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

Q3 2007 Earnings Call

October 22, 2007 9:00 am ET

Executives

Graeme Bell - ED, IR

Dick Clark - Chairman, President & CEO

Peter Kellogg - EVP & CFO

Analysts

Tony Butler -Lehman Brothers

Barbara Ryan -Deutsche Bank

David Risinger - Merrill Lynch

Tim Anderson - SanfordBernstein

Chris Schott - Banc of America

Bert Hazlett - BMO Capital Markets

John Boris - Bear Stearns

Seamus - Fernandez - Leerink Swann

Steve Scala - Cowen

Roopesh Patel - UBS

Jami Rubin - Morgan Stanley

Operator

Good day, everyone, and welcome to Merck's Third Quarter2007 Earnings Conference Call. Today's call is being recorded.

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

Graeme Bell

Thank you, Crystal,and good morning. Welcome to our call this morning to review our results forthe third quarter of 2007. Joining me on the call today are our Chairman,President and CEO, Dick Clark, and for the first time we welcome Peter Kellogg,our Executive Vice President and Chief Financial Officer.

Before we go into the details, I would like to go over somelogistics. On this call, we will review the results contained in the release weissued at 7:30 this morning. You can access this through the Investor Relationssection of merck.com, and I would remind you that this conference call is beingwebcast live and recorded. The replay of the event will be available latertoday via phone, webcast and as always, our podcast.

As we begin to review the results, let me remind you thatsome of the statements made during this call may contain subjects that maycontain forward-looking statements as that term is defined in the PrivateSecurities Litigation Reform Act of 1995. These statements are based onmanagement's current expectations and involve risks and uncertainties, whichmay cause results to differ materially from those set forth in the statements.

The forward-looking statements may include statements regardingproduct development, product potential or financial performance.

No forward-looking statement can be guaranteed, and actualresults may differ materially from those projected. Merck undertakes noobligation to publicly update any forward-looking statement whether as a resultof new information, future events or otherwise.

Forward-looking statements on this call should be evaluatedtogether with the many uncertainties that affects Merck business, particularlythose mentioned in the risk factors and cautionary statements set forth in item1A of Merck's Form 10-K for the year ending December 31, 2006, and in itsperiodic report on Form 10-Q and Form 8-K, which the Company incorporates byreference and that are also posted on our website.

As always, we will begin with remarks from our seniormanagement, then open the call for all of your questions, and expect the callto last approximately 60 minutes.

So with that, I will turn the call over and we will beginwith remarks from our Chairman, President and CEO, Mr. Clark.

Dick Clark

Thank you, Graeme, and good morning, everyone. I am pleasedto report that the momentum that Merck began to build last year continues, asproven by the strong performance in this last quarter. In an increasinglydifficult healthcare environment, our company has been resilient whiledemonstrating an outstanding capacity to innovate, driving near-flawlessexecution, as shown by our regulatory and commercial success, and postsignificant revenue growth, show gains in market share and increase operatingincome.

The results reported today show that Merck continues todeliver on its promise to remain a leader in the pharmaceutical industry.

Year-to-date, we have reported solid growth of 8% on thetop-line and 24% on the bottom line. We are also working to ensure sustainedgrowth in 2007. We remain convinced our plan will enable us to achieve ourbusiness targets, meet emerging challenges,and discover and develop breakthrough medicines and vaccines.

Merck's reported earning per share for the quarter was $0.70.Third quarter EPS, excluding restructuring charges was $0.75. That represents a47% increase compared to third quarter 2006. This increase includes the impact theNovaCardia charge in 3Q '07, as well as the legal defense cost in '07 and '06.

The company's worldwide revenue was $6.1 billion during thequarter, which is an increase of 12.3% over the third quarter in 2006.Year-to-date, our worldwide revenue was $18 billion, up 8.2% compared to the firstnine months of 2006. Net income for the quarter was $1.5 billion.

What distinguishes our performance is that it was driven bythe rapid uptake and strong growth of our new first-in-class vaccines andmedicines like GARDASIL and JANUVIA, as well as sustained growth from our broadrange of estimated franchises, including SINGULAIR.

GARDASIL's performance has been up outstanding. In the thirdquarter, total Merck revenue for GARDASIL was $418 million. Year-to-daterevenue exceeds $1.1 billion. Merck has distributed more than 13 million dosesof the vaccine worldwide since it came to market in June of 2006. Today, GARDASILhas been approved in more than 86 countries and it is in various stages oflaunch in 72.

Looking forward, study to evaluate the efficacy of GARDASIL inwomen up to age of 45 and 16 to 26-year-old young men are underway. Based on dataavailable at this time, a presentation of the mid-adult women data are expectedthis quarter. We also have two supplemental Biological License Applications forGARDASIL under standard review at the U.S. Food & Drug Administration toupdate the leveling for GARDASIL.

Global revenue for JANUVIA and JANUMET reached $185 millionand $19 million respectively in the third quarter. Our revenues reflect thehigh value that physicians, patients and payers are placing on our products andon the healthcare benefits they provide. They also demonstrate that we continueto build on momentum established with our product launches last year.

JANUVIA has already become the second leading branded oralantidiabetic agents in U.S.in terms of new prescription share. Going in to the fourth quarter, JANUVIA hasachieved reimbursement coverage in approximately 200 million lives on Tier 2,representing over 80% of targeted lives and more than 210 million lives in Tier2 and Tier 3, combined in the U.S. And JANUMET has achieved reimbursementcoverage in more than 179 million lives on Tier 2 and more than 200 millionlives in Tiers 2 and 3 combined, in the United States.

Our overall financial results were also supported by thestrong performance of our partnership and alliances, specifically theMerck/Schering-Plough partnership, which continues to drive our equity income.[That positive] contribution helped us fund our increasing research spending oninvestigational product development, the acquisition of NovaCardia, and variouslicensing activities.

It is encouraging that our business continues to deliversubstantial growth. This has been an outstanding quarter for Merck, as our newproducts established their leadership in an increasing competitive market. Evenas older products have gone off-patent, we are leveraging earnings from our newproducts and vaccine launches, while utilizing the new commercial model tofurther support and consolidate the strong positioning of our establishedin-line brands.

