Merck & Co., Inc.

Good morning. My name is Harlow, and I will be your conference operator today. At this time, I would like to welcome everyone to the Merck and Company Quarter 4 Sales and Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, seem to press star and then the number one on your telephone keypad. To withdraw your question, press the pound key. Please limit your questions to just one or two. Thank you. I would now like to turn the call over to Peter Denenbaum, VP of Investor Relations. Please go ahead.

Thank you, Carlo, and good morning. Welcome to Merck's fourth quarter 2019 conference call. Today I'm joined by Ken Frazier, our Chairman and Chief Executive Officer, Rob Davis, our Chief Financial Officer, Dr. Roger Perlmutter, President of Merck Research Labs, and Kevin Ali, who will be named Chief Executive Officer of the new company we have announced today. Each will have prepared remarks. In addition, I am also joined by Frank Clyburn, our Chief Commercial Officer, and Mike Malley, our Chief Marketing Officer, who will be available for the Q&A portion of the call. Before I turn the call over to Ken, I'd like to point out a few items. You will see that we have items in our GAAP results, such as acquisition-related charges, restructuring costs, and certain other items. You should note that we've excluded these from our non-GAAP results and provided reconciliation in our press release. We have also provided a table in our press release to help you understand the sales in the quarter for the business units and products. I would like to remind you that some of the statements that 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 made based on the current beliefs of Merck's management and are subject to significant risks and uncertainties. If our underlying assumptions prove inaccurate or uncertainties materialize, actual results may differ materially from those set forth in the forward-looking statements. Our SEC filings, including item 1A in the 2018 10K, identify certain risk factors and cautionary statements that could cause the company's actual results to differ materially from those projected in any of our forward-looking statements made this morning. Merck undertakes no obligation to publicly update any forward-looking statements. You can see our SEC filings, as well as today's earnings release, on Merck.com. We've also posted a presentation to the investor section of Merck.com, which includes some of the highlights from our results and announcements. With that, I'd like to turn the call over to Ken. Thank you, Peter. We're very pleased to speak with you this morning as we close out what we consider to be an exceptional year for Merck. And we're excited to announce our intention to create two leading growth companies through the spinoff of our women's health, legacy brands, and biosimilar products into a new company. As you can see from our results and our 2020 guidance, Merck had an extraordinary year. and is in a position of operational and financial strength driven by strong execution of our strategy and focus on our key growth drivers and innovative pipeline. It is this position of strength, born of that focus, that gives us the confidence to do what we believe will best position us to deliver even greater value to patients and shareholders. Throughout my entire tenure as CEO, we have consistently focused on science as core to our strategy to not only benefit the most patients, but also as a means of creating the most value. As you've seen, Merck's portfolio has evolved from one focused largely on primary care products to one focused on oncology, vaccines, hospital, and animal health. It is this purposeful shift coupled with greater prioritization and focus on key growth drivers that has led to the unprecedented growth that we are now experiencing. Going forward, we see even greater opportunities to invest behind our innovative growth drivers. In placing greater focus and prioritization behind these products, we must also think carefully about how to make the best possible use of the remainder of our expansive human health portfolio. which is comprised of more than 160 products in total. Our responsibility to patients and shareholders has led us to think about how we can maximize the impact of this vast array of human health products. Therefore, after careful consideration over time, we've made the decision to separate into two companies, one a research incentive by a pharmaceutical leader, The other, a new company focused on becoming a leader in women's health with the capability to realize the full potential of a portfolio of trusted and medically important legacy products and a rapidly expanding biosimilars business. By spinning off NUCO as a distinct business, we can better prioritize and support a set of products that no longer fit in Merck's strategic framework, but which remains important to public health and the patients who rely on them, and which, if managed and resourced appropriately, present real opportunities for growth. We're also mindful of the changing industry landscape and believe that evolving our operating model in this way will allow Merck to benefit from an even more intense focus