Merck & Company, Inc. (MRK)

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Merck & Co Inc. (MRK)

November 10, 2011 8:30 am ET

Executives

Michael E. Kamarck - Member of Management Committee, Member of Law/Regulatory Review Committee, Member of Operations Committee and President of Technical Operations & Product Supply

Peter S. Kim - Executive Vice President and President of Merck Research Laboratories

Michael Mendelsohn -

Roger Pomerantz -

Kenneth C. Frazier - Chief Executive Officer, President, Director and President of Global Human Health

Unknown Executive -

Darryle Schoepp - Senior Vice President and Director of Neuroscience Drugs

Nancy Thornberry -

Adam H. Schechter - Executive Vice President and President of Global Human Health

Alex Kelly - IR

Analysts

Steve Scala - Cowen and Company, LLC, Research Division

Charles Anthony Butler - Barclays Capital, Research Division

Gregory B. Gilbert - BofA Merrill Lynch, Research Division

Tim Anderson - Sanford C. Bernstein & Co., LLC., Research Division

Seamus Fernandez - Leerink Swann LLC, Research Division

Jami Rubin - Goldman Sachs Group Inc., Research Division

Christopher Schott - JP Morgan Chase & Co, Research Division

John T. Boris - Citigroup Inc, Research Division

Barbara A. Ryan - Deutsche Bank AG, Research Division

Unknown Analyst -

Presentation

Alex Kelly

Good morning, everyone, and welcome to Merck, and welcome to our R&D and business briefing. This morning, we have a full lineup of speakers for you. We have some good content that everybody's been working hard to prepare for you. So thank you for joining. Also, for those on the web, thank you for joining us. We will get started just a moment.

But before we do, I wanted to take a moment to introduce some of the management team at Merck who has joined us today.

So if I can start on the left side of the room. Frank [indiscernible] , if you can stand. So Frank is Head of our Primary Care and Women's Health Global business line. Joe Romanelli, who you know -- who is now working in Global Human Health business, supporting Adam Schechter. Mark Timney. Mark Timney leads the U.S. organization for Global Human Health. Mike Nelley, [ph] who you know. Mike, at the moment, supports Ken Frazier in a Chief of Staff role and he's soon to be taking a new role where he'll be heading our country operations in Sweden. So congratulations, Mike. Chris Scalet. Chris runs our IT group, our facilities and a lot of the other internal functions inside the company. Rick Bowles, who leads our compliance organization. Mirian Graddick-Weir, who leads our HR organization. Rick DeLuca is a new member of the management team. Rick has just joined recently to head the Animal Health business. Mike Rosenblatt, who is our Chief Medical Officer. Next, Willie Deese. Willie leads our Global Merck Manufacturing division. Bruce Kuhlik, who is the Head of Legal and Global Communications group. Adele Ambrose, who is the Head of Global Communications. Tom Hall, who works in our Strategy group. And Luciano Rossetti, who works in R&D's Scientific Strategy. And then Julie Gerberding, who leads our Vaccines division is here with us. And finally, Carol Ferguson, who you know on the Investor Relations team.

So with that said, let me remind you that some of the comments we make today might be considered forward-looking comments and statements, and as a result, you should know that some of those statements may turn out to not be true with the passage of time. We make our best efforts to make them factual, but there are certain risk factors that we identify in our SEC filings that could cause our actual results to differ materially from any forward-looking statements we'd make today. We also refer you to our website for those SEC filings. It will give that information. And then also you can see on the web we have our materials from our third quarter earnings call, including financials, that we may refer to during today's presentation.

So with that said, I'd like to get started. And our first speaker is Ken Frazier, who is our CEO and President and soon-to-be Chairman of the Board.

Kenneth C. Frazier

Thank you, Alex, and thanks, everyone, and good morning. We appreciate you joining us here this morning. And I am, along with my colleagues, honored to have the opportunity to spend some time with you this morning talking about our future. I'm also honored to be the new CEO of Merck. Merck is an exceptional company that, over the years, has done a great deal for so many people all around the world. But along with that great honor comes a very sobering responsibility, and that is the responsibility to ensure that we position this company in such a way as to be a sustainable enterprise that can continue to create value for customers, for patients and shareholders over the long term, and that is what I concentrate on when I come to work every day.

So we're delighted today to have an opportunity to host you at the second anniversary of our merger with Schering-Plough. We believe it's been a very successful union despite a few challenges along the way, and we'd like to help you understand today sort of how we intend to move forward as a unified company creating value.

