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Merck & Co. Inc. (NYSE:MRK)

Q4 2013 Earnings Conference Call

February 5, 2014, 8:00 a.m. ET

Executives

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

Analysts

Chris Schott - JPMorgan Chase

Seamus Fernandez - Leerink Swann

David Risinger - Morgan Stanley

Jami Rubin - Goldman Sachs

John Boris - SunTrust Robinson Humphrey

Andrew Baum - Citi

Gregg Gilbert - Bank of America Merrill Lynch

Steve Scala - Cowen & Company

Tim Anderson - Sanford Bernstein

Mark Schoenebaum - ISI Group

Jeff Holford - Jefferies

Alex Arfaei - BMO Capital Markets

Operator

Question-and-Answer Session

Operator

Good day everyone, and welcome to Merck’s fourth quarter 2013 earnings call. [Operator instructions.] At this time, I would like to turn the call over to 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 fourth quarter 2013 conference call. Before I turn the call over to Ken, I just want to point out just a couple of items.

First, you’ll see that we items in our GAAP results, such as acquisition-related charges, restructuring costs, and certain other items. You should note that we have excluded those items from our non-GAAP results. The reconciliation tables are available in our press release, so you can bet a better understanding of the underlying performance.

We’ve also provided tables to help you understand the sales results in the quarter for the business units as well as for the products. This can be found in table three of our press release, and the reconciliation table I mentioned earlier is in table two of the release. During the call, we’ll be referring to table two for the P&L and table three as it relates to revenue.

Second, I would like to remind you that some of the statements we make during today’s call might be considered forward-looking statements within the meaning of the Safe Harbor provision 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 risks or uncertainties materialize, actual results may differ materially from those set forth in the forward-looking statements. Our 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 of our forward-looking statements made this morning. Merck undertakes no obligation to publicly update any forward-looking statement, and you can see our SEC filings as well as today’s earnings release on merck.com.

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 our outlook for 2014; and Dr. Roger Perlmutter, president of Merck Research Labs, who will provide you with an update on some of our key programs.

So with that, I’ll turn the call over to Ken. Ken?

Ken Frazier

Thank you, Joe. Good morning everyone, and thank you all for joining the call today. This morning we reported earnings consistent with the guidance that we provided last year. We did so by managing through faster than anticipated generic erosion, a significant impact of foreign exchange, and other headwinds in our business environment.

At the same time, we took proactive steps to further sharpen R&D and commercial focus, bolster our innovative pipeline, and accelerate our efforts to redesign our operating model and reduce our cost base.

The events of last year underscore the imperative for Merck to remain both a highly innovative company and one that can respond to the fast-evolving healthcare environment. Now I’d like to take just a few minutes to reaffirm our strategy and the approach we will continue to take moving forward.

As we’ve consistently said, Merck remains committed to innovation, applying cutting edge science in order to develop clinically meaningful medicines and vaccines that save and improve lives throughout the world. It’s only by bringing to market new products that make a meaningful difference to patients, healthcare providers, and payers that we’ll continue to drive value over the long term for patients, customers, and of course our shareholders.

Our goal is to position Merck at the forefront of introducing these kinds of important new products. In this regard, we took an important step last year when Dr. Roger Perlmutter rejoined Merck as head of R&D. Roger’s mission is to help us improve our productivity and our pipeline execution with the firm intention of reestablishing Merck as a leading research intensive biopharmaceutical company.

I’m delighted that we’re already seeing progress with the kind of innovation that can make a life or death difference to patients, like MK3475, our anti-PD1 immunotherapy for oncology. Last month we announced that we initiated the rolling submission of a BLA in the United States for this important investigational antibody, which we expect to complete in the first half of 2014. And then this morning, we announced that we signed three additional collaboration agreements to evaluation MK3475 in combination regimens to treat a broad range of cancers.

Last month, we also received a favorable recommendation from the FDA’s advisory committee for vorapaxar, and in 2013 we initiated Phase III trials for our base inhibitor and received breakthrough therapy designation from the FDA for our combination regimen for the treatment of chronic hepatitis C.

Looking ahead, we also anticipate completing regulatory applications for odanacatib, suvorexant, and sugammadex, and may receive regulatory approvals for multiple others. Each of these candidates is based on a novel mechanism that addresses the treatment of a disease or condition in an entirely new way.

Roger will talk more about our pipeline and the progress he and his team are making towards moving ahead promising pipeline candidates and increasing R&D productivity overall.

2013 was an important year for Merck. We continued implementing our strategy of driving underlying growth while aggressively managing our cost to deliver bottom line performance. We focused on making the right investment decisions across our businesses while continuing to advance our near term and late stage pipeline.

The strength of our underlying portfolio, combined with our aggressive cost management and productivity initiatives, enabled us to deliver non-GAAP EPS of $3.49 for the year. To ensure that we have a strong growth profile in the years to come, we placed our efforts and resources behind the franchises that we believe will help us grow, such as our diabetes and vaccines businesses, and in many cases were able to drive double-digit growth.

We also continue to invest in the key geographies that will remain drivers of growth now and into the future, including in our key emerging markets, where we saw another year of solid growth. To maintain this momentum, we announced a strategic initiative in October designed to sharpen our focus on our best growth opportunities and to redesign our operating model while reducing our cost basis.

We have made solid progress on all of these fronts. You’ll recall that following our merger with Schering Plough as of 2012, we achieved merger synergies resulting in $3.5 billion in net savings. In addition to those synergies, we expect a further $2.5 billion in cost savings by the end of 2015 off our 2012 base.

This initiative will also increase our operating efficiency, provide us with the flexibility to take action on our best opportunities, and to be responsive to the challenges of a dynamic healthcare environment. This includes investing in new licensing and business development activities to acquire external innovation that will further strengthen our pipeline.

I remain confident that these actions will help make Merck a more competitive company, better positioned to drive innovation and growth. We also will continue to return a high level of cash to our shareholders. In 2013, we returned $11 billion through both the dividend and share repurchases.

Finally, I would like to remind you that we continue to evaluate all aspects of our business. Our goal is for each of our priority businesses to be industry leaders. We must determine whether particular assets are core to our strategy, whether they will provide strategic advantage going forward, and whether they will generate greater long term value as part of the company or not.

Through this process, we are exploring strategic options for both our animal health and consumer care businesses. We could reach different conclusions about the two businesses, and anticipate that we’ll complete the process and take action, if any, in 2014.

In closing, in 2013 we took decisive action to revitalize our research and development, strengthen our pipeline, and sharpen our focus. As we look forward to 2014, I’m confident that we’re positioning the company for long term growth, and I’m excited about the potential of our near and long term pipeline.

I’m also confident that we’re moving quickly to make Merck a leaner, more agile company, focused on our best commercial and innovative product development opportunities. And now I’d like to turn the call over to my colleague, Adam Schechter.

