Merck & Co.'s CEO Discusses Q2 2011 Results - Earnings Call Transcript

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


Good day, everyone, and welcome to Merck's Second Quarter 2011 Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn the call over to Alex Kelly, Senior Vice President of Investor Relations. Please go ahead.

Alex Kelly

Thanks, Brooke, and good morning, everyone, and welcome to Merck's 2011 Second Quarter Earnings Call. Before I turn the call over to Ken, I want to point out a couple of things. First, there are a number of items in the GAAP results this quarter such as acquisition-related charges, restructuring costs and a one-time tax benefit. We have excluded those items in our non-GAAP reconciliation tables, so you can get a better sense of the underlying performance.

Next, we've also provided tables to help you understand the revenue trends. So in our press release, you see 3 tables. First table is the GAAP results. The second table reconciles GAAP to non-GAAP P&L. And the third table provides the sales results of the company, the products and the business units. During the call, we'll be referring mostly to Tables 2 and 3 when we discuss our performance.

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

Our SEC filings, including Item 1A in the 2010 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. The SEC filings, as well as our earnings release and the tables are available on our website at

So now we're ready to begin. This morning, I'm joined by Ken Frazier, our President and Chief Executive Officer; Adam Schechter, our President of Global Human Health; and Peter Kellogg, our Chief Financial Officer.

Now I'd like to introduce Ken Frazier.

Kenneth Frazier

Thank you, Alex, and good morning, everyone. This is a time of great opportunity at Merck and our second quarter, which was strong, is indicative of the focused progress we're making to deliver on the goals I outlined for you earlier this year. This quarter, we delivered top line sales growth of 7%, driven by a strong in line portfolio and new product launches together with disciplined expense management while allocating targeted resources to fund our future growth drivers. This resulted in double-digit non-GAAP EPS growth. That is our game plan, and we are continuing to execute on all aspects of our growth strategy by maximizing our product portfolio, delivering the R&D pipeline, expanding geographically and building upon the newly renamed Merck Animal Health division and Merck Consumer Care. We're delivering this top line growth, while continuing our efforts to streamline and transform Merck's operating model.

In terms of maximizing the current portfolio, we had another quarter of double-digit growth for many of our key products such as JANUVIA, JANUMET, REMICADE and ISENTRESS. In addition, Merck Animal Health, once again, made solid contributions to our total performance. Another driver of our second quarter performance is the progress we are making in launching new products around the world. With more than a dozen product launches underway in various markets, we believe this speaks well of our ability to deliver new drugs from our research pipeline. As I said last quarter, we firmly believe that the predominant driver of long-term growth and sustainable value creation for Merck will continue to come from discovering and developing new and differentiated products that address unmet medical needs.

VICTRELIS is just such a product. It is a first-in-class protease inhibitor and a significant medical advance. As you know, the U.S. launch is underway. We are concentrating our efforts to ensure that patients are treated appropriately with the new standard of care. While many physician prescribers, thus far, have yet to initiate patients on triple combination therapy, we are encouraged both by the early demand and positive feedback from physicians, payers and patients. It is hard to overstate how rewarding it is for the Merck team to be able to bring such a significant new product to patients who need it. Our recent approval in Brazil now makes VICTRELIS the first in this new class to be approved in the U.S., EU and Latin America. Adam will speak more about the VICTRELIS launch in a moment.

Beyond the VICTRELIS approval, we've also received 3 recent approvals in Japan: GARDASIL, ZOLINZA and CUBICIN. From a life cycle management standpoint, we filed 2 applications with the FDA. The first is for an expanded indication for both VYTORIN and ZETIA, based on the data from the SHARP trial, for the treatment of patients with chronic kidney disease. If approved, this will be the first and only cholesterol-lowering therapy with proven cardiovascular outcomes for this set of patients. The second is for a preservative-free formulation of COSOPT. We've also made additional progress in the pipeline by enrolling the first patients in the 30,000-patient anacetrapib outcomes trial. As I mentioned to you last quarter, we are not in a business-as-usual mode when it comes to managing our investments in R&D. We continue to improve the decision process by which we either commit to or discontinue projects, and we're being more aggressive about prioritizing the programs, as well as the therapeutic areas where we will invest. With the number of important trials scheduled to complete in 2012 and 2013, we remain confident in Merck's late-stage pipeline, and we look forward to telling you more about our progress at the R&D and business briefing, which is planned for November 10.

While our late-stage pipeline holds great promise, we know that to become a global healthcare leader, we must tap into research and pipeline opportunities wherever they are around the world. To do that, we have to continuing our partnerships with the right companies. One such example is our strategic collaboration with Hanwha Chemical Corporation. Under the terms of this agreement, Hanwha and Merck will work together to develop and commercialize a biosimilar form of Enbrel, one of the leading biological products on the market today. This unique collaboration is entirely consistent with our approach to allocating investments across R&D segments that reside at different points on the risk-reward continuum. This enables us to better balance risk and timing within our overall portfolio and maximize the value of our pipeline and in-line product assets. Biosimilar candidates, for instance, can provide Merck with a solid return on investment with less product development risk relative to an unproven mechanism. Overall, we remain on track to have 5 biosimilar candidates in late-stage development by the end of 2012.

