Merck & Co. Q1 2010 Earnings Call Transcript

 |  About: Merck & Co Inc. (MRK)
by: SA Transcripts


Good day, everyone, and welcome to Merck's First Quarter 2010 Earnings Conference Call. [Operator Instructions] At this time, I'd like to turn the call over to Alex Kelly, Vice President of Investor Relations. Please go ahead.

Alex Kelly

Thanks, Amanda, and good morning, everyone. And welcome to the 2010 First Quarter Conference Call for the new Merck. This is our first full quarter of combined operations, so there are a number of items in the GAAP results, such as purchase accounting adjustments, merger-related expenses and restructuring costs that we've excluded from our non-GAAP results. We've also excluded the impact of the tax charge related to healthcare reform, as Peter Kellogg will discuss.

We've provided you a number of tables in our earnings release to help you understand the trend, and in particular, there are five tables. There's a table on the GAAP sales results. Table 2 and 3 deal with our reconciled GAAP P&L to our non-GAAP results. There's also a supplemental Table 4, which provides the sales performance for the company, the business units and the products, as if the company had been in operation in the first quarter of 2009. And Table 5 is a supplemental non-GAAP table, which provides the sales for the major products.

So during the call, we'll be referring mostly to Tables 2 and 3 when we discuss the P&L, and Table 4 when we discussed the revenue performance. I'd also like to remind you that next Tuesday, May 11, we are hosting our first R&D and business briefing, and as a result, we won't be discussing individual R&D projects on this call.

In addition, I'd like to remind you that some of the statements we make during this call today 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 team and are subject to significant risks and uncertainties.

The company's SEC filings, including Item 1A in the 2009 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 we make today. Merck undertakes no obligation to publicly update any forward-looking statement. You can find the SEC filings and today's earnings release on our website at

This morning, I'm joined by Dick Clark, our Chairman and Chief Executive Officer; Ken Frazier, the President of Merck; and Peter Kellogg, our Chief Financial Officer. Now I'd like to introduce Dick Clark.

Richard Clark

Thank you, Alex, and good morning, everyone. Today, we reported the first full quarter of financial results for the new Merck. Our first quarter 2010 results demonstrate early success in the integration of Merck's worldwide operations, and we are well-positioned to continue the grow globally and achieve our overarching goal of becoming the best healthcare company in the world.

On the top line, the company recorded worldwide sales of $11.4 billion for the first quarter. Earnings per share for the first quarter on a non-GAAP basis was $0.83 versus $0.74 for the last year's first quarter for the standalone Merck. So you can see that our merger is already producing positive results. These results reflect the new Merck's expanded global footprint and the strong sales performance of key brands, including JANUVIA, JANUMET, REMICADE, SINGULAIR, ISENTRESS and TEMODAR. I think you can see from our results that we are focused on driving revenue growth, maintaining the momentum of the business and reducing our cost structure.

In a few moments, Ken will provide you with additional details around our specific global product performance. In today's announcement, we shared our financial targets for the full year 2010, and also reaffirmed our long-range financial target. Peter will have more to say about our financial outlook in just a few minutes.

On the integration front, we remain on course and continue to build momentum on multiple fronts. We have accomplished a lot in just six months. In the first quarter, we moved rapidly on executing our integration plans while maintaining our business momentum, growing the top line this quarter by 7%. We announced, with sanofi-aventis, our plan to create a global leader in Animal Health by combining Intervet/Schering-Plough with Merial into a proposed new joint venture that will equally be owned by Merck and sanofi-aventis.

We completed the prioritization of R&D portfolio. Merck now has one of the industry's best pipelines, with more than 20 compounds in late-stage development. And we are well into the implementation of our previously announced global restructuring program. This includes the full integration of commercial operations in 12 out of our top 20 markets around the world.

I've also spent quite a bit of time in the past few months meeting with employees, customers and other key external stakeholders at various sites around the world, and what I saw was exciting. It is clear to me that there's considerable energy and disciplined thinking going on at Merck to ensure that we capture the many opportunities before us. Already, I am seeing signs of a more productive and sustainable culture beginning to emerge. We are intensely focused on what will add value, and most importantly, satisfy our customers' needs by providing them with innovative distinctive products and services that save and improve lives. And today, given our expanded worldwide presence and broader product portfolio, many more individuals have access to the valuable and diverse set of healthcare solution Merck provides than they did just a few months ago.

Turning to U.S. healthcare reform. While the legislation passed by Congress in March is not perfect, we continue to believe that overall, it will have a positive impact. Ultimately, the legislation passed will ensure that 32 million more Americans will have access to critical healthcare products and services. That's why we believe that healthcare reform, well not without its costs, will position Merck to better help patients to obtain the medicine and vaccine they need. For a company like Merck with a long history in vaccines, we are particularly pleased to see first dollar coverage of preventive services and vaccines for all new plans commencing in October 2010.

Also, defining the day exclusivity period for Biologics is 12 years will help protect innovation that our company has and will generate. I believe that protecting innovation goes hand-in-hand with expanding access to millions of Americans in need for healthcare, because our innovation can improve their care and reduce overall costs. We intend to remain on top of the issues related to healthcare reform and support our customers as we all navigate these significant changes to the U.S. healthcare system.