As we look to the final quarter for this year and into 2008,we are purposely moving ahead the launch of ISENTRESS after the FDA granted theproduct accelerated-approval on October 12th. This represents the eighth approvalfor Merck in the last 24 months. This FDA approval clearly demonstrates ourability to deliver on our strategy of providing physician and patients withinnovative medicines that meet unmet medical needs.

Introduction of ISENTRESS is the realization of thecompany's 20-year commitment to HIV/AIDS, and we are prepared to ensure thatISENTRESS launches well and reaches its full market potential.

We will continue to work closely with our stakeholders toensure access when we have the SUPPORT program available in the U.S. to assistpatients in need. I want you to know the following approvals. Within one day wewere printing the product circulars. Within two days we began packaging andshipping products to our distribution centers, and within three days we beganto process and ship initial customer orders.

The first business day after approval, our fully trainedspecialty representatives went to doctor's offices, informing them aboutISENTRESS. And as of today the first prescription has been filled.

And we earmarked strong financial performance in the firstnine months of this year. We are raising our EPS guidance range for the fullyear 2007. We now anticipate a full year EPS range of $3.08 and $3.14,excluding restructuring charges and reported full-year EPS range of $2.87 to$2.93.

I also want to tell you that CORDAPTIVE, proposed trademarkfor MK-524A, which is our investigated atherosclerosis compound, has been filedwith the FDA. This compound combines Merck's extended-release niacin with anovel Merck compound that reduces flushing, the common side effect of niacintherapy.

Over and above that, we've added three compounds to thePhase III pipelines in the third quarter. MK-822 for osteoporosis, MK-7418 foractive CHF and we licensed MK-8669, an oncology compound from ARIADPharmaceuticals, with whom we've signed a licensing agreement last quarter.

In addition to our internal pipeline progress, we continueto seek new licensing opportunities and targeted acquisitions in therapeuticareas that are of strategic importance to Merck. Indeed, our externalpartnerships and alliances have become an integral part of our considerableresearch efforts towards discovery and development of effective medicines.

Meanwhile, our global restructuring initiatives is proceedingand on track. And ongoing initiatives will further reduce our cost structure;create a leaner and more nimble business model, so that we can respond quicklyand efficiently to customer's expectations. We can address emerging marketingdemands and so that we can support the drug discovery and development effortsthat are core to our business model.

As we implement fundamental changes to every aspect of ourbusiness, we remain confident that our current products and anticipated newproduct introductions, as well as our cost saving initiatives will helpposition this company to deliver what we promised in December 2005. That is, wecontinue to believe that we can generate top-line growth in the range of 4% to6% on a compound annualized basis from 2005 through 2010, including 50% of therevenue from the joint ventures from which the company derives equity income.

By sustaining our cost management initiative, Merck expectsto fulfill our promise to expand the product portfolio while maintainingmarketing and administrative expenses flat in 2010, relative to thereof 2006,and compound annual double-digit earnings growth excluding restructuringcharges and one-time items by 2010 from a 2005 base.

Although the healthcare market continues to be challenging,we are confident that our customers will continue to find value in our productsthat are our products sets us apart from the rest of the industry.

I want to add a note about one other thing that makes meproud to work at Merck. Today marks the 20th anniversary of our commitment todonate MECTIZAN to all those in need of the treatment of river blindness andprevention of LF for as long as these diseases continue to be public healthproblems. And today after seeing both the positive health on the demonic impactof Merck's Mectizan Donation Program in areas affected by the disease, we haverenewed our commitment to this initiative. Thanks to the efforts of Merck andour many partners since 1987, we have distributed more than 530 milliontreatments in 33 countries where these diseases are epidemic.

This is but one reflection of our company's philosophy andpractice to ensure that the outcome of our discovery and development effortsreach the patients who need them most.

Now, I would like to take a moment to introduce to Mr. PeterKellogg, our new Chief Financial Officer. This is his first earnings call atMerck and we are pleased to welcome here today. Peter will provide more detailsof Merck's financial performance and guidance, and we will be happy to answeryour questions at the end of the call.

So with that, I am pleased to turn the call over to Peter.

Peter Kellogg

Thank you, Dick and good morning. It's a pleasure to behere. As Dick said, we are extremely pleased with our business results. In thethird quarter, the company reported double-digit growth in the top-line anddouble-digit growth on the bottom line. The performance is achieved while thecompany is actively re-engineering the way we work, Merck operate in severalareas. It included the impact of R&D charge for NovaCardia of $325 millionor $0.15 per share, and it is in a period when we are lapping a major part ofproduct exploration last year.

The third quarter reported EPS, excluding restructuringcosts, was driven by several lines in the P&L, all with strong results.First, revenue growth of 12% reflects strong performance of our new and in-linevaccine, the continued uptake of JANUVIA and JANUMET, and the continued marketleadership and strong performance of SINGULAIR.

Secondly, product gross margin continued to improve and thistrend is the result of both operational efficiencies and certainly Q3 favorablemix.

Finally, we continue to see outstanding performance in ourpartnerships and alliances, which resulted in strong equity income growth.

So, while I'll go into more detail about the underlyingdrivers of our performance in a minute, I should note that this exceptionalperformance has led us to increase our full-year 2007 EPS guidance yet again.So, let's begin with top-line revenue. Dick mentioned several of the highlightsof the quarter a moment ago, so I'll build on that.

Let's start with Q3 total revenue, which was $6.1 billion,that's a 12% increase over the same period last year and it, included ninepoints of growth in volume, two points of benefit coming from foreign exchangeand one point from price.

A major contributing factor to our top-line growth came fromour vaccines business. In Q3, vaccines revenue as recorded by Merck was over$1.2 billion. That's a 124% increase as compared with the same period in 2006.And this is driven by the continued uptake of GARDASIL, ROTATEQ, and ZOSTAVAX.So, our three new vaccines accounted for roughly $650 million in Q3.

Let's start with GARDASIL. We are obviously extremelypleased with global sales for GARDASIL, as recorded by Merck, which reflectsthe continued strong underlying demand for the vaccine in both the public andprivate sector. Of the $418 million recorded in the quarter, $328 million wasin the United States.Sales outside the U.S.continue to show strong growth and increased 27% sequentially, as we continueto successfully navigate the processes surrounding regulatory approval, countryrecommendations and reimbursement with government.