Another key aspect of our growth strategy is geographic expansion. Just last week, we announced an agreement with Simcere Pharmaceutical Group in China. This partnership leverages our marketing capabilities and Simcere's broad reach in China's emerging cities to increase access to medicine, while providing potential for near-term commercial benefits to both companies. Overall, this agreement increases Merck's presence in China while also helping us to operate in this must-win market, with margins consistent with the profitable growth strategy. Meanwhile, we are seeing strong year-over-year growth of 30% in China.

Moving on to operations. This is a time of ongoing transformation as we reshape our company to adapt to our changing environment while becoming more lean and nimble. We remain on course to achieve our $3.5 billion target merger cost savings by the end of 2012. We remain on track. Beyond this, however, we believe we need to do more. As I've said previously, we are committed to growing our company. To do that, we are moving on from our initial merger integration target to focus even more aggressively on reducing our cost structure so that we can continue to invest in profitable growth.

Therefore, today we announced a new phase of our merger restructuring program, which we first began in February of 2010. The program is designed to further optimize our cost structure. Here are the highlights of the phase we announced today. We plan to reduce our combined workforce by an additional 13% by 2015. These planned job reductions will come disproportionately from the elimination of non-revenue generating positions such as administrative and headquarters personnel, consolidation of office facilities and ongoing sale or closure of manufacturing sites, including Animal Health facilities. Importantly, at the same time, as we are reducing our overall employee base, we have been hiring and we'll continue to hire in key areas like emerging markets where we have significant growth opportunities before us.

We also expect to realize additional annual cost savings of $1.3 billion to $1.5 billion. My intent is that most of this will drop to the bottom line through a combination of investments that produce top line growth and reductions in our operating cost base by the end of 2015. Depending on the opportunities in front of us, we will reinvest some of the savings whenever the returns justify the investment to drive longer-term growth and profitability. This will enable us to boost both near- and longer-term profit margins and ensure that we can be fast and flexible in capitalizing on the best growth opportunities whenever they arise.

For our people, this won't be easy, but the realities of our environment dictate the need to operate more flexibly and nimbly from a lower cost base. We are taking these difficult actions now so that we can grow profitably and continue to deliver on our mission well into the future. By improving the effectiveness and efficiency of our operations and focusing on ways to deliver customer value through innovation, we are positioning Merck for sustained profitable growth.

In closing, Merck remains totally focused on growing both the top and bottom line. Our results demonstrate our ability to do just that, as well as advance the pipeline and establish innovative partnerships, which will support our growth strategy. I believe we are well positioned to continue accelerating our momentum, leveraging the benefits of the merger and delivering on our mission to discover, develop and provide innovative products and services that save and improve lives around the world.

Thank you for listening, and I'd like to now turn the call over to Adam.

Adam Schechter

Thank you, Ken, and good morning, everyone. It is a pleasure to speak with you today and provide you with an overview of the performance of Global Human Health. Global Human Health had another strong quarter, with revenue growth of 7.5% or 3%, excluding the impact of foreign exchange. The acceleration of our Human Health top line sales to $10.4 billion was driven by growth across all regions and double-digit growth for several of our largest products. We are continuing to execute on our commercial growth strategy, that I discussed last quarter, and we're doing that through the following: growing our core business, expanding our core business and accelerating new launches such as VICTRELIS. We will do this while making smart and timely investments in the growth opportunities before us and by focusing on the needs of our customers.

So first, let me focus on what grew in the core business, which includes the largest most developed markets. I'll start with the United States. The United States represents about 40% of our pharmaceutical and vaccine sales. U.S. sales grew 2% year-over-year and were driven by double-digit growth from our diabetes, infectious disease, neuroscience and vaccine businesses. Our core brands such as JANUVIA and ISENTRESS continued their consistent, strong growth. This quarter, we also had solid contributions from GARDASIL and better supply levels of ZOSTAVAX, which is encouraging. The fast growth of these brands was offset by lower sales in our respiratory franchise, due to a slow allergy season and lower U.S. sales for our cholesterol franchise. The overall positive performance in the United States shows the benefits of having a strong portfolio of diverse brands in multiple therapeutic areas.

Moving to Europe and Canada. Sales were up 9% this quarter driven by double-digit growth of our diabetes, immunology and infectious disease franchises; the favorable impact of foreign exchange; and the impact from movement in inventory ahead of our SAP implementation in Europe. The growth was achieved despite approximately $250 million of unfavorable impact from EU austerity measures, generic erosion and a return of SUBUTEX and CAELYX. We continue to see the EU as an area of long-term opportunity for differentiated brands, despite many of the macro challenges in the individual markets.

Moving on to other areas of growing the core. There are several brands that standout as examples of winning through differentiation and execution. Let me start with JANUVIA and JANUMET, which grew 35% this quarter. With only 5 years on the market, the JANUVIA and JANUMET franchise is our second largest franchise and now has 26% market share in the global branded oral anti-diabetes market. We are investing globally and locally in JANUVIA and JANUMET to ensure we continue to grow the business and capitalize on all market opportunities. We are also investing in life cycle management as we have multiple fixed-dose combinations under regulatory review.

Moving to SINGULAIR. Sales grew 8% driven by the strong growth in Japan and U.S. pricing, which is offset by a lighter-than-expected allergy season in the United States, as well as austerity measures in Europe and Turkey. In immunology franchise, strong REMICADE sales with about 26% year-over-year growth were driven largely by class-leading share of the gastrointestinal indications. We are enthusiastic about the opportunities ahead for REMICADE as we leverage our robust life cycle management platform and grow the brand in the retained markets. As a reminder, as of July 1, we have retained territories representing about 70% of our 2010 REMICADE sales as part of our arbitration settlement. In the markets that we are retaining, Europe, Russia and Turkey, REMICADE sales were $552 million.

