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Merck & Co., Inc. (NYSE:MRK)

Q4 2006 Earnings Call

January 30, 2007 9:00 am ET

Executives

Graeme Bell - Executive Director of IR

Richard Clark - President and CEO

Judy Lewent - CFO and EVP

Analysts

John Boris - Bear Stearns

Tim Anderson - Prudential

David Risinger - Merrill Lynch

Michael Castor - SIO Capital Management

Jami Rubin - Morgan Stanley

Seamus Fernandez - Leerink Swann

Steve Scala - Cowan and Company

Chris Shibutani - JP Morgan

Mike Krensavage - Raymond James & Associates

Presentation

Operator

Good day, everyone, and welcome to Merck's fourth quarter 2006 earnings conference call. Today's call is being recorded.

At this time, I would like to turn the call over to Mr. Graeme Bell, Executive Director of Investor Relations. Please go ahead, sir.

Graeme Bell

Thank you, Cynthia, and good morning. Welcome to our call this morning to review our business results for the fourth quarter and full-year 2006. I'm Graeme Bell, Head of Investor Relations. Joining me on the call today is our CEO and President, Dick Clark, and Judy Lewent, our Executive Vice President and Chief Financial Officer.

Before we get into the details, I would just like to cover the logistics. On this call, we will review the results contained in the release we issued at 7:30 this morning. You can access this through the Investor Relations section of merck.com and I would remind you that this conference is being webcast live and recorded for replay later today via phone, webcast and podcast.

As we begin our review of the results, let me remind you that some of the statements made during this call may discuss certain subjects that may contain forward-looking statements as that term is defined in the Private Securities Litigation Act of 1995. These statements are based on management's current expectations and involve risks and uncertainty that may cause results to differ materially from those set forth in these statements.

The forward-looking statement may include statements regarding product development, product potential or financial performance. No forward-looking statement can be guaranteed and actual results may differ materially from those projected. Merck undertakes no obligation to publicly update any forward-looking statement whether as a result of new information, future events or otherwise.

Forward-looking statements in this call should be evaluated together with the many uncertainties that affect Merck's business, particularly those mentioned in Merck's most recent 10-K or Form 10-Q that are posted on our website. As always, we will begin with brief remarks from our senior management then open the call for questions and expect this call to last approximately an hour.

With that, I'll turn the call over and we'll begin with remarks from our CEO and President, Mr. Dick Clark.

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Richard Clark

Thank you, Graeme, and good morning, everybody. Thanks for joining us on the phone and webcast today. Today, we announced results for the fourth quarter and full year 2006 and I'm very pleased to be able to discuss them in greater detail with you this morning.

Our topline results show that we are off to a strong start in our effort to return Merck to a leadership position in the pharmaceutical industry, both in terms of financial performance as well as meeting important medical needs. Our full-year earnings per share of $2.52 in 2006 demonstrate our ability to drive sales growth while making significant changes to our business, both of which are essential to our future growth.

As many of you may have already seen in a table on the first page of today's release, our full year earnings per share of $2.52 excludes charges related to our ongoing global restructuring effort and an acquired research charge of $0.21 per share related to the purchase of Sirna Therapeutics, which we completed just before the end of the year. Including these charges, reported earnings per share for the full year 2006 were $2.03.

And for the fourth quarter, our earnings per share excluding the same items, Sirna and a restructuring charge, were $0.50, right in line with the FirstCall consensus. Including these items, reported EPS for the quarter were $0.22. These results support the remarks made at our December Analyst meeting that in 2006 we successfully set the stage for our performance in 2007, as well as continued progress towards our long-term financial targets.

I would like to take just a few moments to walk you through some of the highlights. In 2006, our products including Singulair, Vytorin, Zetia and our vaccines delivered impressive sales growth. Overall, sales rose 3% for the year and this increase was achieved despite facing the largest patent expiration in our history when we lost US exclusivity of simvastatin in June.

The impressive sales performance of our newer and in-line products, coupled with the early indications of the long success of our new vaccines and medicines like Gardasil and Januvia, speaks to the underlying strength of our product portfolio. These results clearly lay the foundation for continued success in 2007 and for our achievement of our long-term financial targets.

With an important year behind us, we remain firmly committed to our long-term goal of achieving compound annual revenue growth of 4 to 6%, including 50% of our joint venture revenues and double-digit compound annual earnings growth by 2010, excluding one-time items and restructuring charges over the 2005 base period.

Our fourth quarter EPS of $0.50 includes a charge of $123 million associated with increasing our legal defense reserves. After reviewing the actual cost incurred, and estimates of future cost, it was appropriate to charge -- to record a charge of $75 million to increase the reserve solely for legal defense cost related to the VIOXX litigation to $858 million as of December 31st. This reserve is based on certain assumptions and it represents the Company's best estimate of the legal cost that will be incurred through 2008.

Incremental to that, as of December 31st, the Company established reserves of approximately $48 million solely for its future legal defense cost for the Fosamax litigation. The reserve is our best estimate of cost through 2008.

As previously discussed, the Company is a defendant in product liability lawsuits in the United States involving Fosamax and as of December 31st, 104 cases have been filed against Merck, the majority of which are coordinated in Federal Court in New York. We do not anticipate any trials in these cases until at least 2008.