Merck's year-to-date revenue for GARDASIL is now over $1.1billion, as Dick said. So it is already a blockbuster after only nine months,and remember this is a vaccine. When you take the end market sales as recordedby Merck and include end market sales recorded by the Sanofi Pasteur MSD jointventure, global sales of GARDASIL increased 28% sequentially in the thirdquarter.

Now let's turn to VARIVAX. In the third quarter revenue was$284 million, a 218% increase over prior year. This strong quarterly result wasthe function of two major factors. First, as of September 30th, all 55 VFCprojects had adopted the second dose varicella recommendation. 52 had adoptedthe recommendation for all children, including catch-up, while the other threeprojects have adopted for 4 to 6-year-olds. Now the cohort where we are seeingthe most uptake in the second dose is in the 4 to 6-year-olds.

Secondly, the use of vaccine business experiences a certainback-to-school surge. It does make Q3 a peak period. Indeed, recent demand forVARIVAX has been unprecedented, and when coupled with the ACIP recommendation,we have to acknowledge that there is some seasonality here. Now, Merck isfurther increasing production of VARIVAX and we fully expect to meetanticipated market demand for varicella, measles, mumps and rubella vaccine.

So let's move to the category of other promoted medicine. InQ3, total sales were $1.5 billion and that's an 18% increase compared with thesame period in 2006. And of course, we have to go straight to JANUVIA. As youknow, we launched JANUVIA late last year. It is currently approved in 58countries worldwide. With this JANUVIA is the only DPP-4 inhibitor available inevery region of the world for use in the treatment of type 2 diabetes when dietand exercise are not enough. In a third full quarter in the market, globalrevenue for JANUVIA reached to $185 million, of which $171 million is in the U.S.

Then turning to alliance revenue, that obviously contributedto our top-line revenues as well and primarily AstraZeneca is the key playerthere. Q3 revenue recorded by Merck from our relationship with AstraZeneca was$416 million, and that's a slight decrease versus prior year. As always, keepin mind that there is inherent variability relating to this revenue, given thatMerck is not actively managing these products.

Our revenue recognition takes into account inventory levelsat AstraZeneca, for PPI and non-PPI products, as well as their productshipment. So, we try to capture and adjust for any fluctuations in inventory.

So, moving to the total revenues for medicines and vaccines,as we have stated many times, we have the opportunity to capitalize on ourrobust product portfolio and deliver compound annual growth rate that areattracted through 2010.

Despite certain patent expirations during this timeframe, wecontinue to expect revenue growth of 4% to 6% on a compounded annualized basis,driven by our in-line products, our launch products and our new potentialproducts in the pipeline. And of course, this includes 50% of the revenues ofthe joint ventures moving out of the 2005 base.

Taking the third quarter revenue announced today and adding50% of the revenues from the Merck/Schering-Plough, Merial, Sanofi Pasteur MSD,and Johnson & Johnson-Merck joint ventures and partnerships. Our Q3 revenuewith $7.3 billion, that's a 15% increase if you do the same adjustment in thebase period. Year-to-date, the same measure is $21.3 billion, and an 11%increase over the same period last year.

And again, this stellar, year-to-date top-line growth isover a base period that included ZOCOR prior to the loss of marketingexclusivity. Just to take that a little further, if we were to exclude ZOCOR,PROSCAR, and the revenue associated with the supply of authorized generics fromthe first nine months of 2007 and the first nine months of 2006, then for whatyou might consider the ongoing portion of business, our year-over-year revenuegrowth would have been 25%.

This again emphasize the strength of our organic business,fueled by our established brands and the newer recently launched nextgeneration of products that will take us forward.

Regarding 2007, this third quarter and year-to-dateperformance has driven us to revise our full year revenue guidance to supportour increased full year EPS guidance. This guidance revision includes five ofour product guidance elements. SINGULAIR, where we narrowed the full year rangeby $100 million, that now stands at $4.1 billion to $4.3 billion, vaccines,where we increased by $300 million the full year range. That now stands at $4.2billion to $4.6 billion. COZAAR and HYZAAR, where we narrowed the full yearrange by $100 million, so that's $3.2 billion to $3.4 billion. FOSAMAX, wherewe also narrowed the full range by $100 million and that stands at $2.9 billionto $3.1 billion. And ZOCOR, where we narrowed the full year range by $100million as well, and that now stands at $0.7 billion to $0.9 billion.

We are reaffirming full year guidance for other reportedproducts and AstraZeneca, and as always the AstraZeneca guidance is an updatebased on recent results, as well as future expectations and reflects thedynamics of the PPI market, which includes multiple generics, OTC products andthe uncertainty these create with regard to future volume and pricing. Alsokeep in mind that our reaffirmed guidance incorporates the expectations of thenon-PPI products.

As always, to assist your modeling, we provide a breakdownof the product revenues in our other financial disclosure schedule attached tothe press release issued this morning.

So moving past revenue into the materials and productionline, in the third quarter materials and production were $1.5 billion. Now,this quarter includes $129 million for costs associated with the globalrestructuring program, primarily related to accelerated depreciation and assetimpairment costs. Excluding these costs, materials and production increased 3%in the quarter.

Our Q3 product gross margin with 75% and this reflected a2.1 percentage point unfavorable impact related to the restructuring cost thatI just mentioned. Excluding these restructuring charges, we have the thirdquarter product gross margin of 77.1%. Just as in previous periods theseresults were indeed, affected by the final product mix.

Our year-to-date adjusted gross margin therefore is 76.4%.Given the strength of this result, we are raising our full year 2007 guidancerange and now anticipate our product gross margin to be approximately 76% to76.5%. This guidance excludes the portion of the restructuring cost that willbe included in product cost and will affect reported PGM in 2007.

Moving to the marketing and administrative line, in thirdquarter our marketing and admin expense was $2 billion, an 18% decrease versusthe same period last year. In the third quarter, after reviewing the actualcost incurred and estimates for future costs, the company determined that itwas appropriate to record a charge of $70 million to increase the reservesolely for the future legal defense cost related to the VIOXX litigation, andthat takes it up to $720 million as of September 30, 2007.

Regarding the legal defense reserve charge, the company accrueslegal defense cost expected to be incurred in connection with the losscontingency when such costs are probable and reasonably estimable.

In the third quarter, the company spent a $160 million inthe aggregate for legal defense costs worldwide related to VIOXX litigation.