So the first thing I want you to know is that we've spent some time thinking about transforming our company. We'll talk about what we mean by transforming Merck. But let me also tell you at the core, that we are committed, as committed as we've ever been as a company to scientific excellence and to innovation.

When I say we're committed to science, I mean that we're committed to it today and that we'll be committed to it tomorrow and we'll be committed to it for as long as I have anything to say about it.

We also have an exciting pipeline with a number of potential catalysts in 2012 and 2013, and Peter Kim will be talking about that later. As a company, I want you to know as a management team, we remain confident in our future. But while we're confident in our long-term future, we also recognize that we can't ask you, our investors, to wait for us to achieve all of our long-term aspirations without getting a reasonable return on your investment in the short term. So while we're confident in our long-term future, I want you to know that we intend to perform in the short term, and I hope that you will agree that in the year 2011, we have been performing.

The third point, as I mentioned earlier, is I think the merger has gone extremely well. Inside the company, it feels like we have been one company now for a long time. We're operating as one company. There's still some things that we have to do around systems and our network strategy, but even those things we're working on as we continue to fulfill our obligations under the integration.

The fourth thing I want to talk to you about today is how we're executing on a 4-part strategy that aims to deliver superior shareholder value over the long term.

I want you to know the fact is as Merck's new CEO, I am not satisfied with our current underlying valuation. But at the same time, I'm committed to ensuring that we build upon and restore the historic strengths that have made Mark successful over the long term. By design, my management team and the Board of Directors have spent a fair amount of time trying to objectively look at what it is that we do well as a company and what it is that we could do better. And we know that when it comes to some of the fundamentals, we have to find new and better ways of getting the job done.

So the marketplace is demanding more of us and you, our investors, expect more of us, and I want you to know that I appreciate that. But at the same time, again, given the long lead times that are inherent in this business, we have to think about how to build on our strengths for the long term to have competitive advantage and success as a company. At the same time, in the near term, the bottom line is we want to maximize cash flow. So we can invest in our business for that long-term growth, but also, so that we can have a sustainable enterprise that can continue to contribute to global health care over the long term.

At the same time, I want you to know that we're also committed to returning a significant amount of cash to you and value to you in the short term.

So now let's look at our plan for growth. Despite an early setback here in the year 2011, we laid out a challenging and ambitious plan to accelerate our business momentum. We said back in February when we first talked to you that 2011 would be a year that was all about execution. And we believe we're executing this year. Through September, we have delivered 5% top line growth, higher than expectations coming into the year, increasing sales by nearly $2 billion. In order to drive those top line investments, we said we would make strategic investments behind launches and the emerging markets. And thus far, we've invested more than $500 million in those key growth geographies and key growth drivers in our portfolio. And despite those targeted selective investments in 2011, we have still achieved net synergies of $2.8 billion since the merger.

In July, we announced a new wave of cost reductions to further drive efficiency inside our company. We said back in February that we would grow the bottom line faster than the top line. And so far this year, we've grown non-GAAP EPS by 10%.

We also said that we would advance the pipeline. And this year, we've been making what we believe are the right investments while also moving products to our late-stage pipeline. This year, we received approval to sell 5 new medicines including VICTRELIS, the first-in-class protease inhibitor for hepatitis C, and JUVISYNC, the first ever approved combination product for type 2 diabetes and cholesterol control.

Now we know that we need to do a lot more in terms of return on investment and R&D, and Peter Kim will share with you some of the significant steps that we're doing inside the company or taking inside the company to do just that.

Now looking ahead to 2012, I also want you to know that we're excited about our prospects next year. Right now, we're in the middle of developing our annual plans and our long-term operating plans. We will provide you our guidance for next year on our February call where we report our fourth quarter earnings.

But I'd like to tell you a little bit about how you might be thinking about 2012 given where we're aiming to be in 2012. First of all, we all know that 2012 will be a challenging year with certain known headwinds including the SINGULAIR patent expiry in August. Notwithstanding those challenges, we are setting high expectations for ourselves as a company next year. We intend to advance and augment our pipeline. We intend to deliver again strong operational performance next year. That means, for us, maintaining revenues at or near 2011 levels despite the SINGULAIR patent expiry. It also means that we have to continue reducing costs in the right way in order to deliver a leveraged P&L. In other words, we're talking about a company with a similar profile to the one we described in February 2011 when we said what we aspire to be like for investors over the long term.