It is important to remember that Fosamax has been marketed in the US for over 10 years. Reports of ONJ are relatively rare and may occur for a number of reasons. Most reported cases of bisphosphonate associated ONJ have been in cancer patients treated with intravenous bisphosphonates, although there may have been reports with Fosamax. We are actively defending the Company in this litigation and we will continue to provide updates on the litigation as appropriate.

Let me also note that the fourth quarter EPS of $0.50 excludes net charges for site closures and position eliminations in the acquired research charge related to the purchase of Sirna. When taking these charges into consideration, our reported fourth quarter earnings per share were $0.22.

As I mentioned, we completed the acquisition of Sirna Therapeutics at the end of 2006. It is a significant acquisition because of its potential to use RNAI to completely transform the drug discovery and development process. We believe once integrated into our existing internal capability, this $1.1 billion investment, of which $466 million is accounted for as acquired research, will pay off for many years to come.

Moving on to a few other financial items. Marketing and administrative expenses, excluding legal defense costs in 2005 and 2006, increased by 21% in the fourth quarter and 9% for the full year 2006. The primary driver of the M&A increase was promotional spending, DTC spending for Gardasil and to a lesser extent, Zostavax and efforts to more aggressively support the Januvia launch. These were conscious choices made in the latter part of 2006, the response to the evolving, competitive dynamics that we felt could provide additional advantages as we have the first in class products.

While it is too early to adjust any product-specific financial guidance, we made these incremental investments in order to enhance our opportunity to better position our products in 2007 and beyond.

Reflecting our commitment to realizing efficiencies throughout the Company, and optimizing our cost structure, the component of M&A consisting of selling administration and general administration cost, which support our core operations, was flat year-to-year. Even as we launch additional new products as anticipated, this year, in continuing to build on the momentum of our successful 2006 launches, we expect that our cost containment efforts and initiatives will allow us to meet our guidance on M&A spending in 2007 and our commitment to maintaining flat M&A expenses in 2010 relative to the 2006 base, excluding charges taken to increase the legal defense reserves.

We also experienced somewhat higher than anticipated spending in our research labs, as we continued our strategy of establishing strong external alliances. In the fourth quarter alone, we closed 29 key deals including the acquisition of Sirna Therapeutics. Several end-of-year, research-based partnerships worthy of mention include Advinus Therapeutics, for developing drug candidates targeting metabolic disorders, Neuroptix using the priority technology to detect Alzheimer's disease and Idera Pharmaceuticals to collaborate on vaccine development for oncology, infectious disease and Alzheimer's disease.

Of course, all of our alliances and acquisitions reflect our commitment to invest in our future success by identifying and successfully completing transactions with companies that will enable to enhance our ability to deliver and develop differentiated products to provide real healthcare value.

During 2006, we approached a launch of our five new medicines and vaccines with intensity. The success of the early stages of our launches is demonstrating the effectiveness of our efforts to change the way Merck brings new products to market.

Gardasil is just one early success story. Gardasil is the only available vaccine to protect against cervical cancer caused by HPV. To date, it has been an approved for use in 52 countries, all under accelerated review and regulatory applications are pending in more than 50 countries around the world. I am pleased to report that our fourth quarter sales of Gardasil, as recorded by Merck, reached $155 million.

Another is Januvia, our novel new mechanism for treating type 2 diabetes. Sales of Januvia in the fourth quarter exceeded $42 million and last week we received a recommendation for approval in the European Union. Including the 27 countries in the EU, we now anticipate approval for Januvia in at least another 55 countries in 2007.

Our performance during the fourth quarter and throughout 2006, together with our ongoing strategic initiatives, reinforces our confidence in the financial targets we have provided for 2007. Today, we are reaffirming our full-year 2007 guidance of $2.51 to $2.59 excluding the restructuring charges related to site closures and position eliminations and one-time items and we anticipate reported full-year 2007 EPS of $2.36 to $2.49.

So, while all of us at Merck are firmly focused on what we have to achieve in 2007 and to build on momentum generated in 2006, this results being reported today increases my confidence that we are on track to deliver the results we promised for 2010.

Now, I would like to turn the phone over to Judy who will comment on more details of Merck's fourth quarter and full year 2006 results. Following that, we'll be happy to take your questions. Judy?

Judy Lewent

Thank you and good morning. As Dick said, we are pleased that our full-year reported results were consistent with our previously disclosed guidance. Our earnings in the quarter from ongoing operations were driven by topline revenue growth that reflects the rapid early uptake of Januvia and the continued strong growth of our new first-in-class vaccine, Gardasil. As usual, I'll go into more detail about the important underlying drivers of our performance and explain why we remain confident in reaffirming our financial guidance for 2007.

To summarize the quarterly performance. For the fourth quarter, our in-line franchises and the vaccines launched in 2006 exhibited strong growth, and when taken together, their performance more than offset the revenue impact of the loss of marketing exclusivity for Zocor and Proscar in the United States.

We also saw continued strong performance of our partnerships and alliances, specifically Merck Schering-Plough, resulting in increased equity income from that partnership. As mentioned, the impact of these positive revenue contributions were partially offset by important choices made in the latter part of 2006 to increase product support which we hope will provide continued growth to our key products in the future.

Dick mentioned several of the highlights of the quarter and full-year results a moment ago, so to build off that in the fourth quarter, we saw revenue of $6 billion. That represents a 5% increase over the same period last year including in the aggregate, an overall 2% decrease from price offset by 6% growth in volume and 1% positive impact of foreign exchange.