Adam Schechter

Thank you, Ken. Good morning everyone. This morning I’ll provide you with an overview of global human health results for 2013, and also touch on the 2014 outlook. In 2013, global human health took action, action to focus our resources on core markets in core therapeutic areas that provide the greatest potential for long term growth.

Top line results continue to reflect the loss of exclusivity of a number of brands and weakness in the yen. However, we did have a number of areas of growth in 2013, including vaccines, immunology, diabetes, and HIV. Our underlying portfolio grew 4% on a constant currency basis for both the full year and in the fourth quarter, excluding the recent patent expiries.

Let me provide more details on the performance of our core products and our core markets. My comments will be on a constant currency basis. I’ll start with the Januvia franchise.

The franchise had sales of $1.6 billion and 6% growth in the fourth quarter. In the United States, sales declined 3%, driven by a slight decline in PRx volume. A small benefit from price was offset by reduction in customer inventory levels this quarter.

Our international markets, which now represent 50% of total sales, grew 15%. We drove good very good in each region, in Europe, the emerging markets, and Japan, and we maintained market leadership. Globally, the diabetes market is significant, and the macro trends support a growing market. We will continue to focus significant resources around the world on this core franchise, with about $6 billion in annual sales.

Moving to Isentress, we had another good quarter, with 16% 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 next to immunology, the combined immunology business, consisting of REMICADE and SIMPONI, grew 15% in the quarter. Sales of SIMPONI grew over 40% to $146 million, and reached $500 million on a full year basis. We are seeing good growth across our markets, including the recent launch in France.

Lastly, moving to our vaccine business, in the fourth quarter vaccine sales grew 1%. The timing of public sector purchases for Gardasil and RotaTeq had a negative impact on vaccine growth in the quarter. In addition, last year’s fourth quarter sales included the launch of Gardasil in Japan and ProQuad in the U.S.

Demand for our vaccines portfolio remains strong, with full year sales growing 11% to over $5.5 billion. Now let me touch on two core vaccines, and I’ll start with Gardasil. Gardasil sales declined by 9% in the quarter. International sales growth of 12% was offset by 19% decline in the U.S.

In the U.S., Gardasil sales were affected by the timing of public sector purchases, which do not occur at the same level each quarter. Public sector purchase were about $50 million lower this quarter than in the fourth quarter of 2012. Internationally, Gardasil sales grew 12%. Strong growth in emerging markets benefited from the start of the national immunization program in Brazil.

Sales growth in the emerging markets more than offset the loss of all sales in Japan. Sales in Japan reflected the government’s decision in June to suspend proactive recommendation of HPV vaccines. For reference, Japan’s sales were $40 million in the prior year quarter.

Moving on to Zostavax, Zostavax sales were $264 million this quarter, the highest since launch. As expected, sales in the U.S. grew sequentially due to seasonality. Internationally, we now have launched Zostavax in select Asian markets and in the U.K. We’re seeing good uptake in those markets. But as an important reminder, our European vaccine results are reported through equity income. We continue to see Zostavax as a growth driver in the future.

Now I’d like to touch on our overall performance at a regional level. In the United States, Europe, and Canada, sales continued to be affected by the loss of exclusivity of a number of brands, including Singulair, Maxalt, and Temodar.

Excluding these products, U.S. sales increased by 2%, and Europe and Canada sales increased by 5%, compared to the prior year. We expect continued pricing and rebate pressure in 2014, similar to prior years. Japan sales declined 4% ex-exchange, primarily due to lower sales of Gardasil. As we move into 2014, sales in Japan will be adversely impacted by the biannual price decreases and repricing of the DPP4 class in the first quarter.

Sales in emerging markets grew 8% ex-exchange. Double-digit growth in key emerging markets like Brazil, Korea, and Russia were partially offset by declines in China and Mexico this quarter. In our key emerging markets, our base business is strong, and it’s diverse, and Merck’s growth continues to outpace the overall market. Looking ahead, we expect the emerging markets, including China, to be growth drivers for us.

In summary, in 2013 global human health drove performance of our underlying portfolio of key brands. These brands grew 4% in the fourth quarter, as well as for the full year. We also continue to prioritize investments and sharpen focus on the best opportunities for long term growth.

We have already made good progress, including the following: building Merck’s oncology business unit to execute the future launch of MK3475. We are recruiting external talent, with deep scientific and deep commercial experience in oncology. We also divested noncore assets like Saphris, certain ophthalmology products in the U.S., and some off-patent brands internationally.

In 2014, we will continue to prioritize and focus on our most promising investment opportunities. In addition, we’re preparing for multiple near term launches. We’re anticipating regulatory actions for V503, our 9-valent HPV vaccine candidate; for vorapaxar; for vintafolide in the E.U.; for vaniprevir in Japan for HCV; for suvorexant in Japan; and for the allergy immunotherapies Grastek and Ragwitek.

I believe that our strong portfolio, the actions we are taking to prioritize investment, and our near and long term opportunities 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, we took action in 2013 to ensure that we are resourcing our key underlying growth drivers and sharpening our focus to invest in our best pipeline opportunities. We are starting to see the benefit of those actions. Moreover, we’re ensuring that the savings and efficiencies we are creating in our businesses are translated into continued focus on cash returns to shareholders.

This morning, I will highlight the financial elements of our fourth quarter as well as discuss our outlook for 2014. And my remarks will focus on our non-GAAP financials.

With solid growth in our underlying business and strong cost management, we were able to deliver EPS growth of 6% this quarter. Additionally, we delivered full year EPS within our guidance range. Adam has already discussed highlights from the top line, so let me discuss some of the other elements of the quarter.

First, product gross margin. This declined on a year over year basis to 73% this quarter. As was outlined in prior quarters, generic erosion of high gross margin products created a headwind. This is compounded by solid growth in some of our lower margin products such as vaccines and immunology.

We expect this mix shift to continue in 2014, with the first half gross margin being at a similar level as the fourth quarter of 2013. Later in the year, however, we anticipate improvement in PGM, particularly with the anticipated inclusion of the AstraZeneca joint venture. Taken together, we expect the 2014 full year gross margin ratio to be slightly lower than the 2013 full year rate of 74.3%.

Moving to other areas of spending, during the fourth quarter, we continued to find opportunities to lower our cost base. You can see the results of our efforts to reduce R&D spending of about $440 million. Please note that this is in part due to a $150 million upfront licensing payment in the base period. Also in the fourth quarter, SG&A expenses were reduced by approximately $400 million compared to last year, including a roughly $60 million benefit from foreign exchange.

The fourth quarter also marked an important milestone for our capital allocation efforts. We successfully completed the $5 billion accelerated repurchase program announced earlier in the year. Coupled with our ongoing share buyback activity, we repurchased approximately 5% of our shares this year. Additionally, we increased our dividend for the third year in a row, and as Ken said, our share repurchases and dividend payments amounted to over $11 billion being returned to shareholders in the year.

