Source: Seeking Alpha
Merck & Co., Inc. (NYSE:MRK)
Q2 2014 Earnings Conference Call
July 29, 2014 08:00 AM ET
Joseph Romanelli – VP of IR
Ken Frazier – Chairman and CEO
Rob Davis – CFO
Adam Schechter – Head of Global Human Health
Roger Perlmutter – Head of Merck Research Labs
John Boris – SunTrust Robinson Humphrey
Colin Bristow – Bank of America Merrill Lynch
David Risinger – Morgan Stanley
Jami Rubin – Goldman Sachs
Mark Schoenebaum – ISI Group
Tim Anderson – Sanford Bernstein
Seamus Fernandez – Leerink
Marc Goodman – UBS
Alex Arfaei – BMO Capital Markets
Jeff Holford – Jefferies
Vamil Divan – Credit Suisse
Steve Scala – Cowen
Chris Schott – JPMorgan
Good day everyone, and welcome to Merck’s Second Quarter 2014 Earnings Conference Call. Today’s call is being recorded. At this time I’d like to turn the call over to Joseph Romanelli, Vice President of Investor Relations. Please go ahead.
Joseph Romanelli – VP of IR
Thank you, Jacky and good morning everyone. We’d also like to say good afternoon and good evening to everyone listening outside the United States. Welcome to Merck’s second quarter 2014 conference call. Before I turn the call over to Ken, I want to point out just a couple of items.
First of all there are a number of items in the GAAP results, such as acquisition-related charges, restructuring costs, and certain other items. You should note that we have excluded those items in our non-GAAP reconciliation tables and you can see them in our press release in table two. This will give you a better sense of our underlying performance.
There are three tables in the press release. The first table provides the GAAP results. Table number two reconciles our GAAP P&L to the non-GAAP results for the first quarter and table three provides the sales performance for the company’s business units and our products both on a reported basis and excluding exchange. During the call we will be referring to table two when we discuss the P&L and table three when we talk about revenue performance.
Finally I would like to remind you that some of the statements we make during today’s call may be considered forward-looking statements within the meaning of the Safe Harbor provision of the U.S. Private Securities Litigation Reform Act of 1995. Such statements are based upon Merck’s current beliefs and are subject to significant risks and uncertainties.
If underlying assumptions prove inaccurate or uncertainties materialize, actual results may differ materially from those set forth in the forward-looking statements. The company’s SEC filings, including Item 1A in the 2013 10-K, identify certain risk factors and cautionary statements that could cause the company’s actual results to differ materially from those projected in any forward-looking statements made this morning. Merck undertakes no obligation to publicly update any forward-looking statement. Our SEC filings can be found on the website at merck.com and you can also find our earnings release and all the tables there as well.
Now this morning, I’m joined by Ken Frazier, our Chairman and CEO; Rob Davis, our CFO; Adam Schechter, Head of Global Human Health; and Dr. Roger Perlmutter, Head of Merck Research Labs. So with that I like to introduce Ken Frazier. Ken?
Ken Frazier – Chairman and CEO
Thank you, Joe. Good morning everyone, and thank you all for joining the call today. Our performance this quarter reflects our continuing progress towards transforming Merck and building a platform for future growth and innovation. Our underlying portfolio is growing and we are particularly pleased to have reported solid growth in our top five brands. We’ve now delivered a strong first half of the year which we believe positions us well to deliver on our full year non-GAAP EPS guidance. I’m excited that as we move into the second half of the year we’re preparing for a series of promising product launches and data presentation. These represent near and longer term opportunities that will allow Merck to drive value for shareholders and society. They include pembrolizumab our Anti-PD-1 Antibody. New treatment options for hepatitis C; Zontivity for post-MI or PAD patients; Sugammadex for the reversal of neuromuscular blockade; suvorexant for the treatment of insomnia; odanacatib for the treatment of osteoporosis; and V503 or 9-valent HPV vaccine. Importantly each of these candidates underscores Merck’s commitment to translating cutting-edge science into medicines and vaccines that have meaningful differentiated attributes.