Collectively, worldwide revenue of Merck's products was consistent with our expectations. For the quarter alone, we saw the anticipated decline of Zocor and Proscar in the US, as well as a decline in Fosamax outside the US where there is access to other alendronate sodium products.

However, these declines were more than offset by the positive performance of our other products. Singulair showed strong, global growth as it continues to experience robust demand, driven by continued strength in the asthma and allergic rhinitis markets. Cozaar and Hyzaar increased 11% year-over-year. In addition, total sales of Merck's other promoted medicines and vaccines were collectively $2 billion for the fourth quarter, representing a 25% increase as compared with the same period in 2005.

A major contributing factor to the strong growth came from our vaccines business. Collectively, vaccine revenue as recorded by Merck was $683 million in the fourth quarter and $1.86 billion for the full year 2006. Vaccine sales were driven by the continued uptake of Gardasil, Rotateq, ProQuad and Zostavax. In the fourth quarter alone, our four newest vaccine products collectively accounted for $340 million of revenue.

To assist in your modeling, we continue to provide a breakdown of the new product revenues on our other financial disclosures. We're extremely pleased that global sales, as recorded by Merck of Gardasil in its second full quarter continue to grow and reached $155 million. Since launch, we have recorded revenue of $235 million.

Recording the source of business for Gardasil, initial data indicates that it is distributed across physician specialties with the breakdown among physician type, be it OB/GYN, pediatricians, or PCPs, being relatively equal. We are also pleased to note that we see rapid uptake across the indicated age group.

To date, Gardasil has broad access on US managed care formularies. Managed care plans representing more than 96% of covered lives of girls and women age 9 through 26 have implemented coverage of Gardasil on their respective formularies.

As you know, in the fourth quarter, we launched Januvia in the United States, our first-in-class DPP-4. We are pleased with the early uptake of Januvia, reflecting the powerful efficacy and overall clinical profile of the product. In the fourth quarter, global sales reached $42 million.

The strong launch performance was largely a result of the compelling prescribing information approved for Januvia. The very early availability of the product in pharmacies, and the rapid initiation of promotional and educational activities directed as physicians, patients and payers. To date, Januvia has broad access on US managed care formularies. Januvia is on tier-one or tier-three coverage for the majority of reimbursement lives. And we are very pleased that Express Scripts, which manages over 50 million lives, has added Januvia to its national formulary in January, second-tier, unrestricted.

Januvia has been well received by both primary care physicians and endocrinologists. New prescription share among endocrinologists, a leading indicator of market uptake, has already surpassed the TZD metformin and sulfonylurea metformin six dose classes. One in two endocrinologists has already written a prescription for Januvia. Regarding the source of business for Januvia, initial data indicates it is distributed across new, add-on, switch and continuing patients. And I just want to modify that Januvia is on tier-two and tier-three in formularies.

Januvia use also appears to be well distributed across disease severity as represented by use in Mono therapy, as well as use with one, two or more oral anti-diabetic agents and/or insulin. We see Januvia is being used with all other major classes of oral anti-diabetic agents in proportion to their respective market shares.

Two other notes about revenues for the quarter. During the quarter, Merck recorded revenue associated with the doctor-ready authorized generic arrangement for simvastatin of approximately $130 million. Please note Merck records revenue on the topline as part of other revenue and not within our branded Zocor revenue.

As you know, the 180-day first filer generic exclusivity period for simvastatin and finasteride ended in December 2006, and we don't expect to see material additional revenue from this relationship in 2007. In addition, but not related to that, as part of the manufacturing network reconfiguration of our new supply strategy, we recorded a nonrecurring supply revenue of approximately $150 million as part of other revenue.

Full year 2006 revenue was $22.6 billion, representing an increase of 3% when compared to 2005. This 3% increase was a function of volume growth with zero contribution coming from exchange or price.

Also contributing to our topline, our revenues from our alliance is primarily AstraZeneca LP. In the fourth quarter, revenue recorded by Merck from the Company's relationship with AZLP was $568 million. For the full year 2006, we recorded $1.8 billion, reflecting strong growth of 9% over full year 2005.

As always, keep in mind that there is inherent variability relating to this revenue given that Merck is not actively managing these products. Our revenue recognition takes into account inventory levels at AZLP for PPI and non-PPI products, as well as their product shipments. As we have stated previously, we have the opportunity to capitalize on our robust product portfolio and deliver compound annual revenue growth through 2010.

Despite the patent expirations that we all know will occur during this timeframe, we continue to expect that our in-line products, our launch products, and our potential new products, if approved, can drive revenue growth of 4% to 6% on a compound annualized basis, including 50% of the revenues of the joint ventures from the 2005 base.

Taking the fourth quarter revenue announced today and adding 50% of the revenues from the Merck/Schering-Plough, Merial, Sanofi Pasteur MSD, and Johnson & Johnson and Merck joint ventures and partnerships, revenue was $7 billion. If you do the same adjustment in the base period, the revenue growth was 8%. On a similar basis, the full year increase was 6%.

Regarding 2007, we are reaffirming guidance for all components of total revenue. As always, the AZLP guidance is an update based on recent results as well as future expectations and reflects the dynamics of the PPI market, multiple generics, OTC products, and the uncertainty these create with regard to future volume and pricing. Also keep in mind that our reaffirmed guidance incorporates the expectations of the non-PPI products, such as Atacand, Plendil, Lexxel and Entocort.