Now, turning to guidance and our outlook for 2014, our guidance reflects a reshaping of our portfolio, reductions in expenses and infrastructure, and targeted investments to drive future growth and long term shareholder value. That said, at current exchange rates, we expect revenue of $42.4 billion to $43.2 billion.

Let me outline a few key factors and assumptions included in this guidance. First, we anticipate AstraZeneca will exercise their option to end our longstanding partnership. If they exercise the option, the JV would come to a close at the end of June. At that time, we would no longer report supply sales nor equity income from the joint venture.

Furthermore, in the first half of the year, we continue to expect sharp year over year declines in both of these line items. Second, while not as significant as in 2013, we still expect negative top line impacts from patent expiries in 2014, and we expect that impact to be about $500 million.

Third, in regard to divestitures, as we announced over the past several months, we began divesting noncore assets such as [unintelligible] in the ophthalmics products in the U.S. as well as other products. Sales from these divested products contributed approximately $600 million in 2013.

Finally, our EPS guidance spans a wider range than in prior years. This guidance range plans for a potential devaluation of the Venezuelan bolivar. The higher end of the range assumes no devaluation, whereas the bottom end of the range accounts for a possible devaluation under certain scenarios.

As you may recall, the devaluation of this currency in 2013 led to a $0.07 negative impact. We cannot predict the timing or the magnitude of this potential devaluation in 2014. However, if it does occur, we do expect that the impact would be greater than the impact in 2013. As a result, we expect non-GAAP EPS between $3.35 and $3.53. Accordingly, as the year progresses, we would expect to narrow the EPS range. The corresponding GAAP range is $2.15 to $2.47.

Taking into account the divestitures and the anticipated conclusion of the AstraZeneca joint venture, 2014 will be a trough year for earnings. Now, I would like to provide some additional color on the other elements we have built into our EPS guidance.

On R&D, we expect our 2014 non-GAAP R&D expenses to be below 2013 levels, despite heavy and focused investments in our anti-PD1, hepatitis C, diabetes, and Alzheimer’s disease programs. Similarly, for SG&A, we expect to be below 2013 levels, as we continue to prioritize and focus spend in core product lines and the upcoming launches Adam mentioned earlier.

Regarding tax, we expect the full year tax rate to be 24% to 26%. As in prior years, our 2014 guidance does not include a renewal of the R&D tax credit. Now, let me outline how you should think about the spread of earnings across the quarters.

On an operating basis, we expect EPS in the first half of 2014 to be lower than in the second half, with the first quarter being the lowest. As I mentioned earlier, this is driven by the gross margin being lower in the first half of 2014.

Regarding capital allocation, we remain poised to bolster the pipeline with external innovation, and we maintain a strong balance sheet and an efficient capital structure for the right opportunities. In 2014, you can expect continued shareholder friendly returns of cash through our $15 billion share repurchase program announced last May, as well as through the quarterly dividend.

So, in conclusion, 2013 was a pivotal year for our company. We have emerged with a promising pipeline to deliver future growth. Additionally, we committed to a strategic reshaping of the company to maximize our core in line assets and key pipeline programs. Finally, we accelerated returns of cash to shareholders. In 2014, we will continue to execute upon our strategic initiative of prioritization and focus, and we will capitalize on opportunities to drive long term shareholder value.

Thank you. Now I’d like to turn the call over to Roger.

Roger Perlmutter

Thank you, Peter. As Ken highlighted at the beginning of the call, we’re making steady progress in MRL, crafting a more cost-effective organization focused on innovative products with meaningful differentiated attributes.

Our R&D expenditures in the fourth quarter, as Peter noted, declined by more than $440 million versus the prior year. While reducing our cost base, we have simultaneously advanced important regulatory filings, made tangible progress in our late development programs, and introduced significant new molecules into early clinical development.

I should also note that we have recruited key personnel into our development, regulatory, and discovery groups, and established a new licensing and business development function. Each of these changes is having a significant favorable impact on our activities.

I will summarize some of our accomplishments in the fourth quarter and discuss our plans for 2014. Beginning with regulatory activities, we completed our filings for vorapaxar and for our grass and ragweed oral desensitizing therapies for allergic rhinitis. All three of these received favorable reviews at their respective FDA advisory committees. We have submitted potential labeling language for each to the FDA, and look forward to discussions with the agency on further steps in the review process.

At the end of the fourth quarter, we filed a U.S. biologics licensing application for V503, our nonvalent human papilloma virus vaccine, which we believe will extend protection substantially against this important cause of cervical cancer in women.

Also, I’m pleased to report that the Japanese regulatory agency granted priority review to vaniprevir for the treatment of chronic HCV infection.

As most of you know, we received a complete response letter following our NDA submission for suvorexant, based on the need for lower dosage forms that would permit reduced exposure to this novel orexant antagonist for the treatment of insomnia. We have now completed the studies suggested by the FDA and we expect to be able to submit our responses to their request by the end of the first quarter.

Similarly, we have initiated a definitive hypersensitivity study for sugammadex, our novel agent designed to reverse neuromuscular blockade employed during anesthesia. Completion of this study will permit us to submit an updated application for this important product.

Turning from regulatory affairs to clinical development, we were active on many fronts. Data presented at the Society for Melanoma research meeting last fall demonstrated favorable overall survival trends in patients with advanced melanoma who received MK3475, our PD1-specific antibody that has received breakthrough designation from the FDA.

Currently, we have more than 4,000 patients enrolled in clinical trials for MK3475 in multiple tumor types, including non-small cell lung cancer, triple negative breast cancer, uroepithelial tumors, head and neck cancer, and some hematologic malignancies, among others.

Response rates in our large [salvage] studies encouraged us to initiate a rolling submission to the FDA, with the goal of making this new therapy available to patients with advanced melanoma who have exhausted all other treatment options. As we announced last month, we expect to complete the follow up for MK3475 during the first half of 2014.

This morning, we announced further progress in the evaluation of PD1 and other regulatory targets. First, we’ve opened a signal detection study seeking to identify other malignancies for which MK3475 may provide therapeutic benefit.

The trial will enroll approximately 320 patients suffering from one of 20 different tumor types, which were selected based on a variety of attributes, including the pattern of expression of PD-L1. In our experience to date, high levels of this PD1 ligand appear to correlate with tumor responses.

Second, we announced significant new partnerships testing the ability of MK3475 to add benefit to patients undergoing treatment with other investigational agents, including a 41BB specific antibody from Pfizer, a small molecule [IDA1] antagonist from Insight, and an oncolytic virus from Amgen, which has been shown to cause significant tumor shrinkage in many patients with malignant melanoma.