Let me put that differently. We are not talking about a trough here. Next year, we intend to make the investments that will allow us to succeed in 2012 and beyond, and we're confident in our ability to do that. Now, we also understand that just setting goals for sales and EPS is not enough. So we're taking concrete steps to deliver profitable sales growth to generate an improved return on everything we do and even more cash flow tomorrow.

Now with respect to cash flow, we plan to remain shareholder-friendly with the added cash flow, and I'll talk more about that specifically in a moment.

Now if you allow me, I'd like to run through today's agenda. I will cover our strategy, our investment approach and our priorities for capital allocation. Next, Peter Kim will talk about some of the key drivers in our pipeline, but he will also talk about the efforts that are under way in Merck research laboratories to drive sustainably positive return on investment going forward. Then Peter will introduce 5 scientific colleagues who will help you understand how we plan to differentiate various parts of our pipeline when it comes to innovating. Finally, Adam Schechter will tell you about how we're trying to drive more revenue and more value in our human health business and our strategy for developed markets, as well as our strategy for emerging markets.

Let me reiterate that at Merck, the heart of what we do, you might say, who we are, is a company that translates cutting-edge science into medically important products, medicines and vaccines that have saved and improved and extended lives all over the world.

Now at the same time we know the substantial changes in the external world and that we have to adapt and transform Merck to ensure our future success. But the thing that will not change is our commitment to innovation. We believe innovation remains the single biggest driver of value for customers, for patients and for shareholders. That's what leads us to our 4-part strategy.

The first part of our strategy is to optimize our core human health business. The second part of our strategy is to expand in key growth markets all around the world. The third part of our strategy is to extend opportunities in our complementary and synergistic businesses of Animal Health and Consumer Care. And the fourth part is to excel in managing costs so that we can reinvest in growth while providing a good return to our shareholders. That 4-part strategy, if executed well, we believe will lead to increased shareholder return. So now let me start with what we're doing to optimize our core business.

As I've said before, this is basically all about execution, that means maximizing the growth of our in-line products, capitalizing on our late-stage pipeline by successfully launching new drugs, driving stronger return on investment across our entire R&D portfolio, including external innovations and partnerships that will help us either maintain or build leadership positions in the key therapeutic areas where we choose to compete.

Speaking of optimizing our core business, let's look at the innovation spectrum. For the past decade, at Merck, innovation has typically meant discovering and developing first-in-class medicine. We have a strong track record in discovering and developing first-in-class medicines and I think most people would agree that it's historically been a strength of Merck with compounds like JANUVIA, ISENTRESS and GARDASIL.

Now without losing our interest and desire around doing path-breaking research, we're broadening our thinking on scientific innovation to also include striking a balance between first-in-class molecules and molecules that can be considered best-in-class, that is to say molecules that the marketplace would differentiate favorably.

Looking across this entire spectrum, it is also important for us to get the maximum value out of every discovery that comes out of our research labs, and that implies more effective efforts around life cycle management than has historically been the case at Merck. I would say that JANUVIA and REMICADE are both good examples of effective life cycle management.

We also see a lot of value in the biosimilars space. Biosimilars are innovation-oriented, and we believe that few companies will have all the skill sets that are necessary to compete across the portfolio of biosimilars. Merck wants to be and intends to be one of those companies that can do that.

There's also a role for innovation when it comes to branded generics. That could be new formulations or combinations that meet unmet medical need, and we want to be at the forefront of innovative branded generics, particularly in the emerging markets where those kinds of products matter most.

Next, we will focus on optimizing our launches. We fortunately have multiple ongoing and upcoming launch opportunities. This year, we received approvals for 5 new drugs, and we have filed 8 more new drugs for approval between 2012 and 2013 and Peter Kim will cover that when he stands up here, so we have opportunities.

The next element of our strategy is growing our business in key geographic markets. Now the way we think about this, the best measure for this is looking at what we call evolution index by market. To answer a key question, are we growing faster than the market? Are we growing faster than our competitors? Adam will show you that we are focused on that relative growth in both mature markets and developing markets alike. The good news is that we're growing faster than our competition right now in many markets, including what we call the critical must-win 3 markets of the U.S., Japan and China.

Now let's talk about business development. Another way of optimizing our business is to work with diverse partners to strengthen our presence in these key markets. And this year, we signed more than 30 agreements to do just that. This slide shows you just a few examples of that. For example, Sun Pharma, which will help us provide innovative branded generics in the emerging markets; Simcere, which will expand our reach to doctors and patients in lots of places across China where our own sales force capabilities would not be able to reach without this kind of partnership; BGI enhances our capabilities in genomics, not just in the emerging markets but globally; Parexel and Hanwa will help us expand our portfolio within the biosimilars business; and Roche, which, for us, was an out-of-the-box agreement to help patients and physicians understand the benefit of VICTRELIS, and going forward, to help us collaborate around new therapies in the hepatitis C field.