As we move into the next three lines on the income statement, recall that they include the consequence of FAS 123(NYSE:R) or expensing of stock options consistent with where payroll costs are incurred. In the fourth quarter of 2006, our total stock option expense was $45 million, resulting in a full year expense of $228 million.

Moving down the P&L, materials and production came in at $1.7 billion for the quarter and $6 billion for the year. The quarter and the year include $164 million and $736 million, respectively, for costs associated with the global restructuring program, primarily related to accelerated depreciation and asset impairment costs.

Excluding these costs, materials and production increased 16% for the quarter and 6% for the year. The gross margin in this quarter was 72.4%, reflecting a 2.7 percentage point unfavorable impact relating to the restructuring costs. Excluding restructuring charges, the fourth quarter PGM of 75.1% was consistent with the PGM recorded in the third quarter.

For the full year, our gross margin was 73.5%, which reflects a 3.3 percentage point unfavorable impact relating to restructuring costs. It also includes $4 million and $24 million for the quarter and full year, respectively, recorded in accordance with the adoption of FAS 123(R).

Just as in previous periods, these results were affected by the final product mix. When adjusted for restructuring, the PGM was within our disclosed guidance range. Given this result, we are comfortable with our full year 2007 guidance range, and we are reaffirming that our product gross margin is estimated to be approximately 74% to 76%.

This guidance, which is consistent with the actual PGM reported in the second half of 2006, excludes the portion of the restructuring cost that will be included in product costs and will affect reported PGM in 2007.

On marketing and administrative, fourth quarter expense came in at $2.3 billion, which is an increase of 10% over the same period last year. Per our financial footnotes in today's press release, this includes charges of $123 million related to legal defense reserves which consisted of $75 million for VIOXX and $48 million for Fosamax and a $31 million charge associated with stock option expense.

Regarding the legal defense reserve charge, the Company accrues legal defense costs expected to be incurred in connection with a loss contingency, when such costs are probable and reasonably estimable. During 2006, the Company spent $500 million in the aggregate, including $175 million in the fourth quarter, in legal defense costs worldwide related to VIOXX litigation. This spend is reflected in the current legal defense reserve balance.

As Dick mentioned, the Company determined that it was appropriate to record a charge of $75 million to increase the reserve solely for its future legal defense costs related to the VIOXX litigation to $858 million at December 31, 2006.

Some of the significant factors considered in the establishment and ongoing review of the reserve for the VIOXX legal defense costs were as follows: the actual cost incurred by the Company up to that time, the development of the Company's legal defense strategy and structure in light of the scope of the VIOXX litigation, the number of cases being brought against the Company, the cost and outcomes of completed trials, and the most current information regarding anticipated timing, progression and related costs of pretrial activities and trials in the VIOXX product liability lawsuits.

Events, such as scheduled trials that are expected to occur throughout 2007 and into 2008, and the inherent inability to predict the ultimate outcomes of such trials, limit the Company's ability to reasonably estimate its legal costs beyond the end of 2008. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves.

The Company has not established any reserves for any potential liability relating to the VIOXX lawsuits and the VIOXX investigations. We continue to believe that every case contains a unique set of facts and the appropriate strategy is to defend these matters on a case-by-case basis.

As Dick said, marketing and administrative expenses excluding legal defense costs in 2005 and 2006 increased by 21% in the fourth quarter and 9% for the full year 2006. The full year 2006 marketing and administrative expense growth excluding legal defense reserves was within our disclosed guidance range.

As Dick described more fully, this underlying level of spend reflects activities required to support the launches of our recently-approved products and vaccines, to continue to support our in-line products and to maintain the ongoing needs of the business.

Regarding guidance, we're continuing to provide it on the change in marketing and administrative expense relative to the base period excluding one-time items to help your modeling and we are reaffirming our full year 2007 guidance.

That is, we anticipate marketing and administrative expense to increase between 0 and 2 percentage points over the full year 2006 level. The 2006 marketing and administrative expense level referred to excludes the charges taken during 2006 related solely to future legal defense costs of VIOXX and Fosamax litigation.

Regarding research and development, expenses were $1.7 billion for the quarter and $4.8 billion for the year, an increase from the comparable periods in 2005 of 55% and 24%, respectively. Fourth quarter R&D expense includes a $466 million charge for acquired research associated with Sirna. Excluding the Sirna charge and the full year restructuring charges of $57 million, research and development expenses grew 11% for the year.

During 2006, Merck entered into a total of 50 licensing agreements reflecting our strategy of establishing strong external alliances and made three targeted acquisitions in order to drive both near and long-term growth.

As we move into 2007, Merck is in discussions with over 40 companies regarding potential transactions and is also actively monitoring the landscape for a range of targeted acquisitions that meet the Company's strategic needs. We are reaffirming our 2007 guidance for research and development expense and anticipate it to increase at a low to mid single digit percentage growth rate over the full year 2006 level.

The 2006 level to which we are referring includes the $296 million acquired research charge relating to GlycoFi, but excludes the impact of the acquired research charge relating to the Sirna acquisition. The full year 2006 level excludes the portion of the restructuring costs that are reported in research and development expense.

Moving on to restructuring, total costs associated with the Company's global restructuring program were $221.5 million in the fourth quarter and $935.5 million for the full year. As previously stated in 2006, over 70% of the full year pre-tax restructuring costs were non-cash relating primarily to accelerated depreciation for those facilities scheduled for closure. These costs are displayed on the P&L lines in which they were incurred.