We believe that the scientific justification for each of these partnerships is very strong. Moreover, the breadth of these partnerships, added to our previously announced collaboration with GlaxoSmithKline, demonstrates our substantive commitment to MK3475.

Third, we also announced a new partnership with Ablynx to develop nanobodies that combine into other regulatory molecules, and in particular can be used to form multivalent complexes such that PD1 antagonism is combined with specific binding to other important proteins on the lymphocyte surface.

The driving force for this collaboration derives from studies in our own Palo Alto laboratories examining the molecular basis of checkpoint activity in T-cells. This effort with our colleagues at Ablynx will add considerably to our repertoire of immunoregulatory modulators, the cornerstone of our new approach to oncology therapeutics.

Beyond PD1 and immunoregulation, we made significant additional progress in several important areas of development, including expansion of our hepatitis C virus portfolio. We also advanced potential new therapies for human immunodeficiency virus infection and the development of compounds that act by novel mechanisms to augment glucose lowering in patients with diabetes.

Finally, in the fourth quarter we announced progression of our base program into Phase III, based on satisfactory evaluation by our independent data monitoring committee of the results obtained with the lead cohort.

Looking forward, as I indicated, we expect to complete our filing of the suvorexant response in the first quarter, and the MK3475 rolling submission before the middle of the year. Our sugammadex filing will occur before the end of the year, and depending upon the review of the final data, we hope to be able to proceed with our odanacatib filing as well.

These regulatory accomplishments will be augmented by additional progress in Phase III clinical studies, which I will describe in detail at our R&D day on May 6. And it is fair to predict that additional business development activity, principally in the form of collaborations and alliances, will emerge throughout the year.

I now turn the call back to Joe.

Joe Romanelli

Thank you, Roger. And operator, we’ll get ready to start the Q&A segment. And for all the callers, if you can just limit your questions to one or two, so that we can get through as many callers as possible. So with that, operator, I’ll turn it over to the first caller.

Question-and-Answer Session

Operator

[Operator instructions.] Your first question comes from the line of Chris Schott with JPMorgan.

Chris Schott - JPMorgan Chase

First one for Ken, maybe. As you’ve had a chance to review your animal health division, can you share any updated views on how core of a franchise you see this business to Merck? And then the second one is on immuno-oncology. Two part question. First, what’s your view at this point on how much of this market will ultimately be monotherapy versus a combination of immuno-oncology assets? And then as you think about the combinations, how important is it for Merck to own both assets versus working with partners as you look to maximize the value of this platform for the company?

Ken Frazier

I’ll start with your first question. As we mentioned before, we are looking at our entire portfolio, but to respond specifically to your question about animal health, we have always viewed this as a very good business for Merck. We think of it as being one of the industry leaders. It’s the second largest. It has good margins. The science that we employ in our human health efforts often has application across species. The underlying macroeconomic drivers both on the companion side and on the production animal side are very favorable.

So I can say that this is a very good business that we like very much. And the question becomes, what are the alternatives? And is there’s something that actually makes that more valuable to our shareholders over the long term?

Roger Perlmutter

With respect to monotherapy versus combination therapy, I think, again, as I’ve said previously, we’re really at a very early point in the study of immunoregulatory molecules. We’re quite impressed with the data that we’ve been seeing using MK3475 as monotherapy, but certainly the history of cancer therapy is that over time oncologists seek to employ combinations in order to get better benefit-risk ratios, and to get better responses in a larger fraction of patients.

With respect to owning both versus collaborations, obviously under the best of circumstances you’d like to own both, but you can’t expect to discover everything yourself, and we want to do absolutely the best thing for patients and advance the best therapies.

Operator

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

Seamus Fernandez - Leerink Swann

Ken, can you first maybe talk a little bit about the interest in expanding the animal health franchise, whether it be via swaps or other type of collaborations with other players in the space on the animal health side? And then can you also provide some additional feedback on your interest in the consumer health business and how that fits overall? We’ve seen a lot of speculation in the press in that regard. Interestingly, we just met with Novartis’ CEO, and he expressed that this is the time for the industry to be working together in terms of swaps and things like that.

Separately, Roger, just a quick question. Congratulations on the collaborations in particular. Can you just give us a little bit of color into whether or not you think that PD-L1 biomarkers are basically when you have high PD-L1 expression, that you fully maximize the efficacy of those products? Or if you will be pursuing combinations in high PD-L1 expressing patients as well?

And then just in terms of the [IVO] collaboration, and the 41BB in particular, what tumors do you think, obviously non-small cell lung cancer is one with strong interest, but what other tumor types should we be thinking about these mechanisms having interesting activity?

Ken Frazier

To respond to your first question, as I mentioned previously, we are exploring strategic options for both our animal health and consumer care businesses. Getting a business versus getting cash is something that we obviously need to think about, so I’m not going to comment on any one hypothetical swap or anything of that nature. We are looking at all options, I can assure you, with the sole objective of maximizing the long term value to our shareholders.

I will also comment that, again, we think these are terrific businesses. In animal health, we have the number two business in terms of sales and healthy margins, as I mentioned before. In consumer, we have very attractive brands like Coppertone, Dr. Scholl’s, Claritin. I have said that this is a business that is geographically concentrated in the United States.

And so as I think about these things going forward, I’ve got to look at what the practical actions are that present themselves, and whether or not these assets are going to create more long term value inside the portfolio or outside the portfolio.

Roger Perlmutter

For those two questions, the first, with respect to PD-L1 expression and maximal efficacy, again, I think it’s important to stand back from this and recognize that we are testing a hypothesis with respect to PD1 activity. What we believe is that there are resident cytotoxic T lymphocytes directed against tumors, and that those T lymphocytes are inactivated or prevented from becoming activated by PD1 engagement.

And it stands to reason that PD-L1, as one of the two principal ligands for PD1, PD-L1 expression would be an indicator of the degree of inactivation of those cells, and if we could block that, we should activate T-cells and destroy tumor. That’s a lovely hypothesis. It sounds great, but there are many parts of that that have yet to be tested experimentally, particularly in the human setting.

So there’s a lot of work to be done to understand whether that’s really what’s going on. Even if that is precisely what’s going on, there’s no reason to believe that PD-L1 engagement with PD1 by itself is the only thing that controls T-cell activation and hence tumor responses. So I have every reason to believe that we can build on this, and certainly we have preclinical data that indicate that we can do exactly that, and we tend to pursue that very aggressively in patients.

The second question is, what tumor types will we explore with our Insight and Pfizer collaborations? Obviously, there are a lot of tumors that we can look at. And again, we are driven by both the pattern of 41BB expression in the Pfizer case and also early data that are becoming available through Insight’s studies on their small molecule antagonist of IDA1. So we’ll move forward together with them in those collaborations, but I’m not going to specify tumor types for you at the moment.