on breakthrough science immunization. As I stated on Investor Day in June, Our mission and rich legacy of inventing to save and improve lives is the foundation of our company. The separation of NUCO will help us in our aspiration to be the premier research-intensive biopharmaceutical company by allowing us to focus on innovations that prevent and treat diseases. And over the past few years, we have seen how more focus and more prioritization leads to more growth, more efficiency, and more value creation. The spinoff will also create significant opportunities for NewCo. As an independent company, NewCo will pursue its strategic intent of becoming a global leader in women's health, an area where the future opportunities are significant. In addition to the growth potential in women's health, NewCo's growth will be fueled by more fully realizing the full potential of a portfolio of trusted legacy brands in pain, dermatology, cardiovascular, and other areas, as well as its rapidly expanding biosimilars business. This new company will have the strategic freedom to pursue additional growth opportunities through lifecycle management and targeted acquisitions and partnerships in women's health, dermatology, and other fields. NewCo will be led by a highly experienced leadership team, including Kevin Ali, who has been named Chief Executive Officer. Kevin has a proven track record of leadership at Merck, with deep experience in global pharmaceutical markets and diverse therapeutic areas. In addition, Newco's board will be chaired by Carrie Cox, who has extensive experience in pharmaceutical commercialization, particularly in women's health, as well as broad leadership and board experience, including as former chairman and CEO of Humacyte, former chairman of Array Biopharma, and is president of Global Pharmaceuticals at Schilling Cloud prior to its merger with Merck. We're confident that NewCo will be in experienced and capable hands with this leadership team. Our industry faces emerging challenges, such as the rising cost of innovation and increasing pressures around pricing and market access. In this environment, we must maximize our opportunities to act with greater operational agility, efficiency, and productivity. As separate, more focused companies with more optimal resource allocations, both Merck and NUCCA will be better positioned to continue to positively impact the lives of patients, improve global public health, and achieve faster growth. As a result, we expect Merck shareholders to benefit through ownership of two focused companies, each with attractive financial characteristics and growth profiles. In summary, we are seeing the benefit of focusing our organization on its best growth opportunities. As we look out to 2024, we believe the strength of our business is underappreciated. We are more confident than consensus on every key financial metric, including revenue, operating margins, and EPS growth. Our commitment to maintaining and growing the Merck dividends is evidence of the confidence we have in the long-term prospects for our business. Our fundamental operating and financial strengths allow us to take bold steps to stay ahead of the curve by reshaping our operating structure, focusing and streamlining Merck, enabling Merck to become an even stronger, more agile, and faster-growing company. I strongly believe that this is the right thing for patients, for public health, and for shareholders. With that, I'll now pass it on to Rob to discuss our results and provide more details on the spinoff. Rob? Thanks, Ken, and good morning, everyone. I'm excited to speak to you this morning about our 2019 results, as well as our decision to spin off a portion of our human health business, a decision that will enhance the value of both Merck and NUCO. 2019 was a year of exceptional growth for our business, with revenues increasing 13%, and non-GAAP EPS increasing 21%, excluding the impact of foreign exchange. Our strong performance reflects the continued execution of our science-led strategy, and we expect our business momentum to continue, particularly as we enhance our focus on our key growth drivers through this spinoff. I'll start by highlighting our strong fourth quarter results before providing more details on the transaction and 2020 guidance. Total company revenues were $11.9 billion in the quarter, an increase of 8% year-over-year, or 9% excluding the negative impact from foreign currency. Both our human health and animal health divisions contributed to the growth this quarter. The remainder of my comments pertaining to sales will be on an exchange basis. Our human health revenues grew 8%, led by products in oncology and hospital. In oncology, Keytruda fourth quarter sales were $3.1 billion, and for the full year, sales exceeded $11 billion, representing 58% growth versus 2018. In the U.S., growth was driven by strong demand across all indications. Keytruda continues to lead across many indications, including lung, bladder, and heavy neck cancers, with strong momentum in adjuvant melanoma and renal cell carcinoma, where we are seeing strong uptake across all patient subgroups. Outside the U.S., protruded sales in the quarter grew 