Combined sales of VYTORIN and ZETIA were flat in the quarter as sales growth in international markets offset declines in the United States. The international performance was driven by growth in Japan and the emerging markets. This quarter, we also submitted supplemental applications to the U.S. and European authorities for the use of VYTORIN and ZETIA in the treatment of patients with chronic kidney disease based upon the findings from the soft trial.

Now I'd like to discuss how we're expanding the core. As part of expanding the core strategy, we are making plan and opportunistic investments to grow our business in the fastest-growing markets, the emerging markets and Japan. In the second quarter, we invested in excess of $100 million more in emerging markets than we did last year and those investments are paying off. I'll start with the emerging markets, which grew 10% to $1.9 billion in the quarter and contributed 18% of our total GHH sales. The growth was driven by the top 6 markets, which grew a combined 12%. We continue to see the benefits of our strategy and investments in high-growth markets like China and Korea.

In China, sales were $206 million, growing 30% driven by the infectious disease and respiratory franchises. Our growth in 2011 has consistently exceeded market growth and is being driven by the top 10 products, which account for 90% of the sales and growth in China. One of the opportunities we have is to expand our reach with our core brands in China, and we believe it's important to partner with a local Chinese company. Therefore, we've entered into important partnership with Simcere. This JV will give us greater reach and a broader portfolio in the fast-growing cardiovascular market in China. Unlike some deals, which take time to develop, we believe the Simcere partnership will provide immediate benefits in 2012 that will build over time. We look forward to building the JV with our partner and for looking for further opportunities to expand the JV in the future.

We're also expanding the core by investing in Japan, which grew 23% to $1.1 billion in the quarter. The performance in Japan was driven by the strong growth of JANUVIA, SINGULAIR and ZETIA, as well as solid contributions from new launched brands such as BRIDION. We look forward to launching GARDASIL, CUBICIN and ZOLINZA, which were all recently approved in Japan. We're building a strong track record of launch excellence in Japan, and we have high expectations for bringing these new life-saving products to patients and physicians.

It's not only Japan where we're accelerating new launches. In total, we now have more than 12 products launching around the world, which together contributed more than $350 million to the top line this quarter. I'll share some insights from 2 of our key launches VICTRELIS and SIMPONI. For VICTRELIS, we're pleased with the execution of the U.S. launch. Given the particular dynamics of this market, the differences in the length of treatment, 4-week lead-in and the use of specialty pharmacies, many of which do not report data to IMS. Tracking weekly IMS data cannot yet paint a complete picture of performance. It's still early, but we expect to be able to share more robust data with you in the third quarter call when the launch will be further along. There are, however, some insights we can share that make us confident that the launch is off to a strong start. Managed care is providing coverage along the lines we expected. In Tier 3 for most commercial accounts and Tier 4 for Medicare Part D, although most plans have not yet completed their formal reviews. We had a good level of initial orders at the launch, and we're already seeing reorders from customers. And the feedback from the field has been very positive. It increases our confidence in the uptake of VICTRELIS in the United States.

In the EU, as you saw last week, VICTRELIS, again, was first to market, which is important as we head into the second half of the year and help ministries make reimbursement decisions. I was in Paris for the global launch meeting a few weeks ago, and I can tell you the team is ready to go. The team is ready to launch in emerging markets as well. Brazil became the first of these high-growth markets to approve VICTRELIS just last week. This is one of the top markets for PEGINTRON, so we expect to have a strong position in Brazil with both physicians and payers. And now that we have agreements in place with Roche in both the United States and other markets, we'll have deeper reach to support the launches of VICTRELIS around the world.

For SIMPONI, we have more robust data to provide. We've already launched in 21 markets where Merck has retained commercial rights, and we're doing very well. We are exceeding the performance of others in the class and generating great momentum as we head into the second half of the year. In some countries, market share is already above 7%. And in many markets, our market share is greater than the 2 most recent competitive launches. While there've been supply issues on the auto-injector, we expect these issues to be resolved by next year and we have enough pre-filled syringes to meet demand.

In the territories that were retained as part of the J&J arbitration settlement, our combined immunology business with both REMICADE and SIMPONI generated $611 million and about 70% of the growth in total of the franchise. Looking at the broader group of new product launches, we see at our current pace the new product launches are expected to contribute in excess of $1 billion in incremental revenue in 2011. Therefore, accelerating new launches continues to be a very important element of our growth strategy.

So in summary, we had another strong second quarter, and it's clear that our focus is on driving profitable top line revenue growth. And we did that in the second quarter. We will continue to elevate our resources and evaluate them to ensure that we are funding the right growth opportunities in a very targeted manner, and we will continue cutting costs where possible and appropriate. We look forward to updating you on our progress and performance throughout the year.

And now I'd like to turn it over to my colleague, Peter Kellogg.