Operator

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

David Risinger - Morgan Stanley

I have questions on the P1 as well. So I’ll just try to run through them pretty quickly. Some of them are very simple. But they’re under the umbrella of a single question, so don’t cut me off please.

First, in terms of the collaborations announced today, is there any way that you can frame the economics to each party if one of the combinations announced today were to be commercialized? Is it something like 60-40 to Merck because your PD1 is the core therapy? Second, what is needed to complete the rolling submission for your PD1 for [unintelligible] failures? And then third, with respect to ASCO, should we be expecting any interim data on your PD-L1 positive lung cancer trial, which is scheduled to complete in September, or your Phase I triple negative breast, head and neck, and gastric trial, which completes in October?

Roger Perlmutter

With respect to the collaboration’s economics, we’re not going to go into the details of that. Suffice it to say that these are deals that are structured in a way that’s very attractive for both parties. What is needed to complete the file, well, each of the modules associated with a biologics application, and obviously there’s a lot of detail there, not only with respect to the clinical data and the greatest safety summaries, but also CMC data, etc. As I said, we’re confident we can get this done and we will complete the rolling submission by the middle of the year.

And finally, for ASCO, we’re going to have a lot of data that we will be able to present at ASCO, and we’ll move forward with those. I’m not going to prestage that in any way. But I should also point out that there will be data presented at other scientific meetings, some of which come earlier, including the AACR meeting.

Operator

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

Jami Rubin - Goldman Sachs

Ken, just a first question for you. Clearly the company talked about being poised to pursue external innovation, which signals M&A activity. And I’m wondering if you can just sort of size for us what size transaction you are looking to do. Merck historically hasn’t been that active in M&A in the last couple of years, and just can you give us a sense for are you looking to do a big deal that is transformational, a pipeline deal in the $1 billion to $2 billion range? And if you could just sort of help us size that.

And then Roger, for you, if you could give us a sense for the timing for readouts and potential filings in the new studies that were announced today, specifically Pfizer and Insight. And then just Insight has not disclosed the data for IDO Yervoy in melanoma, and just wondered if you could share with us what you have seen, and what data led you to select lung cancer for your collaboration?

And then just finally, and I’m sorry about this, but with the Amgen assets, Roger, do you expect that that asset can work in other tumor types besides melanoma?

Ken Frazier

Let me just try to respond to your first question. As I said before, a major consolidation of the industry type transaction is not Merck’s preferred strategy. We would like to be much more focused on value added, both on opportunities that provide meaningful, clinically meaningful products and obviously we have to acquire those in a way that we believe will create value for our shareholders over the long term.

So you should know that business development is a major priority for us. That’s why Roger talked about creating a new subunit of MRL. And I believe as you move forward, you will see us demonstrate just how important a priority it is for the Merck research labs.

Roger Perlmutter

I can’t give you too much color on the timing for readouts and the collaborations. These things we’ve just announced are just getting started, and obviously it will take some time before that happens. Nor, of course, can I comment on any data that Insight might have accumulated in terms of their own studies. They’re obviously going to be speaking about that in the future.

With respect to the activity of TVEC in other settings, that oncolytic virus has been studied in other settings early on in its development, and there was evidence of activity, for example, in squamous cell carcinoma of the head and neck. And so there’s always been interest in that. Over time, we’ll see whether or not that’s an important area to pursue.

But I think the important thing to point out is that this modified herpes simplex virus acts in part through direct destruction of tumor cells, but in large part because it stimulates an immune response. The hypothesis which we are pursuing, together with our colleagues at Amgen is that if we can permit that immune response to be even more robust that we’ve now provided two sources of stimulation of the cells that are going to eradicate the tumor. And it should be even more powerful. If that proves to be true in one setting, it could be prove to be true in many, and that obviously is a very exciting possibility.

So the first thing, of course, is we have to demonstrate that the two can be used together safely. That’s the most important part of any of these collaborations. But thereafter, we’re going to be very aggressive about looking at opportunities to improve care for cancer patients.

Operator

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

John Boris - SunTrust Robinson Humphrey

First question just has to do with cost savings and your cost savings initiatives that you have ongoing. Peter, you’ve given guidance for below 2013 guidance. Can you maybe add some color to that?

On the R&D front, Roger, can you maybe shape how deep the cuts have been and how much additional cuts you still need to make within the R&D side of the equation?

And then for Adam, on the SG&A side, understand you have a new leader running the U.S. business. Are you still a believer in feet on the street, or have you reduced your primary care infrastructure within the U.S. based on the evolution of where the U.S. market is going?

On odanacatib, for Roger, what do you need to see in the risk-benefit profile out of the five-year data that you’ll have in house to make it a filable compound? And is that potentially influencing how you’re shaping your primary care infrastructure?

And then just on animal health, when will we see Zilmax back in the marketplace?

Peter Kellogg

Let me take the first one, I think just to talk a little bit about the overall cost savings program and where we are, and how to think about it going forward. What we indicated was that we would see both R&D and SG&A in 2014 to be below the levels reported in 2013. That’s our guidance.

Just to go back and recap the direction we’ve been going, and what we announced earlier in the year, we highlighted that we were launching a new program, which would expect $2.5 billion of annual net pretax cost savings by the end of 2015 compared to 2012. And of course that’s not taking into account foreign exchange, so this is on a constant currency basis.

As we go on to 2013, the tail end of 2013, we actually made a lot of progress, whether it be in SG&A or R&D, throughout the organization, as well as in manufacturing. And we did report very nice numbers. I think very good improvement in 2013. There was some forex benefit coming through that, I would just highlight. Some of those actions, quite frankly, were immediate cost savings and so forth. Ex-foreign exchange, we actually, I would say, came through with about $1.3 billion of savings for that year. So that’s a great start. That’s a real jump right into it.

As we move forward, I think you’ve heard Ken talk a lot about the focus of this program not just being on cutting costs, but really thinking about structurally setting ourselves up to run the business very effectively, in a very focused manner, but in a reengineered manner that really takes out permanent cost savings, allows us to operate, pursue strategic opportunities, whether they be geographic, therapeutic area, or business line, and yet still become more and more productive as we roll forward.

I would say that the savings are split between SG&A and R&D overall. I think I would highlight that in no way are those efficiencies in any way impeding our ability to invest in PD1 or hepatitis C, or any of the other high potential pipeline candidates. It is being aided a bit by the fact that we have been divesting some assets, both from the pipeline as well as from our commercial franchise. And so in general we think we’re on track to achieve the $2.5 billion program by the end of 2015.

It’s a little hard to say how [BD&L] will come into play against that. Obviously, if there’s enormous opportunity that we go after it, then that would be a little bit different. But against normal levels of BD&L I think the program, that’s kind of what we anticipated in our planning.