50%, driven by lung globally, with reimbursement for Keynote 189 now secured across all major markets in the EU, and strong uptake in lung following approvals in Japan and China. We are also seeing positive uptake from early launches in both renal cell carcinoma and adjuvant melanoma in the EU, and expect to see strong global growth as these and other new indications continue to roll out. Our results also reflect continued strength for both Lymparza and Lymvema, important products from our collaborations with AstraZeneca and Esci, respectively. Lymparza continues to have strong growth in ovarian cancer and maintains a greater than 60% total patient share in the PARP inhibitor class in the United States. Growth of Lymvema benefited from the launch of the endometrial carcinoma indication in combination with Keytruda, and continued strong demand in first-line hepatosodial carcinoma, where Linvima is now the leading treatment agent. Our vaccines business declined this quarter due to the impact from the replenishment of Gardasil to the CDC stockpile in 2018 and our borrowing from the stockpile in the fourth quarter of 2019, which negatively impacted the year-over-year comparison of Gardasil revenues by $245 million on a combined basis. Excluding these impacts, Gardasil revenue grew 16% driven by continued strong underlying global demand. Our hospital business benefited from 24% growth in Brion, which reached $1 billion in annual sales for the first time this quarter. Growth was largely driven by an increased share in the U.S. reversal market. For the full year, we achieved strong growth of 14% in our human health business, driven by our growth pillars across most geographies. Animal health revenues increased 10% this quarter to $1.1 billion. Growth for the quarter was driven largely by the products acquired in the Antelic acquisition. Now, turning to the rest of our P&L, my tournaments will be on a non-GAAP basis. Gross margin was 72.6% in the quarter, a decrease of 240 basis points year-over-year, primarily reflecting the impact of unfavorable manufacturing finances and higher inventory write-offs. Operating expenses of $5.2 billion increased 10% year-over-year. Administrative and promotional expenses drove higher SG&A costs in the quarter, while clinical development spend and costs associated with our discovery efforts who were responsible for the increase in R&D expense. Other income and expense was positively impacted by income from our equity securities portfolio, partially offset by higher net interest expense. Our effective tax rate for the quarter was 16.9%, driven by lower and favorable earnings mix. Taken together, we earned $1.16 per share, an increase of 12% excluding exchange. Now, turning to our announced spinoff. As Ken noted, by further evolving our operating model and separating into two simpler, more focused and agile companies, both will be better positioned to respond to the changing external landscape, improve efficiency, and accelerate growth, creating greater value for patients and shareholders than would be achieved as a single company. Spinning off NUCO accelerates Merck's revenue growth by up to one percentage point on a compounded average basis through 2024. But more importantly, it allows Merck to enhance focus on its key growth drivers and robust pipeline. This gives us confidence that Merck will realize even greater incremental revenue growth over time. We will also benefit from more streamlined processes and operations, enabling further operating model efficiencies across the value chain. For context, the products to be spun off into NUCO represent about 15% of Merck's human health revenues based on 2020 forecasts, while consuming a much larger share of our operations and resources. In fact, separating NUCO will reduce Merck's human health manufacturing footprint by about 25%, the number of products by 50%, and the number of SKUs by 60%. As a result of a more optimized operating model, Merck will achieve even higher operating margins over time, creating additional headroom to invest in innovation, which we continue to believe is the key to our long-term growth and value creation, as Ken has referenced. Merck will continue to benefit from broad commercial scale driven by its key growth pillars in oncology, vaccines, hospital, and animal health, as well as our diabetes franchise. Merck will continue to have a strong balance sheet with significant cash flows and financial flexibility. which will allow for investments in innovation and meaningful business development to augment as a pipeline and portfolio, while continuing to return capital to shareholders. We expect to complete the transaction in the first half of 2021. Until then, we will remain focused on continuing to successfully execute our strategy and maintaining our strong financial and operational performance. Now, let's move to our outlook for 2020 the year in which we continue to operate as a combined entity. My remaining comments will be on a non-GAAP basis. We expect full-year 2020 revenue to be between $48.8 billion and $50.3 billion, which represents 4% to 7% growth versus 2019. This range assumes a negative impact from foreign exchange of less