Peter Kellogg

Thank you, Adam, and good morning. As you heard from Ken and Adam, we continue to execute on our growth strategy. This quarter, we grew the top line 7% and non-GAAP EPS 10%, and we continue to make strategic investments necessary to fuel future growth, as Ken mentioned. Based on this performance, we are reaffirming our full year top line targets and raising the midpoint of our non-GAAP EPS target range. My remarks today will focus on our non-GAAP results, which exclude acquisition-related charges; restructuring charges, including those related to the announcement today; and a onetime tax benefit following the conclusion of an examination of certain prior U.S. federal returns.

Now let's get into the results, starting with revenue. Total revenue for the quarter was $12.2 billion, 7% above a year ago. While ForEx benefited revenue this quarter, excluding this ForEx benefit, revenue grew 3% over prior year. As Adam said, our key brands and markets, including the emerging markets and launch products, all contributed to this growth. As you can see from the year-to-date sales growth of 4%, we are right on target to meet our low to mid single digit revenue growth target for 2011. We remain confident in our top line performance and our ability to achieve growth this year, even overcoming the J&J settlement that took effect on July 1.

Now let's talk about expenses starting with product costs. Our non-GAAP product gross margin of 76.7% in the quarter benefited from product mix and manufacturing efficiencies. For example, we continue to drive growth of JANUVIA and produced the higher volume of ZOSTAVAX, while our manufacturing team continued to drive efficiencies that reduced product costs.

Moving on to M&A. Marketing and administrative expenses of $3.4 billion were up over the second quarter of last year. As we said earlier in the year, we are continuing to realize cost reductions, enabling reinvestment and opportunities for growth.

Let me take a moment to provide you with more detail on M&A. This quarter's expense reflected 4 items that added over $300 million when compared to the same quarter last year. First, the unfavorable impact of ForEx was the largest item. Second, we made over $100 million in incremental investment in emerging markets versus the prior year. Third, we invested in the success of our launch brands, most notably VICTRELIS. And lastly, the healthcare reform fee added to our expenses this quarter. These items account for the entire increase versus prior year. Given current spot rates and our continued plans to make targeted investments in growth of new products and emerging markets, you should factor these items into your assumptions for the rest of the year.

Moving on to R&D. Research and development expense of $1.9 billion was below second quarter 2010. We continue to invest in our most promising opportunities and continue to advance the late-stage pipeline. This quarter we are, once again, lowering the top end of our 2011 R&D target range by $100 million to a new range of $8 billion to $8.3 billion. This range reflects our continued focus and financial discipline as we strive to improve the ROI of our ongoing R&D operations.

Moving to tax. Our non-GAAP tax rate was 24.3% in the second quarter. There are a number of items contributing to the rate this quarter. First, we just completed the U.S. federal review for years 2002 to 2005. As a result of that, we increased our FIN 48 reserves on a few item. Second, there was a discrete item in the second quarter that will not reoccur in future quarters. And third, the rate was affected by product mix. As a result of these items, we are updating our anticipated tax rate for the year to a new range of 23% to 24%. Non-GAAP EPS for the second quarter was $0.95 per share, up 10% over the same quarter in 2010. Our 2011 non-GAAP EPS range is now $3.68 to $3.70. The new 2011 GAAP EPS range is $1.95 to $2.17. As we look to the balance of the year, we do expect that the fourth quarter will be stronger than the third quarter.

So to wrap up my comments about the second quarter, the quarter was characterized by operational sales growth and continued cost efficiencies, which enabled us to fund strategic investments in new product launches and emerging markets and still grow non-GAAP EPS by 10%. Now we have been very aggressive at taking out costs since the merger. I am pleased to tell you that we are right on track to achieve our $3.5 billion merger synergy target. The reality is we need to do more. We want to position ourselves for sustained and profitable growth well into the future. Today, we are announcing plans to further streamline our operations and reduce our cost base. These plans include further reducing headcount by an additional 12% to 13% beyond our previous target of 17% and further reducing the number of manufacturing sites, including Animal Health sites and the consolidation of other facilities. These will generate an additional $1.3 billion to $1.5 billion in annual savings by the end of 2015.

So in summary, what you've heard from Ken and Adam and myself is that we are executing on our growth strategy in 2011. With the additional efforts we announced today, we continue to demonstrate our commitment to driving out inefficiencies in our cost structure, while making the right investments necessary for growth. This quarter, we received approval for 4 new innovative medicines in the U.S., the EU and Japan; and we launched VICTRELIS in the U.S. We also continued investment in key growth areas such as the emerging markets. We entered into important external collaborations with Simcere and Hanwha, and we delivered growth on the top line and double-digit growth on the bottom line. Thank you.

Now I'll turn the call back over to Alex.

Alex Kelly

Thanks, Peter. And now we're ready to open up the call to answer your questions. [Operator Instructions] So Brooke, we're now ready to begin the Q&A.

Question-and-Answer Session


[Operator Instructions] Your first question comes from Catherine Arnold with Crédit Suisse.

Catherine Arnold - Crédit Suisse AG

I have 2 questions. One I wanted to ask if you could give us a directional sense for what pricing of VICTRELIS will be in Europe and Latin America relative to the U.S., even if you can't give specific pricing, just a directional sense. And then secondly, Ken, you talked about the 5 biosimilars that you expect to be in late-stage development next year, and I was wondering if you could give us an update on where Merck stands right now as far as the current capability to manufacture biosimilars and to the extent you'll need external capabilities, how do you see that market opportunity?

Adam Schechter

Catherine, I'll answer the first question. So giving you a directional sense of the pricing of VICTRELIS, it's going to be about the same as that in the U.S.