So on the next question, there’s a question about Zilmax, I believe, right, in the animal health business? And I think that what I’ve highlighted is, just to back up for a second on that, we did voluntarily implement a temporary sales suspension of Zilmax in the U.S. and Canada to give us a little time to really work with our industry partners so that we provide real strong, accurate data that will reaffirm confidence in Zilmax, and it remains an FDA approved product.

We’ve worked with the advisory board in itself, the formal certification process for anyone that uses Zilmax. Certification has started in preparation for field evaluations for Zilmax [fed in controlled] cattle. And we’re on track to begin all of that in the first quarter of 2014. So progress, I think we’re following a very thorough approach to this, very important and very responsible.

Overall, the animal health continues to be a very nice business. I would highlight that around the world many parts of the world grew very nicely last year. Latin America, Canada, North America, Asia Pacific, all on an ex-exchange business, did very well. Really the softness in the business was primarily in the U.S., based on this.

I would say overall animal health sales ex-Zilmax in the fourth quarter, just as an analogy… So if you take the total business sales ex-Zilmax, it was up 4% in the fourth quarter. So it still continues to do quite well.

Adam Schechter

If you look at 2013, we really did prioritize our investments and we made sure that we focused on the best opportunities for long term growth. So in areas like diabetes, we actually increased our spend in 2013. In other areas, we significantly decreased our spend.

As we go into 2014, we’re going to continue to prioritize and focus on the best investment opportunities that we have. So I mentioned, for example, that we’re building Merck’s oncology business unit. So we’ll be increasing in the United States significantly and other parts of the world as well, the number of people that we have to prepare for the launch of that product.

At the same time, in other parts of our business, where we’re deprioritizing, we’ll be reducing our SG&A pretty significantly. Overall, in the United States we’ve had significant reductions over the past several years in our field sales force. We think we’re about rightsized now. But we’ll continue to look for opportunities for growth to make sure we prioritize them appropriately.

Roger Perlmutter

Just to comment on the R&D spend issue, which Peter handled, but I want to emphasize that from the beginning, we’ve focused on three aspects, on processes, on portfolio, and on staffing. And we’re working hard on all of those, and it’s a journey. We’ll continue to work on it. Adam and I have worked very closely rationalizing the portfolio. We’ve improved the processes whereby we make decisions and reduce frictional coefficients, and it was necessary for us to reduce staffing. The kinds of run rates that you’re seeing now are the result of those efforts, and we’re going to keep at it.

And then with respect to odanacatib, again to keep in mind that our data safety and monitoring committee did come back really actually early in the analysis, and say that the study should be stopped because of an overwhelming efficacy and a favorable benefit-risk profile. So we know that based on their analysis, we know unambiguously that there is a treatment effect.

The study was designed with an additional blinded extension, and until we have the full intention to treat data set, we don’t know what those data look like and hence exactly what a file would look like. But I would say, based on just what the data safety monitoring committee had told us previously, that one has reason to be optimistic.

Ken Frazier

Can I frame the whole issue around cost reduction? The way that we’re looking at this whole thing is if we can drive much greater efficiency in our infrastructure, then we can continue to invest assets where it’s going to matter in the long run, whether that is in the commercial space, or whether that is in the R&D space.

When you have an asset like PD1, which I think you can already see is an asset that we could be studying as monotherapy and in combination with various agents for quite some time, it’s incumbent upon us to make sure that we don’t in any way constrict our ability to reach the full potential of our pipeline because we haven’t been very tough on our infrastructure.

And I would use the word tough because I would say that this is not an easy thing to do, particularly as it relates to the significant reduction in force of our employees. But I think it’s an obligation we have. In an external healthcare market looking for greater innovation and greater efficiency, so too, our business model has to be about greater innovation and greater efficiency.

Operator

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

Andrew Baum - Citi

Number one, regarding the IDA, as with the other programs, are there any first mover advantages here in doing collaboration deals with these three high profile products? I’m assuming there’s no exclusivity precluding licensing to other owners for PD1 assets. So just in terms of bandwidth, are there any advantages here?

And then second, I know it’s not immunotherapy, but just in relation to anacetrapib, could you remind us how many interim analyses that compound and that trial has had? And when will the next one be? And when is it possible that you could potentially present blinding if there was a strong efficacy signal?

Roger Perlmutter

First of all, with respect to the question of first mover advantages, I think at the highest elevation, what we have to say is we are anxious to bring the potential benefits of PD1 antagonism to every patient possible. And that means we have to choose what we think would be the best combinations and try to pursue those aggressively.

I think when we do that, of course, we generate data sets that, if they are attractive and promising, provide a basis for moving forward commercially. But the first thing is, number one, can these things be used together safely, and then number two, do we really get a benefit from an efficacy point of view. And we’ll find out. And no, of course, these things would not be exclusive, and should not be exclusive, because you want to do the best thing for patients.

The second thing is with respect to anacetrapib, keep in mind we do have a 30,000 patient outcome study that is going on right now. The data safety monitoring board met recently and recommended to us that the study be continued without any modification.

And there are three interim analyses that are planned. The first interim analysis will be at this point in early 2015. Now, I just would like to mention here it’s important to know that this is a study that is being conducted by an independent academic-based group. The steering committee for that study has control over the conduct of the study, and so while we are involved on that steering committee, nevertheless, strictly speaking, the study is being run by the Oxford group. And so that’s just important to keep in mind.

Operator

Your next question comes from the line of Gregg Gilbert with Bank of America Merrill Lynch.

Gregg Gilbert - Bank of America Merrill Lynch

Roger, could you comment on how your all-oral HCV regimen stacks up versus Gilead and AbbVie’s now that we’ve seen some more complete data sets? Sort of a crystal ball question there, I understand. And then for Ken, in the 1990s many large pharma companies divested non-pharma businesses, and many of those companies regretted those actions. So at a high level, what do you think is different in this day and age?

Roger Perlmutter

With respect to HCV, I think what everybody wants, of course, is to have a fully oral regimen that is ribavirin free and that is pangenotypic and achieves sustained virulogic load reductions as close to 100% as possible. And thus far, we’re not there. Nobody’s there yet. We don’t have the data sets there.

But I think that we’re in a pretty attractive place with our 5172 molecule, which is a very novel protease inhibitor that has very desirable characteristics and conserves the foundation for future combination regimens including with our 5A antagonist, as well as with other molecules that we have in development.

So I think we definitely have a good regimen. I think there’s a lot of work yet to find the ideal regimen. Obviously the other companies, including Gilead and AbbVie and Bristol and others, are working very hard to find ideal regimens also. But it’s a competitive race.

Ken Frazier

On your question about comparing the 1990s to now, first of all, I appreciate the fact that you are implying that there’s a lot to be learned by looking at what’s happened in the past, period, and whether those decisions actually drove long term shareholder value. And that’s why we are saying we are committed to doing what we believe will drive long term shareholder value.

