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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 - Sanford Bernstein

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 Quarter 2007 Earnings Conference Call. Today's call is being recorded.

At this time, I would like to turn the conference over to Mr. 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 for the 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 some logistics. On this call, we will review the results contained in the release we issued at 7:30 this morning. You can access this through the Investor Relations section of merck.com, and I would remind you that this conference call is being webcast live and recorded. The replay of the event will be available later today via phone, webcast and as always, our podcast.

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

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

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

Forward-looking statements on this call should be evaluated together with the many uncertainties that affects Merck business, particularly those mentioned in the risk factors and cautionary statements set forth in item 1A of Merck's Form 10-K for the year ending December 31, 2006, and in its periodic report on Form 10-Q and Form 8-K, which the Company incorporates by reference and that are also posted on our website.

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

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

Dick Clark

Thank you, Graeme, and good morning, everyone. I am pleased to report that the momentum that Merck began to build last year continues, as proven by the strong performance in this last quarter. In an increasingly difficult healthcare environment, our company has been resilient while demonstrating an outstanding capacity to innovate, driving near-flawless execution, as shown by our regulatory and commercial success, and post significant revenue growth, show gains in market share and increase operating income.

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

Year-to-date, we have reported solid growth of 8% on the top-line and 24% on the bottom line. We are also working to ensure sustained growth in 2007. We remain convinced our plan will enable us to achieve our business 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 a 47% increase compared to third quarter 2006. This increase includes the impact the NovaCardia 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 the quarter, 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 first nine months of 2006. Net income for the quarter was $1.5 billion.

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

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

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

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

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

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

It is encouraging that our business continues to deliver substantial growth. This has been an outstanding quarter for Merck, as our new products established their leadership in an increasing competitive market. Even as older products have gone off-patent, we are leveraging earnings from our new products and vaccine launches, while utilizing the new commercial model to further support and consolidate the strong positioning of our established in-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 the product accelerated-approval on October 12th. This represents the eighth approval for Merck in the last 24 months. This FDA approval clearly demonstrates our ability to deliver on our strategy of providing physician and patients with innovative medicines that meet unmet medical needs.

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

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

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

And we earmarked strong financial performance in the first nine months of this year. We are raising our EPS guidance range for the full year 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 trademark for MK-524A, which is our investigated atherosclerosis compound, has been filed with the FDA. This compound combines Merck's extended-release niacin with a novel Merck compound that reduces flushing, the common side effect of niacin therapy.

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

In addition to our internal pipeline progress, we continue to seek new licensing opportunities and targeted acquisitions in therapeutic areas that are of strategic importance to Merck. Indeed, our external partnerships and alliances have become an integral part of our considerable research efforts towards discovery and development of effective medicines.

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

As we implement fundamental changes to every aspect of our business, we remain confident that our current products and anticipated new product introductions, as well as our cost saving initiatives will help position this company to deliver what we promised in December 2005. That is, we continue to believe that we can generate top-line growth in the range of 4% to 6% on a compound annualized basis from 2005 through 2010, including 50% of the revenue from the joint ventures from which the company derives equity income.

By sustaining our cost management initiative, Merck expects to fulfill our promise to expand the product portfolio while maintaining marketing and administrative expenses flat in 2010, relative to thereof 2006, and compound annual double-digit earnings growth excluding restructuring charges 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 products that are our products sets us apart from the rest of the industry.

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

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

Now, I would like to take a moment to introduce to Mr. Peter Kellogg, our new Chief Financial Officer. This is his first earnings call at Merck and we are pleased to welcome here today. Peter will provide more details of Merck's financial performance and guidance, and we will be happy to answer your 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 be here. As Dick said, we are extremely pleased with our business results. In the third quarter, the company reported double-digit growth in the top-line and double-digit growth on the bottom line. The performance is achieved while the company is actively re-engineering the way we work, Merck operate in several areas. It included the impact of R&D charge for NovaCardia of $325 million or $0.15 per share, and it is in a period when we are lapping a major part of product exploration last year.

The third quarter reported EPS, excluding restructuring costs, 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-line vaccine, the continued uptake of JANUVIA and JANUMET, and the continued market leadership and strong performance of SINGULAIR.

Secondly, product gross margin continued to improve and this trend is the result of both operational efficiencies and certainly Q3 favorable mix.