Additionally, we represent the kind of innovation that while making a potentially significant difference to patients also can provide strong value to payers, providers and healthcare systems.
This quarter we further sharpened our commercial and R&D focus by continuing to rigorously prioritize our portfolio to ensure that all of our businesses have the potential to be market leaders and create value for shareholders. This approach led us to enter into an agreement with Bayer for the sale of our consumer care business for $14.2 billion and concomitantly to establish a worldwide collaboration with Bayer to develop and market, Adempas, a novel sGC modulator for the treatment of pulmonary arterial hypertension as well as other novel compounds in development.
We also entered into an agreement to acquire Idenix Pharmaceuticals and its promising portfolio of hepatitis C candidates. These candidates will both complement our hepatitis C therapies currently in development and advance our work to develop highly effective once daily oral, pan-genotypic regimen that could benefit millions of patients around the world. We remain on track to complete this acquisition in the third quarter. These transactions are in keeping with our intention to be the premier research intensive bio pharmaceutical company by focusing on our highest potential growth opportunities and augmenting our pipeline with external assets that can create value and continue to provide an industry leading return of capital to our shareholders.
In closing, as I said last quarter this is an exciting time at Merck as we prepare to commercialize the next wave of innovation coming out of our labs. This innovation represents a suite of near and longer term opportunities that will make a meaningful difference to patients, healthcare providers and payers while also creating value for our shareholders. And now I would like to turn the call over to Adam Schechter.
Adam Schechter – Head of Global Human Health
Thank you Ken, good morning everyone. This morning I will provide you with an overview of Global Human Health second quarter results. My commentary will be on a constant currency basis. Overall, sales reached $9.1 billion. Immunology, diabetes and vaccines continue to be areas of growth. However, these areas were offset by the continued impact of loss of exclusivity of several brands, product divestitures that we announced previously and the biannual price declines in Japan.
As we move through 2014, I look forward to speaking with you about our core business and also multiple launches that we are planning for including pembrolizumab, suvorexant and others. I would now like to discuss results from some of our core product areas and I will start with the Januvia franchise. Januvia franchise had sales that reached $1.6 billion and grew 2% in the quarter. Growth was driven by our international markets which represent about half of our total sales.
These markets grew 4% as a result of strong growth in Europe and the emerging markets. In the United States, sales declined 1% but volume growth continues to improve. In fact volume growth was 3% in the latest rolling four week average. We are encouraged by the volume trends that we are seeing. We expect that volume growth will continue in the U.S. over the remainder of 2014 as we defend our market share of nearly of 75% and we work to grow the DPP-4 class. Importantly, we continue to expect global sales growth of the Januvia franchise in 2014.
Moving to Isentress, sales grew 10% driven by solid performance in Europe and emerging markets and some benefits from buying patterns in the U.S. Growth outside of the U.S. remains an important driver for the brand that help offset slight volume declines we are seeing in the U.S. The START Merck study in treatment naive patients provides long term head-to-head data in our label that will help support the continued growth of Isentress.
Next, our immunology business consisting of Remicade and Simponi saw another strong quarter of growth. Sales grew 15% driven by continued strong uptake of Simponi and steady growth of Remicade despite biosimilar entry in some of the smaller EU markets.
Now moving to our vaccine business; in second quarter vaccine sales grew 3%; Gardasil growth of 9% and Zostavax growth of 10% were partially offset by declines in Varivax and Pneumovax. Gardasil increases were driven by the U.S. and emerging markets. Sales growth of 16% in the U.S. reflects higher public sector purchases of about $30 million. Zostavax growth came from our ex U.S. launches. In the U.S. we remain focused on educating our customers on the reimbursement process and we are also initiating promotional efforts ahead of the fall flu vaccine season. Zostavax is now available in over 25 markets and we expect additional launches in 2014.
Now I’ll briefly outline sales performance on a regional level beginning with the United States. In the U.S. sales growth for the Zetia franchise, Dulera and Gardasil was more than offset by the loss of exclusivity of Temodar, HCV declines and product divestitures. In Europe, we drove strong growth in immunology, diabetes and Isentress.