So you’ll see, first of all, within our pharma business, we’ve already started to focus on streamlining that business. When you see the changes that have been made in neuroscience, with [unintelligible], with the ophthalmology businesses, with the divestitures to Aspen in our [unintelligible] facility, we’re really looking at which assets give us the greatest opportunity to drive growth going forward.

And that is really the lynchpin for us. Is a particular asset going to create more long term value inside our portfolio or outside our portfolio? Because everything that you have to devote capital to inside your portfolio has an opportunity cost somewhere else in your portfolio. So we’re really looking to have the kind of portfolio that actually drives the greatest long term growth and value for our shareholders.

Operator

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

Steve Scala - Cowen & Company

First, for Peter, I believe you said you had $500 million in patent pressures in 2014, which is far less than the impact from Singulair, but with roughly similar, if not even more gross profit margin erosion that you’re setting now. So would you explain that dynamic? Why are we seeing such extreme erosion with even less patent expiration pressures?

And then for Dr. Perlmutter, just stepping back, based on what your immune oncology competitors have said and done, what is your sense of where Merck stands competitively both in number of available combinations, number of tumor types explored, use of companion diagnostics, and any other metric you wish to cite?

Peter Kellogg

Let me just recap kind of the background for your question. So you’re right, we did highlight that going from ’13 to ’14 we will see, from lost exclusivity, about a $500 million impact. And that’s a tail on Singulair in Europe, Temodar, and a couple of other products going off. And I did highlight in the past that a lot of our PGM effect is being driven by mix of the different products.

Now, in ’13 I mentioned that we saw Singulair going away, which was a very high gross margin product, and very strong growth, though, in some other products, that have very good gross margins, just not quite as high as our average, such as vaccines and immunology, REMICADE, SIMPONI, in Europe and so forth.

I think the other thing I would say is that we’ve always commented over time that we are continually under margin pressure. We see on a regular basis pressure in Europe, and we will also see next year, we anticipate, as Adam mentioned, a biannual price decrease that is kind of a standard practice in Japan. And so all of those kinds of items are factored into our thinking and our modeling.

The last thing I would say, though, is that the AstraZeneca joint venture, we do expect to wrap up in the second half of the year. So in the first half of the year, we’ll still be seeing supply sales going to AstraZeneca, albeit at a slightly lower level. Still those are lower gross margin products, as you might imagine. And that would go away in the second half.

So I did highlight that while the first half of the year would look a lot like the fourth quarter, as we see volume picking up, which drives productivity and manufacturing as well as we see AstraZeneca going away, we’ll see kind of forces that also improve our PGM as we go through the second half of the year.

So I think net-net for the year, on average, we expect to be a little bit below, on average, the full year of ’13, but we do see it kind of bottoming out as we look to the first half of the year, and starting to pick up as we go into ’14 and onward.

Roger Perlmutter

Again, at a high elevation, as you know, there’s a lot less to be learned about how best to use PD1 antagonists in the treatment of cancer. We don’t yet know the full impact of PD-L1 expression and how best to assay for it. And different companies are using different assays. As I said, our evidence is supportive of the idea that this could be an important marker for responsiveness.

We don’t know which tumors are most responsive in a monotherapy setting, the range of tumors and the degree of response, and the durability of response. And we don’t know how to make that better either through combinations with other immunoregulatory agents or through combinations with targeted therapies or even conventional cytotoxic therapy. So there’s still an enormous amount to learn.

When you look at our program, we’ve got more than a dozen studies now. We’ve got thousands of patients enrolled. We’re looking at a broad range of tumor types. We’ve been enormously thoughtful about which combinations, how to look at biomarkers, and how to proceed. And I have to tell you, I like our program. I really do.

On the other hand, I also recognize that we’re treating a devastating illness that there’s a lot of important information to get, and there’s room for many different companies to contribute. And all of the groups are good, and that’s great for patients.

Operator

Your next question comes from the line of Tim Anderson from Sanford Bernstein.

Tim Anderson - Sanford Bernstein

You’re running a Phase II-III trial in lung, looking at high expressors of PD-L1, and if I look at the Roche and Genentech data, it would suggest that it’s about 25% of non-small cell patients that are high expressors. I’m wondering what your data is, using your assay, using your cut points. Is it similar to that 25% figure for lung? I’m just trying to gauge the size of the commercial opportunity if biomarker kind of limits it.

And then second question, unrelated to PD1, Ken, just a couple of years ago, you resisted the idea of getting rid of consumer animal health, and now obviously those are on the table. I’m just wondering, what changed in that fairly short timeframe? And you’re saying that all things are under consideration now, so my question is, is it a realistic possibility that you might go even further and actually split up the drug side of the business into different companies like Pfizer is considering doing? Or would it likely stop with reevaluation of animal health and consumer health?

Ken Frazier

I’ll start by going back to where we were before. I would say what’s consistent is I think these are terrific businesses. I think what we have to say now, given the size of our company, given the opportunities that we have, like PD1, we have to look at where our capital should go from an allocation standpoint. So what we’re really doing is looking at all aspects of our company. I remind you that we have divested Saphris. We have divested the ophthalmology business.

So we are not just looking at animal health and consumer. We’re looking at the sum total of what we have, where we should put our capital, where we can have the greatest amount of growth going forward. So that’s how we’re looking at things, and that’s how I’m going to answer those questions.

Roger Perlmutter

First of all, the percent positive in non-small cell lung cancer with PD-L1, that moves a little bit as you accrue more data. But just to be very clear, we have had no difficulty enrolling. There are lots of patients out there who are PD-L1 positive.

Number two, as we’ve explained, it is not the case that PD-L1 expression is determinative. There are responders in our data sets, as we’ve presented, that are PD-L1 negative. That’s true in different tumor types. And others have presented the same thing. Whether that reflects our improper setting of the cut point, as you suggest, our inability to measure PD-L1 expression at the target where it’s active, or some other ligand that’s involved, we don’t know. We can’t say that.

But what we should recognize is, in the first instance, one wants to look in patient populations where one can best characterize the treatment effect, and our data indicate that that is in the PD-L1 positive segment. There will be patients, potentially quite a lot of patients, who don’t score in that assay, but nevertheless have responses. That a second issue, and one which we want to address, because obviously you don’t want to deny the benefits of this therapy, particularly if it’s well tolerated, to patients who have no other alternatives.

Operator

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

Mark Schoenebaum - ISI Group

I actually have a question for Adam, if he’s awake, after all the PD1 questions. [laughter] My question is, embedded in your 2014 guidance, do you anticipate that there will or will not be Januvia and Janumet volume growth in the United States in 2014? If you’d be willing to provide any color on that, that would be great.