Kenneth Frazier

And on the biosimilars question, first of all, we'll have a lot more about -- to say about this in November, but let me assure you that we are working to ensure that we have in place all the capabilities necessary to succeed in this marketplace. We realize that it's important for us to get these products to market early on and that means that we have to have all aspects of our production chain in place.

Peter Kellogg

And Catherine, I would just note that we have identified 3 of the programs already in biosimilars. So first is, the Enbrel biosimilar that we just announced with Hanwha and then we have 2. We have a Neupogen biosimilar in development and also a Neulasta biosimilar in development as well. More to come.


Your next question comes from Marc Goodman with UBS.

Marc Goodman - UBS Investment Bank

I just want to make sure I understand on these cost savings. Should we go into the model and take out $1.3 billion of savings just across the board, or are you saying that part of it may be made up for from revenues instead of just taking costs out? And then, the second question is, can you just give us a sense of -- you said in the press release something about JANUMET with manufacturing being an issue for not getting approved. Can you give us a little more sense of what happened there?

Kenneth Frazier

Let me just reiterate how I am thinking about the additional cost savings of $1.3 billion to $1.5 billion. As I said earlier, my overall intent is that most of this, not all of it, will drop to the bottom line through a combination, first of all, of investments that drive top line growth. Secondly, some reductions of our operating cost base. So I'm looking at it from the standpoint of what I've said all along, which is that we intend to invest with high ROI hurdles in what we think are good growth opportunities on the top line while at the same time, having a very strong bottom line. And so as I sit here today, I don't know all the opportunities that we'll have to reinvest some of the savings to justify longer-term and short-term growth. But I do anticipate that some of it will be invested in the top line and other parts of it will be sent to the bottom line directly by reducing operating costs.

Adam Schechter

And then, Marc, I'll answer your question with regard to JANUMET XR. So we received a complete response letter related to the resolution of pre-approval inspection issues. And the issues do not require any further clinical studies. We anticipate being able to respond to their questions very quickly within weeks and that we anticipate the issues will be resolved quickly.


Your next question comes from Tony Butler with Barclays Capital.

Alison Yang - Barclays Capital

This is Alison Young asking a question on behalf of Tony. I would like to address the press release statement regarding telcagepant. We were wondering how many Phase III trials have already been done or completed for the project? If Ken and Dick have both focused on striving to achieve ROIC, was there anything that can be done to arrest the project earlier in the process?

Alex Kelly

So Adam, you want to start with that?

Adam Schechter

Yes, so with regard to telcagepant, it was a decision to discontinue the development of it because of an assessment of data that we had across the clinical program that included findings from our recently competed Phase III studies. So the Phase III studies are completed. Based upon that and the data, we made the decision to discontinue the clinical development program. And I think that we continue to look for ways that we could try to eliminate programs quicker where it makes sense, and I think there's some learnings from this, but also we continue to evaluate ways that we can end programs when they make sense as quickly as possible.


Your next question comes from Jami Rubin with Goldman Sachs.

Jami Rubin - Goldman Sachs Group Inc.

My question to you, Ken, is very good news on the long-term cost savings. I think that's something that investors wanted to see. I'm just curious to know, why you're now not reinstating your long-term earnings guidance, which you pulled after the fourth quarter? And my other questions relate to VICTRELIS. Adam, if you could tell us what VICTRELIS sales were and a little bit of color around how you think the co-promoting agreement with Roche is going. I noticed that the PEGINTRON sales looked a little bit light this quarter, which I'm not sure I entirely understand. And if you could talk about the European label, EPO used in Europe tends to be more restrictive than it is in the U.S. I'm just wondering if you see that as a headwind as you market this drug.

Alex Kelly

I'll have Ken start.

Kenneth Frazier

As I said when I withdrew the long-term guidance, the way that I intend to run this company is I intend to make smart investments that will drive our long-term profitability and growth, and that continues to be my view of how I should look at this company. What matters in the long term, as far as I'm concerned is, are we making the right investments in our product portfolio to grow it, products like JANUVIA and ISENTRESS and others? Are we making the right investments today that allow us to have a long-term profitable growth strategy in the emerging markets? And then lastly, are we being smart about the investments that we make on internal and external R&D? That's basically where I continue to see the company going. I don't intend to reinstate the long-term guidance. What I believe is the case is that we need to be flexible and responsive and adaptive to whatever happens in the outside world. But my ambition, I want to just underscore, is to grow the top line with a leveraged P&L, and I will continue to deal with the issues that I confront, both opportunities and challenge, with that model of a company in mind.

Alex Kelly

Okay. Adam, you wanted to take the VICTRELIS question, please.