We also saw a continued generic erosion for Nasonex as well as declines for our HCV products. Japan sales declined 6% primarily due to the biennial price decreases and the negative impact of suspended promotion for HPV vaccines. Sales in emerging markets grew 2% on good growth from vaccines, acute care products and Isentress.
China grew 6% and growth in other important emerging markets such as Brazil and Turkey were partially offset by continuing pressure in Mexico, Egypt and Eastern Europe. For the full year, we continue to expect that the emerging markets will be good growth drivers for us.
Moving to the future, we are looking forward to important launches and we are investing in pre-launch preparations. First on suvorexant, we’re anticipating regulatory action in the middle of August. Following that we need to await the DEA decision on product scheduling. We anticipate launching late this year or early in 2015. We are very excited about the potential launch of suvorexant. Second and importantly, we are ready to launch pembrolizumab as we continue to expect regulatory action by October 28, this year.
We are resourcing the launch with a focus on clinical capabilities that will help address the needs of oncologist, our payers and cancer patients. We built our capabilities with an emphasis on assembling the best internal and external talent. Upon approval, we will rapidly engage oncologist to ensure they are prepared to appropriately prescribe this potentially first in class breakthrough product.
We will partner with payers to ensure that pembro is readily accessible for patients and we will have support for patients with reimbursement assistance. The anticipated approval of pembro would mark the first approval from our exciting clinical development immuno-oncology program. More importantly this will be a tremendous opportunity for Merck to help make a difference for patients and their families.
Let me be clear, we are ready to launch pembro. In summary, Global Human Health drove growth of key franchises including diabetes, immunology and vaccines. We are prioritizing our investments and we are intent on driving future growth with our core brands, with our core markets and with our exciting new launch opportunities. Now I’d like to turn the call over to my colleague Rob Davis.
Rob Davis – CFO
Thanks, Adam. It’s a pleasure to be here this morning for my first earnings call as CFO. We’ve had a strong first half of 2014 and our second quarter results demonstrated that we continue to sharpen our focus as a company. This morning I’ll provide additional color on our P&L and comment on our outlook for the rest of the year. My remarks will focus on our non-GAAP financials. On this basis, we earned $0.85 per share in the second quarter as compared to $0.84 per share in the prior quarter. Our EPS was driven by growth in key brands and effective cost management, which was partially offset by patent expiries and divestitures.
Turning to the top line, total revenue in the quarter decreased 1% year over year. Foreign exchange did not have a material impact on the revenues this quarter. As Adam stated our sales in the pharmaceutical business were driven by solid growth in key brands. Animal health revenues increased $27 million, 3% year over year, excluding exchange or 9% if we also excluded the impact of the Zilmax suspension.
Our Animal Health results were driven by the strong performance of bravecto, our newly launched oral flea and tick treatment for dogs in the US and Europe and the strong growth from our poultry business. Consumer care revenues increased $100 million or 20% excluding exchange. Sales in the quarter were driven by sales of Claritin and Coppertone. As you may recall, we had a onetime unfavorable adjustment to sales in the second quarter of 2013, which represents a single significant percentage of the positive year over year comparison this quarter.
Excluding those actions, Consumer Care global sales grew 4% including 1 percentage point of negative impact due to foreign exchange. As a reminder, we expect the divestiture of the consumer care business to close this year.
Regarding the joint venture with AstraZeneca, revenue from the JV was $316 million and benefited from the timing of purchases in the quarter. As expected, Astra exercised its option to end our partnership on June 30th. As a result we will no longer record supply sales or equity income from the JV in the second half of this year.
Moving to expenses, gross margin was 72.6% in the quarter, representing a decline of about 300 basis points from last year. The decline was the result of product mix and inventory write-offs primarily for Victrelis. We continue to expect the 2014 full year gross margin to be slightly lower than 2013’s full year ratio of 74.3%.