In adjusting the reserve the company considered the samefactors that it considered when it previously established reserves for theVIOXX litigation, including the actual cost incurred by the company, thedevelopment of the company's legal strategy and structure, in light of thescope of the VIOXX litigation, the number of cases being brought against thecompany, and the cost and outcomes ofcompleted trials and the most current information regarding anticipated timing,progression and related costs of pre-trial and trial activities.

Events such as scheduled trials, which are expected to occurinto 2008, and the inherent inability to predict the ultimate outcome of such trials,limits the company's ability to reasonably estimate its legal cost beyond theend of 2008. Accordingly, the reserve at September 30, 2007 represents thecompany's best estimates of legal cost that will be incurred through 2008.

While the company does not anticipate that it will need toincrease the reserve every quarter, it will continue to monitor its legaldefense cost and review the adequacy of the associated reserves. They maydetermine to increase its reserves for legal defense cost at any time in thefuture if based on the factors mentioned above, it believe it would beappropriate to do so. To date, the company has not established any reserves forany potential liability relating to the VIOXX litigation itself.

Excluding the charges in 2006 and 2007, M&A actincreased 6% in the quarter. Regarding underlying level of spend, once again,the primary drivers of the marketing and administrative increases werepromotional spend for JANUVIA and JANUMET, and continuing efforts to moreaggressively support the ZOSTAVAX launch.

While appropriate, these were deliberate choices made inresponse to the evolving competitive dynamics that we felt could provideadditional advantages as we have the first-in class product. As you see fromour revised product specific financial revenue guidance, we are increasing ourrevenue guidance to reflect this incremental investment.

Reflecting on our commitment to realizing efficienciesthroughout the company and optimizing our cost structure, the component ofmarketing and administrative consisting of selling and general administrativecosts, which support our core operations, remained down year-to-date over theprior year.

So, let's turn to guidance for marketing and administration.It's pretty clear from the Dick's comments and what should view the commercialteam continues to have a very full agenda there really indeed. We are beginningto launch ISENTRESS and continue to build on the momentum on the previous sevenlaunches over the last 24 months, that's quite a handful to juggle.

As we look at trends and opportunities in the rest of 2007,we are increasing our guidance for marketing and admin to 2.5% to 3.5% growthover prior year. Now, a good part of this change is driven by the Euro, whichhas significantly increased during 2007. It now stands above 140 to a dollar ascompared to mid 120 at the beginning of the year.

Now, of course, we see this is as a benefit on our top-linerevenues, adding roughly two points to the overall Merck revenue growthyear-to-date and in Q3.But this will also add roughly 2.5 points to the fullyear marketing admin growth. Secondly, we are maintaining a healthy amount ofsupport behind the success of our growing core and new franchises.

In Q4, we anticipate DTC efforts for SINGULAIR and JANUVIA,as well as increased promotional support for GARDASIL, ROTATEQ and ZOSTVAX. Wewill also be supporting our ongoing launch agenda at Merck, MK-524A and ISENTRESSfor the U.S.and continued support for the international rollouts of the JANUVIA andGARDASIL.

Finally, we are comfortable with the focus and management ofthis investment. It is being very well spent and managed. It is important tonote that in Q4, we anticipate a reduction in marketing and admin spendingversus the prior year.

Now, let's turn to research and development. In Q3, ourR&D expenses were $1.4 billion, that's a 52% increase from the comparableperiod in 2006. And of course, it included the NovaCardia in-process R&Dcharge. Excluding NovaCardia, R&D was up 18% versus 2006.

I want to take an extra minute to explain this result andour R&D guidance for the remainder of year. At Merck, we remain committedto fully funding core, internal R&D to ensure the continued progress ofcompounds in all phases of development. Internal R&D growth remainedstrong. We continue to invest in late-stage, clinical programs on ISENTRESSMK-524A, MK-524B, MK-364, MK-822, MK-974, you get the point. In addition, allof our vaccine developments and progress.

So, in addition, the company continues in active externalcollaboration and business development agenda, funding clinical grant programs,third-party scientific collaborations and important licensing transaction. Sooverall, our R&D spend is focused on progressing our pipeline and adding toit any outsider as well.

So regarding the full year, we are raising our 2007 guidancefor research and development expense to adequately resource incrementalexternal R&D opportunities. And now anticipate R&D spend to increase 13to 15 percentage points over the full year 2006 level.

Our R&D guidance includes the impact of the acquiredresearch charge associated with NovaCardia and I would refer you to our pressrelease to see how we define the base period on a similar basis. Although, Ibelieve all of you have it captured correctly in your models and reports.

So, in the third quarter, turning to the restructuring, ourtotal cost associated with the global restructuring programs was a $178million. Now, as I mentioned before, $129 million was for asset related chargesthat are included in materials and production.

The restructuring cost line itself reflects $49 million ofcost for employee separation, and other related costs associated wasapproximately 250 positions eliminated and that is now a total to 6,000 todate. So, we remain on track to eliminate 7,000 positions by the end of 2008.Restructuring guidance for the full-year 2007 would indicate that our aggregate2007 pre-tax expense related to these activities is estimated to beapproximately $700 million.

Now, let's turn to the equity income line. In the thirdquarter, equity income from affiliates was $769 million. Just to remind to you,this line relates to the contribution from all of our JVs, AstraZeneca, Merck/Schering-Plough,Merial, Sanofi Pasteur, Johnson & Johnson.

Our Q3 performance reflects the continued success of theMerck/Schering-Plough cholesterol franchise in the U.S.and Europe, The seasonality of the MerialAnimal Health Business and an increasing contribution from our Europeanvaccine, JV Sanofi Pasteur.

Regarding the Merck/Schering-Plough partnership, the thirdquarter combined MSP cholesterol franchise global revenue as reported by theMerck/Schering-Plough partnership continued to grow at $1.3 billion. Q3revenues of VYTORIN and ZETIA were $693 million and $607 million respectively.

In the U.S.,VYTORIN was $526 million, up 22% and ZETIA was $443 million, up 14%. WithinMerck's quarterly equity income result, the Merck/Schering-Plough partnershipcontributed $481 million and that reflects a 37% increase over the prior year.