than one percentage point using mid-January rates. Our gross margin will be roughly 75.5%. We expect operating expenses to increase by a low single-digit rate year-over-year due to higher IR&D spending as we remain committed to fully funding the meaningful opportunities in our pipeline. Best G&A expenses will remain tightly managed. We expect other expense of roughly $200 million driven by higher net interest expense. We expect our tax rate to be roughly 17.5% to 18.5% for the year. We project average diluted shares to be 2.54 billion for 2020. And we expect EPS to be between $5.62 and $5.77, which represents growth of 8% to 11%, including a roughly 1.5 percentage point negative impact from foreign exchange using mid-January rates. Longer term, Merck continues to expect strong revenue growth driven by growing demand for our innovative products. When looking out to 2024, we believe our revenue growth potential is underappreciated, even more so as we begin to realize the benefits of this transaction. We continue to expect meaningful operating and margin expansion over time. The separation of NUCO enables $1.5 billion in pre-tax operating efficiencies, rateable over three years. While initially Merck's operating margins will decline slightly, we expect to achieve operating margins of greater than 40% in 2024, higher than Merck would have achieved as a combined company. The transaction is expected to result in $8 to $9 billion of proceeds from a special tax-free dividend from NUCO. Merck's capital allocation priorities remain unchanged, and we expect to maintain a very solid financial and credit profile. First and foremost, we will fund our best growth opportunities through investments in R&D, product launches, and capacity expansion, and we believe the spinoff allows us to better focus on these activities. Merck's dividend will be unaffected by this transaction, and we anticipate future dividend increases from the current 2020 dividend of $2.44 per share post-separation with the goal of achieving a 47% to 50% payout ratio over time. We will continue to have ample capacity for value-enhancing business development, and finally, we will continue to repurchase shares as a way to return excess cash to shareholders. Turning now to NUCO's financial profile, the products represented by the new company, Corpolio, are expected to achieve 2020 revenue of approximately $6.5 billion with an operating margin of approximately 45% as part of Merck. As an independent company, NUCO is expected to achieve low single-digit revenue growth off of a 2021 base of $6 billion to $6.5 billion. Taking into consideration the cost to operate as an independent company, operating margins for NUCO are expected to be in the mid-30% range and increase over time. And finally, we anticipate EBITDA margins to be in the low to mid 40% range in 2021 and also increase over time. NUCO will have strong cash flows and a balance sheet position to invest in growth opportunities and expects to pay a meaningful dividend, which will be at least as competitive as any likely peer company and entirely incremental to Merck's dividend. In total, we expect combined EPS of NUCO and Merck together to initially be nominally lower than what Merck would have achieved without the spinoff. But as a result of the incremental growth that Nucro will achieve standalone, combined with the benefit of the operating efficiencies that Merck will realize, we expect that shareholders owning both companies will realize higher EPS within 12 to 24 months. In summary, we are confident that through the spinoff, both companies will have strong prospects for future success and sustainable possible growth, given the clear benefits each will realize as independently operated entities, including enhanced strategic and operational focus on their key drivers to accelerate growth, improved agility to anticipate and respond to customer needs and evolving market dynamics, simplified operating models with reduced complexity and improved efficiencies. optimize capital structures and resource allocation to pursue their distinct strategic agendas, and improve financial profiles, making for unique and compelling investment cases. We are excited by this opportunity to create two patient-focused growth companies and look forward to continuing to deliver significant long-term value to our patients and shareholders. With that, I'd like to turn the call over to Roger. Thanks, Aaron. Looking back on 2019, and in particular on our fourth quarter results, there is much to celebrate. In December, our keynote 057 data were reviewed at an FDA Oncologic Drugs Advisory Committee meeting, which was followed three weeks later by FDA approval of Keytruda as monotherapy for the treatment of certain patients with high-risk non-muscle invasive bladder cancer. This represents the 23rd FDA-approved indication for Keytruda, broadening still further the benefits It can be expected from the use of Keytruda in the urologic setting. Keytruda also gained three new approvals in Japan during the fourth quarter, as combination therapy and the first-line treatment of advanced renal cell carcinoma, based on the Keynote 426 study, and for the first-line