No matter what challenges we may face from generic competition to the new requirements of healthcare reform, we are prepared to tackle them, because we understand it truly because to be the best healthcare company in the world, we must execute on many levels. We will continue to remain intensely focused throughout the rest of this year and beyond on executing our strategy, discovering new therapies, successfully launching new products and delivering growth from our in-line products throughout the world. At the same time, we remain committed to achieving our merger synergy target of $3.5 billion in annual savings in 2012. We look forward to telling you more about our accomplishments, our pipeline and our areas of opportunity next week at our R&D and business briefing.

Before I turn the call over to Ken, I want to say a few words about the senior leadership announcements we've made last week. As you know, Ken was elected President of Merck with responsibility for our three largest operating divisions, Global Human Health, Merck Manufacturing division and Merck Research Laboratories. We also announced that Adam Schechter was elected to succeed Ken as President of Global Human Health. I'm very confident in Ken and Adam are the right leaders and that these changes further strengthen an already outstanding senior leadership team. As CEO and Chairman, I remain fully committed to Merck and with Ken, to steering the company through this critical post-merger launch phase and positioning us for success in the future.

Now I'll turn it over to Ken.

Kenneth Frazier

Thank you, Dick. At the outset, please allow me to say that I am actually deeply, deeply honored to have been asked to serve in this new role. Because I believe still passionately in the company and its people and its mission. I look forward to working with you, Dick, Peter Kim, Willie Deese and all the rest of my senior management colleagues to help ensure that we deliver on the full promise of the merger and achieve sustainable performance going forward.

As Dick mentioned, we were off to a great start in 2010. Overall, Global Human Health delivered a strong quarter with sales of $9.8 billion, which represents 6% growth on a supplemental combined non-GAAP basis from the previous year. In describing in our first quarter performance, please note that I will refer to supplemental combined non-GAAP results, which includes the impact of foreign exchange for the rest of my comments.

While my focus today is to review the strong performance of the Global Human Health business during the first quarter, I do want to make a few comments about the focus and resilience our marketing and sales team showed in delivering these strong results. At the same time, we were integrating our operations and markets around the world.

As I shared with you during the fourth quarter call, we fully integrated our U.S. customer facing organization in January. And since then, we've made substantial progress in a number of other markets. As we integrated our customer facing groups, our primary focus was on minimizing customer disruption in order to maintain business momentum, while at the same time becoming both more effective and more efficient.

Throughout the first quarter, our commercial teams around the world were required to take time off territory for brand and portfolio training as we merge the portfolios of the two legacy company. Nonetheless, I believe it is clear from the first quarter results that our sales force is focused on their customers and the new portfolio opportunities available to them. I think what our customer facing organization achieved was outstanding. Fully-integrated, trained, energized and refocused teams in a number of our major markets that delivered strong results.

We'll share additional insights into the progress we're making across the business next week during our R&D and business briefing meeting. For the rest of today's call, I'll focus my comments on our first quarter performance.

We drove growth and most of our markets and international sales grew at 10% in the first quarter. Taking a look at our largest market, we drove growth in nine of our top 10 country, and seven of the top 10 grew at double-digit rates. We also continued to see double-digit growth in our core emerging markets. We will discuss our emerging market strategy at the business briefing next week also.

Turning to individual brand performance. We continue to see broad-based growth with eight of our top 10 product families growing in the first quarter. As I address the individual product performance, you can feel free to follow along in Table 3 from our supplemental financial package.

Starting with SINGULAIR, sales in the first quarter were $1.2 billion, an increase of 10% versus the prior year. SINGULAIR's growth was largely driven by strong performance in Japan and double-digit growth across the emerging markets. In the U.S., the allergy season in the first quarter was generally mild and comparable to the previous year. However, we started to see pollen counts intensified in late March. One of our main priorities following the close of the merger was to rapidly and effectively co-position the products in our respiratory portfolio. As the allergy season accelerated in March and April, our teams leverage our broad respiratory portfolio to drive volume growth. In addition to the growth of SINGULAIR, sales of NASONEX grew 4% to $320 million, driven by results in the EU, Japan and the emerging markets.

Moving to JANUVIA and JANUMET, global revenue grew 32% to a combined $172 million (sic) [$712 million]. The JANUVIA franchise continues its strong performance, despite the introduction of new branded competition and the continued utilization of generics, because JANUVIA has a differentiated label and brings real benefit to patients with type 2 diabetes. Sales in the U.S. grew 16% this quarter. We continue to invest in the promotion of JANUVIA and JANUMET to maintain our leadership position in the diabetes market and to grow this franchise.

We are focused on highlighting the strong value proposition of JANUVIA versus sulfonylurea. We also plan to capitalize on the new label changes for JANUVIA, which includes the label changed to allow use with insulin. We believe this represents a significant opportunity for growth and differentiation going forward.

Outside the U.S., we continue to see growth in the EU, and the launch of JANUVIA in Japan is tracking well. Due to the strong product profile and significant labeling advantages, we expect that this franchise will continue to be a major growth driver for Merck.

Our immunology franchise also achieved strong growth during the quarter. REMICADE continues to be a leading immunologic therapy. Sales in the quarter were $674 million, an increase of 30% from the previous year. REMICADE continues to deliver growth across all indications rheumatology, gastroenterology and dermatology.

In rheumatology, REMICADE is maintaining its market share despite multiple new product launches in the class. In fact, we're seeing some benefit in REMICADE's performance from the launch of SIMPONI which I'll discuss shortly. REMICADE's market share and growth in the GI indications remains class leading.

