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Merck & Co. reported third quarter 2012 earnings per share (excluding special items) of 95 cents, a couple of cents above the Zacks Consensus Estimate and 1.1% above the year-ago earnings.

Revenues for the quarter fell 4.4% to $11,488 million, missing the Zacks Consensus Estimate of $11,672 million. Revenues were hit by the patent expiry of Singulair (indicated for the chronic treatment of asthma and relief of symptoms of allergic rhinitis) and negative currency fluctuation.

Despite the decline in revenues, net income benefited from cost control and a lower tax rate. Including one-time items, earnings increased 1.8% to 56 cents per share.

The Quarter in Details

Merck’s Pharmaceutical segment posted sales of $9.9 billion, down 5%. Negative currency movement impacted Pharmaceutical segment sales by 5%. Products like Januvia, Janumet, Zostavax, Isentress, Victrelis and Gardasil contributed to sales.

However, the strong performance of these products was partially offset by lower sales of Singulair, Vytorin and Cozaar/Hyzaar. Remicade sales continued to decline during the quarter, most likely being impacted by austerity measures.

Singulair sales experienced a severe decline following its US patent expiry in August 2012. Sales fell 55% from the year-ago period to $602 million. We note that Singulair will retain exclusivity in the EU until February 2013 and in Japan until 2016.

Meanwhile, with Merck transferring exclusive marketing rights for Remicade and Simponi to Johnson & Johnson , Remicade and Simponi combined sales fell 9% to $576 million. We expect Merck to focus on improving penetration rates and drive growth in Europe, Russia and Turkey. Merck is looking to expand Simponi’s label and is seeking EU approval for ulcerative colitis which is a fast growing anti-TNF category.

Isentress, the company’s product for HIV infection, recorded an increase of 16% to $399 million during the reported quarter. Performance was driven by strong growth in the US and emerging markets.

The diabetes franchise, consisting of Januvia and Janumet, continued to perform well, and witnessed growth in the US and Japan. Combined sales increased 15% to $1.4 billion. While Januvia sales increased 15% to $975 million, Janumet sales increased 16% to $405 million.

Merck is working on increasing sales of its diabetes franchise by gaining approval for additional indications.

Gardasil, Merck’s cervical cancer vaccine, recorded sales of $581 million, up 31% year over year. Sales were driven by increased vaccination of males in the US and strong performance in emerging markets.

Zostavax sales came in at $202 million, up 87%. Merck initiated a TV advertising campaign in April to increase awareness about the risk of shingles. The company also launched a new branded print and online campaign.

Meanwhile, Merck’s ProQuad, MMR II and Varivax vaccines recorded combined sales of $396 million, up 1%. Vytorin sales declined 10% to $423 million during the quarter.

Merck’s hepatitis C treatment, Victrelis (boceprevir) posted sales of $149 million, up from $126 million, $111 million, and $87 million reported in the last three quarters. We were encouraged to see the sequential improvement in Victrelis sales.

Victrelis was added to the VA formulary, which is the largest single provider of services to hepatitis C patients in the US. This represents a significant commercial opportunity for Victrelis.

Merck has an agreement with Roche for the global marketing of Victrelis as part of a triple combination therapy.

Emerging markets accounted for 20% of pharmaceutical sales in the third quarter of 2012 with China continuing to put in a strong performance.

Merck’s animal health segment posted sales of $815 million, down 1%. Results were affected by unfavorable currency movement.

Consumer Care sales increased 7% to $451 million in the third quarter of 2012, mainly due to Dr. Scholl’s and Coppertone.

Marketing and administrative expenses declined 9.1% to $3.0 billion in the third quarter of 2012 due to productivity measures undertaken by the company and currency impact. R&D spend remained flat at $1.9 billion in the third quarter of 2012.

2012 Guidance Narrowed

Merck tightened its outlook for 2012 and now expects adjusted earnings in the range of $3.78 - $3.82 per share. Earlier, the company was expecting adjusted earnings in the range of $3.75 - $3.85 per share. Revenues are expected to remain flat or close to 2011 levels. The company expects full year revenues to be negatively impacted by more than 2% at current exchange rates. The Zacks Consensus Estimate currently stands at $3.81 per share, towards the higher end of the revised guidance range.

Currency could cut fourth quarter sales by 1% at current rates. Merck expects R&D spend to increase from 2011. The company spent $7.7 billion on R&D in 2011. The company’s late-stage pipeline is advancing with several regulatory filings expected by late 2013. These include odanacatib (once-weekly oral treatment of osteoporosis), suvorexant (insomnia) and Tredaptive (multiple lipid parameters).

We currently have a Neutral recommendation on Merck, which carries a Zacks #3 Rank (short-term ‘Hold’ rating). Merck has entered a challenging period with erstwhile blockbuster drug, Singulair, losing exclusivity in the US in early August 2012. We were encouraged to see Merck beat earnings expectations despite the significant decline in Singulair sales. New products and the diabetes franchise helped soften the impact of the genericization of Singulair.

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