I'd like to now talk about some of our complementary and synergistic businesses, and I'd like to start first with Consumer Care. We think Consumer Care is a good strategic fit with our Rx business, and it also is a business that has strong underlying market trends. We like the business because it has, among other things, attractive operating margin. And it also has enduring brands that are positioned well in their respective market segments. Having an OTC presence benefits Merck even though we recognize we do not have a business that has the global scale of the market leaders. It enables us, again, to extend the life cycle of our Rx products when it's possible to have an Rx-to-OTC switch.

In many markets, the distinction or delineation between OTC products and Rx products like CLARITIN is actually less than it is in some of the Western markets. And so we use the same channels, we appeal to the same customers. So it's important for us to have that opportunity.

Now with respect to market trends, they are also driving growth in the consumer health business. First of all, people all over the world are feeling more empowered to take care of their health. Secondly, people are also extremely focused on wellness. Next, governments and other payers are shifting costs increasingly for consumers. So all of those trends, we believe, support our Consumer Care business. I'd like to turn to another complementary area, which is Animal Health. Here, Merck Animal Health is a global leader. In the third quarter, as you know, we had 20% growth in this business, and importantly, half of that growth was from new products. We have a portfolio like our human health business that is focused on innovative medicines and vaccines. And we're looking to extend the value of our research discoveries across multiple species. The business has certain features that are common to human health, including, as I just said, the innovation orientation, but it also has attractive profit margins. Again, turning to the broader trends, they also favor this business. The market is expected to grow faster than 5% on an annualized basis between now and 2017.

There's a growing world demand for protein consumption. Well, I have a growing demand for it myself, but there's a growing demand for protein consumption all around the world, especially in the emerging markets, and Merck Animal Health is ideally positioned to capitalize on that development. There's also favorable trends in companion animals. It's a great opportunity and we have a great pipeline when it comes to companion animals. So Merck Animal Health, I think, has a tremendous opportunity given its relatively low market share and its strong pipeline to grow in the companion animal business. And again, underlying this is tremendous global growth. There's been a doubling in the last 10 years of pet ownership as well as veterinary professionals. So all in all, we see Animal Health and Consumer Health as both complementary and synergistic businesses.

Now I'd like to shift to the fourth aspect of our business, which is managing costs while investing for future growth. Following the merger, we've delivered 80% of the promised synergies. We're ahead of schedule with respect to our basic merger target. As I mentioned earlier, in July, we complemented that with an additional $1.3 billion to $1.5 billion in additional cost reductions. Now make no mistake about it. These kinds of cost reductions require major changes in how we operate this company. It also, I think, gives us greater variability in our cost base. Now as I said before, we intend to redeploy some of those savings to drive growth and productivity and profitability in our underlying business where that return, we believe, is justified.

Our goal was to be a stronger company with better long-term growth prospects as well as increased near-term profitability. Our strategy is aimed at generating substantial cash on a sustainable basis. So given that, let me talk a little bit about our priorities for capital allocation.

So obviously, the first priority for any company is to operate the business, to make the necessary capital investments and other investments that we need to keep our business going. To meet our obligations now and in the future, it's important for us to maintain a strong balance sheet that gives us the flexibility and the ability to make the kinds of investments that you need to do in a long lead time business. The second thing is we need to invest in growth opportunities where we have value-creating business development opportunities, be those licenses or targeted acquisitions that will help us, again, augment our pipeline and either build or maintain leadership in key therapeutic areas.

After we do those things, that is to say, operate the business for the long term and invest in business development, we want to continue to return cash to shareholders through our dividend and share repurchase program. I want to give you a sense of the opportunities that we have to enhance our current business. As I said, we're actively pursuing new products to bolster our portfolio and therapeutic areas where Merck either already leads or we're targeting for future leadership. We want to have value-creating partnerships that drive our business and enhance our portfolio in the emerging markets. They help us expand our capabilities, those kinds of partnerships, with the kind of local knowledge that makes a real difference in those markets. As I mentioned before, we will look for value-creating opportunities, and I stress value-creating opportunities, if they are available to us in Animal Health and Consumer Health.

Read the rest of this transcript for free on seekingalpha.com