In April, the New England Journal of Medicine published the Sonic study. Sonic showed that patients with Crohn's disease were more likely to achieve steroid free clinical remission with REMICADE compared to patients taking azathioprine.

Moving to SIMPONI, while we're still in the early stages of the launches, we are encouraged by the quick adoption in key markets where we have reimbursement. We are driving SIMPONI primarily to take share from Humira and Enbrel, not REMICADE. In addition to the five countries where we currently have reimbursement, we plan to launch SIMPONI in many of the other EU markets and key emerging markets in the second half of this year. We continue to view REMICADE and SIMPONI as significant growth drivers.

Turning to ZETIA and VYTORIN. Sales were $1 billion this quarter, which in the aggregate, represents 2% growth compared to the previous year. Sales in the U.S. declined due to market share erosion and movement in inventory. VYTORIN and ZETIA remain a key focus of our promotional efforts this year. We continue to see solid growth in many markets outside the U.S. and are encouraged by the performance of our teams in the EU and Japan.

Moving on to COZAAR/HYZAAR. As you know, the brands recently lost marketing exclusivity in the U.S. and most major EU markets. Globally, sales in the first quarter were down 7%. Recent weekly prescription data in the U.S. indicates that there has been a rapid erosion of the brands now that we are no longer enjoying market exclusivity. I will now move to our Vaccine business.

In the first quarter, the Vaccine business benefited from an inventory build of approximately $75 million to $100 million. First quarter sales of ZOSTAVAX, as reported by Merck, were $95 million, a 27% increase from the previous year. We did see an inventory build due to the timing of customer orders in the first quarter. While demand remains high for ZOSTAVAX, we continue to be constrained by supply.

Moving to GARDASIL. Sales as reported by Merck in the first quarter were $233 million, an 11% decline. GARDASIL continues to maintain market share leadership in the U.S. and also remains the global market leader.

In infectious diseases, ISENTRESS continues its outstanding launch performance and is now one of Merck's top 10 brand. Sales in the first quarter were $232 million, an increase of 57%. The continued growth of ISENTRESS reflects the unique efficacy and tolerability profile of this product, which has been widely embraced by physicians, patients and health organizations.

In closing, I want to thank my colleagues across the new Merck for a successful quarter. Since the close of the merger, I've spent a great deal of time with our teams and our customers around the world in the U.S., Latin America, U.K., Greece, Italy, Switzerland and other places.

And while growing our business, in the midst of integration was an enormous challenge, the progress and enthusiasm of our teams to build a new commercial organization that embodies the best of legacy Schering-Plough and Merck commercial organizations with minimal customer disruption was truly a tribute to the organization's focus and execution.

I look forward to updating you all on our progress during the business briefing next week. We've had another strong quarter, and I think our review of the business will help you better appreciate exactly what is driving this success.

And so now it is my pleasure to pass the call over to my colleague, Peter Kellogg.

Peter Kellogg

Thank you, Ken, and good morning. As you've heard from Dick and Ken, we are pleased with our first quarter performance and our integration efforts are well underway. Ken shared with you how our key brands contributed to our strong growth this quarter. I would like to cover two areas with you. First, our earnings performance this quarter and second, I will provide some commentary on our targets for full year 2010 and beyond that, our long-term EPS target.

Let's begin with our results. This is the first quarter that we are reporting a full three months of results for the combined company. You'll see the tables in our news release and supplemental charts that we added last quarter to help you navigate through our non-GAAP adjustments to the P&L, which exclude purchase price accounting adjustments, merger-related costs, restructuring charges and a $150 million tax charge related to elimination of a tax benefit for retiree prescription drug coverage. To simplify my remarks today, I will speak mostly to the non-GAAP results. On this basis, the new Merck reported first quarter non-GAAP earnings per share of $0.83.

Our performance this quarter is characterized by the strong operational sales that Ken just discussed. The cost management and benefits of merger synergies in our cost base, lower equity income from partnerships, due to the elimination of Merial and the cholesterol joint venture and lower interest income and higher interest expense due to the merger financing.

In addition, we also had about a 4% benefit from foreign exchange on the top line, which also had the effect of increasing our operating expenses. So let's get into some of the individual items beginning with revenue.

Total revenue for the quarter was $11.4 billion. On a supplemental combined non-GAAP basis, sales were up 7%. This basis assumes that Schering-Plough and the cholesterol joint venture were included for all three months of the first quarter of 2009 as well. Our Global Human Health business grew 6% in the quarter. Our Animal business grew 14% to $709 million, reflecting continued growth among companion animal and poultry products. Meanwhile, our Consumer Care sales were $379 million, slightly lower than prior year due to the launch purchases of Claritin Liqui-Gels in the first quarter of 2009.

Now moving on to the expense side in the P&L. As you know, our cost base now includes the cost from Schering-Plough, Merck and the cholesterol joint venture, whereas only the Merck costs were included in the first quarter of 2009, so it's a little hard to see underlying trends. So this quarter though, we reduced our headcount, we generated savings from procurement actions and discontinued certain R&D projects through our pipeline prioritization process. As a result of these and other actions, we are on track to realize our $3.5 billion synergy target by the end of 2012. Over time, I am confident that you will see even more evidence that our costs are coming down.