Marketing and administrative expenses were $208 million lower than prior year driven by reductions in promotion and direct selling costs. While we continue to focus our resources on key markets and core products we’re also preparing for additional product launches later this year. We will invest in these launches to maximize our opportunity for growth. We’re also making resource allocation decisions so that we remain on track for full year marketing and administrative reductions versus 2013. Likewise research and development expenses were $232 million lower year over year as a result of our continued prioritization and rationalization efforts. As we said last quarter our R&D expense for our current portfolio will increase in the back half of the year. In addition we will also invest in the HCV assets we will acquire from Idenix and the research collaboration with Bayer. As a result, we now expect our R&D expense in the second half of 2014 to be a few hundred million dollars higher than the second half of 2013. Overall, we continue to expect our full year R&D expense to be below 2013 levels.
Finally, on our tax rate our non-GAAP effective tax rate was 24.2% in the quarter which was in line with our expectations for the year. We continue to anticipate the tax rate for the full year to be between 24% and 26%.
Now our outlook for the rest of the year, on the top line we are reconfirming our revenue guidance up $42.4 billion to $43.2 billion at current exchange rates. We’re narrowing our non-GAAP EPS guidance to a range of $3.43 to $3.53 which excludes a potential impact from a devaluation of the Venezuelan Bolivar. This range reflects our strong performance in the first half of the year and includes roughly $0.06 to $0.09 of dilution from the divestiture of the consumer care business, the resulting research collaboration with Bayer and the acquisition of Idenix and its HCV assets.
On a GAAP basis, we now expect to earn between $4.44 and $4.77 in 2014. As noted earlier both marketing and administrative and R&D expenses in 2014 are expected to be lower than 2013. Due to the strength of the results in the first six months of the year and the additional developmental costs associated with the Bayer collaboration and Idenix portfolio. We now expect EPS in the second half of the year to be generally consistent with the first of the half of 2014.
With that, I’d like to provide a quick update on capital allocation. While we continue to focus on improving our productivity and transforming our business model, we also remain committed and focused to return cash to shareholders.
As we said, during the investor briefing in May, we are going to use the proceeds from the Bayer transaction to augment our pipeline with business development activity and returning capital to shareholders. We’ve delivered on that commitment by agreeing to acquire Idenix for $3.85 billion and we expect to deploy a significant amount of the after tax proceeds to repurchase shares this year.
We now project our average diluted shares to be slightly lower than the 2.95 billion share count we gave last year for 2014 depending on the timing of the purchases. In summary, we feel good about the results and are reassured by the strength of the performance in the first half of the year. That strength is allowing us to invest in the business in the second half of 2014, meet our guidance targets despite the dilution of two transactions and return cash to shareholders.
Now, I will turn the call over to Roger.
Roger Perlmutter – Head of Merck Research Labs
During the second quarter, our R&D organization made substantial progress in advancing important new therapies. In April, our regulatory affairs group obtained FDA approval for Zontivity, the first thrombin receptor antagonist ever introduced into clinical practice. Zontivity has been shown to reduce the risk of cardiovascular death, heart attack stroke and the need for procedures to restore blood flow to the heart in patients with a history of heart attack or a peripheral arterial disease who are already receiving optimal therapy.
Because of the increased bleeding risk associated with this anti-platelet therapy, Zontivity should not be used in patients with a history of stroke or transient ischemic attacks. We are excited about the potential for Zontivity to improve outcomes in patients at high risk for heart attacks and are working assiduously to make certain that heart specialists are aware of the clinical data supporting the use of Zontivity.
In Europe, we’re engaged with the Committee on Medicinal Products for Human Use of the European Medicines Agency, who are evaluating our file for this product.
Meanwhile, during the second quarter, we advanced a regulatory review of Suvorexant, our orexin antagonist for improving sleep in patients with insomnia. You will recall that we submitted our response to the FDA’s complete response later in February. We’ve worked closely with the agency and are now discussing features of product labeling. The PDUFA date for action by the FDA with respect to Suvorexant is August 14. We’re also making progress in supporting the regulatory review of V503 our 9 valent human papillomavirus vaccine designed to extend protection from the risk of cervical cancer across approximately 90% of vaccine genotypes associated with this disease. We are eager to bring this important new vaccine to world markets.