We provide this breakout to assist in tracking the restructuring-related expenses and to ensure fair comparisons of the underlying business. This line captures primarily the separation costs and, in accordance with GAAP accounting, it also includes asset related dismantling cost, demolition expenses, cost to relocate assets being put to alternative use and any gains on facility sales.

Remember, any accelerated depreciation associated with our global restructuring program is being reported in the respective line items, namely materials and production, and R&D. So in our fourth quarter results, the restructuring cost line reflects $56 million of costs related to the global restructuring program for employee separation and other related costs associated with the approximately 900 positions eliminated, bringing the total to 4,800 to-date in the global restructuring program.

Therefore, we remain on track to eliminate 7,000 positions by the end of 2008. Accordingly, we are reaffirming our guidance for 2007 as part of the Company's restructuring of its operations, additional costs related to site closings, position eliminations and related costs that will be incurred in 2007. The aggregate 2007 pre-tax expense related to these activities is estimated to be $300 million to $500 million.

In reviewing equity income from affiliates, you will see $584 million in the fourth quarter income related to the contribution from all of our joint ventures. Fourth quarter 2006 equity income was flat compared to fourth quarter 2005. This result reflects the continued success of the Merck Schering-Plough cholesterol franchise in the US and Europe, offset by lower contributions from AZLP and the seasonality of the Merial animal health business.

For the full year 2006, equity income from affiliates is up 34% at $2.3 billion with several of the JVs driving the strong performance, and this was consistent with our disclosed guidance. I would remind you that there are several components to the AZLP equity income which make it inappropriate to draw significant conclusions just based on PPI products. There are complexities that involve, at a minimum, timing and tax differences.

That said, the full-year equity income contributions from Merck's share of the partnership with AstraZeneca LP was $784 million, representing a decline of 6%. Regarding the Merck Schering-Plough partnership, the fourth quarter combined MSP cholesterol franchise global revenue, as reported by the Merck Schering-Plough partnership, continued to grow to $1.1 billion.

In the fourth quarter, revenues of Zetia and Vytorin were $536 million and $553 million respectively. Full year revenue of this franchise exceeded $3.8 billion. Within Merck's full-year equity income result, the Merck Schering-Plough partnership contributed $1.2 billion and that reflects a 114% increase over the prior year. The balance of equity income comes from our other joint ventures, namely Merial, Sanofi Pasteur MSD, and Johnson and Johnson Merck.

Again, Merck's 50% of the revenues of the Merck Schering-Plough, Merial, Sanofi Pasteur MSD and Johnson & Johnson Merck joint ventures and partnerships total $3.6 billion in 2006 up from $2.8 billion in 2005. We are reaffirming our guidance for full year 2007 and continue to expect equity income from affiliates to be approximately $2.6 billion to $2.9 billion.

Turning to other income, within this line, interest income continues to come in at a higher level as a significant portion of our portfolio benefits from the short term rate environment. For the quarter, income before taxes was $912 million. Taxes on income in the period were $438 million and the reported tax rate was 48%. But included in the effective tax rate was an unfavorable impact related to the acquired research expense for the Sirna Therapeutics acquisition, and that equates to 16.2 percentage points.

The full year underlying effective tax rate, excluding the tax rate income of restructuring cost and Sirna, was 27.7%. This reflects, in general, the changes in foreign and domestic mix and currency fluctuations and these elements change throughout the quarters. We are reaffirming our full year tax rate and I would direct you -- that is for 2007 -- and I would direct you to today's press release for the details.

Moving to net income and earnings per share. Net income for the quarter was $473.9 million, down considerably when compared to the same period last year. But remember that in this period we have taken a number of charges. For the full year 2006, net income was $4.4 billion or down 4% over the prior year and, of course, this result is affected by all the factors I just described. During the quarter, we spent $250 million in treasury stock and now have $6.5 billion under the current authorization from the Board with -- remaining with no time limit.

In summary, earnings per share for the fourth quarter were $0.50, including the legal defense reserves of $123 million, but excluding both a net $0.07 charge for site closures and position eliminations primarily associated with the global restructuring, and a $0.21acquired research charge related to the acquisition of Sirna. Our reported fourth quarter EPS were $0.22.

For the full year 2006 earnings per share were $2.52 excluding $0.49 related to the global restructuring program and the acquired research charge for Sirna Therapeutics. Our full year 2006 reported earnings were $2.03. That is including the $0.28 related to the global restructuring program, the $0.21 for acquired research charge for Sirna and the $721 million of charges to increase or establish legal defense reserves compared to $2.10 for the full year 2005.

Now, let me turn briefly to our guidance. I have mentioned this several times as part of the results review, but as you will see in today's release, we are reaffirming all the elements of our 2007 guidance and all of the details of the guidance are provided to you in the earnings release.

Given these guidance elements, Merck anticipates full year 2007 EPS of $2.51 to $2.59, excluding the impact of the restructuring charges related to site closures and position eliminations. Merck anticipates reported full year 2007 EPS of $2.36 to $2.49. As stated, this guidance does not reflect the establishment of any additional reserves for any potential liability relating to the VIOXX litigation.

Regarding the first quarter of 2007, Merck believes that as a principle, there is value in providing quality financial guidance because it assists investors and promotes strong capital markets. We also recognize that our business is complex and we serve our investors well by communicating our financial performance expectations. As a result, we are committed to providing quality full year guidance and updating it during the year.