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

So, while I'll go into more detail about the underlying drivers of our performance in a minute, I should note that this exceptional performance 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 highlights of 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 nine points of growth in volume, two points of benefit coming from foreign exchange and one point from price.

A major contributing factor to our top-line growth came from our 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 extremely pleased with global sales for GARDASIL, as recorded by Merck, which reflects the continued strong underlying demand for the vaccine in both the public and private sector. Of the $418 million recorded in the quarter, $328 million was in the United States. Sales outside the U.S. continue to show strong growth and increased 27% sequentially, as we continue to successfully navigate the processes surrounding regulatory approval, country recommendations and reimbursement with government.

Merck's year-to-date revenue for GARDASIL is now over $1.1 billion, 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 recorded by Merck and include end market sales recorded by the Sanofi Pasteur MSD joint venture, global sales of GARDASIL increased 28% sequentially in the third quarter.

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

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

So let's move to the category of other promoted medicine. In Q3, total sales were $1.5 billion and that's an 18% increase compared with the same period in 2006. And of course, we have to go straight to JANUVIA. As you know, we launched JANUVIA late last year. It is currently approved in 58 countries worldwide. With this JANUVIA is the only DPP-4 inhibitor available in every region of the world for use in the treatment of type 2 diabetes when diet and exercise are not enough. In a third full quarter in the market, global revenue for JANUVIA reached to $185 million, of which $171 million is in the U.S.

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

Our revenue recognition takes into account inventory levels at AstraZeneca, for PPI and non-PPI products, as well as their product shipment. 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 our robust product portfolio and deliver compound annual growth rate that are attracted through 2010.

Despite certain patent expirations during this timeframe, we continue 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 potential products in the pipeline. And of course, this includes 50% of the revenues of the joint ventures moving out of the 2005 base.

Taking the third quarter revenue announced today and adding 50% of the revenues from the Merck/Schering-Plough, Merial, Sanofi Pasteur MSD, and Johnson & Johnson-Merck joint ventures and partnerships. Our Q3 revenue with $7.3 billion, that's a 15% increase if you do the same adjustment in the base 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 is over a base period that included ZOCOR prior to the loss of marketing exclusivity. Just to take that a little further, if we were to exclude ZOCOR, PROSCAR, and the revenue associated with the supply of authorized generics from the first nine months of 2007 and the first nine months of 2006, then for what you might consider the ongoing portion of business, our year-over-year revenue growth would have been 25%.

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

Regarding 2007, this third quarter and year-to-date performance has driven us to revise our full year revenue guidance to support our increased full year EPS guidance. This guidance revision includes five of our product guidance elements. SINGULAIR, where we narrowed the full year range by $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 $4.2 billion to $4.6 billion. COZAAR and HYZAAR, where we narrowed the full year range by $100 million, so that's $3.2 billion to $3.4 billion. FOSAMAX, where we also narrowed the full range by $100 million and that stands at $2.9 billion to $3.1 billion. And ZOCOR, where we narrowed the full year range by $100 million as well, and that now stands at $0.7 billion to $0.9 billion.

We are reaffirming full year guidance for other reported products and AstraZeneca, and as always the AstraZeneca guidance is an update based on recent results, as well as future expectations and reflects the dynamics of the PPI market, which includes multiple generics, OTC products and the uncertainty these create with regard to future volume and pricing. Also keep in mind that our reaffirmed guidance incorporates the expectations of the non-PPI products.

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

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

Our Q3 product gross margin with 75% and this reflected a 2.1 percentage point unfavorable impact related to the restructuring cost that I just mentioned. Excluding these restructuring charges, we have the third quarter product gross margin of 77.1%. Just as in previous periods these results 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 guidance range and now anticipate our product gross margin to be approximately 76% to 76.5%. This guidance excludes the portion of the restructuring cost that will be included in product cost and will affect reported PGM in 2007.

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

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

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

In adjusting the reserve the company considered the same factors that it considered when it previously established reserves for the VIOXX litigation, including the actual cost incurred by the company, the development of the company's legal strategy and structure, in light of the scope of the VIOXX litigation, the number of cases being brought against the company, and the cost and outcomes of completed 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 occur into 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 the end of 2008. Accordingly, the reserve at September 30, 2007 represents the company's best estimates of legal cost that will be incurred through 2008.