Adam Schechter

So Jamie, let me give you a little more color on VICTRELIS and I'm going to start with sales are $21 million, and those were strong initial orders that were part of the launch and we've already seen reorders already occurring. And the way I think about the initial orders is most wholesalers look to get a couple months of supply and you have to look at the cost of a month of supply, it gives you a sense of what that initial ordering was. In terms of what we're seeing in the U.S., first of all, most healthcare professionals haven't even written for either of the PIs right now. Less than 10% of the targeted prescribing universe of 8,000 physicians have already initiated a patient on triple therapy. So that's why I keep saying it's still very early. What we're hearing qualitatively from market research and also from our field representatives and also with physicians that I've talked with is that they see a very strong and good efficacy profile with VICTRELIS. They believe there's good overall safety and tolerability profile with no surprises and the dosing of personalized therapy, they believe it's a bit complicated, but they believe it'll become easier over time. So it's early. There's still a lot of work to do, but it's going well. In terms of the Roche co-promotion, that is going well also. They are out there with material to be able to talk about the appropriate use of VICTRELIS with their physicians. And we see that, that co-promotion agreement is going well, and that's why we were excited to expand it outside the U.S. to other parts of the world. With regards to the European label, we're pleased with the label. EPO use, as you know, varies market by market, but they deal with the issues that they need to deal with already with PEGINTRON. So I believe that they'll be able to figure how they want to deal with the issues around EPO market by market. In terms of PEGINTRON, sales were lower primarily due to the continued warehousing of HCV patients as they're still bringing these patients into the market, and there's a lot of clinical trials out there, which also accounts for lower use of PEGINTRON.


Your next question comes from Tim Anderson with Sanford Bernstein.

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

I want to pick up on Jamie's point about long-term guidance. Your policy of not giving any long-term guidance elements essentially puts you out of sync with the majority of your peers, and I'm wondering why they feel comfortable giving it and you guys don't. There's a lot of moving parts, things like your cost-cutting program, you just goosed up your tax rate for the year by 250 basis points. What should we expect on something like that going forward? So I hope you change your policy at some point and start to reinstate long-term guidance. My question on IMPROVE-IT, can you confirm that you have the 75% of events now that we might get an update on the second interim look soon? And then, can you update us on where you are with your ZETIA/atorvastatin fixed-dose combination from what we can tell it's something that you're still very actively pursuing?

Kenneth Frazier

Tim, Thanks for the comment. I appreciate your sharing of views. I continue to believe that the right approach for us, at this time, is to continue to invest in what we believe would be profitable growth opportunities to grow the top line with a leveraged P&L, and that's where we are at the moment. And I continue to think that in the world in which we're operating, my responsibility is to make the right investments to drive growth in the long term, but also to allow the company to be adaptive to what's happening in the environment, and that's again, how I intend to run the company.

Adam Schechter

And Tim, this is Adam. With regard to IMPROVE-IT, the 75% interim look will occur this year, and we also plan to file the eze/atorva combination product in 2011 as well.


Your next question comes from David Maris with CLSA.

David Maris - Credit Agricole Securities (USA) Inc.

Since everyone is opining I might as well do the same. Ken, I'm actually fine with no long-term guidance, so tick one in the other column. Too many companies set it out there, it's an artificial thing to an excuse to do bad acquisitions and all sort. It's managing to a bar. But that aside, can you tell us a little bit about the strategy in China, you've done a couple of really interesting deals there recently. Is this building out a footprint for a sales force? Is it accessing drugs, maybe a little bit more detail on Simcere? But also, where in a few years you'll be sales force-wise in China? Will it be predominantly Merck reps or will it be some sort of combination of the 2?

Kenneth Frazier

Okay, David. I'm going to turn it over to Adam, but I will just say from a big picture standpoint, I continue to believe that the right way to approach a big must-win market like China is to not necessarily duplicate the model that we've had in the developed markets. A model that, frankly, we are now, in some ways, dismantling in these markets. I think the right thing is to decide how you can be flexible and how you can ensure that the growth that you have today and in the future is profitable growth in those markets. We know the pricing is different in those markets. We know that it's helpful to actually have partners in those markets who know the markets, who can help us have the right kind of cost structure. So that's my overall view is, I want to have growth. I think there's tremendous opportunity in these markets, but it has to be profitable growth that rewards shareholders.

Adam Schechter

And let me give you some color on China. So we're pleased with the performance in China. And the way I think about our strategy in China, it really is to develop a significant presence with Merck Sharp & Dohme, but to partner with local companies to augment our capabilities and also to expand our reach significantly. We currently have about 5,000 people in China. We have about 3,500 sales representatives and we continue to increase our sales representatives, but they're concentrated primarily in the largest provinces in China. With deals like Simcere, we're able to expand our reach into other provinces in China, but also capitalize on their knowledge and know-how to operate within the Chinese market. And I think that, that's very helpful and very important. In addition to that, we're looking for ways to improve our access through multi-channel capabilities. We already have the ability to reach 170,000 physicians in China that our representatives don't call on through multi-channel capabilities, whether it be mobile technology, teleconferencing capabilities and other ways, e-mail and so forth. So we continue to look to utilize technology, which in China there's multiple different technologies we can use to expand our reach. So we look at it as a way for us to invest, but to invest where it makes sense from multinational company to invest and then to utilize partnerships where partnerships can help us significantly.


Your next question comes from Barbara Ryan with Deutsche Bank.

Barbara Ryan - Deutsche Bank AG

Most of mine have been asked but just a follow-up on VICTRELIS. I appreciate that it is early days, but I think in the Vertex call, they did talk about what they saw that there's a mix of patients between treatment naïve and add-on therapy. And I wonder if sort of 50% of the patients coming from treatment naïve pool is consistent with what you're seeing as well.

Adam Schechter

And it's really is just too early to give you percents in breakdown. I can tell you we're doing a lot of work, a lot of research to understand the mix, but the data that's out there is really not robust enough to give you a number that I feel confident is a right number. Let us continue to do some more work. I'll have some more information and I'll be able to share on the next quarter call, and we'll share with you the best information we have that we believe is accurate as soon as we can.