That being said, we also recognize that our business profile currently has many factors that impact the variability of individual quarters. In the first half of 2007, we faced the annualization of the loss of marketing exclusivity for simvastatin.

In addition, while we are very pleased with the initial successes of the 2006 launches, you all know there is inherent variability of the timing of new product approvals, the need to prepare for their launches as well as the uptake of recently-launched products.

Therefore, we believe it is prudent not to try to give specific EPS guidance for the first quarter of 2007. As this year progresses and we gain more clarity on the many opportunities we have, we will evaluate the best way to provide you with insight into our progress towards our annual financial guidance.

In addition, as Dick noted, the Company remains on track in terms of both strategy and performance to deliver long-term double-digit compound annual earnings per share growth from 2005 through 2010 excluding one-time items and restructuring charges.

I also want to continue to emphasize that we have the financial strength to support our dividend. And we remain fully committed to maintaining it at the current level while at the same time continuing to fund our investment priorities.

With that, I'll turn the call back over to Graeme.

Graeme Bell

Thank you, Judy. We appreciate the extent of the prepared remarks. We will now open the call to take your questions. We'll take them in the order that they're received and try to get through as many as possible in the remaining time.

At this point, I'll turn the call back over to Cynthia, who will communicate instructions for the Q&A format, then introduce the first question. Cynthia, please?

Question-and-Answer-Session

Operator

Thank you, Mr. Bell. [Operator Instructions].

Your first question comes from John Boris with Bear Stearns.

John Boris - Bear Stearns

Thanks for taking my question. The first one just has to do with your return to your growth strategy here, Dick, on the manufacturing side. Obviously improving the efficiency of vaccine yields is an important part to getting back to gross margin levels or '05 gross margin levels. Can you just talk about some of the progress that [Willy B] and his team is making on that and how you see that having an impact on the progress of gross margin improvement in '07, '08?

Richard Clark

Yes, thanks for the question. I believe it's going to have a -- play an important part in it. As I said before, we have been very effective in how we approached our vaccine and biologicals to make sure that from a regulatory and an FDA standpoint and a Merck standpoint that we have been able to put the right processes in place and the right validation capabilities. And we've been very, very, very successful with that.

And our goal now is to keep that effectiveness in place and to be able to put in efficiency mechanisms in place. And the methodology that we're using now as a company is really around Lean Six Sigma.

And so in 2007 and in 2008, putting Lean Six Sigma, putting master black belts into the process within manufacturing from a biological and sterile standpoint is going to substantially improve all of the complex processes that you have in place.

And what I mean by processes, I'm not only talking about manufacturing processes. I'm talking about release of product, distribution of the product, particularly from the vaccine and biological standpoint, interfaced with research and how we've bring over new additions from the biological and vaccine standpoint.

And in addition to that, we have a new vaccine facility in North Carolina that's being finalized and built, too, which is beyond state-of-the-art. So when I think you combined all of those, that the focus on PGMs from a biological and vaccine is extremely important.

Other than just a vaccines and sterile, as you know, in the pharmaceutical business, we are leaning our plants in that -- about half of the plants leaned from the Six Sigma standpoint. Now, we are going to do the rest in 2007. And a major part of that is still external manufacturing and outsourcing. We have made the commitment that we will be outsourcing about 30% of our business.

And so in combination of having strategic partnerships with vendors who have the same quality and FDA approvals we do and substantially lower cost, combined with what we're doing in the biological and vaccine business, take that to a new level, you know, we have confidence in where we're headed with our future PGMs.

Graeme Bell

Thank you. Next question, please.

Operator

Your next question comes from Tim Anderson with Prudential.

Tim Anderson - Prudential

Thank you. I have three questions. First is can you update us on your expectations for whether states will mandate vaccination with Gardasil? When could that happen or when would we find out more about it and what age ranges would you expect?

Second question is -- it actually goes back to the TRICARE decision in late '06. I'm wondering when that affected your numbers. If I remember right, you said it didn't impact 3Q. So I am wondering if it impacted this quarter at all.

And then third question is on ProQuad and RotaTeq. Going from second quarter to third quarter of last year, you had big step-ups. But going from third quarter to fourth quarter of this year, the sequential step-up was modest. And I'm wondering if there was stocking in 3Q or if the new numbers are reflective of underlying demand or what exactly.

Judy Lewent

Well, let me just clarify the TRICARE question. We actually did speak to that, and it was a third quarter event. So we mentioned that the impact of that was reflected in our third quarter results.

Richard Clark

Tim, in your question about the state mandate, as you know, that over a period of time, that is important to us. It's is going to take time. In addition to Michigan, which introduced legislation at the end of '06, we have 10 other additional states, New Jersey, Massachusetts, Texas, California, Ohio have also introduced similar bills.

And it's is clear that a broad range of stakeholders are recognizing the value and acting with urgency on this. So we're just going to have to wait to see how it reports out. Certainly, Merck is supportive of these bills and this full requirement has provided -- prevents infectious disease. And what the age is going to be will be different by state to state.

I think with your previous question, I don't think I can add anymore from the ProQuad/ RotaTeq. It really wasn't a stocking issue. It's essentially the difference from quarter to quarter. And in the fourth quarter of '06, sales of RotaTeq were $69 million, and for the full year, $163 million.