So let's move on to materials and production. The non-GAAP gross margin in the first quarter was approximately 75%, which was similar to the rate in the first quarter of 2009 when Merck was a stand-alone company. On a non-GAAP basis, marketing and administrative expenses in the first quarter were $3.2 billion. While research and development expenses for the first quarter were approximately $2 billion, slightly lower than we expected. Included in the R&D expenses this quarter was continued investment in late-stage projects, such as TRA [thrombin receptor antagonist], boceprevir, [indiscernible] (40:05), CORDAPTIVE and our CETP-Inhibitor.

Let's move to equity income. In the first quarter, Merck recorded $138 million of equity income, a $450 million decline over the prior year. This decline is primarily attributable to the unwind of the cholesterol joint venture and the sale of Merial. There was also a $43 million decline in income from the AZLP partnership. Now as you're aware, AstraZeneca gave us notice that their intent to exercise their option to buy the non-PPI products, which will result in a one-time gain of approximately $440 million in the second quarter. This gain will not be included in our non-GAAP results.

Going forward, Merck equity income will be earned from three partnerships AZLP, our vaccine joint venture with sanofi in Europe, and the J&J Merck OTC partnership. Beginning in 2011, we expect to also have equity income from our new Animal Health joint venture once it is completed. Until that time, we continue to own and consolidate the interventuring Plough business in our full P&L. This quarter's equity income is a good barometer of the anticipated quarterly equity income in 2010.

Now let's discuss other income and expense. In the first quarter of 2010, other expense on a non-GAAP basis is $160 million compared to other income of $80 million in the first quarter of 2009. There are a few items driving this year-over-year change. First, and most notably, is the inclusion of interest expense from the Schering-Plough debt and the merger related debt. Second, interest income was lower as a result of lower interest rates and lower cash and investment balances. Third, the current quarter's expense includes an $80 million exchange loss, as a result of the currency devaluation in Venezuela, and the translation of assets in Venezuela on our balance sheet. Lastly, a favorable settlement of a dispute contributed approximately $100 million to the line.

Moving to the tax line. The new Merck non-GAAP tax rate was 23% for the first quarter. This is consistent with the rate that we saw in 2009 on a full year basis, excluding discrete items. So that's the first quarter, a strong start for the new Merck.

Now let's talk about our financial targets beginning with our long-term targets. We remain very excited about the future of the new Merck and we continue to target a high single digit non-GAAP EPS compound annual growth rate from 2009 to 2013 regardless of the outcome of the REMICADE arbitration. As we indicated in our press release on April 23, this guidance is also still applicable, despite the anticipated impacts from healthcare reform.

So specifically in 2010, the company is targeting a full year 2010 non-GAAP EPS range of $3.27 to $3.41 excluding certain items. On a GAAP basis, we are targeting an EPS range of $1.15 to $1.50. We have also provided guidance on the reconciliation of the GAAP to non-GAAP EPS on Page 3 of our news release. Our 2010 EPS target and other financial targets assume that Merck retains full rights to REMICADE and SIMPONI in our markets.

Now I'd like to provide targets in a few select areas to help you better understand the earnings targets. First, beginning with the sales line. We are launching an impressive number of new products globally, and we anticipate that sales from these new products, combined with strong growth in our key brands JANUVIA, ISENTRESS, REMICADE and SINGULAIR will replace the significant sales loss from patent expiry of this year.

COZAAR/HYZAAR would represent the third major patent expiry after ZOCOR in 2006 and FOSAMAX in 2008, that Merck has grown through in the years of expiry. We anticipate full year 2010 sales to be in the range of $45.4 billion to $46.4 billion at current exchange rates. This range reflects the unfavorable $170 million impact from the healthcare reform as previously discussed on April 23. Now let's discuss R&D.

In 2010, we will continue to invest in our late-stage pipeline. We are also driving efficiencies through the combined R&D infrastructure. We anticipate full year non-GAAP R&D expense to be in the range of $8.3 billion to $8.7 billion.

Moving to the tax line, we anticipate a non-GAAP tax rate in the range of 22% to 24% in 2010. So let me summarize. We are pleased with our strong first quarter results. We clearly had a stronger-than-expected first quarter, and our expense management contributed to that performance. Three other factors contributed to our strong first quarter performance. First, we had about $75 million to $100 million in U.S. inventory build in the vaccines area. Second, our R&D expenses were lower than expected, due to timing of clinical trials. We do expect to make up that spending in subsequent quarters of 2010 and currently target R&D expenses of $8.3 billion to $8.7 billion that I just mentioned, which implies higher quarterly spending going forward. Finally, foreign exchange gave us a lift this quarter, and we don't expect the same degree of benefit going forward based on current ForEx rates.

Our results and the targets provided demonstrate that we are on track, had a good first full year as a combined company. We expect to continue our business momentum for key brands, launch products globally and make significant investments in our promising late-stage pipeline, and we expect to realize substantial cost synergies. Thank you. And now I'll turn the call back over to Alex. Alex?

Alex Kelly

Thank you, Peter. Now we'd like to open up the call to answer your questions. In order to help us get through as many of your questions as possible, please limit yourself to one or two questions and note that we won't take any follow-up questions. But feel free to join the queue, if you have additional questions. Also, as a reminder to what I said at the beginning of the call, we will take your R&D related questions next Tuesday, during our R&D and business briefing. Operator, we're now ready for the Q&A.

Question-and-Answer Session


[Operator Instructions] Your first question is from John Boris, Citi.

John Boris - Citigroup Inc

First question just for Peter Kellogg, just on your cash flow. Can you comment on what your cash flows were in the quarter and any color around what cash flow targets could it potentially be for the new co in 2010? And then, a question for Ken, congratulations on your broader responsibilities. As you do take on those broader responsibilities, can you outline what your top three priorities will be going forward as you now assume responsibility for Human Health, Manufacturing, R&D, et cetera?