treatment of metastatic squamous cell carcinoma of the head and neck, either as monotherapy or when combined with chemotherapy, based on results of the Keynote 048 trial. The Keynote 048 data also permitted approval of Keytruda in Europe with a similar indication. Finally, we gained approval of Keytruda in China for the treatment of metastatic squamous cell carcinoma of the lung in combination with chemotherapy based on data obtained in the Keynote 407 study. Substantial progress was also made in the registration of LinPARSA, our leading PARP inhibitor that we are developing in collaboration with colleagues at AstraZeneca. At the December FDA Oncologic Drugs Advisory Committee, a majority of committee members supported the use of LinPARSA as first-line maintenance therapy for patients with germline BRCA-mutated metastatic pancreatic cancer whose disease had not progressed after at least 16 weeks of first-line platinum-based chemotherapy, all based on data from the Phase III POLO trial, which demonstrated a 47% reduction in the risk of disease progression or death in the LinPARSA treatment arm. FDA granted approval for mnPARSA in this setting at the end of 2019. I should also note that data from our Paola 1 trial of mnPARSA were accepted by the FDA for priority review with a pedofilate in the second quarter of this year. In Paola 1, maintenance mnPARSA plus bevacizumab treatment of women with advanced ovarian cancer that had responded to first-line platinum-based chemotherapy plus bevacizumab reduced the risk of disease progression or death by 41%. Additional files supporting the use of LinPARs in the treatment of men with mutation-selected metastatic, cascade-resistant prostate cancer, based on the results of the Phase 3 Crofound study, was also accepted by the FDA for priority review with the PDUPA data in the second quarter of 2020. While we were clearly very active in advancing new cancer treatments, during the fourth quarter, we also made important progress in other areas. For example, in the management of highly resistant bacterial infections, The Committee for Medicinal Products for Human Use of the European Medicines Agency adopted a positive opinion for Recarbrio, our novel combination of imipenem, psilocybin, and relapactam for the treatment of infections due to aerobic gram-negative bacteria with demonstrated resistance to other agents. Recarbrio is also under priority review by the FDA for the treatment of adult patients with hospital-acquired or ventilator-associated bacterial pneumonia caused by susceptible organisms with the Pidupidate of June 4th. Important progress was also made in cardiovascular medicine with the completion of the Phase III Victoria study, in which varisiquat, a novel 1LH cyclase activator being developed in collaboration with colleagues at Bayer, was found to reduce the composite risk of heart failure hospitalization or cardiovascular mortality as compared with placebo in patients with worsening heart failure with a reduced ejection fraction who were receiving standard heart failure therapy. Time does not permit me to list the many other regulatory and clinical milestones that we achieved in the fourth quarter. However, I cannot fail to note that Aviva, the first effective vaccine against an Ebola virus, was approved by the FDA and received conditional approval from the EMA for the prevention of disease caused by Zaire's Ebola virus. We have now provided more than 275,000 doses of this vaccine by experimental use protocols, to support the efforts of the World Health Organization and other agencies attempting to halt the spread of Ebola virus disease in the Democratic Republic of the Congo. Approvals have also been obtained in certain African nations, including Burundi, Zambia, and the Democratic Republic of the Congo itself, which should greatly improve the process whereby individuals at high risk can be immunized. It has taken many years to reach this important moment. My colleagues and I feel privileged to have contributed in this way to the control of an otherwise fatal disease caused by this virus. Lastly, I wish to comment on the spin-off of the new company that we announced this morning. I begin with a deep belief in the power of simplification to enhance productivity. My colleagues and I have important objectives over the next few years that will, we hope, improve treatment for malignant disease and heart failure and provide vaccines that reduce suffering from infectious diseases. Simplification of our corporate structure can only sharpen our focus on these critically important programs. I have confidence that we can achieve this increased focus internally while providing the near-term support necessary to implement new code to establish itself as a highly effective separate entity. I'll now turn the call back to Ken. Thank you, Roger. And before turning the call over to Kevin, I'd like to take a few minutes to share with you some details on his background. Kevin brings a wealth of knowledge to NUCO based on three decades of pharmaceutical and commercial experience at Merck. His experience ranges from leading different regions, including our entire international human health business and the