Your next question comes from Greg Gilbert with Merrill Lynch.

Gregory Gilbert - BofA Merrill Lynch

Two for Ken. Ken, within the additional cost savings you outlined, what difficult decisions did you have to make as it relates to R&D either specific programs or philosophies? And secondly, at this point, how would you describe your strategy and goals for Consumer and for Animal Health? I'm not asking if they're core, we've already asked that. Asking for a little more meat on the bones on how you view the strategies and goals for those 2 segments going forward.

Kenneth Frazier

Greg, I would say, first of all, with respect to R&D what we're doing in R&D is a continuous effort to provide more rigor and focus on ROI. That preceded the latest announcements. The latest announcements will affect R&D in the same way that it affects the rest of the company. We're really trying to go at administrative headquarters type personnel, the people who are, in effect, not directly as involved in discovery and development. We're trying to spare what we call revenue generating. You might think of it as more aimed at indirect labor than direct labor, if I can put it that way. I think on the Animal Health situation, I would say that we think we have a very strong business. It's the #2 business in the world in terms of size. We think it has really good profit margin. We see an opportunity to build on that business as we go forward, and we're going to look for really good opportunities to build on top of that business where we can create shareholder value. We think there's really great macro trends that affect that business, so we're very happy with that. We also are happy with our Consumer business, although I frankly acknowledge that the Consumer business could benefit from having greater scale and particularly internationally. And again, the way that I think about that is, I have to look at that as a part of our portfolio and look at the opportunities that we have across the entire portfolio in terms of how we run, in effect, our internal capital markets, in terms of how we allocate capital to create the most return for shareholders. So I would just say that Animal Health and Consumer are important to us. They are a part of our strategy. How we proceed to make them even more meaningful in the context of Merck is, I think, the challenge that we have going forward, but we will not make investments anywhere unless we think they will pay off for shareholders.


Your next question comes from David Risinger with Morgan Stanley.

David Risinger - Morgan Stanley

I have 2 questions. First, I was hoping that you could please discuss hepatitis C in a little bit more detail, including how much of the $21 million was stocking, and how IMS data for boceprevir may be different from telaprevir because it was a decent leading indicator for telaprevir sales? And then second, Simcere's annual China sales run rate is about $350 million, which is pretty small for a business. Could you please remind us what Merck's sales run rate is in China, and how your partnership is going to work with this small organization?

Kenneth Frazier

Why don't I take that, and I'll answer your first question and then get to the second. For hepatitis C, we had $21 million in stocking, and there's a couple of ways to think about it. The first one is, we were approved in the middle of May. If physicians were going to do a 4-week lead-in, which is the label, then we'd have about 2 weeks worth of actual prescriptions according to label. Now we know some physicians already had patients on INTRON and just added VICTRELIS immediately. So it's very difficult for us to know exactly how many physicians were following the 4-week lead-in exactly or how many were adding to patients that were already on PEGINTRON. The second thing to think about is the wholesalers think about how many months of inventory they want to have on the shelves. And based upon the number of months they want to have on the shelves, they'll purchase that from us. When you think about the cost of VICTRELIS per month, then you have to think about how many months of supply the $21 million could actually equate to. What I will tell you is that wholesalers have begun to reorder already. In terms of the IMS data, the other thing to think about is that most of this business goes through specialty pharmacies and the IMS data is not nearly as robust in specialty pharmacies. We are shipping to almost all of the specialty pharmacies. There's over 20 of them out there, and IMS ability to report depends on which specialty pharmas actually give data to them. We don't have insight into that. So at this point in time, it's just way too early to try to look at share from IMS data or to actually try to extrapolate share from sales data because the cost of therapy per month is very different between the 2 products. With regard to China, it's about $200 million per quarter. We grew 30% this quarter.


Your next question comes from Seamus Fernandez with Leerink Swann.

Seamus Fernandez - Leerink Swann LLC

So I was just wondering if we could maybe get an update from Peter, specifically on the thoughts again around the second option with AstraZeneca and again, expectations for timing of when that decision would be made if it's made in 2012 and what's baked into your guidance assumptions? Second, for Adam, just wondering, can you update us in terms of just the pharmaceutical sales in the emerging markets, which accounted for 18% in the quarter, are you still targeting 25% of sales in 2013, particularly given the restructuring of the REMICADE agreement?

Alex Kelly

Peter, you want to start?

Peter Kellogg

Sure. So as you know, the AstraZeneca JV has a -- or AstraZeneca, the company has an option that they can exercise next year. And of course, we have no insight. And I think they've actually articulated they haven't made a decision yet. So at this point though, and what we've always assumed is that they would exercise their option probably some time during the first half of next year. And obviously, we have no insight to that, but it's just planning assumption that we make to think about that. Of course, if they do exercise their option then our equity income will be reduced following the close of that, but we'll get a payment as it's calculated in the agreement. At this point though, and unfortunately, Seamus, we really don't have anything else to add. It's really their decision, and I think they've articulated they haven't yet made that decision.

Kenneth Frazier

And then with regard to the 25% of sales in emerging markets, the answer is, yes, that is still our target.


Your next question comes from Steve Scala with Cowen.