Peter Kellogg

John, it's Peter. So unfortunately, we really haven't state, talk about cash flow and the balance sheet on this call until the 10-Q goes out. So if I can, I'll defer on that. But I would focus everyone back on where we were at year end, obviously, from a cash balance standpoint and we do expect to have a strong cash flows. I think at year end and as we go through this quarter, we have roughly $12 billion in cash and about $19 billion of debt, and we expect to have very strong cash flow performance even this first year of the merger. And we've highlighted that by the end of the guidance period, we actually expect that cash flow to be a very strong operational cash flow by that time period so that also is instead, the second question for Ken, I guess.

Kenneth Frazier

Yes, I would say that my top three priorities, so first of all, to continue to work with Dick, with Peter and Willie and in this vein to actually learn a lot from the three of them regarding the new areas of responsibility that I have, so that would be my first responsibility. The second one is, obviously, to ensure that these three operating divisions continue to collaborate and work jointly in order to produce value, and I would say the third one is continuing to push for the kinds of product performance that we've seen in the first quarter. We're still in the middle of integrating many of our markets and while my colleague, Adam Schechter is very able, I think we want to be sure that we have a seamless transition on the commercial side.


Your next question is from Marc Goodman with UBS.

Marc Goodman - UBS Investment Bank

You mentioned that there was inventory changes in ZETIA/VYTORIN. Can you just help quantify that? And then second of all, in the diabetes market, DPP-4 class, I would have expected this market to be growing a little bit faster. And can you comment on what's happening with your competitor along coming in, usually we see a second player coming in and market start to expand faster. We're not really seeing that and your thoughts on just [indiscernible] (49:16) had an impact at all? Or how these longer acting are going to play into the impact of the DPP-4 over time.

Richard Clark

So I think on VYTORIN and ZETIA, I think we saw inventory patterns this quarter that we thought were consistent with our expectations and consistent with what we saw frankly in the first quarter of 2009. As it relates to the oral diabetes market, we were very pleased that JANUVIA and JANUMET continue to grow very strongly. They have shown strongest growth in that market. Remember that we are up against established entrenched generic entities that are used by a lot of physicians, and that's our primary focus. We're pleased with -- there are in-class market share that we've maintained in the U.S. against on class and around the world, against other DPP-4 inhibitors. And I think what you're seeing with the new class is that while you have seen the COZAAR/HYZAAR inroads, they're really not at the expense of JANUVIA.


Your next question is from Tim Anderson with Sanford Bernstein.

Tim Anderson - Sanford C. Bernstein & Co., Inc.

Just going back to JANUVIA, you mentioned that being a growth driver for Merck, but if I look at what you reported in the Q, quarter for the U.S., it was flat with third quarter, and it was below fourth quarter levels. JANUMET pretty much the same thing, so it's not clear to me how the U.S. is going to be a driver of growth going forward. So I'm just wondering if you can clarify that. And then on VYTORIN and ZETIA, I know those products have been through a lot, but can we get an update on the timing of the sharp trial, that if I remember correctly, should be coming out in the current year?

Kenneth Frazier

We're starting on the sharp trial, I think we'll be able to provide that information next week at our business briefing. As it relates to, again, the issue around JANUVIA and JANUMET in the first quarter, sequentially, we also experienced a pretty strong inventory build in the fourth quarter and we're seeing some adjustments downward in this quarter. I think, overall, we're pleased though with the volume growth of JANUVIA and JANUMET across markets.


Your next question is from Eric Lo with Bank of America.

Eric Lo - BofA Merrill Lynch

First, on reform. In terms of your guidance for next year of $300 million to $350 million in revenue impact, so hoping you guys could potentially break that down between what industry fee is and what your assumptions are in terms of Part D donut hole impact? And also, how much of that might actually fall to the bottom line. Second question is on your geographic sales. I noticed you guys book up what your sales were in terms of Latin America, Asia-Pac and Eastern Europe. I was hoping you guys could

provide some color in terms of what the sales growth year-over-year was, and how that compares to performance in 2009 sales growth and maybe some color in terms of profitability in these regions, maybe rank order them?

Peter Kellogg

From your question with healthcare reform, although we don't give specific breakdown of details, we can tell you about 50% is from Medicaid rebates and 50% from fee in the donut hole plus the 340B. That's the breakdown, it's about a 50-50 breakdown.

Richard Clark

And as it relates to the regional breakdown that we provided in Table 3b, I would say that we're pleased with the double-digit growth that we're seeing across Latin America, Asia Pacific and Eastern Europe, Middle East, Africa. Everyone has a definition of emerging markets, but if you look at those three together, we had growth of in the high teens. And so we are pleased with where we are. We know that that is where the growth is for this industry going forward. We are very focused on getting more than our per capita share of that growth. We want to grow faster than those markets and we'll talk next week at the business briefing about our strategies for ensuring that we do get that kind of growth.


Your next question is from David Risinger from Morgan Stanley.

David Risinger

First of all, with respect to the second quarter sequentially, I know that you don't provide guidance, but can you please just run through -- and I know you mentioned some anomalies in the first quarter, but could you please run through how we should think about the second quarter, sequentially, in terms of revenue and EPS trends? And then second, another revenue question. Could you just talk to the revenue outlook longer term? So you've provided high single-digit EPS growth guidance, but it's unclear if you're assuming revenue growth from 2010 to 2013 or revenue to be flat. So if you could provide some color on that, that would be helpful.