Returning to AstraZeneca, as always, I have to remind youthat there are several components to AstraZeneca equity income that make itinappropriate to draw significant conclusions just based on PPI products. Thereare complexities involved with a minimum timing and tax differences. That said,the third quarter equity income contribution for Merck's share of thepartnership with AstraZeneca was a $181 million.

The balance of equity income comes from our other jointventures namely Merial, Sanofi-Pasteur and Johnson & Johnson-Merck.

Given this result we are narrowing our guidance for fullyear 2007 by $100 million and now expect equity income from affiliates to beapproximately $2.8 billion to $3 billion.

So, let's move to our tax line. First, our Q3 income beforetaxes was $2.1 billion. So, our taxes on income in the period were $539 millionand the reported tax rate was 26.1%. This reflects in general the changes inforeign and domestic mix and currency fluctuations. These elements changethroughout the quarters as always.

We are reaffirming our full year 2007 tax rate guidancerange and I would direct you to today's press release for details.

So, moving to net income, our Q3 net income was $1.5 billionand our Q3 earnings per share was $0.75, excluding a 5% charge for siteclosures and position eliminations, primarily associated with the globalrestructuring. Our reported third quarter EPS was $0.70.

So, let's turn to 2007 guidance. I had mentioned severalchanges as part of the results review already and I will direct to you to thedetails of our financial guidance contained in today's press release. We areraising or changing many elements of our full year 2007 guidance and as aresult, Merck is raising the full year 2007 EPS range to $3.08 to $3.14,excluding the restructuring charges related to site closures and positioneliminations.

In another words, we anticipate that the EPS,ex-restructuring will grow in the range of 36% to 48% in the fourth quarter ofthis year versus prior year. On a reported basis, we now anticipate GAAP fullyear 2007 EPS of $2.87 to $2.93. As stated, this guidance does not reflect theestablishment of any additional reserves or any potential liability regardingthe VIOXX litigation.

We are committed to providing quality full year guidance andupdating it during the year. We believe that there is value in providingquality financial guidance, because it assists investors and we do recognizethat our business is complex, and we serve our investors well by communicatingour financial performance expectations.

So in summary, the company remains on track, both in termsof strategy and performance, to delivery long-term double-digit earning per sharegrowth from 2005 to 2010, excluding one-time items and restructuring charges.We have the financial strength to support our dividend and we remain fullycommitted to maintaining our dividend at the current level, at the same time wecontinuing to fully invest in our key strategic priorities.

With our year-to-date performance and our guidance for fullyear it is clear that the products are driving a healthy top-line, despitelapping the ZOCOR expiry. We anticipate continued strong performance from ourkey franchises in the remainder of this year.

So, if you take this all together, Merck is clearly verybusy with its successful product launches worldwide. And behind the scenes, wecontinue to reengineer the company into a lean and effective competitor for thefuture, for the good quarter.

With that said, I will turn the call back to Graeme. Graeme?

Graeme Bell

Thank you, Peter, and we certainly appreciate your patienceduring the prepared remarks. We will now open the call and take your questions.We will take the questions in the order in which they are received and try to getthrough as many as possible. Please help us to keep on track by asking a one ortwo part question only.

So at this point, I will turn the call back over to Crystal,who will communicate instructions of our Q&A format, and then introduce ourfirst question.

Question-and-AnswerSession

Operator

(Operator Instructions). Your first question comes from theline of Tony Butler with Lehman Brothers.

Tony Butler - LehmanBrothers

Yes. Thanks very much. Just back to the gross margin, Peter,if possible, the rise to 76%, to 76.5% from 75% to 76% is curious. And youmentioned the principal driver, if I am not correct please help me, is mix.However, if I am not mistaken, the greatest delta from the beginning of thisyear until today has been the growth in the vaccines component of revenue. Do Ihave just the wrong impression that vaccines might be a lower margin component,yet the increase in overall GM is critical? If you could help us with someunderstanding of the income grew and see of that of that notion. Thanks.

Peter Kellogg

Sure. Tony, let me just make some general comments. First ofall, your observation is correct, and that is, vaccine has been doing verywell. But, obviously the other product lines we have as well, are very big, andso you take kind of the weighted average of all those, you got factors movingboth ways. But in fact, as we went from the second quarter to third quarter andas we projected out for the full-year, you do see some mix affect that helpedus in Q3.

What I would recommend is that we updated it and narrowedthe range for product gross margin and excluding restructuring charges. So, Iwould go with that. But, in fact, you are right, there are different mixeffects, some of which based on like, for example, vaccines would cause you togo one way, but some of the other products over way that for the time being.But in general, obviously, as we narrow the range, we actually also increasethe range, excluding restructuring. So obviously, the general conclusion is thetrend is positive despite some of the vaccine business activity.

Tony Butler - LehmanBrothers

Thanks, Peter.

Dick Clark

And Tony, another point is around supply strategy as well.So, as our strategy is put in place, and as we do the right combination ofoutsourcing and put the Merck the production system, which is Six Sigma Lean processin place, and you are seeing improvements. And as I have mentioned many times,it's not only on the pharmaceutical side of business, the biological vaccines,which is obviously very critical to us ensuring a volume increase, to be ableto improve them and our ability to improve those PGM will be substantial, ofcourse, looking forward.

Tony Butler - LehmanBrothers

Okay.

Graeme Bell

Next question please.

Operator

Your next question comes from the line of Barbara Ryan with DeutscheBank

Barbara Ryan -Deutsche Bank

Good morning. Thanks for taking my question. I wonder if youcould just speak to some of the trends for JANUVIA in the U.S., relative to the reportedresults in the scrip because, obviously the scrips are up about 50% in thethird quarter versus the second. Although, those revenues reported in the U.S.are relatively flat. So, I am assuming that there were some stocking in thesecond quarter and maybe de-stocking in the third. But maybe, if you could justhelp us understand that sequential line, just for the purposes of understandingbetter the fourth quarter, thank you.

Dick Clark

Yes. Thank you, Barbara.

Barbara Ryan -Deutsche Bank

Thanks, Dick.

