malignant disease.


And your last question comes from the line of Chris Schott with JPMorgan.

Christopher Schott - JPMorgan

Maybe the first one for Ken, just coming back to strategic alternatives on animal health and consumer. When you talk about evaluating whether it’s more advantageous for these businesses to be part of Merck or not, can you help us understand, is that a decision based on whether these businesses could operationally perform better inside or outside of Merck, or whether these businesses would be worth more, or be more valuable to shareholders, inside or outside of Merck?

My second question was on PD1. Just two questions. Maybe the first one, in lung, can you just elaborate a little bit more about how you’re thinking about PD-L1 status and the role that’s going to play in the development of the category? I think there’s been some debate on this topic given some of the responses in PD-L1 negative patients, we’ve seen in some studies.

And my second question was when we think about additional tumors beyond melanoma and lung that you’re looking at, what are you most excited about there? And what does the science suggest in terms of likelihood of success relative to some of the initial tumors where we’ve seen activity so far? I’m just trying to understand, when you look at those additional areas you’re looking at, which ones should we really be focused in on?

Ken Frazier

First, with respect to your question about animal health and consumer, whether it’s the operational issues or the value to shareholders, it’s both. And at the end of the day, our goal is to maximize long term cash flow for our shareholders, and we are looking at these businesses like we do everything else, versus other opportunities that would allow us to drive that long term cash flow.

Roger Perlmutter

And for PD-L1, first of all, I think we know already, as is typical in malignant disease, that PD-L1 is not an exclusive biomarker. It’s not the case that only those individuals whose tumors have expressed PD-L1 are going to be responsive. And hence there’s a reason, depending upon the magnitude of the response, and the degree of adverse effect, to think about treating with PD1 even in those who are PD-L1 negative.

The question is what is the correlation and does it differ from one tumor type to the other, and can you use it as a way to begin to focus your attention on different patient subsets? And I think more data are coming out on that. I think there will be more data that will be available coming up at the lung cancer meetings and then at meetings after that. So that’s a useful thing to look at.

The second thing is when you think about where else to go with PD1, and one of the advantages of having a 1,000 patient Phase I study that focuses on many groups, but including all epithelial tumors, is that we have a chance to look at individuals in whom we see evidence of a response and ask can we tell from that whether there might be subsets of patients who would really benefit. And then from that we roll out more focused studies. That’s what we’re doing.

And you’ll have a chance to see those data, as I indicated, that there’s now quite a number of different tumors that we are exploring directly. We’ve announced previously that we’re doing work in triple negative breast, for example, and head and neck cancer, and uroepithelial tumors. And in all of these areas, we have found evidence for a therapeutic effect.

The question is, how good is it? How do you use this drug in combination with others? There’s a lot of work to be done here. But I’d just say, from my perspective, the breadth of responsiveness is quite impressive, and suggests that we could have a very, very active agent here that would prove to be useful in a number of different settings.

Ken Frazier

Okay, let me just close by saying this was another solid quarter, driven by vaccines, immunology, and HIV businesses. Going forward, I’d have to say that none of us are pleased with the Januvia performance in the United States, and we’re going to continue to focus our efforts and our investments on making Januvia in the U.S. stronger going forward.

We are obviously focusing on reducing costs, but reducing them in a way that doesn’t compromise this company’s long term ability to do that which it’s here to do, which is to do the innovation, that actually makes a huge difference to patients and payers and to society in general.

In that regard, we’re very pleased with the breakthrough designation that we got for our HCV regimen. We’re also very excited and hopeful about the interim lung data for anti-PD1 as well as the future for this therapy going forward.

So, in the end, I would say that we continue to plug on here at Merck. We’re hoping to drive greater growth as we go forward, and we’re very much focused on our pipeline as the means for doing that, both our internal pipeline as well as a reinvigorated approach to business development.

Thank you very much, and look forward to speaking to you soon.

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