And as you know, we had a positive ACIP vote, as well. And RotaTeq was made available to the Vaccine for Children Fund. So I don't see anything really of an issue there. And the applications for ROTATEQ have been filed in more than 100 countries. So overall, it has been approved in 34, and we've been launching in 12. And so you'll just continue to see the uptick there.

Graeme Bell

Thank you. Next question, please.

Operator

Your next question comes from David Risinger with Merrill Lynch.

David Risinger - Merrill Lynch

Yes. Thanks very much. I had a couple of questions. First of all, could you comment on why the equity income was flat sequentially between the third and fourth quarters?

Second, the Januvia number was quite large, but seemed to be well above TRXs times the price of the product. So could you comment on stocking of Januvia in its first quarter, so that we can think about how to model the first quarter of '07?

And then in terms of the tax rate, I might have missed it, but I was hoping, Judy, that you could provide a little bit more detail on how we should think about the tax rate for '07. Thank you.

Judy Lewent

So on equity income on sequential as I noted, there were some fourth quarter impacts both on the AZLP and the Merial areas and that was in my earlier remarks. As far as the tax rate for '07, we provide the guidance of 24% to 26% which obviously does not reflect any unusual items.

So any new IPR&D charges, for example, which as you know had a tax rate impact in the fourth quarter relative to Sirna and GlycoFi had an impact on the tax rate in the second quarter, clearly we're talking about on a normal for the continuing operations basis. That's our expectation and that's just the reflection of the configuration of our business.

So I know we discussed that a little bit about a month ago when we gave the guidance for '07.

Operator

Your next question comes from Michael Castor with --

Graeme Bell

Sorry, Cynthia. Can we just address the question with regard to Januvia?

Richard Clark

Yeah. Concerning the discussion around Januvia, obviously, it is too early to tell just from a stocking standpoint and an early revenue standpoint. We know we're off to an excellent start and Januvia was approved in 11 countries and the launch has been extremely robust.

We have seen strong launch performance which is really, really important to us. And as Judy said for Januvia, we're on tier two or three for coverage for major reimbursements. And we're also pleased to announce that Express Scripts, which manages over 50 million lives, has added Januvia to its national formulary in January and it's unrestricted.

So I think we'll probably need a few more months to know how you can model the Scripts versus how much of it was early stocking, but it's off to a great start and certainly from a manufacturing standpoint with Januvia, we're making sure that we see the new potential for what our forecast could be and making sure that we have the capability to support it.

Graeme Bell

Thank you, Cynthia. And next question, please.

Operator

Your next question comes from Michael Castor with SIO Capital.

Michael Castor - SIO Capital Management

Thank you. I've got two questions, please. First, I didn't entirely catch it in your prepared remarks -- you mentioned there were $150 million in supply sales. Is that inclusive of the $130 million that was from Dr. Reddy's for Symba or those two distinct numbers?

And second, probably for Dick, I'm hoping that you can talk a little bit about some products that are mature like Fosamax and Cozaar. Are those ones where all of the historical SG&A has really implanted those as key useful medicines in doctor's minds and they just need a little bit of reminding, maybe a second or third detail or, in order to maximize the dollar, do they need a full marketing spend over the last couple of years of patent protection?

Judy Lewent

Okay. So just to clarify, the $130 million from Dr. Reddy is separate and distinct from the $150 million of supply revenue. So those are two discreet elements in the fourth quarter.

Richard Clark

When you look at past history, when you're thinking about promotion and selling expenses and relationship to mature products, what we have found out is that if you minimize it to a greater extent, you can have a negative impact on revenue so you need to get the right balance of making sure that you can redirect some of your promotion and direct expense -- selling expenses to the new products like Januvia, but at the same time to make sure that you're continuing to support our products, moving forward.

I think the good news with the new commercial model that we are putting in place and with our sales effectiveness capability that we are actually able to do both of that -- we are able to get a better bang for our buck with our promotion and direct selling capability, our sales effectiveness and having our same sales reps on territory for a greater period of time and getting more calls per rep is really helping us move forward.

But you also have to remember that a product like Cozaar or Hyzaar is extremely important to us and we will continue to see growth. And I really believe the answer to all of this is two-fold. A new commercial model that we're implementing in making sure that our general administration costs across the company are flat or down in order to support new products and inline products.

Graeme Bell

Next question, please.

Operator

Your next question comes from Jami Rubin with Morgan Stanley.

Jami Rubin - Morgan Stanley

Hi. Just a couple of questions. Dick, for you, SG&A for the year was up a full 9% and you had mentioned that it was a conscious decision by the management team to accelerate spending in the fourth quarter to support new brands. But the guidance is still to keep SG&A, core SG&A excluding the VIOXX and Fosamax defense legal fees -- the guidance is to keep that flat.

So am I to assume then I should hold that $7.4 billion relatively flat between 2006 to 2010? I just wanted to confirm that that is the number of which you are basing your guidance for 2010 around $7.4, $7.5 billion.

And secondly, Judy, the question is again on the tax rate. I am just a little bit confused. In the fourth quarter, after you strip out the 16 percentage points for the acquired R&D from Sirna, I'm getting a 32% tax rate, which is well above the 26% tax rate, the average for the first three quarters of the year.

So was there anything else because obviously that is a big swing factor for earnings? Thanks.

Richard Clark

Jami, concerning your first question, $7.444 is the number that is correct. You should etch that into your model, we certainly have it etched into our minds and it is our target moving forward.