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

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

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

Reflecting on our commitment to realizing efficiencies throughout the company and optimizing our cost structure, the component of marketing and administrative consisting of selling and general administrative costs, which support our core operations, remained down year-to-date over the prior 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 commercial team continues to have a very full agenda there really indeed. We are beginning to launch ISENTRESS and continue to build on the momentum on the previous seven launches 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% growth over prior year. Now, a good part of this change is driven by the Euro, which has significantly increased during 2007. It now stands above 140 to a dollar as compared to mid 120 at the beginning of the year.

Now, of course, we see this is as a benefit on our top-line revenues, adding roughly two points to the overall Merck revenue growth year-to-date and in Q3.But this will also add roughly 2.5 points to the full year marketing admin growth. Secondly, we are maintaining a healthy amount of support 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. We will also be supporting our ongoing launch agenda at Merck, MK-524A and ISENTRESS for the U.S. and continued support for the international rollouts of the JANUVIA and GARDASIL.

Finally, we are comfortable with the focus and management of this investment. It is being very well spent and managed. It is important to note that in Q4, we anticipate a reduction in marketing and admin spending versus the prior year.

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

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

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

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

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

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

The restructuring cost line itself reflects $49 million of cost for employee separation, and other related costs associated was approximately 250 positions eliminated and that is now a total to 6,000 to date. 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 aggregate 2007 pre-tax expense related to these activities is estimated to be approximately $700 million.

Now, let's turn to the equity income line. In the third quarter, 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 the Merck/Schering-Plough cholesterol franchise in the U.S. and Europe, The seasonality of the Merial Animal Health Business and an increasing contribution from our European vaccine, JV Sanofi Pasteur.

Regarding the Merck/Schering-Plough partnership, the third quarter combined MSP cholesterol franchise global revenue as reported by the Merck/Schering-Plough partnership continued to grow at $1.3 billion. Q3 revenues 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%. Within Merck's quarterly equity income result, the Merck/Schering-Plough partnership contributed $481 million and that reflects a 37% increase over the prior year.

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

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

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

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

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

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

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

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

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

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

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

So, if you take this all together, Merck is clearly very busy with its successful product launches worldwide. And behind the scenes, we continue to reengineer the company into a lean and effective competitor for the future, 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 patience during 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 get through as many as possible. Please help us to keep on track by asking a one or two 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 our first question.

Question-and-Answer Session

Operator

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

Tony Butler - Lehman Brothers

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 you mentioned 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 this year until today has been the growth in the vaccines component of revenue. Do I have 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 some understanding of the income grew and see of that of that notion. Thanks.

Peter Kellogg

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

What I would recommend is that we updated it and narrowed the range for product gross margin and excluding restructuring charges. So, I would go with that. But, in fact, you are right, there are different mix effects, some of which based on like, for example, vaccines would cause you to go 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 increase the range, excluding restructuring. So obviously, the general conclusion is the trend is positive despite some of the vaccine business activity.

Tony Butler - Lehman Brothers

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 of outsourcing and put the Merck the production system, which is Six Sigma Lean process in 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 able to improve them and our ability to improve those PGM will be substantial, of course, looking forward.

Tony Butler - Lehman Brothers

Okay.

Graeme Bell

Next question please.

Operator

Your next question comes from the line of Barbara Ryan with Deutsche Bank

Barbara Ryan - Deutsche Bank

Good morning. Thanks for taking my question. I wonder if you could just speak to some of the trends for JANUVIA in the U.S., relative to the reported results in the scrip because, obviously the scrips are up about 50% in the third 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 the second quarter and maybe de-stocking in the third. But maybe, if you could just help us understand that sequential line, just for the purposes of understanding better 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 that Managed Care Advisory increasing for JANUVIA, and JANUVIA also ranks second in branded New Rx volume. There is some stocking impact in the second quarter, particularly for JANUMET since some initial purchases for whole of the launch of the product is in April of 2007. And as you also know is that it's a proven in 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, and that's not only for this year, but obviously in the future years and it's off to a great start with a great franchise team in the U.S. and global franchise team that's holding it up across the globe. Thank you.

Graeme Bell

Next question, please.