Peter Kellogg

This is Peter. So the first quarter, obviously, we did a little better than we thought, and some of the factors that I mentioned were net build in our U.S. vaccines inventory out in the channels and that was to a multitude of different effects. Some of it was the fact that we were seeing some increased customer purchasing of vaccines, because we're going live on SAP in the beginning of April. Some of it was actually some advance purchasing of ZOSTAVAX due to some concerns about the fact that we'd mentioned there might be some back orders and so people were picking up some inventory. And probably we would expect that not to be sustained as we go forward. So in the second quarter, you'd probably see that balance out. We don't have a perfect crystal ball on that, but it would be reasonable for that, I think. The second thing is as I mentioned, the R&D expenses were a little lower than we would've expected, but really everything's still moving ahead. I just think that we maybe didn't quite get the exact calendarization rate. We did give you the full year guidance or target of $8.3 billion to $8.7 billion. And obviously, the math would tell you that that implies higher quarter spending going forward. And then third, we got a nice benefit from foreign exchange in the first quarter, which I don't think we'll get quite as much of going forward in the balance of the year. In fact, I think the foreign exchange rates are moving a little bit as we speak. And obviously that's a volatile state in [ph] rate now. I think that, obviously, we do have some seasonality in our revenue, and I think that probably that will cause the second half of the year to look a little stronger. And likewise, we're seeing COZAAR/HYZAAR, as we mentioned earlier, went off patent so that's really, as Ken mentioned, start to have a very strong impact in Q2, Q3 and Q4. And what we you mentioned in the Q4 call was that we did see that the second half of the year be a little bit stronger than the first half, and we do think that continues to be true from a calendarization standpoint. Longer-term basis, we haven't guided to revenue. We've focused on EPS as obviously a lot of moving parts here, and so I don't want to just kind of quickly give guidance that showing on the revenue line. I think that obviously everyone knows where clearly what all of the moving parts are and we're launching a lot of products. We've got a lot of exciting late stage pipeline items. We've got some in-line commercial asset, as Ken's talked about, have tremendous potential so exactly where those land, it's hard to call. Going against that, obviously, we're in a challenging global economy right now with a lot of fiscal budgets and governments trying to manage through that. So at this point, what we do know is we have the right levers in place through putting these two companies together to manage the EPS guidance, we think we're in very good shape on that. Dick or Ken, do you want to add anything?

Richard Clark

I would say that from a commercial standpoint, obviously, we believe that this is a very strong portfolio when you've put these products together, and we're very much committed to driving very strong growth within the portfolio without making any specific comments around guidance. I want you to know that our commercial organization believes in this portfolio, they're motivated. And I think we are seeing the beginning of some benefits from putting these products together. For example, in the respiratory portfolio this quarter, when we look at SINGULAIR's performance and you look at MASONEX's performance from a volume issue [ph] basis recently, I actually think we're starting to see some benefits.


Your next question is from Jami Rubin from Goldman Sachs.

Jami Rubin - Goldman Sachs Group Inc.

First, for you Peter, after the fourth quarter call, you've signaled a very weak first half followed by a very strong second half. It sounds to me like based on the pushes and pull with R&D, currency, et cetera, that we should now expect a more even, even quarters throughout the year. Second question for you, Dick, is given your strong operational cash flow, curious to know how you are thinking about the dividend, which I would point out, hasn't been raised since 2004 because of the Vioxx overhang, which has been lifted now long ago. And third question for Ken, and again I offer my congratulations to you, too, Ken, if you can provide us any color on the reimbursement environment for SIMPONI. It would be great if you could share with us what your revenues were. But more importantly, what is the tenor of discussions with European regulators given the economic budget crisis and some of the reform programs that we've seen put in place such as in Germany?

Peter Kellogg

On the calendarization this year, obviously, we did signal on the fourth quarter call that we thought the first half would be weaker, and we did get some benefits in the first quarter. A part of it was just good expense management, and some of the inventory build that we talked about certainly helped and we got a nice ForEx impact as well. We do expect the second half to be stronger than the first half, and think Q2, I just would be cautious that inventories may reverse. But overall, though, versus what we originally thought, I think you're right that the quarters won't be quite as different as we first thought because we obviously were anticipating a weaker first quarter. Dick?

Richard Clark

Certainly, Jami, from a dividend standpoint, and we look at it [indiscernible] dollar value is that the dividend was sharply increased particularly as to the Schering-Plough shareholders, based on the merger that took place and so there has been an increase. Just as important as we look forward to our cash flow and we look toward how to continue to invest in the company, and think about dividend and think about share buybacks is just something that is a part of our strategic review and something that we will consider in the future.

Kenneth Frazier

On SIMPONI, the sales in the quarter were about $10 million which is roughly double the sales that we saw on the fourth quarter. We're still very much in the early days. We have reimbursement in five countries. We have Germany, we have the private part of the Canadian market. I think what I would say about the overall background is, obviously, all these European countries are struggling with budgetary issues including healthcare issues. We know that the anti-TNF category is a significant cost item to them. But we think SIMPONI really brings to the table a lot of benefits. And so for us right now, it's actually going in with the dossiers that we prepare, which we feel very good about, to convince both national and regional price and HTA organizations to actually see the benefit of SIMPONI, its convenience and its benefit to patients. And so we're very confident that over time, we'll be able to persuade people to include SIMPONI within the reimbursement, but I have to say that it's a very difficult economic environment in which we are launching this drug.