And then I guess for Roger, I will slip in one PD1 question if I might. A question I know you’ve gotten before, but since you have breakthrough status and you’re probably speaking to the FDA frequently, I was just wondering if you would be willing to provide any kind of update as to the earliest timeframe that you might be able to file for approval in any of the lung cancer settings. And I know this is competitive and there may or may not be a lot you can say, but anything you can say, we’d certainly appreciate.

Adam Schechter

Thanks for the question, and talking about PD1 gets me just as excited as Roger, and I can’t wait until I have more to say about that when we start to launch. With regard to your question on Januvia, if you look at the full year sales in ’13, we had 5% growth ex-exchange. If you look at 2014, we expect growth in 2014. The macro trends support a growing market. In the U.S., it looks like the decline has stabilized. Now the question is, can we get it to turn around, and we’re working hard to see if we can do that.

Internationally, the market is growing, and we expect that growth. We have high penetration in some markets, like in Japan, but we have other opportunities in the international markets we believe we can get volume growth as well. We expect some pricing pressure internationally. You’ve heard about the repricing of the BPP4s in Japan. That will occur effective April, but it’s going to affect the wholesalers in February and March. And that could be a maximum of 15%, although we don’t and won’t have the exact number until March.

We also have good data in Germany, where they looked at Januvia and said that there was incremental benefit versus the products in the market. We don’t know the magnitude of the price decrease, but there will be some price decrease, we expect, in Germany. But net-net, we expect to grow in 2014.

Roger Perlmutter

With respect to our discussions with FDA and breakthrough status, of course FDA is interested to know what kinds of things we’re seeing in all patient subsets, particularly for reasons of safety and exposure. But right now we’re completely focused on completing the rolling submission with respect to melanoma in patients previously exposed to ipilimumab. That’s what we’re doing. We will get that done by the middle of the year. Other discussions, of course, will occur after that.

Ken Frazier

Mark, in your preamble, you referenced our comment about the trough year for EPS. What I want everyone to understand is that our team is very focused on and committed to driving growth, and we expect to grow earnings off this new base in 2015.

Operator

Your next question comes from the line of Jeff Holford with Jefferies.

Jeff Holford - Jefferies

… structurally, at least initially in the melanoma indication. Will this be focused and built upon PD-L1 selection in any way? It just seems that there are many issues about limiting how broadly these treatments could be used during that, even though it’s somewhat of a prognostic marker.

And then secondly, on Zilmax, what’s the risk here, that this is not to do with getting additional safety data? What’s the risk for companies like Tyson Foods and other companies? Are they just worried about bad publicity using these products and really coming back is going to be difficult from there?

Roger Perlmutter

With respect to PD-L1 expression, and you were cut off a bit at the beginning, but I think the important thing to emphasize again is that in terms of trying to understand the benefit-risk profile of the drug, it’s important to focus on populations where the responses are easiest to demonstrate.

We have been working hard on looking at the PD-L1 marker as a way of identifying sensitive populations, but as we said before, PD-L1 negative patients do have responses. And in a patient population that has exhausted other treatment options, it’s not reasonable to withhold a therapeutic option that holds promise provided it’s reasonably well tolerated. So I think that’s going to be the view, always, and with time, we’ll know more about how to select patients for this therapy and for other therapies.

Ken Frazier

Quickly on Zilmax, I just want to stress, again, that we voluntarily implemented a temporary sales suspension in the United States and Canada, so that we could work with our industry partners, so that we could reaffirm confidence in Zilmax, which we really have. And so we’re now working with an advisory board which includes some of the big players in the industry to provide a profit for certifying people who use it to show that the product actually is very helpful.

I think we also ought to keep in mind the underlying dynamics, which is there is an increasing need for protein consumption around the world and that requires greater productivity going forward. So this is an important product. It is a useful product. And what we did was to ensure that everybody was on board to understand the benefit of this product going forward. And we’re confident that this process will actually lead to a good outcome for Zilmax.

Operator

Your last question comes from the line of Alex Arfaei with BMO Capital Markets.

Alex Arfaei - BMO Capital Markets

Roger, obviously you’re taking a broad combination strategy for MK3475, and I certainly appreciate your comments about how much we still don’t know. What I’m wondering is if you could elaborate a little bit more on the strong scientific justification you mentioned in your prepared remarks. And could we see data supporting this approach at AACR in April?

And a follow up for Ken. Last October you mentioned an increased focus on your top 10 geographic markets. What are your plans for the other markets as you prioritize resources?

Roger Perlmutter

The scientific justifications are of several forms. Clearly we like to have preclinical data at a minimum that is supportive of the idea that PD1 antagonism will work effectively with another therapy. In many cases, we have exactly that.

In some cases, as we reported in our press release with Pfizer, we’re seeking that kind of preclinical information, and in other cases there’s data that’s been developed, for example with TVEC, with respect to the underlying mechanism of action and the expansion of T-cell subpopulations that’s extremely supportive for the idea that those two will work in combination.

We will have the opportunity to talk about some of those data coming up at AACR, for example, and ASCO, and of course at our May 6 business review, RD review, which is not too far away.

Adam Schechter

Regarding the top 10 markets, the top 10 markets represent a very significant amount of our total sales. So what we were signaling is, we have to be successful in those markets in order to grow in the future. That does not mean that there aren’t other markets that remain important for growth opportunities.

So we’ll make sure that we invest in the top 10 markets and we first and foremost have the right promotional resources and resources in those markets. And then we’ll look at the other markets on an individual basis to ensure that we maximize those, albeit we might use different models and different approaches in those markets.

Ken Frazier

Let me just summarize. First of all, I thank you all for staying on the phone so long as you did. Really quickly, as a management team, we’re very excited about where Merck is today. Our goals are two. One is growth, the second is innovation. Everything that we’ve talked about with respect to our portfolio is to put together the right combination of assets that will allow us to drive the greatest amount of growth going forward.

We’re pleased that we have some very strong assets in our business now. Eight of our top 10 brands grew double digit last year. We want to continue to grow our company, and I restate that we expect to grow earnings off the new 2014 base going forward.

But the most important thing in our business for the long term is innovation, and we are excited by the evidence of progress that we’re seeing in the Merck research labs. MK3475 obviously is one of the first and most important of those things. But HCV, vorapaxar, additional catalysts like suvorexant, odanacatib, and other things coming forward this year, we’re extraordinarily excited by what can happen for Merck in the near future, and we would just say stay tuned. We believe that we’re going to have very exciting things to report. Thank you.

Operator

Thank you for participating in today’s Merck fourth quarter 2013 earnings call. This call will be available for replay beginning at 11 a.m. Eastern standard time today through 11:59 p.m. Eastern standard time, February 12, 2014. The conference ID number for the replay is 26402847. The number to dial for the replay is 1-855-859-2056 or 404-537-3406. Thank you.

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