Operator

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

David Risinger - Merrill Lynch

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

Dick Clark

Well certainly starting with ZOSTAVAX. As you know, what we have said that we are back in production again for various double component of ZOSTAVAX. And so, as that continues to move forward from a production standpoint, that will put us in a refrigerated ZOSTAVAX versus the frozen ZOSTAVAX, which we need globally. ZOSTAVAX in my opinion is a key vaccine for our future, and that we'll see growth. We are working with our customers, and with physicians, and with CMS to try to come up with a process in place that makes it less onerous from a reimbursement standpoint for the physician, as well as, for the client and patients to overcome 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're moving forward as long as we can consolidate that, and particularly with the volume depth moving forward.

Obviously, in the third quarter with everything that we have done from a vaccines standpoint, with GARDASIL in the uptick, particularly with the initial dose, one of the keys is to make sure that we don't lock it in for the second and third dose. And so, we have put in place substantial reminder programs that allow them to improve the ability to remember 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 of different technologies to be able to make sure as they come, particularly college students 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 to revenue, domestic revenue for GARDASIL in the quarter, you know, we are still seeing that contribution coming from both the public and private. There was no marked increase in the orders being placed by the public sector through VFC and CDC. So, we're seeing this leveling off in terms of underlying demand in the market 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 Sanford Bernstein.

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 the product is being used in a population different from what's technically indicated in the label? And then the second question is, just looking at FOSAMAX sales in the quarter, in international markets can you update us on what's happening or what's likely to happen with generic FOSAMAX in Europe, following the previous restatement of the patent protection there. I am just wondering what to expect in 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% through 26% at this point. We are seeing very, very limited use beyond that initial indication, primarily because physicians are focused in obviously on the data that we have in hand and as we've communicated to all including the physician community who are administering, that we will not have efficacy data pertaining to the mid-adult woman in-house until the fourth quarter. So, as Dick mentioned in his prepared remark, the expectation is that we will have that data and begin 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 from nine through twenty six-year-olds. But, clearly with the concentrated effort that Dick just articulated pertaining to going after college students and the appropriate age range, you'd expect to see the origination all the immunization occurring 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 identifying where there is currently illegal weekly alendronate on the market and taking appropriate legal steps to determine what actions we can take to remove that off the market. The other complexity comes of course, in the fact that toward the end of this year and as to early part of next year there will be legal alendronate sodium available in the EU for the daily dosing. So we got a two part challenge really, that is to A). remove from the market the illegal weekly and keep it off while simultaneously, B). renegotiating with countries in terms of ensuring that we can continue to have weekly branded in Europe through the period immediately following patent expiry all the way through 2018.

Tim Anderson - Sanford Bernstein

Thank you.

Graeme Bell

Next question please.

Operator

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

Chris Schott - Banc of America

Great, thank you, just got two quick questions. Maybe, first on your gross margin side, you get a strong increase year-over-year. Can you maybe 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 looking at it, are our current numbers reflecting much of that benefit or should we expect additional opportunities over the next couple of years?

And then just quickly in your CT pre-inhibitor, has a decision been made moving into Phase III? I know the Phase IIB [cetropib] data that showed some strong LDL reductions, I guess, and based on your discussions with 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 decision yet to go in Phase III. So we are still evaluating, not only our compound but the mechanism in general, and are waiting for an additional external information before we make the decision.

Concerning our PGM's moving into future and in our supply strategy, as we said positional eliminations around 6,000 of the 7,000 that we committed to back in December 2005. But when it comes to where we are from a Lean and Six-Sigma process and our outsourcing capabilities, and our ability to increase 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 in effectiveness in standard efficiency within the supply chain. And also something that we are very excited about when it comes to PGM, we also naturally gravitate towards the supply strategy and production, but many parts of the PGM are also based on marketing concepts and packaging, and what customer's and physicians need and distribution.

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

Graeme Bell

Next question, please?

Operator

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

Bert Hazlett - BMO Capital Markets

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

Dick Clark

I think with the ROTATEQ question is that obviously, our reimbursement 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 other countries. But it just takes times. As you know, vaccines are different than pharmaceutical products and getting them positions approved and reimbursed positively in degree and though Merck also has a responsibility to as we've been through this in the developed world, as also think about accessing this in developing world and to make sure that we put programs in place to have it available there.

From a SINGULAIR standpoint, I can't give you the specifics towards your question other then say that we are pleasantly surprised about not only SINGULAIR in United States with its labeling and where it's positioned from a formula standpoint. But, it is an outstanding product and it still is receiving uptake throughout the world, and much of it is based on volume.