During the second quarter, the FDA accepted our filing for pembrolizumab in the treatment of patients with advanced melanoma refractory to all available therapies. FDA review of our filing including a number of clinical and manufacturing inspections is proceeding in advance of the PDUFA date of October 28. During the second quarter, we also filed for approval of pembrolizumab in the treatment of advanced melanoma in Europe. This file has been accepted for review by the European Medicines Agency.
At the American Society for Clinical Oncology meeting in June, we’ve summarized a very large body of information that we are assembling regarding the use of pembrolizumab both by itself and in combination with other agents in the treatment of malignant disease.
Currently, we have pivotal studies underway or in planning for the treatment of malignant melanoma, non-small cell lung cancer, head and neck cancer and bladder cancer and we have early evidence of activity in several other important tumor types.
In all, we are testing pembrolizumab in a treatment of more than 30 different malignancies. Our clinical development organization working closely with the bio-process groups involved in supplying clinical material has managed to maintain a very challenging schedule of patient enrollment with a goal of determining the full spectrum of activity of pembrolizumab. We have submitted numerous abstracts for the European Society for Medical Oncology meeting in September and we will hope to share quite a bit of new data with you regarding pembrolizumab at that time.
At our May 6 Business Review in Boston, we described our plans for the development of novel treatment paradigms for patients infected with hepatitis C virus we have made excellent progress in advancing our registration enabling program using a fixed dose combination of MK-5172 and MK-8742 in treatment naïve and previously treated patients and those with and without evidence of significant liver injury and in more complicated patients with renal insufficiency or who have simultaneous inflections with human immunodefficiency virus.
Our goal as I have made plain, is to advance an effective therapy for all patients irrespective of the genotype of their HCV infection and regardless of co morbidities and to achieve a very high rate of sustained virologic response following less than six weeks of active therapy. To this end, we have initiated studies combining the MK-5172, 8742 doublet regimen with Gilead’s sofosbuvir.
We will use information from this triplet regimen to advance our internal programs that employ a uridine analogue HCV polymerase inhibitor to complement MK-5172, 8742 therapy. Of course this was the reason that we pursued the acquisition of Idenix to gain access to their advanced nucleoside-based polymerase inhibitors. We’re looking forward to working with our new colleagues at Idenix and we’re very encouraged by what we have seen to this point. We believe quite strongly that these new regimens which are advancing quickly in the clinic will form the basis of rapid genotype independent definitive therapy for millions of patients at risk for liver failure, as a result of HCV infection.
We also announced in May that through the sale of our consumer products division to Bayer we will gain access to a set of soluble guanylate cyclase activators including Adempas. We’re working closely with our colleagues at Bayer as we assume shared responsibility for the development of Adempas which is approved in the United States for the treatment of pulmonary hypertension in two different settings and which is being studied as a possible treatment for pulmonary hypertension and a third setting in patients with idiopathic interstitial pneumonia.
Meanwhile we continue to actively prosecute our C. difficile toxin antibody program, our novel non-nucleoside reverse transcriptase inhibitor doravirine for HIV therapy. Letermovir for the prophylaxis and treatment of cytomegalovirus infection in patients undergoing bone marrow transplantation, our beta secretase program in patients suffering from or at risk for Alzheimer’s disease, our development of long acting DPP-4 inhibitors for diabetes and our late stage program testing the ability of anacetrapib to reduce cardio-vascular risk in patients on optimal cholesterol lowering therapy among many, many others. Despite this deep clinical agenda, we have managed to reduce expenses versus 2013 largely through operating efficiencies.
As Rob noted, we do expect that clinical trial expenses will increase in the second half of the year principally as a result of the large set of late-stage opportunities in cancer treatment that we see for pembrolizumab. Nevertheless through rigorous portfolio prioritization, we will ensure a highly disciplined approach to expense management. Joe.
Thank you Roger, and thank you Jackie. Before we open up the line to Q&A just a quick reminder to get to as many callers as possible please limit your questions to one or two that way we can try to make sure we cover everyone. Jackie, why don’t we go ahead and take the first caller.
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