Steve Scala - Cowen and Company, LLC

Regarding the ZOSTAVAX sales of $122 million in the quarter, is manufacturing sufficient such that we may view $122 million as a minimum number in any quarter through the end of 2012? So that's the first question. And then the second question regards telcagepant, was the discontinuation due to liver findings and is Merck's view that the mechanism is flawed or that telcagepant is a sub-optimal molecule?

Kenneth Frazier

Well, on the second one, I think that we will be able to address that in greater detail at our annual business briefing. Certainly, we ran into issues with the molecule here. I wouldn't necessarily extend that logic to all molecules in a class. I'm not saying one way or the other. I think that's a question that we continue to look at in our research labs, and we'll have more to say about that. In terms of the run rate in the second quarter, we were pleased in the second quarter to have available supply to clear significant number of accumulated back orders. We're continuing to work to release doses as quickly as possible going forward. But as inventory builds, we may have additional back orders going forward. So I would say that I can't say that the supply in the second quarter necessarily dictates quarterly sales going forward. What I can tell you is that we are working diligently to solve the issues. So that, as we go forward, we can get out of back order and assure the kind of supply that the marketplace is looking for with respect to a vaccine that is well received.

Alex Kelly

Yes. And Steve, it's Alex. I would just note that on our website we do -- on the there is a supply statement that's posted there and that indicates when we plan to ship orders based on when they are received. So we're still in a delay of shipping orders from the time they're received.


Your final question comes from Chris Schott with JPMorgan.

Christopher Schott - JP Morgan Chase & Co

I just had 2 questions. The first was on -- coming back to the restructuring. When I consider the level of annual savings, can you just give us some color of where you're going to be at the end of 2011 relative to this $4 billion to $4.6 billion target. I'm just trying to think about how much incremental savings we should be thinking about if we look at the end of this year through 2015 that could either flow through the P&L or be used for reinvestment? And the second question if you just comment on share repo activity in the quarter. I guess, I was surprised we didn't see share -- a little bit more share count reduction, given last quarter share repo announcement and your significant ongoing cash flow. I guess, maybe when you're answering that, can you just also comment is there a target net debt or leverage ratio that you're aiming for that we also should be keeping in mind as we consider cash flow here?

Alex Kelly

Okay. Peter?

Peter Kellogg

Okay. Chris, I think, actually, all those questions are mine. So that's great I think -- let me take the first one, which is the restructuring and let me holistically answer that one. So going back to the merger value capture piece, the $3.5 billion, as we come to the midyear point right now, we're basically at about the $2.5 billion out of $3.5 billion achievement level in terms of savings and productivity inefficiencies from that. So we feel pretty good about that. The additional announcement we made today will rollout over the next couple of years. So it is not all active this year. It'll begin kicking in probably more significantly in 2012 because of actions taken as we go through the balance of this year. So that's probably the way I would assume it is, we'll continue to move forward on the value -- original value capture and this new plan will really take the balance of this year to get rolling and start to see some benefits as we go into next year. On the share repurchase, we were active actually during the quarter on share repurchase. We actually repurchased 9 million shares for something in the neighborhood of $300 million. So as of midyear, we have $6.1 billion outstanding on the board authorized share repurchase program. Obviously, offsetting that was the timing of stock grants to employees in the first half of the year. So that's our status, and we do sense that we will -- on an ongoing basis, see a downward trend on shares outstanding. I think that's a fair assumption given the share repurchase program we have outstanding. So that's certainly an ongoing program. Finally, in terms of net debt, as you know, we have a slight net debt position today. And the way we think about it as we think about that holistically relative to our credit rating, and I think, we'd be glad to go through into that more detail, but we worked very closely with the credit rating agencies and understand their methodology and applying that methodology to our balance sheet and our business mix and portfolio, we target to be in the credit rating or have the credit score that we have right now. And we don't intend to have that go up very importantly as our balance sheet strengthens nor do we intend to have it go down unless something catastrophic or significant happen. So -- and I think we kind of announced that at the start -- announcement of the merger that we were targeting this credit rating zone and that we would try to stay there for as much as possible. Now you'll see on our balance sheet that for the second quarter, as we finish the second quarter, we had about $16.5 billion of cash and investments and about $18 billion of debt. That's the detail, but a slight net debt position. But we really focus on the credit rating, and we like where we are. But very importantly, as we go forward in future years, we do not intend to have the credit rating go up, which means that obviously we would be very shareholder friendly as we continue to have strong cash flows. We do not plan to have that build up on the balance sheet.

Alex Kelly

Okay. Ken, would you like to say anything in closing?

Kenneth Frazier

Yes. First of all, I thank you all for being on the call today. And just to remind you, the way we're thinking about the future in this company we're very optimistic that we can grow both the top and the bottom line in this company over time. What that means, first of all, is that we have to be really focused on executing in the in-line products we have and the launch products we have and in the pipeline importantly. In terms of ensuring that we can make the necessary investments to drive top line growth, we're also focused on our cost structure. We recognize that we are facing a SINGULAIR patent expiration next year, as well as an environment that is a lot tougher than in the past. And so we're determined to look at our cost structure to make the kinds of changes to allow the company to operate at a lower cost base and to be able to adapt to the market conditions and to take advantage of the opportunities that we believe that Merck has in front of it. So thank you very much for listening today. We look forward to talking to you again in the future.

Alex Kelly



Thank you. This concludes the conference. You may now disconnect.

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