Dick Clark

You are absolutely right. Even though we mentioned thatManaged Care Advisory increasing for JANUVIA, and JANUVIA also ranks second inbranded New Rx volume. There is some stocking impact in the second quarter,particularly for JANUMET since some initial purchases for whole of the launchof the product is in April of 2007. And as you also know is that it's a provenin 58 countries, but we are just beginning a process outside of the U.S.So we are very, very optimistic and very strong with the future of JANUVIA, andthat's not only for this year, but obviously in the future years and it's offto a great start with a great franchise team in the U.S. and global franchise teamthat's holding it up across the globe. Thank you.

Graeme Bell

Next question, please.

Operator

Your next question comes from the line of David Risingerwith Merrill Lynch.

David Risinger -Merrill Lynch

Yes. I am now French. I have two questions. First, onGARDASIL, could you please comment on government purchases in the third quarterrelative to the second quarter? If you could provide any detail, that would behelpful and also, if you could talk about compliance with the three doses, andwhat you are seeing to date? And then in addition, if you could just discussthe ZOSTAVAX opportunity going forward, it seems to me that that is asubstantial opportunity yet the trajectory to date has not been thatsignificant. And, as part of your answer, if you could just discuss anychanges, in reimbursement for 2008?

Dick Clark

Well certainly starting withZOSTAVAX. As you know, what we have said that we are back in production againfor various double component of ZOSTAVAX. And so, as that continues to moveforward from a production standpoint, that will put us in a refrigeratedZOSTAVAX versus the frozen ZOSTAVAX, which we need globally. ZOSTAVAX in myopinion is a key vaccine for our future, and that we'll see growth. We areworking with our customers, and with physicians, and with CMS to try to come upwith a process in place that makes it less onerous from a reimbursementstandpoint for the physician, as well as, for the client and patients toovercome that. And we haven't been able to come up the right partnership for that.I think we are making process on it, and so I am very happy with where we'removing forward as long as we can consolidate that, and particularly with thevolume depth moving forward.

Obviously, in the third quarterwith everything that we have done from a vaccines standpoint, with GARDASIL inthe uptick, particularly with the initial dose, one of the keys is to make surethat we don't lock it in for the second and third dose. And so, we have put inplace substantial reminder programs that allow them to improve the ability toremember to go back to the second and third dose. So, we're doing it by mail,we're doing it by e-mail, we're doing it by text messages, and a variety ofdifferent technologies to be able to make sure as they come, particularly collegestudents as they come back for grades, that they get to second, and third dose.And so that compliance capability is extremely important to us.

Graeme Bell

And Dave, just on your initial question with regards torevenue, domestic revenue for GARDASIL in the quarter, you know, we are stillseeing that contribution coming from both the public and private. There was nomarked increase in the orders being placed by the public sector through VFC andCDC. So, we're seeing this leveling off in terms of underlying demand in themarket and the 3Q revenue reflects that.

David Risinger -Merrill Lynch

Thank you.

Graeme Bell

Next question please.

Operator

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

Tim Anderson - Sanford Bernstein

Thank you. Couple of questions, on GARDASIL, in the U.S.specifically, can you give us a rough idea for what percent of the time theproduct is being used in a population different from what's technically indicatedin the label? And then the second question is, just looking at FOSAMAX sales inthe quarter, in international markets can you update us on what's happening orwhat's likely to happen with generic FOSAMAX in Europe, following the previousrestatement of the patent protection there. I am just wondering what to expectin terms of future brand performance as long as it technically remains on patent.

Graeme Bell

All right, gentlemen, I'll take that if you don't mind. So,with regard to GARDASIL in the U.S.in terms of percentage used outside the approved range, so again, it is 9% through26% at this point. We are seeing very, very limited use beyond that initialindication, primarily because physicians are focused in obviously on the datathat we have in hand and as we've communicated to all including the physiciancommunity who are administering, that we will not have efficacy data pertainingto the mid-adult woman in-house until the fourth quarter. So, as Dick mentionedin his prepared remark, the expectation is that we will have that data andbegin to move that forward for labeling expansion.

With regard to the age range that was currently indicated,we began to see a little more use in the twelve through eighteen-year-old range.Initially, when we launched the product we were seeing even distribution fromnine through twenty six-year-olds. But, clearly with the concentrated effortthat Dick just articulated pertaining to going after college students and theappropriate age range, you'd expect to see the origination all the immunizationoccurring in the twelve through eighteen-year-old. And that is also a phenomenon,which is taking place ex-U.S. as well.

With regard to your FOSAMAX question internationally,obviously you are aware of the reinstatement by the European patent office.Where we are with regard to that is, clearly were in a process of identifyingwhere there is currently illegal weekly alendronate on the market and takingappropriate legal steps to determine what actions we can take to remove thatoff the market. The other complexity comes of course, in the fact that towardthe end of this year and as to early part of next year there will be legalalendronate sodium available in the EU for the daily dosing. So we got a twopart challenge really, that is to A). remove from the market the illegal weeklyand keep it off while simultaneously, B). renegotiating with countries in termsof ensuring that we can continue to have weekly branded in Europethrough the period immediately following patent expiry all the way through2018.

Tim Anderson - Sanford Bernstein

Thank you.

Graeme Bell

Next question please.

Operator

Your next question comes from the line of Chris Schott withBanc of America.

Chris Schott - Bancof America

Great, thank you, just got two quick questions. Maybe, firston your gross margin side, you get a strong increase year-over-year. Can youmaybe talk about, aside from the mix, the benefits of restructuring program?How far are we through that program at this point? I guess, another way lookingat it, are our current numbers reflecting much of that benefit or should weexpect additional opportunities over the next couple of years?

And then just quickly in your CT pre-inhibitor, has adecision been made moving into Phase III? I know the Phase IIB [cetropib] datathat showed some strong LDL reductions, I guess, and based on your discussionswith the FDA, do you believe LDL could be part of a filing pathway there?Thanks.

Dick Clark

Regarding the second question, we have not made a decisionyet to go in Phase III. So we are still evaluating, not only our compound butthe mechanism in general, and are waiting for an additional externalinformation before we make the decision.

Concerning our PGM's moving into future and in our supplystrategy, as we said positional eliminations around 6,000 of the 7,000 that wecommitted to back in December 2005. But when it comes to where we are from aLean and Six-Sigma process and our outsourcing capabilities, and our ability toincrease the PGMs within the vaccine areas by using any of this methodology.