And one of the reasons we're confident in that aggressive cost management is that with the new commercial model and with a we are doing with shared services and global support functions, and looking at our marketing and medical services responsibilities worldwide and we're implementing them as we speak.

We have a great deal of confidence that with that and procurement activities and others that the $7.4 billion is the number that we are committed to and that we will hit.

Judy Lewent

And regarding the tax rate, yeah, when you exclude restructuring and Sirna impacts that is the general range that you should find yourself in and, as I noted in my remarks, there's nothing unusual in there. This is just the standard kind of fluctuations that we experience as a result of the mix of a foreign and domestic income, and currency impact.

And as I noted though, again, on the same basis, if you look at it for a full year basis, we're within our tax rate guidance. Again, there is nothing unusual in that -- its quarterly fluctuations.

Graeme Bell

Please know the time is 10 o'clock. We would just like to keep on going a little longer with the questions. So could we have the next question, please?

Operator

Your next question comes from Seamus Fernandez with Leerink Swann.

Seamus Fernandez - Leerink Swann

Thank you very much. I just have a couple of quick questions. If you can update us on the timing of the first VIOXX appeal and when you anticipate that occurring. And would that appeal if it went against Merck, would that require a booking of a charge associated with that? And then, secondly, can you just update us if it there have been any changes in access restrictions to Singulair in 2007 versus 2006 for either asthma or allergy? Thank you.

Graeme Bell

Seamus, Let me try and take the first question for you with regard to appeals process in terms of where we are. As you know, we've indicated that we are going to appeal these verdicts with regard to the first one, which is Ernst in Texas. Merck has filed an appeal and we are waiting for an appellate court date on that particular one and we don't have any indication as to when the appellate court might schedule that.

With regard to Garza, which was also in Texas, the judge entered the plaintiff to verdict and Merck has filed a motion for a retrial based on several issues. And again, we don't have any scheduled date. With regard to Conna/McDarby, New Jersey, there is a ruling that's pending with regard to that and we expect Judge Higbee to address that at an appropriate time. So we don't have any firm appeal dates at this time. It's still a work in progress.

Richard Clark

Your question about Singulair, I am unaware of any additional access restrictions going into 2007.

Graeme Bell

Next question, please.

Operator

Our next question comes from Steve Scala with Cowen.

Steve Scala - Cowan and Company

Thank you. Judy, you did a very nice job describing the VIOXX defense strategy and Merck has obviously been very successful in court. But when you took the $598 million charge in the third quarter for VIOXX defense, I thought you said that that would be sufficient through the end of 2008.

And today, you're taking another charge. So specifically, what has changed in the last three months? And secondly, the Gardasil number was very, very impressive, but what is your understanding of stocking either at the wholesalers or in physician's offices? Thank you.

Judy Lewent

So you're absolutely correct that with the third quarter charge, we said we saw the horizon for that as an estimate through 2008. But we've also noted that, as you know, we look at this every quarter based on the different factors in the evolution of the different factors.

So as I noted earlier, we have to, on a regular basis, look at what the actual costs were that were incurred, how our legal strategy is evolving, what the structure of that is in light of the scope of VIOXX litigation, looking at the number of cases that are being brought and looking at our costs and outcomes of completed trials and the anticipated timing and progression and related cost of pretrial activities.

So we have noted since we established the reserve in 2004 and beyond, we have to continue to monitor the situation. And as we get more data, we have to reflect that in our reserve. So, I hope that is helpful. As far as the stocking question on Gardasil, that's -- that's not really an issue. Recall that we basically supply Gardasil to doctor's offices and not through wholesalers -- so that's demand pull.

Graeme Bell

So Cynthia, given the time, we'll take one or two more questions.

Operator

Your next question comes from Chris Shibutani with JP Morgan.

Chris Shibutani - JP Morgan

Thanks very much. Two questions on Gardasil, I apologize if you described this. Could you give us sense of the geographic breakdown for the quarter and also to what extent are you seeing compliance with the second and/or third dose on the immunization schedule?

And then secondly, on the tax, can you give us an update on the ongoing IRS transfer tax dispute and provide us with some perspective on what kind of timing we should be thinking about to receive any updates there? Thank you.

Judy Lewent

On Gardasil, 111 million in the quarter was US and 44 million was ex-US. Let me just clarify, I believe your question on tax -- we are not debating transfer tax issues at all. So I want to be really clear about that, but if you're referencing the tax matter that we've discussed in quite a few of our 10-Qs, with the IRS, we're continuing to work with the IRS exam team to conclude this matter. But I don't have an update on that -- any further update at this time.

Graeme Bell

Cynthia, could we take the last question, please.

Operator

Your final question comes from Mike Krensavage from Raymond James.

Mike Krensavage - Raymond James & Associates

Good morning. What's the nature of the $150 million of supply payments that you received in the quarter and would you expect that to recur?

Judy Lewent

That is nonrecurring. And as I noted, that's really linked to supply agreements that we had in place that were a source out of one of the plants that was the subject of the restructuring in our supply strategy. So that is a finite event and at the end of '06, that's completed.

Graeme Bell

So, with that last question, that concludes today's conference call. The information from today's call, both the transcript and the replay, will be available on our website for the next seven days. And as usual, Mike and I will be available to take your questions all day. We certainly appreciate your interest, time and participation. Operator, thank you very much.

Operator

Thank you, ladies and gentlemen. This concludes today's Merck's fourth quarter 2006 earnings conference call. You may now disconnect.

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