emerging markets region, to leading markets such as Germany and Turkey. Most recently, Kevin has been instrumental in evaluating Merck's options to optimize the entire human health portfolio, and in envisioning what success looks like for NUCO while providing invaluable counsel to me and the rest of the senior management team. I'm confident that under Kevin's leadership, NUCO will reach its full potential and drive greater value for patients, shareholders, and employees. And with that, I'd like to turn the call over to Kevin. Thanks, Ken, and good morning. I'm excited to share with you today the creation of our new company. which we believe has a remarkable opportunity to unleash the potential of a leading portfolio of assets in women's health, a rapidly growing biosimilar business, and a portfolio of trusted and medically important legacy brands. NUCO revenue was expected to be flatly declining through 2024 within Merck due to limited investment and focus. However, we believe that by allocating the appropriate resources and by focusing management's attention, NUCO will achieve sustainable growth and create value outside of Merck. Although revenues are expected to decline in 2021 versus 2020 to a base of approximately $6 to $6.5 billion, largely due to the loss of exclusivities of Zetia in Japan and Nubering in the U.S., the new company will be well-positioned to achieve low single-digit revenue growth off of that base. As no new LOEs loom, and we have identified lifecycle management and commercial investment opportunities, some already underway. NUCO will have a strong global scale and geographic diversification, and as a standalone entity, will be better positioned to capitalize on attractive opportunities across its portfolio. NUCO will pursue global leadership and sustainable growth in women's health, to its growing contraceptive and fertility business, including Nexplanon, which grew 14% in 2019 and is the leading implantable, long-acting, reversible contraceptive worldwide with U.S. patent protection through 2027. In fact, we expect Nexplanon to be our first billion-dollar women's health product. The growing $40 billion women's health market is highly fragmented. With over 400 products and development interests industry-wide, NUCO will be well-positioned to capitalize on this attractive market opportunity to become an industry leader through investments in both organic growth and business development opportunities and to deliver better and more innovative and holistic care to women. NUCO growth will also be driven by a stimulus business in the early stages of a long-term growth opportunity. with three products currently on the market through its partnership with Samsung BioEpis. Revenues of the three currently marketed products are expanding rapidly and were approximately $250 million in 2019. NUCO is well-positioned to benefit from increased biosimilar demand as markets around the world continue to seek healthcare cost savings through greater biosimilar adoption in a growing market. The women's health and biosimilar businesses will represent a larger proportion of Nuclo's revenues over time and are expected to account for more than 50% of sales by 2024. Nuclo will also have the opportunity to realize the full potential of its portfolio of globally trusted legacy brands through increased focus and targeted investment. Importantly, the infrastructure and cash generation within this broad portfolio provides a scale, geographic reach, and capital to support the growth opportunities that the women's health and biosimilar businesses present. In addition to a strong product portfolio, NUCO's global scale and geographic reach will serve as an important competitive advantage. The company will have the capability to potentially commercialize and distribute for other innovative industry players. Finally, NUCO will be highly profitable with stable and strong cash flows. As a standalone company, it will be able to make the capital allocation decisions that best suit its long-term interests, including organic and inorganic growth opportunities, paying a meaningful dividend, debt pay down, or returning cash to shareholders through share repurchase. In summary, I'm very excited about the future of NUCO and the opportunity to work with Cary Cox. This company will have a distinct opportunity to address the health needs of women around the world and to build off of important growth pillars such as Nexplanon, pain, and dermatology and biosimilars. As a focused company with dedicated resources, a strong global footprint, and talented and experienced employees who embody the shared values of the Merck culture, NUCO will be better positioned to create value for patients and shareholders. With that, I'd like to turn the call back over to Peter. Thank you, Kevin. We recognize today's upfront comments ran longer than normal, so we're prepared to extend the call beyond 9 a.m. if necessary. So, Carla, will you please line up the queue for Q&A?

Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. Again, to ask your question, you will need to press star 1 on your telephone keypad. Our first question is from Chris Cott from J.P. Morgan. Please go ahead.