I would say, we are probably around 50% where we want to be,and so within the next two years we will be continuing to make progress ineffectiveness in standard efficiency within the supply chain. And alsosomething that we are very excited about when it comes to PGM, we alsonaturally gravitate towards the supply strategy and production, but many partsof the PGM are also based on marketing concepts and packaging, and whatcustomer's and physicians need and distribution.

And so there is many parts of that we integrate, that weneed to think about and I think Merck has this one Merck approach, of how wethink about PGMs now across all the functions in a company. So, I am verybullish in where I think our PGMs will be moving based on the statements wemade in December 2005 and our ability to achieve a pre-ZOCOR numbers in thenear future.

Graeme Bell

Next question, please?

Operator

You next question comes from the line of Bert Hazlett withBMO Capital Markets.

Bert Hazlett - BMO CapitalMarkets

Thanks, good morning. Thanks for taking my questions. Firston SINGULAIR, could you just comment on international trends you are seeingthere. Again, uptake in foreign sales has been significant, could you justcomment on currency effects, price volume and maybe what's driving that? Andthen secondly, with regard to ROTATEQ, again it's proved in sixty ninecountries we have a significant pickup in the U.S., what's holding back theinternational sales, is it the question of the bulk of them being driventhrough Sanofi Pasteur, or is it a question of pricing or reimbursement or justa little color there? Thank you.

Dick Clark

I think with the ROTATEQ question is that obviously, ourreimbursement act that we need to be able to put in place throughout the world.The supply is available and we're now rolling it across and then in many othercountries. But it just takes times. As you know, vaccines are different thanpharmaceutical products and getting them positions approved and reimbursed positivelyin degree and though Merck also has a responsibility to as we've been throughthis in the developed world, as also think about accessing this in developingworld and to make sure that we put programs in place to have it availablethere.

From a SINGULAIR standpoint, I can't give you the specificstowards your question other then say that we are pleasantly surprised about notonly SINGULAIR in United States with its labeling and where it'spositioned from a formula standpoint. But, it is an outstanding product and itstill is receiving uptake throughout the world, and much of it is based onvolume.

Graeme Bell

Yeah. So, I would just add to that I mean, in Europe, MiddleEast and Africa as we see it SINGULAIR washealthy in the quarter. We seldom breakdown revenue by geographical region, butI can't tell you that in the region it was up over 20%, about 22%, the majorityof which was volume. So the volume growth is primarily a function of labelexpansion of montelukast sodium and the label carries off these indication forallergic rhinitis and it is one of the, in fact, it is the only product on themarket with that indication. So, that's what is fuelling that strong Europeandrive.

Bert Hazlett - BMOCapital Markets

Thank you.

Graeme Bell

Next question please.

Operator

Your next question comes from the line of John Boris withBear Stearns.

John Boris - BearStearns

Just have two questions. And thanks for taking the questionand congratulations on the quarter. First question you, Dick, on the JANUVIA,JANUMET, there appear to be case studies on how to decrease cycle times. Isthere any additional room for taking additional days, months, years out of thecycle time with respect to products and other any that you would like to key usin on as to what you might be applying to those products going forward that areentering or have entered the clinic?

And then on GARDASIL, of the $328 million reported in thequarter, can you comment on the stocking at the physician level? How many dosesis the physician stocking and can you comment on the total number of patientsin the U.S. that have been treated to-date and with your three key strategyhere what percentage of them have been treated once, twice, or three times.Thanks.

Dick Clark

With your first question concerning cycle time with JANUVIAand JANUMET, I believe as you look at the progress we made from a cycle-timereduction, not only a clinical base in these products but in the manufacturing,the supply side has been significant and we believe that there is moreopportunity there. And so we've actually made a commitment. What's importantabout it is, and the practices were put in place across the company is not onlyto do it, obviously with JANUVIA and JANUMET, but to do it for the entireportfolio.

So, if you can do that for the portfolio, you can imaginethe impact this is going to have on a companywide basis. And so, we've putsubstantial resources in focus on our clinical development, as well as ourother aspects of the company to be able to continue that. And I think you'llsee much more progress in the next several years in continued cycle timereduction. And as you know, once you are able to reach a steady state, itcontinues improvement, methodologies tell you that there's always room forfurther improvement.

So, I am never going declare victory when it comes to cycletime reduction, either in research or in the manufacturing side. There isminimum stocking on GARDASIL from our physician level standpoint. I can't tellyou specifics around where we are with our three key areas of going for thesecond dose and the third dose or what that minimum is. It's still too earlyfor us to be able to provide data on.

Graeme Bell

And part of the reason why we can't do that John, is thatI'd have to remind you that, we are going after approximately 118 million girlsand women in the U.S., EU and other highly developed markets that are withinthe appropriate age range for GARDASIL indications. So, even if you pad up backand look in the United States alone, there are thirty six millionfemales who are eligible to receive this vaccines and the intent here is toensure that all of them, obviously receive all three doses from a complianceperspective. And as you've heard from the prepared remarks, since June of 2006 whenthe product was approved we have shipped and sold 13 million doses.

So there's certainly a long way to go and we continue togather the intelligence. But one data point that I would point to you is, ifyou go on gardasil.com, which we constantly update, you can see and read as dothe individuals who are getting GARDASIL, the new banner there which is threeis key. And three is key, is the compliance message that we're basicallycommunicating to the physician community, to pediatricians, and the OB/GYN.

John Boris - BearStearns

Okay. That helps.

Graeme Bell

Next question please.

Operator

(Operator Instructions). Your next question comes from theline of Seamus Fernandez with Leerink Swann.

Seamus Fernandez- Leerink Swann

Thank you. Just a couple of quick questions, I just steppedout of the room for a second, but I apologize. I wanted to know if you couldupdate us on timing of the PROQUAD, re-launch and manufacturing and just giveus a manufacturing update on that front. And then secondly, SINGULAIR after theend of this year will be the last allergic rhinitis drug or branded allergicrhinitis drug on the market to our knowledge and as the Zyrtec comes offpatent, are there potential formulary risks for Merck here in 2008, whether itbe on prior authorization or on formulary changes and how would that impactyour growth rate? Thanks.

Dick Clark

Your question on PROQUAD is, and I mentioned that in earlierquestion that we are now back in production with the varicella component ofPROQUAD and started up and are waiting for the results. We are very optimisticabout the result of that. It's really difficult to commit to a specific datehere once till we see titers and the potency performance for that movingforward. But, I am optimistic that we have a solution there, and manufacturingis back in action and that's very positive.