Your next question is from Steve Scala with Cowen.

Steve Scala - Cowen and Company, LLC

First, Dick, you started by saying that healthcare reform will have a positive impact. Are you saying that reform will be accretive Merck profits over the long term? So that's the first question. Secondly, regarding the impact of REMICADE and golimumab on 2010 guidance, would you say that guidance will only change if you lose arbitration or will it change if you settle as well? In other words, must Merck win arbitration to maintain guidance? I appreciate that the answer requires knowledge of any proposed but not public settlement, so based on any proposed but not public settlement now contemplated, would guidance change?

Peter Kellogg

This is Peter. First of all, just to kind of clarify, we're really not making any comments about the REMICADE situation at all. Obviously, we have indicated that that'll start to come together in late September. So by the time that is sorted through, I think we're through a lot of the year anyway. And I think that's the spirit in which we said as you think about guidance for 2010, assume that REMICADE and SIMPONI are in our portfolio for most of this year. I would just like to highlight there's a lot of pluses and minuses in any given year at the revenue line so I wouldn't go too far on that. And then long term, as we said a year ago when we announced this merger, we have thought about our long-term guidance so that the EPS guidance that we're providing is achievable with or without the REMICADE, SIMPONI portfolio just to settle those questions or concerns as people think about the financial prospects of the company. On healthcare reform?

Richard Clark

Steve, it's hard to tell yet when we think about all the details that need to be rolled out with healthcare reform, what it does long term. Having said that, though, I am optimistic because we are a company that focuses on innovation and if innovation has unmet medical needs that are being satisfied, certainly, there are patients both in Medicare and [indiscernible] not covered today that will need our medicines and vaccines in the future. There's a stronger component within the donut hole that people don't have to go off their medicines. As we continue to think about our Merck Bio ventures and Biologics in the future that the fact that we've got the type of patent protection we need from an innovation standpoint is important. The first they covered for prevention and vaccine is important. There are enough positives on one side of the equation even though there are fees and increased Medicaid rebates on the other side that you would think over time that as healthcare reform is put in place and that we are a major component to help reduce healthcare costs by innovation and by prevention, that it would be a positive for the company.


Your next question is from Catherine Arnold from Credit Suisse.

Catherine Arnold - Crédit Suisse First Boston, Inc.

I wanted to ask Dick if you can give us an update. You have made some public comments in the past about Merck's mindset on acquisitions. Now, I guess I wondered what you thought the organization [indiscernible] in regards to transaction size and timing as you move through the integration. And if you could specify whether your interest is primarily in pharmaceuticals or whether you would also be considering augmenting non-pharma or increasing your diversification. And then I had a follow-up on your dividend comment. I just wondered if you could give us a sense for your preferential interest in dividend increase versus share repurchase.

Richard Clark

Certainly from an acquisition standpoint, our focus right now has to be on execution. We have a tremendous opportunity here to bring two very important assets together from a merger standpoint and whether, as Ken said, that we're integrating from a commercial standpoint in the top 20 markets we've already integrated it across our top 12 of the 20, whether we're just bringing our network together or portfolio together, it's very, very important as we go forward. So we can't lose focus around the capabilities both on the topline and the cost standpoint around this valuable merger that we're putting together. And so that is extremely important. And then we have this very strong pipeline that we had to continue to build both internally because we have a strong late-stage development process in place. But we're always looking externally to make sure that from a licensing or an acquisitions, whether it's something that will help our individual franchises move forward, and so that support bodes well. Having said that, Animal Health, Consumer Health, what we're doing in emerging markets are very critical to us as part of our strategy, and we will continue to look at those as being an important part of organic as well as inorganic growth. I don't see diversification outside of that core as important, but as we continue to grow on the global stage, it's important that we build our global presence in many of the division I just talked about, so I think that's important. On your question concerning dividends or share buyback, they're very important to us and it's very difficult at this stage to bring the companies together on where we are from a cash flow to really tell you a priority on that.


Your next question is from Chris Schott with JPMorgan.

Christopher Schott - JP Morgan Chase & Co

First question just following up on business development. Many of your pharma peers obviously are making a big push in the emerging markets. I know Merck is doing that as well, but expanding their generic or brand generic portfolio as a way to target come of these opportunities, can you just maybe talk a little bit about Merck's efforts on this front and again interest in expanding its, again, genetic or brand generic portfolio? And then a second question on currency, can you just give us a little bit more color on what exchange rates and EPS impact is reflected in the 2010 guidance provided this morning? And I know Merck and Schering had different hedging policies. Can you just also update us on the policy of the newly combined company as it relates to currency hedges?

Kenneth Frazier

As I mentioned, we intend to spend some time next week going through our strategy. But generally speaking, I would say that we continue to look at all opportunities to have profitable growth in the emerging markets. So that includes, obviously, continuing to drive our innovative portfolio, but also we recognize that branded generics or should I say branded off patent products actually play a significant role. We have, in our own portfolio, a significant number of key brands. Let's talk about Zocor or COZAAR or FOSAMAX. Those are very significant contributors to the standard of care and they are ringing our portfolio. And one of the things that we got from the Schering merger is the capability of really driving those kinds of mature products through formulations, et cetera. So that's a big part of it. Lastly, in terms of expanding the portfolio, we do have interest in creating the kinds of partnerships that would actually also expand the number of products in the representative's bags. We have really expanded our commercial infrastructure so we look for those as of partnerships; but again, against the background of ensuring that we are driving profitable growth in emerging markets.