Graeme Bell

Yeah. So, I would just add to that I mean, in Europe, Middle East and Africa as we see it SINGULAIR was healthy in the quarter. We seldom breakdown revenue by geographical region, but I can't tell you that in the region it was up over 20%, about 22%, the majority of which was volume. So the volume growth is primarily a function of label expansion of montelukast sodium and the label carries off these indication for allergic rhinitis and it is one of the, in fact, it is the only product on the market with that indication. So, that's what is fuelling that strong European drive.

Bert Hazlett - BMO Capital Markets

Thank you.

Graeme Bell

Next question please.

Operator

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

John Boris - Bear Stearns

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

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

Dick Clark

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

So, if you can do that for the portfolio, you can imagine the impact this is going to have on a companywide basis. And so, we've put substantial resources in focus on our clinical development, as well as our other aspects of the company to be able to continue that. And I think you'll see much more progress in the next several years in continued cycle time reduction. And as you know, once you are able to reach a steady state, it continues improvement, methodologies tell you that there's always room for further improvement.

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

Graeme Bell

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

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

John Boris - Bear Stearns

Okay. That helps.

Graeme Bell

Next question please.

Operator

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

Seamus Fernandez - Leerink Swann

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

Dick Clark

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

From a SINGULAIR standpoint, when you think about the clinical 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 product like that goes off the patent, there's still obviously a focus on that from a generic standpoint. But, when you have such an excellent label and indications for 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 I believe we have three more questions in the queue. So we will take that and put it off. So, next question please Crystal.

Operator

Your next question comes from the line Steve Scala with Cowen

Steve Scala - Cowen

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

Dick Clark

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

Graeme Bell

Next question please

Operator

Your next question comes from the line of Roopesh Patel with UBS

Roopesh Patel - UBS

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

Peter Kellogg

Bell, if you want, I’ll take the question on the VIOXX litigation, and I had just highlighted. 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. I am obviously involved in situation where we had a number of trials with and outcomes from that. So, it would be hard for us to speculate exactly what the run rate may or may not be because it's really specific to the circumstances that we are looking at, and exactly what the trial count is, what the pre-trial legal activity is, and that’s obviously evolving as we go. So I would caution you 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 9 million doses of ROTATEQ that has been distributed, and it's estimated that about 62% of the birth cohort is now being vaccinated. So there is an uptick based on the cohorts that we have today. And it is available through the Vaccine for Children’s Fund in all 50 states and is 100% covered under Managed Care. So we are very enthusiastic about the future of the product. Concerning the global bases, it’s approved in 69 countries, and we have only launched in 30 countries around the world to date. So, we are still very strong on what the performance is moving forward, but at the same time as you know we’ll have competition 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, with Morgan Stanley.

Jami Rubin - Morgan Stanley

Thank you, Graeme. I'm so flattered. Just I had a couple of follow-on questions on GARDASIL. You -- Peter had talked about VARIVAX, it was a back-to-school effect, I was wondering if there was a back-to-school effect with GARDASIL? And well Graeme, I can appreciate why it's very difficult to pinpoint precisely where this vaccine is being used and what penetration rates are within that VFC market where I would imagine data is much stronger since they are ordering directly from you. Can you tell us what is the penetration of the 11- to 12-year-old cohorts, where my understanding is the goal is over 80%? And then lastly, on international, sales were $90 million, can you tell us what markets that represents and how much of that is stockings? Thanks.

Peter Kellogg

Jami, let me take a shot at the first one, which is the back-to-school dynamic. Obviously, we're dealing with a population where there is, does have a lot of school activity and some of them going 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 strong back-to-school effect just yet, we haven't really concluded on that as much as there is perhaps on the VARIVAX going. But nonetheless, it's certainly clear that we are working with young women who are in the school age area and they may well be visiting physicians before they go back to the universities and so forth, that's a possibility. Relating to the cohort question, actually let me just hold up on that.

Graeme Bell

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

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

I would point out that though, on the other financial disclosures that Sanofi Pasteur MSD recorded revenue for the GARDASIL so end market as recorded by SP MSD was $137 million in the quarter, and again they covered the 19 countries on territory. But again that $137 million only reflects three or four countries that are contributing in a meaningful way about revenue number.

Dick Clark

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

So, thank you again, we appreciate your interest and participation. 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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