From a SINGULAIR standpoint, when you think about theclinical indications we have, and the success we've had with SINGULAIR to date,it reminds me a little bit of the simvastatin situation. And so, when a productlike that goes off the patent, there's still obviously a focus on that from ageneric standpoint. But, when you have such an excellent label and indicationsfor SINGULAIR to be able to have them remain on the second tier of formularies,I think SINGULAIR will do very, very positive.

Graeme Bell

So next question, please. I am conscious of the time and Ibelieve we have three more questions in the queue. So we will take that and putit off. So, next question please Crystal.

Operator

Your next question comes from the line Steve Scala withCowen

Steve Scala - Cowen

Well, thank you. I was just wondering, do you believe yourtop and bottom line guidance through a 2010 is achievable? If you exercise yourput to AstraZeneca for the non-PPI products in Q1 of '08 or will your guidanceneed to altered when you take the non-PPI part? The concern is that, if you doput in Q1 of '08, can't AstraZeneca call the PPI's in Q1 of 2010 and aren'tthey at non-trivial component of your earnings?

Dick Clark

Steve, as we put the December 2005 targets in place, it wasex any impact from the AstraZeneca activity.

Graeme Bell

Next question please

Operator

Your next question comes from the line of Roopesh Patel withUBS

Roopesh Patel - UBS

Thank you. Just a couple of question. First on ROTATEQ. Iwas wondering, if you could just elaborate on the outlook for the product salesbeing very strong for this quarter. Is this the run rate we should be lookingat moving forward? And then just separately on VIOXX litigation charges, I wasjust wondering if the year-to-date spending is a rough representative of thegeneral run rate we should be again looking at moving forward, if not, what arethe factors that led through? Thanks.

Peter Kellogg

Bell,if you want, I’ll take the question on the VIOXX litigation, and I had justhighlighted. What we tried to do is sort out exactly what we know is coming,and so to talk about a run rate beyond 2008 is very difficult for us to do. Iam obviously involved in situation where we had a number of trials with andoutcomes from that. So, it would be hard for us to speculate exactly what therun rate may or may not be because it's really specific to the circumstancesthat we are looking at, and exactly what the trial count is, what the pre-triallegal activity is, and that’s obviously evolving as we go. So I would cautionyou to kind of jump too quickly to a run rate assumption, one way or the other,but I think we are pretty pleased with how things have gone so far.

And your question on the ROTATEQ, there has been more than 9million doses of ROTATEQ that has been distributed, and it's estimated thatabout 62% of the birth cohort is now being vaccinated. So there is an uptickbased on the cohorts that we have today. And it is available through theVaccine for Children’s Fund in all 50 states and is 100% covered under ManagedCare. So we are very enthusiastic about the future of the product. Concerningthe global bases, it’s approved in 69 countries, and we have only launched in30 countries around the world to date. So, we are still very strong on what theperformance is moving forward, but at the same time as you know we’ll havecompetition in the near term with ROTATEQ.

Graeme Bell

And Crystal?

Yes, sir?

Graeme Bell

Our last question for the day,and by no means least, I think we have Jami Rubin on the line.

Operator

Yes sir, that's correct, withMorgan Stanley.

Jami Rubin - Morgan Stanley

Thank you, Graeme. I'm soflattered. Just I had a couple of follow-on questions on GARDASIL. You -- Peterhad talked about VARIVAX, it was a back-to-school effect, I was wondering ifthere was a back-to-school effect with GARDASIL? And well Graeme, I canappreciate why it's very difficult to pinpoint precisely where this vaccine isbeing used and what penetration rates are within that VFC market where I wouldimagine data is much stronger since they are ordering directly from you. Canyou tell us what is the penetration of the 11- to 12-year-old cohorts, where myunderstanding is the goal is over 80%? And then lastly, on international, saleswere $90 million, can you tell us what markets that represents and how much ofthat is stockings? Thanks.

Peter Kellogg

Jami, let me take a shot at thefirst one, which is the back-to-school dynamic. Obviously, we're dealing with apopulation where there is, does have a lot of school activity and some of themgoing and obviously hitting up the couch, so there is always that chance.However, we don't really feel -- it is clear that there is a strongback-to-school effect just yet, we haven't really concluded on that as much asthere is perhaps on the VARIVAX going. But nonetheless, it's certainly clearthat we are working with young women who are in the school age area and they maywell be visiting physicians before they go back to the universities and soforth, that's a possibility. Relating to the cohort question, actually let mejust hold up on that.

Graeme Bell

So Jami, with regard to the cohort question, we're stillseeing a very encouraging uptake within the VFC programs. So the age range thatthey are addressing particularly, right slightly younger female, that’s stillvery, very healthy and certainly moving along as we would expect.

With regard to your question on international revenue, youare absolutely correct. We recorded -- we [Merck], Inc. recorded 91millionex-US, and I would point that out notwithstanding the statistics pertaining tothe approvals and the launches, when you look at the revenue contribution thereare basically six countries that are contributing to the $480 million. So, oneof those countries, I think US at 308, the remaining five countries includesthe likes of Australia and Canada,and that's just starting to continue to launch. So, your question on stockingisn't really a driver for the ex-US business, it is just basically countriescoming on line, but because you can appreciate we moved from approval intolaunch phase, and as we move into launch phase, it progresses through the revenuerecognition.

I would point out that though, on the other financialdisclosures that Sanofi Pasteur MSD recorded revenue for the GARDASIL so endmarket as recorded by SP MSD was $137 million in the quarter, and again theycovered the 19 countries on territory. But again that $137 million onlyreflects three or four countries that are contributing in a meaningful wayabout revenue number.

Dick Clark

Well, thank you Graeme, and thanks for listening to our calltoday. As we stated, we are very pleased with the third quarter results, and weare certainly looking forward to updating you further on our future progress atour annual business briefing that will be held in Whitehouse Station onDecember 11. We'll be in touch with the details on this meeting very soon.

So, thank you again, we appreciate your interest andparticipation. Operator, thank you very much.

Operator

Thank you, sir. This does conclude today's conference call.You may now disconnect.

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Source: Merck Q3 2007 Earnings Call Transcript

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