Peter Kellogg

This is Peter, let me talk about foreign exchange questions and hedging. So we did highlight that foreign exchange do give us a benefit this quarter and base on the current rates, we don't expect the same benefit going forward as we go through sequential quarters and that is obviously comparing to prior year. And I should remind everybody, obviously, last year was a great volatile year. Foreign exchange rates have really moved tremendously from the first quarter through the third and fourth quarters. So we have to take that all into account and that's the basis that we were saying. I think mostly that would be thinking about the current rates that are out there in terms of how we think about the outlook. In terms of hedging, we do have -- as you know, the two companies do have slightly different programs. As the merger took place, we have thought about how we put that together and I think you will see that we'll continue to use hedging as one of the tools to help us manage the business. We had about a $200 million favorable impact from foreign exchange this quarter and included a benefit from hedging of about $50 million. And so there have been some changes at the company together [ph] in terms of how we run that program. It's fairly technically really so it provides [indiscernible] too meaningful from an investor standpoint. But we do continue to believe that the hedging program is helpful to reduce the impact of unfavorable changes, taking the short term, bopping around on foreign exchange as well at because it's more of a longer term stability to devalue the U.S. dollar performance. So we think we will continue for the most part with that kind of a program going forward.

Alex Kelly

Operator, we have time for just two more questions. If I can ask the people asking questions to be brief and we'll try to be brief on our end to make sure that we get through the next two.


Our next question is from Seamus Fernandez with Leerink Swann.

Seamus Fernandez - Leerink Swann LLC

Just a quick question on the manufacturing side. Can you update us on the manufacturing situation with the vaccines and timing of when we should expect a full return to steady state in terms of vaccine manufacturing? And then separately, can you update us on what's happening with ROTATEQ versus ROTOREX, and should we expect a recovery or even an acceleration in sales? Or are you actually seeing some concerns on the part of pediatricians such that they're slowing purchases because of any safety fears?

Kenneth Frazier

I would say first of all, on ROTATEQ, we actually have not seen significant concerns arising from pediatricians about the overall safety of rotavirus vaccine. And so we anticipate being able to supply the market adequately to meet the U.S. demand during the ROTOREX temporary suspension. The overall vaccine manufacturing issues, I'll just hit the high points. Obviously, we are investing a significant amount, over $1 billion in new resources to ensure that we have long-term supply capabilities and our North Carolina facility, which exemplifies that, begins operations in mid-2010. For ZOSTAVAX, we've had it in supply since 2009, but we're now seeing back orders. No new launches planned outside of the U.S. for 2010 or 2011. RECOMBIVAX pediatric became fully available this past quarter. Pedvax HIB is now fully available in the U.S. market and we expect even our ProQuad available in limited amounts to support the back-to-school season. And also I should mention that under ROTATEQ, there will be a vaccine advisory committee this Friday and obviously I think everyone in public health will be waiting to see what the impact of those deliberation.


Your final question is from Tony Butler with Barclays Capital.

Charles Butler - Barclays Capital

Ken, you mentioned nine of 10 countries grew. Which one did not? You also mentioned seven of 10 had double digits, three did not. Can you comment which three those were? And were those out of those four countries, were they above or below plan? And then second, Peter, and I'm sorry to beat this horse, the revenue guidance you give, $45.4 billion to $46.4 billion for the year, is at the current exchange rates? Does that assume that that doesn't turn negative in the second half? I apologize to hit this again, but I just want to be sure.

Peter Kellogg

Tony, I guess the comment I was making about foreign exchange, the question simply was what's the basis of guidance. And I think at anytime we give guidance, we aren't really forecasting foreign exchange rates so it's really based on the deals place [ph] as we see it right now. And the second question was regarding how revenue will perform in the second half, I think was your question. So obviously haven't given guidance by quarter and so forth [indiscernible], but I think, what I think is fair to say is that we are launching a lot of products on the one hand. We have kind of the organic growth of our core stable of commercial products around the world. On the other hand, we do have COZAAR/HYZAAR going patent so we will see that impact particularly in the second quarter kind of pushing against our trend. In the second half, though, hopefully everything else keeps growing. So I don't want to give specific guidance by quarter at the top line, but that gives you some of the factors that are pushing one way or the other on revenue and ForEx. I think, obviously, everybody -- no one's hold up a crystal ball sort of in the field of play as we see it right now.

Kenneth Frazier

So Tony, we don't usually disclose our talk about our internal plans, but what I can tell you is that the one country in the top 10 that didn't grow this quarter was Italy. And I will say that it did miss by an awful lot getting to the point of being at least flat this quarter. Those are very difficult environments. And what I'm pointing out in Europe, often you have volume growth, but because of the pricing pressures you see not growth on the dollar basis.

Richard Clark

Thank you, Ken. And certainly in closing, we are off to a strong quarter as you can see for this year. I am extremely pleased with the progress on integration, the progress on the portfolio, the progress that we've made on the commercial side bringing the organizations together. And so I've lot of work to do yet, but from an execution standpoint and integration standpoint and the leadership standpoint, there's total alignment within the company and we can't wait to get to the second quarter. So thank you again.

Peter Kellogg

Thank you, all. Goodbye.


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